CHAPTER 4: RESEARCH SETTINGBefore analyzing the strategic alliance between these two companies, it is necessary tounderstand the changing competitive environment for Chinese firms, like Lenovo, in a globalcontext.As for the liberalization of the world trade and investment environment, many internationalmarkets are becoming extremely competitive. In almost every industry, capable competitors nolonger confront each other within the national boundary, but more around the globe (Hill, 2005).China is an emerging economy developed at a rapid pace, and it has been experiencingtremendous changes after many economic reforms, which make it become a heated targetmarket for many foreign companies. In the past two decades, China had undergone significantchanges from a centrally planned economy to a more market-oriented one, though the benefitsderived from being a WTO membership to Chinese economy far outweigh its costs, especiallyin the long run, reductions of government protection and loss of monopolistic position implygreater challenges to Chinese firms in a global competitive context (Liu et al., 2000). Inaddition, Chinese government has pushed a “Go Out” policy in recent years, with the intensionto encourage the local companies to develop overseas markets and to acquire the advancedtechnology and distribution networks, thus, the government holds a very supportive attitudetowards the firms that intend to go globally (Dickie and Lau, 2004a). However, the inherentcommon problem of Chinese company is that they are too rush to go global. The handicap ofTCL, China’s large consumer electronics company, gives a good lesson to learn from. As apioneer under this ‘Go Out’ policy to expand its business globally by buying well-known40international brands, in less than three years the firm has experienced a disorderly treat, and hasbeen forced to shut and sell most of its operations in Europe, which are largely due to itsunrealistic objectives, lack of local market knowledge and poor execution (Jonquieres, 2006).As Jonquieres (2006) comments that much of Chinese industry’s foreign expansion to date hasbeen for defensive reasons inspired by the fierce competition that drives down prices andmargins at home. He further says that as Chinese firms cannot easily respond by innovating andmoving up-market, geographic expansion therefore becomes a survival issue. The general aimof the foreign partnership has been to seek access to technology, brands, marketing anddistribution networks.Under these circumstances, many firms in China are compelled to undergo more radicalchanges and tend to adopt these measures more vigorously as a result of the more turbulentenvironment and keener incoming competition (Liu et al., 2000). In order to maintain itscompetitive advantages and profits compared to its rivalries, a firm must make a clear andviable strategic choice with regard to its position at the frontier, and take actions at theoperational and strategic level to support this position. This is especially significant and urgentfor Chinese firms that are not in monopolistic status and struggling for the global presence asmultinational companies. Under this tidal wave of global stretch, Lenovo, like TCL, becomesone of the pioneers in China. Moreover, it is said by Joseph Ho, analyst at Daiwa Institute ofResearch, that, “Lenovo was a lot more ready than TCL when it did the IBM deal. Itsmanagement is more open-minded and determined” (Lau and Dickie, 2006).

4.1 Background of the Company

Lenovo Group is one of the leading IT companies in China, and it has now become the 3rd PCprovider in the world market after the acquisition of IBM’s Personal Computing Division. As aglobal company after the alliance with IBM, it has a number of more than 19,000 employeesworldwide; and with executive offices in Raleigh, North Carolina, USA; Beijing, China; andSingapore (Lenovo.com, 2007a). The company’s main operations are in Beijing, China; andRaleigh, North Carolina, USA, with an enterprise sales organization worldwide (Lenovo.com,2007a). As the largest PC producer in China, it took 27 per cent of China’s PC market share in2003 and Lenovo PCs ranked No.1 in the Asia Pacific (excluding Japan) with a market share of12.6 per cent in that year (People’s Daily, 2004). Since the year 1996, Lenovo has maintainedits leadership position in China for ten consecutive years with over 25 per cent market share till2006. The following is a brief development history of the company:The company was first founded in 1984 by 11 computer scientists in Beijing, China, as the NewTechnology Developer Inc. (the predecessor of the ‘Legend’ Group), which thereafter openedthe new era of consumer PCs in China (Lenovo.com, 2007b). In 1989, Beijing LegendComputer Group Co. was established and launched its first PC in the market in the followingyear, since then, the name ‘Legend’ became a household name in China (Lenovo.com, 2007b).By 1994, Legend was trading on the Hong Kong Stock Exchange, becoming one of the fewChinese companies that listed there (Lenovo.com, 2007b). In 1996, Legend became the marketshare leader in China for the first time and kept with the line thereafter and three years later, itbecame the top PC vendor in the Asia-Pacific region and headed the Chinese national Top 100Electronic Enterprise ranking; furthermore, the company ranked in the Top 10 of the world’s42best managed PC venders (Lenovo.com, 2007b). In the year 2003, with an aim to expand itsbusiness globally with a more global-like brand, the company changed its former brand name‘Legend’ to the name used today as ‘Lenovo’, “taking the ‘Le’ from Legend, a nod to theheritage, and adding ‘novo’, the Latin word for ‘new’, to reflect the spirit of innovation at thecore of the company” (Lenovo.com, 2007b). The change of the brand name from ‘Legend’ to‘Lenovo’ was perceived as the first move under the firm’s global stretch. At the end of the year2004, Lenovo and IBM announced the agreement of Lenovo’s acquisition of IBM’s PersonalComputer Division, which was IBM’s global PC (desktop and notebook computer) business(Lenovo.com, 2007b). In May 2005, Lenovo’s acquisition of IBM’s Personal ComputingDivision was completed, making it a new international IT competitor and the third-largestpersonal computer company worldwide (Lenovo.com, 2007b). After the acquisition and thestrategic alliance with IBM, Lenovo-branded products were introduced to the world outside ofChina at the first time (Lenovo.com, 2007b).Lenovo and its employees are committed to four company values that are the foundation for allthat they do (From Lenovo.com, 2007a):• Customer service: We are dedicated to the satisfaction and success of every customer;• Innovative and entrepreneurial spirit: Innovation that matters to our customers, and ourcompany, created and delivered with speed and efficiency;• Accuracy and truth-seeking: We manage our business and make decisions based oncarefully understood facts;• Trustworthiness and integrity: Trust and personal responsibility in all relationships.43With an aim to provide market cutting-edge, reliable, high-quality products and professionalservices for the satisfaction of the customers, the company is dedicated to research and talentdevelopment (Lenovo.com, 2007a). The company owns research teams who have wonhundreds of technology and design awards, which includes more than 2,000 patents, and hasalso introduced many industry firsts (Lenovo.com, 2007a). The goal of Lenovo’s R&D team isultimately to improve the overall experience of PC ownership while driving down total costs ofownership.Apart from being a prosperous business entity, Lenovo is also committed to being a responsibleand active corporate citizen, which makes it a reputable company in the home market.

Moreover, as one of the major marketing strategy, Lenovo also actively takes a hand with sportsgames to help introduce the Lenovo brand around the world. In 2004, Lenovo became the firstChinese company to join the Olympic Partner Program and a sponsor of the 2006 winter gamesin Turin, Italy, and it will also be a major supplier of computing equipment and funding insupport of the 2008 summer games in Beijing, China (Lenovo.com, 2007).

4.2 The Strategic Alliance with IBM

According to Lenovo’s 2004/2005 Annual Report, Lenovo has always aspired to become aglobal company. Since the year 2003, Lenovo began to lay the groundwork for its global stretch.It firstly changed its former name ‘Legend’ to ‘Lenovo Group Limited’ that could be usedwithout restriction around the world. Then, its wide and active participation in the Olympicevents have accelerated Lenovo’s pace into the international market. On December 8th, 2004,Lenovo announced that it would acquire IBM’s global PC business for US$ 1.25 billion.44According to the terms of the agreement, the acquisition included IBM’s desktop and notebookcomputer business, as well as its PC-related R&D centers, manufacturing plants, globalmarketing networks, and service centers (Lenovo’s 2004/2005 Annual Report). In addition tothat, Lenovo also has the right to use the IBM brand for a period of five years and the permanentownership of the renowned ‘Think’ family trademarks. As part of the transaction, Lenovo andIBM also entered a broad-based, strategic alliance of warranty and maintenance services andpreferred supplier of customer leasing and channel financing services to Lenovo (Lenovo’s2004/2005 Annual Report). On April 30th, 2005, Lenovo completed the landmark acquisitionwith IBM and entered a new era of globalization, making the new Lenovo a PC leader in theglobal market, with approximately 8 per cent of the worldwide PC market by shipments,followed after Dell (16.4%) and HP (13.9%) (Buetow, 2005; Ling, 2006).

4.3 The Necessity to Form the Strategic Alliance

Lenovo was known as one of China’s most promising companies in the early 1990s, with itssales more than tripled between the year 1994 and 1998, and Asia’s leading PC vendor outsideJapan at the end of the 1990s (Lau, 2004a). However, before the declaration of the alliance withIBM, the company had encountered with obstacles for its further expansion and development.Though Lenovo is the largest PC maker in China with more than a quarter of the market share,it does little business outside the country. The increasing fierce competition from aggressiveforeign rivals such as Dell and HP in the past few years in Chinese market has put furtherpressures on Lenovo’s margins. According to Citigroup Smith Barney, although Lenovo stillaccounted for 27 per cent of China’s PC market, the growth rate in 2003 far lagged behind themarket growth rate; by contrast, Dell’s shipment in China grew 48 per cent (Lau, 2004a). Apart45from that, the company also suffered financial problems, earlier in the year 2004; Lenovoconfessed that ‘its performance over the past three years had fallen short of internal targets’(Lau, 2004a). In addition to that, shares of the company dropped nearly 60 per cent in the year2004, and analysts at investment banks including ABN Amro and Citigroup’s Smith Barney,downgraded the company (Lau, 2004b). As one analyst said in June 2004 that “The company isin crisis, it has lost direction and does not know how to move forward” (Lau, 2004a). Therefore,rather than just continue to concentrate on the domestic Chinese market, the decision to goglobal is a necessity for Lenovo at that critical time.Under these circumstances, Lenovo decided to form the deal with IBM to acquire its lowprofitability PC business with US$1.75bn. According to the terms of the agreement, Lenovopays US$650m in cash and up to US$600m in shares (which later changed to US$800m andUS$450m share value), giving IBM an 18.9 per cent stake as well as shouldering US$500m indebt; and IBM will become the Chinese PC maker’s “preferred supplier” of support servicesand customer financing. For Lenovo’s part, the acquisition quadruples its sales to more thanUS$12bn and expands its sales market globally; besides being given the ownership of the Think

family trademarks, Lenovo also gains the right to produce IBM-branded PCs under a five-yearlicencing agreement (FT reporters, 2004; Simon, 2004).

4.4 Motives Toward Lenovo & IBM’s Strategic Alliance

Lenovo’s takeover of IBM’s PC division has been described as “snake ate the elephant”, and thedeal pulls Lenovo from the eighth-largest PC maker in the world to the third-largest just behindDell and HP (Buetow, 2005; Ling, 2006; London, 2004). As the news released by China Daily46(2004), the two computer firms have formed a strategic alliance in PC business worldwide, inwhich IBM positioned as the second largest shareholder with a share of 18.9 per cent. Themotivations that drive the formation of the strategic alliance between Lenovo and IBM can beanalyzed from two perspectives.For Lenovo’s aspect, though Lenovo is the largest IT company in China, its products are mainlywithin China. Michele Mak, an analyst at ABN Amro, once commented that “Lenovo’sdistribution network is its biggest problem, and it is not well adapted to serving the small andmedium-sized companies who usually buy directly” (Lau, 2004a). Thus, in the first place, withan intention to expand its business globally, the firm needs a well-developed worldwidedistribution network, which happens to be the advantage of IBM. As what has been announcedby Lenovo, the agreement between the two firms includes broad-based strategic alliance underwhich Lenovo’s products will be integrated into IBM’s global service offerings, which alsobecame the impetus to the deal (Lenovo.com, 2007c). As Stephen Ward, former head of IBM’sPC division said that IBM promised to push Lenovo’s PCs and offer financing to its customersand business partners by its sales teams (Dickie & Lau, 2004b).Secondly, as a world-leading company like IBM, it has specialized and advanced skills in salesand marketing functions, for Lenovo, the sales and marketing support, as well as the R&Dsupport are significant and of a necessity in its way to a multinational enterprise, which is alsopart of the agreement (Lenovo.com, 2007c). As Dickie and Lau (2004) point out that Lenovocould get access to some of the world’s most popular laptop designs, access to the U.S. market,and technological centers as advanced as any of its rivals after the establishing the alliance with47IBM. Just as what has been indicated by Doz and Hamel (1998), strategic alliance comes alongwith the learning from its partners and the internalization of the new knowledge, therebybenefits the firm. In this case, IBM provides such model and as an iconic enterprise for Lenovo,who is heading its way globally.Thirdly, the use of IBM’s globally recognized brand is an impetus to accelerate the alliance, andalso perceived as a sweet victory for Lenovo. The local brand ‘Lenovo’, formerly known as‘Legend’, will become more valuable in the market after its association with the ‘ThinkPad’series of laptops. And also, Lenovo’s right to use the IBM brand on the computers for five yearsadds more value and trustworthiness to the brand, as despite the fact that Lenovo is the largestPC maker in China and Asia, it is little known elsewhere in the world, even with the ownershipof ThinkPad family trademarks, it can hardly divert the loyal customers from IBM to Lenovo(London, 2004). Furthermore, analysts said that the deal could enable Lenovo to cutprocurement costs (Guerrera and Dickie, 2004).Just as Yang Yuanqing, the chairman of Lenovo, said that ‘Through acquiring IBM’s global PCbusiness and forming a strategic alliance with IBM, Lenovo would absorb and integrate theskills from both sides and acquire global brand recognition, an international and diversifiedcustomer base, a world-class distribution network with global reach, more diversified productofferings, enhanced operational excellence and leading-edge technology’ (People’s DailyEnglish 2004). He also added that, the alliance with IBM would also help establish Lenovo’sinternational recognition by leveraging IBM’s powerful global brand through a five-year brandlicensing agreement as well through the ownership of the globally recognized “Think” family48trademark (People’s Daily English, 2004).For IBM’s aspect, it expects that the deal with Lenovo, China’s largest PC maker will further

consolidate its presence in the world’s fastest growing IT market (People’s Daily English, 2004).The strategic alliance with Lenovo might become a move towards the shifting of demographics(Musthaler, 2005). On the one hand, IBM’s largest markets for its PCs are in North America andEurope, which are saturated, might partially explain its losses in the past two years. On the otherhand, China, as the second largest PC market except the U.S. has become the most importantmarket in the world with its large population and growing per capita income. However, as amarket, China is a tough nut to crack especially for outsiders. Much of the competition comesfrom Lenovo, which is far and away the market leader in China with nearly 25 per cent marketshare, in order to expand Chinese market and enjoy a slice of Lenovo ownership, IBM choosesLenovo as its strategic partner (Musthaler, 2005).Therefore, the driving forces behind the alliance reflect the two companies desires of seekingfor co-option, co-specialization during its globalizing process, with an attempt to learn andinternalize within its own organization, which are also the main three motivations for strategicalliances.