IBM

Samuel Tsang prepared this case under the supervision of Dr. Ali F. Farhoomand for class discussion. This case is not intended to show effective or ineffective handling of decision or business processes.

© 2005 by The Asia Case Research Centre, The University of Hong Kong. No part of this publication may be reproduced or transmitted in any form or by any means – electronic, mechanical, photocopying, recording, or otherwise (including the internet) – without the permission of The University of Hong Kong.

Ref. 05/257C

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ALI F. FARHOOMAND

IBM’S “ON DEMAND BUSINESS”1 STRATEGY In the late 1990s, IBM successfully moved up the value chain and became one of the largest business and information technology (IT) solution providers in the world. To achieve such transformation, the company made a number of strategic moves to reduce its exposure in the commoditization of IT hardware manufacturing. A key success factor was the creation of IBM Global Services and its venture into the high-margin management consulting and technology services industries. Moreover, IBM orchestrated a series of strategic acquisitions, sold ailing business units and outsourced low-value added manufacturing to external contractors and joint venture partners. In 2002, with its introduction of new service offerings (eg, business transformation outsourcing, enterprise-software-as-a-service) enabled by new computing architecture (ie, grid and utility computing,), IBM made a high-profile announcement about its new corporate strategy centred on the concept of “on demand business”. According to an IBM publication in 2004:

On demand business is a new way of conceptualizing and managing business activity. It enables companies to achieve higher levels of responsiveness, flexibility and efficiency than legacy Industrial Age business models – or even those that have been developed more recently. This is now possible through advances in the architecture of computing, which enable new levels of variability and interoperability among previous disconnected IT systems. This technical integration, in turn, enables end-to-end business integration among internal operations that have been separate – and even allows different businesses to interoperate seamlessly…On demand also allows leaders to accomplish the seemingly counterintuitive feat of outsourcing tasks to external partners while tightly integrating them into their internal operations.”

- “Understanding Our Company: An IBM Prospectus”, 2004

1 Trademark of IBM

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05/257C IBM’s “On Demand Business” Strategy

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Nonetheless, followed by the disappointing financial results in the first quarter of 2005 (sales increased by merely 3% from the previous year, far lower than many industry analysts’ forecast of a 6% increase), IBM’s stock price plummeted and hit the lowest point since Sam Palmisano took over as chief executive officer (CEO) in March 2002. The company announced a massive restructuring in its European operations to be carried out in late 2005. Although the second quarter results had improved, some began to doubt whether the “on demand” strategy would deliver the promised results. More specifically, many started to question why and how such a strategy was justified in the first place. Would this new makeover ever work? What difficulties would the company encounter in implementing its new corporate strategy?

Brief History of the Computer Giant

Thomas Watson, a top salesperson of National Cash Register (NCR), left the company and joined Computing-Tabulating-Recording (CTR) in 1914. CTR pioneered punch card processing in the US, but its performance was rather mediocre when Watson arrived. Watson successfully marketed CTR’s tabulators and won a deal to supply the machines to the US government during World War I. The company revenues tripled to almost $15 million by 1920. In 1924, CTR was renamed and became International Business Machines (IBM). Soon after that, IBM became a household name for office machines in the 1940s, particularly in making tabulators, time clocks and electric typewriters. IBM improved electromechanical calculation through Mark I at Harvard University, the first automatic digital computer. However, the company did not take note of the potential of computers until Remington Rand’s UNIVAC computer began replacing IBM machines in 1951. In 1952, IBM introduced its first computer to the market. In the 1960s and 1970s, the company captured nearly 80% of the market. During this period, IBM had transformed the entire computer industry through a range of technological innovations. The first mainframe computer, System/360, was introduced in 1964. In 1981, IBM unveiled the personal computer (PC), and marked the dawn of the personal computing era. Nonetheless, the computer giant underestimated the potential of PCs in changing the nature of computing. Consequently, competitors such as Microsoft, Compaq and Hewlett-Packard capitalised on IBM’s technology and reinvented the computing industry. Besides PCs, the industry began to replace mainframes with nimbler servers that were powered by UNIX, an open operating system that originated from a project developed by the US Department of Defense and subsequently refined by the major universities in the country. In this market space, Sun Microsystems and Hewlett-Packard capitalised on the RISC chip architecture, which was first developed by IBM, for their UNIX-based servers. Since then, customers rapidly embraced the smaller, cheaper and more flexible systems.2 With increasing competition from more agile players armed with new technologies, IBM was experiencing tremendous pressure. However, instead of meeting the new market demands, IBM continued to focus on their mainframe products, which were once the main driver of the business and which earned big bonuses for the salespeople. During the late 1980s and early 1990s, IBM lost a number of high-performance employees. One of them was the current CEO of Cisco Systems, John Chambers, who left IBM in the 1980s owing to his growing dissatisfaction with the company.3

2 Lower, J. (2005) “International Business Machines Corporation”, Hoover’s Company Information, Austin TX: Hoover’s Inc. 3 “Blue Is the Colour”, The Economist, June 4th 1998. Do

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Besides the ailing product lines, IBM suffered because of its uncompetitive cost structure caused by its heavy bureaucracy. In the early 1990s, most employees were still protected by lifetime employment guarantees. After rounds of organisational restructurings, CEO John Akers decided to split the company into a number of autonomous operating units that would have their own brand names. This attempt was to mimic the disaggregating IT industry, so that the computer giant could be more aligned with the customers and the markets. In addition, such ideas were fashionable in the corporate world at the time and generated renewed interests in IBM among the financial advisors. However, prior to executing this break-up plan, Akers was fired by the board. By 1993, IBM had recorded three straight years of net losses totalling nearly US$18 billion. Akers was replaced by Louis Gerstner, the former CEO of American Express and RJR Nabisco. This marked the first time that IBM was to be run by an outsider.4

IBM’s First Corporate Turnaround

With his previous experience as the CEO of American Express (a long-time customer of IBM), Gerstner gained a different perspective about where the computer giant should go. Although IT innovations were mushrooming, customers were finding it hard to follow the technological changes, hence making it impractical to leverage that as its competitive advantage. In particular, in view of putting different IT products to work together, Gerstner realised that integrating the diverse aspects of the technology could be a crucial value proposition to customers. This key insight had in fact reflected the sentiment of many customers at the time. As companies were busy focusing on their core competencies, senior management was hardly able to spare resources to tackle the IT challenges themselves. Since the 1990s, many large corporations in the world had begun to partner with specialist IT services companies such as Computer Science Corporation (CSC), Electronic Data Systems (EDS) and the consulting units of the global accountancies to solve IT integration problems.

IBM Global Services and IBM Research Gerstner saw IBM’s unique breadth and depth of resources. He was convinced that the computer giant could provide customers what they had been looking for – solutions. Hence, he decided to take a bold move by retaining IBM as a single entity. In addition, Gerstner created the services division, currently known as IBM Global Services (IGS), as the main entry point that offered customers holistic solutions, rather than piecemeal hardware or software products. This new unit was founded primarily based on IBM’s experience and expertise in operating large government IT systems. The head of the division, Dennis Welsh, believed such expertise was largely transferable and could be used in the private sector as well. The breadth of resources quickly impressed the unit’s first corporate customer, McDonnell Douglas, an aerospace company later acquired by Boeing. However, there were considerable challenges facing IGS. First, the focus of the services unit was to identify the key problems facing customers and resolve them by applying the right solutions. IGS had to be unbiased in developing the best solutions, whether they were based on IBM products or a combination of products from partners and competitors such as Microsoft and Hewlett-Packard. Second, in view of these potential conflicts of interest, IGS had to earn the trust of their customers and ensure neutrality. Third, if the solutions called for products and offerings from IBM, IGS would need to co-ordinate the diverse parties effectively.

4 The Economist, June 4th 1998 op. cit. Do

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Besides creating a brand new business unit, Gerstner led IBM to take another risk. With severe losses in the past few years, IBM’s enormous research budget was an easy target for cost-cutting. In particular, the research arm often carried out long-term projects that rarely produced winning ideas for the company. Nonetheless, in his first visit to the Watson Research Centre, Gerstner was impressed and envisaged that a research capability would become one of IBM’s key competitive advantages. IBM Research was spared and the researchers were re-deployed to work on both long-term projects as well as near-term solutions for real customers.

E-Business Strategy Although a new business unit was added and the research arm was saved, Gerstner was forced to cut costs and downsize the workforce. In 1994, IBM reported its first net income in four years. However, the rise of the internet was the true driver that put the once troubled computer giant back on the growth path. In 1995, IBM spotted the importance of the internet and envisaged the arrival of a network computing era. IBM understood that the internet on its own could hardly deliver tangible value to customers. In addressing this issue, the computer giant began identifying the links between the internet and traditional IT instead of just promoting the end products or services.5 In 1996, IBM announced its e-business strategy, which mapped the future of the company as well as the industry in general. The new strategy suggested that all companies would operate within virtual marketplaces. Suppliers and customers would meet and conduct business transactions around the clock in a networked environment. To achieve this new business model, companies would need to significantly increase their IT resources. In particular, companies would require highly reliable servers, secure databases, massive data storage, deep processing power, and sophisticated project management and systems integration services in becoming an e-business. Naturally, all these new requirements played to IBM’s strengths. To further enhance its capabilities, IBM made several strategic moves. It decided not to focus on the consumer market and therefore ceased to promote its own browser. In addition, the company shed its Prodigy program, a proprietary online service for the consumer market. In the late 1990s, IBM sold its network services arm (internet service provider) to AT&T. These changes allowed IBM to focus on the high-margin business-to-business market. In 1995, IBM acquired Lotus Development to further strengthen its software portfolio. In particular, the company hoped to make Notes, the groupware product that enabled effective collaboration among employees, one of the foundations in building an e-business. Besides that, Lotus served as the centre of excellence in Java (the programming language first introduced by Sun Microsystems) development for IBM. It was a widely accepted tool in a networked environment, which was made of diverse hardware platforms with different operating systems. In 1996, the company also acquired the network management specialist, Tivoli, to further strengthen its software offering portfolio. To expand its web related offerings to small businesses, IBM in 1999 bought Sequent, which made internet communications servers. With regard to the data management division, IBM purchased the database software unit of Informix in 2001. Moreover, IBM revamped its hardware portfolio to compete in the new era. By introducing a new version of the S/390 server, the company was ready to take on other rising competitors, such as Hitachi, by emphasising its low running cost. As e-businesses often required high processing power, AS/400 (the most popular IBM mid-range server) achieved fast growth again. However, IBM continued to struggle in the PC market, which had been crowded with 5 The Economist, June 4th 1998 op. cit. Do

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leading players such as Compaq (later acquired by Hewlett-Packard) and Dell. To turn around its ailing PC business, IBM cut its manufacturing staff and halted sales of its PCs through US retailers. In addition, the company exited the networking hardware market by selling its related intellectual property to Cisco Systems in 1999. Besides strengthening the hardware and software portfolio, IBM acquired a number of strategy specialists that helped the company become more capable in addressing the business issues arising in e-business, eg, Mindspring, a boutique strategy consultancy. The e-business vision and the new opportunities finally pulled together all IBM’s disparate business units (from services to software to servers) as a solution provider that aimed to realise the shared vision. With the success in IBM’s e-business strategy, in March 2002, Gerstner passed the baton to Sam Palmisano, the president and chief operating officer, to become the eighth CEO and the chairman of the board in 2003 [for a summary of the milestones in the IT industry in relation to IBM, refer to Exhibit 1].

IT Industry in the 21st Century

According to a study conducted by McKinsey & Co. in 2004 on IT spending trends, chief information officers (CIOs) from the Fortune 500 companies spent money quite differently since the burst of the dotcom bubble. Although IT spending increased in 2003 after three years of decline, customers expected to get more out of their technology investments. Companies were more concerned about the value of IT and enforced stringent rules and guidelines to IT spending. For instance, procurement departments became more involved in the IT purchasing process, in particular, the commodity products. Many were applying formal bidding mechanisms that required vendors to go through a competitive process in getting the complex deals. In addition, CEOs became more demanding in the return on investment (ROI) on new technology spending. As such, CIOs were required to develop stronger business cases to support their investments, and tie the overall performance of IT to their personal performance measures. Subsequently, the growth of overall IT spending was expected to be more modest from 2003 onwards (around 4% to 6%). This was far below the double-digit figures of the heydays in the 1990s.6 The IT industry was also considered to be in the middle of an eight-year period of technology digestion (explained further on). Hence, senior managers were reluctant to make any major technology investment. According to Forrester Research Inc, an industry analyst, investment in IT had continued to increase in the past 60 years since 1956. In the US, the ratio of IT investment to gross domestic product (GDP) increased from 1% in the mid-20th century to more than 4% at the beginning of the 21st century. However, such growth was not always constant. In fact, it was characterised by periods (eight to ten years) of fast growth followed by equally long periods of slow or negative growth. Based on previous historical data, there were three growth periods identified in the IT industry corresponding to the introduction of the new technologies [see Exhibit 2]. The first period was the introduction of mainframe computing between the mid-1950s and mid-1960s. The second period was the introduction of personal computing from the mid-1970s to the mid-1980s. The third period was the introduction of network computing between the early 1990s and the early 2000s. In these periods, companies invested in new technologies often on faith and without strong links to ROI measurements. Subsequently, companies went many years before fully exploiting the

6 Davis, K.B., Rath, A.S. and Scanlon, B.L. (2004) “How IT Spending Is Changing”, McKinsey Quarterly, 2004 Special Edition; “IT Spending Growth to Slow”, Red Herring, August 1st 2005; Nystedt, D. “IDC Lowers 2005 Global IT Spending Growth Forecasts”, Computerworld, May 4th 2005; Bartels, A. (2004) “IT Spending Outlook: 2004 to 2008 and Beyond”, Forrester Research Inc., Cambridge, MA. Do

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technologies. During these digestion periods, companies often focused on changing the relevant business processes as well as the corresponding organisational structures. Therefore, this often led to lower spending on new technologies. These spending lags were also noted by researchers from MIT’s Centre for eBusiness. Based on large scale statistical results, they cited that companies often implemented new technologies years ahead of time before they could get value from them. This was particularly true in terms of infrastructural investments.7

IT Hardware By 2005, the IT hardware purchased in the dotcom era was expected to reach the end of depreciation, based on the financial accounting models for capital investment. Moreover, companies had postponed the replacement of old hardware during the economic downturn that followed the dotcom boom. These historical reasons created pent-up demand to replace ageing computing equipment and infrastructure. Several massive data leakage incidents reported in 2005 also prompted CIOs and senior IT managers to upgrade their equipment to ensure security and reliability of the corporate data.8 These factors were the main drivers of increased IT hardware spending in the immediate term. The traditional way of building faster chips yielded marginal gain. With the new approaches to increase the speed of the microprocessor through innovative architecture (by squeezing multiple cores of the processors on the same chip), faster servers would be available in late 2005. The technology was not considered revolutionary by any measure as it was already employed by advanced scientific and engineering computing. However, this would be the first time that the multi-core technology would be made available for enterprise computing. Price-performance ratio was expected to improve significantly. Hardware investment in the medium term would be driven by the adoption of new thin servers, and the increasing demand on data storage capacity (owing to Sarbanes-Oxley compliance and increasing needs of customer data). In the longer term, once the concept of organic IT – automated data centres that could self administer – reached its maturity, analysts expected a new round of hardware purchasing. It was anticipated that the new spending would support the reintroduction of virtualisation. The technology was first introduced in IBM’s mainframe computers in the 1970s. By using computing techniques, a single machine could create multiple computing environments that would look like multiple machines were present at the same time. As companies purchased server capacity exceeding needs during the boom, they were keen to increase their server utilisation and to simplify its infrastructure. Therefore, virtualisation was expected to be in demand again as it could assist companies in consolidating excessive servers (particularly for various applications) into fewer machines.9 IT hardware purchasing was expected to be driven by pent-up demand in replacing ageing machines; new demand on storage; adoption of blade, Linux and other open-standard software; and lastly because of the new concept of building data centres in the future. The annual growth rate of IT hardware spending was estimated at around 14% by the mid-2000s. However, as utility computing (computing delivered as service) became more receptive and the reintroduction of virtualisation in companies succeeded, businesses would be less inclined to renew their hard computing assets. Consequently, purchase and upgrade of new hardware would be impacted. By then, in the late 2000s, the growth rate was expected to have significantly decreased to mid-single digits.10 7 Brynjolfsson, E. and Hitt, L. (1998) “Beyond the Productivity Paradox”, Center for e-business, Massachusetts Institute of Technology, Cambridge MA. 8 “The Leaky Corporation”, The Economist, June 23rd 2005. 9 “Business’s Digital Black Cloud”, The Economist, July 16th, 2005. 10 Davis, Rath, and Scanlon (2004) op. cit.; Bartels (2004) op. cit. Do

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IT Software IT software spending was expected to recover after an initial drop in demand in the early 2000s. In the immediate term, the key drivers of software spending would be for systems management, storage and security applications. Systems management software would mainly be purchased to monitor and manage the distributed computing resources such as PCs. The purchase of storage software was driven by the increasing demand for data storage capacity stated in the previous section. Lastly, security applications would aim to mitigate risks such as data leakage. In the medium term, software spending would remain modest partly due to the delay in releasing the next version of the Windows operating system. Open-standard software such as Linux would become more popular in the desktop market, particularly among cash-strapped enterprises and public sector organisations. On the other hand, Linux was expected to become more appealing to companies as a replacement for UNIX as a server operating system. Since it is free software, vendors such as Red Hat and Novell would continue to make profits by providing maintenance and support services. Besides operating systems, companies were expected to look for specific point solutions, such as business intelligence (BI), portal, enterprise content management, and collaboration, to support their business functions. However, the sale of packaged solutions for enterprises, such as enterprise resource planning (ERP) systems developed by SAP and Oracle, were expected to be low owing to the massive organisational impacts made in implementing these packages in the 1990s and early 2000s. In contrast, purchases related to the development of custom applications were expected to rise. In the long run, when applications based on service-oriented architecture (SOA) – a development approach that emphasised code reuse and business modelling – became more viable in enterprise computing, software spending would increase. As the clock speed of the microprocessors increased, the hardware based on the new chip design would create new challenges for enterprise software vendors such as Oracle, SAP and IBM, and their end-user companies alike. The main concern, however, continued to be the processor-based licensing policy that enterprise software vendors employed. Traditionally, license fees were charged based on the number of processors running the software. As new computer hardware would be powered by the multiple-core processors (virtually multiple processors), enterprise software companies argued that end-user companies would be “getting a free ride” on the additional core deployed on the processor. Therefore, Oracle began to claim that customers would be charged by the number of cores rather than by the number of processors. However, if the industry adopted this new standard, software licensing fees would skyrocket. Aside from the issue arising with the new chip architecture, the revival of virtualisation would significantly reduce the need for new IT hardware. Subsequently, the sale of software would also be reduced. In view of the increasingly complicated licensing arrangement, certain industry players were expected to introduce a pay-as-you-use model by delivering software as a utility service. This would allow users to pay for only what they used. However, end-users would not retain the ownership of the software. Although this so-called utility computing model would simplify the IT operations of companies, software companies would be impacted by the reduction of sales of their previously license-based arrangement. Therefore, the growth rate of software purchase was expected to be only 3% to 7% annually.11

11 Davis, Rath and Scanlon (2004), op. cit.; Bartels (2004), op. cit.; The Economist, July 16th 2005, op. cit.; “Software: Expect the Giants to Stay Sluggish”, Business Week, January 10th 2005. Do

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IT Services IT services could be classified under two major categories: consulting and technology integration services, and outsourcing services. The annual growth rate of the consulting and technology integration services segment was expected to reach mid-single digits in the 2000s. However, niche and high-end consulting companies (focusing on business strategy, operations management, and human resources management consulting) would likely generate higher growth rate, from 15% to 20%. At the same time, the full-fledged consultancies and systems integrators would tend to have lower growth. For the outsourcing segment, the growth of annual spending would be 6% to 7%. On the other hand, non-IT related outsourcing would likely reach the high-single digits in the 2000s.

Consulting and Technology Integration IT-driven management consulting and technology integration services were the growth engine of the industry in the 1990s. However, the segment was badly hit from 2001 to 2003, and had not fully recovered. Given the lack of ubiquitously focused problems like those found in the dotcom boom (eg, e-business strategy, web-enabled application development), the demand for high-end IT consulting and integration services shrank significantly. IT consulting and integration services were also being rapidly commoditised. Unless vendors could leverage their IT outsourcing capabilities with pay-as-you-use offerings, such services would mostly be fulfilled by smaller players that competed on price. In the immediate term, analysts expected pent-up demand for IT consulting and integration to boost the spending in IT services. This was particularly driven by companies that preferred to use consultants in fulfilling their business needs rather than hiring permanent staff. In addition, consultants would help enhance existing applications by adding new functionality, and moving to new platforms. As CIOs were under pressure to achieve high ROI on their IT investments, consultants would also be sourced to help identify key elements that might have caused the lag. This would include services in the areas of business process redesign, and organisation structure change. In the medium and longer terms, spending on IT consulting and integration services would be driven by the deployment of new technologies, such as radio frequency identification devices (RFID) and open source systems. These were, in turn, expected to be driven by business innovations that aimed to generate new revenues. Therefore, the top growth areas of this segment would likely be in the IT-enabled business consulting services.12

Outsourcing The largest potential market of IT services was outsourcing. According to the respective reports produced by Deloitte Research, Forrester Research, and Kennedy Information, outsourcing would continue to accelerate in the 2000s. 13 The market space was mainly dominated by the “Big Six” American outsourcing companies: Accenture, Affiliated Computer Services (ACS), CSC, EDS, Hewlett-Packard and IBM. Several European outsourcers began to gain momentum at the turn of the century, eg, Siemens from Germany and Capgemini from France, as companies became more receptive to outsourcing in Europe.14 Traditionally, the segment was driven by pure IT play, ie, contracting out IT-related operations. This included running the data centre, managing the network and infrastructure,

12 Bartels (2004), op. cit.; Kennedy Information (2005a) “The Global Consulting Marketplace 2005–2007: Key Data, Trends and Forecasts”, Kennedy Information Inc.: Peterborough, NH. 13 Bartlett, B. “The Productivity Advantage in Trade”, The Washington Times, August 27th 2003; Bartels (2004), op. cit. 14 “Time To Bring It Back Home?”, The Economist, March 3rd 2005. Do

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and maintaining applications (eg, ERPs, custom legacy systems) for various business functions. More recently, outsourcing services were extended to cover the non-IT aspect of business operations. This was often referred to as business process outsourcing (BPO). Companies contracted out their non-core functions to the outsourcers, including administrative operations such as finance and accounting, and employee benefits and payroll. On certain occasions, companies even contracted out their design and engineering functions to other companies. Non-IT related BPO business made up around one-third of the total outsourcing business.15 As outsourcing of IT operations could only generate limited savings, companies would increasingly turn to BPO, as it was expected to address the broader scope of corporate interests. Anticipating the continuous growth of the BPO market, two of the Big Six outsourcers appointed new chiefs to head their BPO businesses. Accenture’s new chief of BPO held a bullish view and claimed that the market would become a US$500 billion market in the 2000s. BPO was considered more profitable along the outsourcing value chain, but careful selection was critical. Based on its experience working with the US Navy in the early 2000s, EDS badly miscalculated the costs involved. In turn, the company had to absorb the loss of US$1.5 billion but hoped that it would be recovered by the end of the contract. Early BPO was driven by global financial services firms. As estimated by Deloitte Research in 2003, US$356 billion worth of financial services would be relocated to India in the five years between 2003 and 2008 and produce roughly US$138 billion of savings for the top 100 financial services companies. Recently, BPO business began to spread to other industry sectors as well as high-value areas. For instance, automotive and aerospace industries were planning to outsource their design and engineering services. The most promising area for large-scale BPO was human resource (HR) management. IBM had become Procter & Gamble (P&G)’s outsourcer of HR function since 2001, which marked one of the largest of its kind in the short history of BPO. The deal gave IBM an opportunity to run the non-IT and IT aspects of the conglomerate’s HR function globally.16 Considering the market potential, EDS recently formed a joint venture with a leading HR consultancy, Towers Perrin. Some outsourcers followed suit, including Hewitt Associates with Exult,17 and Buck Consultants with ACS.18 Although the outsourcing market held great potential, outsourcers continued to face difficulties. On the one hand, as outsourcers increased the volume of off-shoring to reduce costs, the higher demand of labour would cause an increase in wages in the offshore economies, such as India and China. On the other hand, politicians and labour unions began to use legislation to limit off-shoring in order to protect local job markets. Both of these issues would significantly impact the main driver of the business, ie, reduction of labour costs. Lastly, according to a survey conducted by Bain & Co. in 2004, many large companies from North America, Europe and Asia grew dissatisfied with their current outsourcing arrangements owing to unmet expectations.19

15 Radjou, N. (2005) “Innovation Network”, Forrester Research Inc.: Cambridge, MA. 16 Hamm, S. “Beyond Blus”, Business Week, April 18th 2005. 17 The Economist, March 3rd 2005. 18 ACS’s Company Website, [www document] http://www.mellon.com/hris/ (accessed 10 August 2005). 19 Bartels (2004), op. cit.; Kennedy Information (2005b) “The Global Outsourcing Marketplace: Key Data, Trends and Forecasts”, Kennedy Information Inc.: Peterborough, NH; IBM (2005) “Understanding Our Company: An IBM Prospectus, 2004”, IBM Corporation: Armonk, NY. Do

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IBM’s New Strategic Position

In the view of most industry analysts, the darkest days of the IT industry were in the past. The global IT industry returned to growth in 2003 and the outlook seemed positive. It was forecast that the US$1.4 trillion industry would approach US$1.8 trillion in global revenue in 2008. However, the annual growth rates were assumed to be in the range of 4% to 7%. This implied that the growth rate of the industry was lower than the historical growth of 1.5 to 2 times the global GDP.20 In anticipation of a shift in industry dynamics in the 21st century, CEO Sam Palmisano led the company to pursue its new strategic position. In 2002, Palmisano made a high-profile announcement about the new corporate strategy that centred on the concept of “on demand business”. Through this new vision, IBM attempted to provide the industry a new agenda by describing how business was supposed to evolve and structure after the e-business era.

The concept of “on demand business” was driven by three historic developments. Firstly, in just a decade, those who participated in the internet had reached 800 million people. Industry analysts forecast that this population would reach 1 billion by 2007. 21 The internet had become the operational infrastructure of the world. It linked people, businesses, and governments and transformed all imaginable commercial transactions and public services from banking and manufacturing to education and health care. Secondly, open standards in the IT industry had finally taken hold. These significantly increased inter-operability and changed the way computing devices were operated; software applications were developed; and digital content was produced, processed, distributed and stored. Thirdly, the emergence of a networked economy and the establishment of open standards enabled new business designs. New options were introduced to senior managers from both public and private sectors. In particular, businesses and governments would become far more responsive and flexible to social, political and economic changes. Managers were able to anticipate the needs and wants of their customers (or citizens). This was because business operations were connected to customers through extended networks. Subsequently, all of the information associated with the behavioural changes of customers or citizens were captured. Businesses and governments were then able to anticipate changes on a real-time basis (or in IBM speak: on demand). To most IT companies, these three major developments would merely mean new opportunities in selling hardware and software based on open standards supporting highly flexible network infrastructures; and services aiming to transform business operations to achieve competitive advantages. Nonetheless, to Palmisano, the essence was the convergence of these developments, which essentially drove the concept of “on demand business”. More specifically, Palmisano saw great opportunities lying in customers’ business processes that were beyond the traditional IT industry. According to estimates provided by industry analysts, companies spent close to US$23.6 trillion annually on business processes such as sales, general and administrative (SG&A), and research and development (R&D). Within that annual spending, approximately US$1.4 trillion was already being spent with third parties (including both non-IT and IT companies) and it was expected to grow by 9% annually through 2008. Some of this spending was found in the areas of supply chain management, design services, human resource management and customer services. These business operations and processes often shared the following common characteristics: they were highly dependent on IT, could be transformed or improved through the application of IT and even outsourced to external process operators. Palmisano reckoned a new market was emerging. This so-called Business Performance Transformation Services (BPTS) segment was expected

20 IBM (2005), op. cit. 21 IBM (2005), op. cit. Do

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to be worth more than US$500 billion. The solutions (more specifically, the business process solutions) for this segment would often require far more than the combination of deep business expertise, advanced technologies, adequate resources and global reach.22 In fact, a new consumption trend had already emerged in the IT industry. According to IBM, business process solutions would drive most of the consumption of IT products and services, up to 70% of the total consumption by 2007. Moreover, changes in IT purchase decision-making were also found. In 1999, 22% of technology purchase decisions were made solely by IT departments, 33% by business executives, and 45% were joint decisions. By 2002, 87% of the IT purchase decisions were made jointly between the IT departments and business executives. These changes indicated that IT was not merely addressing technology-oriented issues. Instead, this new pattern reflected the increasing importance of IT in addressing real business issues [see Exhibit 3]. These trends imposed new challenges to IT companies’ business models. In particular, those companies that focused on selling mass-produced point products or providing IT labour-intensive services would be impacted heavily. In view of these new requirements and the large market potential, Palmisano led IBM to make significant investments in building the capability for BPTS. This entailed transforming customers’ operations that were crucial but not considered a core competency. Subsequently, the transformed capabilities would be delivered as services that were run and delivered by a third party such as IBM.

Aligning Capabilities with New Business Requirements More specifically, IBM strengthened the process transformation and management capabilities. In 2002, IBM acquired PricewaterhouseCoopers Consulting and formed a sub-unit under IBM Global Services, namely IBM Business Consulting Services. This new unit tackled challenges that arose in business operations and process transformation. In particular, IBM business consultants, equipped with deep industry knowledge and business design capabilities, were to help companies reorganise their business strategies, processes, people and assets in their specific industries. Moreover, these newly acquired consultants were more business savvy and able to help IBM penetrate deep into the inner core of the customers’ senior management team. That was far beyond what the existing computer salesforce of the company could reach. With a number of contracts won in the 1990s, IBM acquired a critical mass of human and computing resources from their customers. It was time to turn these valuable assets into revenue generating capital. For instance, IBM leveraged its purchasing power and capability to develop a common procurement platform as part of the business transformation outsourcing (BTO) it offered in supply chain management. Moreover, the company continued to grow its BTO practices to cover other key business functions: finance and accounting, HR, customer relationship management, and industry-specific solutions in government, insurance and banking. With added strength in business expertise, the realignment of the advanced technological capabilities, and the expanded coverage in BTO, IBM redefined its business model. In delivering a business performance transformation services (BPTS) engagement, the company would use its consultants and researchers as the conduit to accessing the customers’ senior executives and helping them analyse the current processes. Subsequently, the professionals would identify improvement opportunities and implement fixes based on technologies provided by IBM or other players. After the problems were addressed (usually processes were transformed), customers could decide to retain control of these new business processes or have IBM take over and run the processes for them. Finally, as new products (or service 22 IBM (2005), op. cit. Do

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methods) were developed along the way, IBM could re-sell (or reuse) such new products for future engagements.

Retraining and Disposal of Assets While IBM was busy making BPTS a reality, the company continued to expand its solution offering portfolio. On the software side, IGS and IBM Software worked together to build services-oriented architecture solutions. With the renewed interest in IT infrastructure owing to the (re)introduction of new concepts such as virtualisation and grid computing, IBM continued to deliver customised hardware to meet customer demands. IBM leveraged its vast R&D resources and experience to help companies generate business innovations. One of the new imperatives was the creation of engineering and technology services. This new service line was intended to bring IBM’s technical know-how and capabilities in advanced technology to customers in solving their problems in engineering, ranging from complex chip design to system design.23 As the top technology patent generator of the world, IBM was experienced and had developed broad capabilities (ie, an army of patent evaluators and lawyers) in identifying and packaging intellectual capital. IBM understood the importance of leveraging reusable assets through the licensing of intellectual property, and applied this patent methodology and reapplied it to its services arm. The goal was to generate patents and licences of its business methods and tools. Subsequently, customers could license IBM’s know-how with or without the presence of the consultants. IBM hoped that these intellectual properties would turn into a steady stream of income with low operating costs and gradually help transform IGS into an asset-based business. To support all of the realignment efforts, IBM aggressively changed the profile of its workforce in order to meet new demand in the coming years. The number of business and industry experts (eg, business consultants, financial analysts, HR specialists in BPOs) employed by IBM increased from 3,000 in 1999 to more than 70,000 in 2004 according to the company’s official count. In addition, 170,000 technology professionals (eg, IT architects, systems engineers, programmers, technical researchers) continued to serve the company and its global customers. To broaden its knowledge base, IBM took great effort to retrain its workforce, in particular, the long-timers. Besides traditional training programs, the company formed new alliances with companies that were in different fields to expand IBM’s business coverage and knowledge. For instance, one of the key alliances was with the Mayo Clinic, which helped IBM propel itself to the forefront of bio-informatics research. Meanwhile, employees involved in low-value added work (eg, computer operations, maintenance and support, administration) were exiting the company around the world. 24 Similarly, under Palmisano’s new vision, IBM had to dispose of its core production assets, which were now low-value added. As hardware production continued to be a burden, IBM decided to look for ways to reduce its costs by forming joint ventures and contracting out manufacturing to OEMs (original equipment manufacturer) such as Acer in Taiwan or Lenovo in China. Since early 2002, IBM had outsourced a significant amount of the manufacturing of its NetVista PC line to Sanmina-SCI, and certain hardware products to Solectron. As part of the deal, both manufacturers acquired hardware production facilities from IBM in the US and Europe. By the end of 2004, IBM reached an agreement with Lenovo to sell the entire PC business to the leading Chinese PC manufacturer. The deal was

23 IBM (2005), op cit. 24 Hamm (2005), op cit. Do

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closed in early 2005. IBM retained a minor stake in Lenovo and became the preferred service and financing partner to the company. IBM also formed a joint venture with Hitachi to combine the companies’ disk drive operations in 2002. The initial investment from Hitachi was about US$2 billion, or 70% stake in the new company. With further payments to IBM over the next three years, the Japanese computer company would own the venture in full. In early 2004, IBM also combined its technology (microchips) and systems (servers, storage) groups to lower costs and increase synergy among these products.25

Assessment of Key Competitors

Many pure services companies were eyeing the same market. Global business service providers (eg, Accenture, EDS, Capgemini) though comparatively less savvy in technologies, had much stronger track records in solving customers’ business problems than IBM. Besides the global players, emerging regional players (eg, Tata Consultancy Services, Wipro Technologies, Infosys Technologies) were much capable of competing with their price advantages by leveraging a cheap labour force in the emerging economies. However, these emerging companies admitted that it would be much too complicated and risky to offer customers low cost as well as complex corporate transformation services. In addition to these rivals, with the expanding coverage of its BPTS offerings, IBM would potentially compete with its existing hardware and software customers in the future (eg, Hewitt Associates, an HR service provider, and American International Group Inc. (AIG), a major insurance service company). To succeed in this increasingly crowded marketplace, IBM would need to be prepared to fend off fierce competition from all fronts. The following sections highlight its major competitors in the market [for the performance comparison between IBM Global Services (IGS) and the selected competitors, refer to Table 1].

2004–2005 Key Performance Figures

IGS Accenture EDS Capgemini Tata Wipro Infosys

Sales (US$ m) 46,213 15,113.6 20,669 8,580.9 1,614 1,699 1,592 Sales Growth (%) 8.4 12.8 -3.8 18.8 55 39 49.8 Net Income (US$ m) 3,26026 690.8 158 -489.7 365.4 38527 419 Net Income Growth (%) 3.5 38.7 NM28 NM29 23 40 55 Employees 175,000 100,000 117,000 59,324 40,992 24,400 36,800 Employee Growth (%) -2.8 20.5 -11.4 19.1 36 28.4 43.2

Table 1: Performance Comparison between IBM Global Services and its Key Competitors

Accenture Among the key competitors, Accenture posed the highest threat to IBM in terms of its breadth and depth in traditional management consulting and technology services, as well as business process and IT outsourcing services. Formerly known as Andersen Consulting, the firm was a unit of Andersen Worldwide, the accountancy company that owed its fall to the Enron scandal. It broke away from its parent in 2001 and renamed itself Accenture. The consultancy went public in the same year. Founded as a systems integrator in the industry, Accenture expanded its businesses into the high-end management consulting and outsourcing segments globally. In particular, its business process outsourcing (BPO) unit was fast becoming the key growth driver for the company. Accenture entered the BPO market in 1991, when it took over the 25 Lower (2005), op. cit. 26 Estimated value derived from the data provided in IBM Annual Report 2004. 27 This was operating income. 28 Not meaningful – net loss of US$1,698 million was recorded in the previous year. 29 Not meaningful – net loss of US$247 million was recorded in the previous year. Do

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accounting operations of both British Petroleum and Northwest Airlines. The unit continued to grow through acquisitions and organic growth. It offered services in a number of areas such as HR management, finance and accounting operations, and procurement. Recently, Accenture began providing life insurance policy management services for a customer in France and gradually to other insurers in Europe, the US and the rest of the world. Although Accenture lacked the technology savvy workforce and research capacity, the consultancy prided itself on its strong industry knowledge and expertise. In addition, the company had a strong track record in solving business problems for many large companies and governments.30

EDS Although EDS had lost its glamour since the late 1990s, the company continued to be a major contender in the business services market. EDS was founded by a former salesman of IBM in 1962. The company was the pioneer in IT outsourcing, and it was one of the largest systems management and service providers in the world. EDS offered a range of IT services such as systems integration, network and systems operations, data centre management, application development, and outsourcing. The company acquired A.T. Kearney, the once leading management consultant in the world, and formed its own consulting arm in 1995. EDS served customers in varied industries in both public and private sectors. The company was spun off in 1996 from General Motors. In the 2000s, EDS continued to face slow growth particularly under the technology downturn. Hoping to put its business back on track, EDS brought costs down through a number of major layoffs and a range of productivity improvement initiatives. The company invested about $1 billion in its transformation effort in 2005. Besides the traditional IT outsourcing, EDS was eagerly hoping to expand into the BPO market. In 2005, EDS made an important strategic move. The company partnered with Towers Perrin, a leading HR and compensation consultant, to form ExcellerateHRO. This joint venture offered targeted BPO offerings in HR outsourcing and benefits administration management services. In the meantime, EDS continued to dispose of its business units that were considered irrelevant to its technology consulting and outsourcing business focus. Potentially, the company might put its management consulting arm for sale. 31

Capgemini Headquartered in Paris, Capgemini was considered as a world leading provider of systems integration and consulting services, particularly in the European market. The company offered a range of business and technology services including systems development and implementation, and management consulting services. The company was also a major player in business process outsourcing covering a number of functional areas such as customer relationship management, finance, HR, and supply chain management. In 2000, Capgemini spent US$11 billion to acquire the consulting arm of Ernst & Young, a leading global accountancy. However, soon after the acquisition, the whole industry was badly hit by the long technology downturn. Capgemini weathered the storm through a number of restructuring efforts. These helped the company further refine its focus, streamline its operations and identify its non-core businesses. In 2005, Capgemini sold its North American health care consulting practice to Accenture for about US$175 million.32

30 Anderson, L. (2005) “Accenture Ltd”, Hoover’s Company Information, Hoover’s Inc.: Austin TX; Hoffman, T. “Business Process Outsourcing Bolsters Accenture”, Computerworld, November 13th 2003. 31 Bramhall, J. (2005) “Electronic Data Systems Corporation”, Hoover’s Company Information, Hoover’s Inc.: Austin TX. 32 Bramhall, J. (2005) “Capgermini”, Hoover’s Company Information, Hoover’s Inc.: Austin TX. Do

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Tata Consultancy Services Formerly a division of textiles and manufacturing conglomerate Tata Group originating from India, Tata Consultancy Services (TCS) was an emerging global leader in consulting and outsourcing services. The company offered a range of business and IT services, including systems installation, offshore software development, systems integration, business process outsourcing, product and industrial process engineering services as well as strategic consulting and project management services. TCS expanded rapidly in 2004 through a number of acquisitions. The company bought Singapore Airlines’ share in Aviation Software Development Consultancy, a joint venture focused on providing travel-related BPO services. In addition, TCS acquired Phoenix Global Solutions, an insurance consulting practice of the Phoenix Companies, and formed TCS Business Transformation Solutions. The company also acquired a majority stake in computer hardware and software supplier CMC Limited. In the same year, TCS was spun off as part of a restructuring effort at Tata Group. In 2005, TCS acquired Tata Infotech, another technology services unit of Tata Group to solidify its overall presence in the industry.33

Wipro Technologies Wipro Technologies, the global technology and consulting services division of Indian conglomerate Wipro Limited, was fast becoming a world leading provider of systems integration and outsourcing services. The division offered a range of business and technology services including application development, systems implementation, network infrastructure design and implementation, business process outsourcing, management consulting, as well as product design and engineering outsourcing services. Wipro Technologies grew rapidly, particularly in the US market. The global services division became the major contributor to Wipro’s business, accounting for about 75% of its total revenues and close to 90% of its operating income.34

Infosys Technologies Infosys Technologies was a leading technology consulting company in India with sizeable global operations. The company offered software development and engineering services through the development centres in Asia and North America. Moreover, the company also provided services in the areas of data management, systems integration, project management, and systems support and maintenance. Progeon, a subsidiary of Infosys, focused on providing business process outsourcing services. Infosys Consulting, a US-based subsidiary, also provided strategic consulting services. The company rapidly expanded internationally. In particular, North America accounted for about 65% of Infosys’ sales. In 2004, with the launch of Infosys Consulting, the company was more equipped to capture the high-end services business in the US. The company also added operations in China and Australia, and continued to eye opportunities in Asia, Africa and Latin America.35

The Way Ahead

Since the late 1990s, IBM became a technology solution provider led by its global services unit. In reviewing the revenue mix of recent years, it seemed that IBM had successfully bridged the gap between selling computing products and services. The services revenue continued to rise from US$28.9 billion in 1998 to US$46.2 in 2004, close to half its overall revenue [see Exhibit 4]. 33 Bramhall, J. (2005) “Tata Consultancy Services Limited”, Hoover’s Company Information, Hoover’s Inc.: Austin TX. 34 Bramhall, J. (2005) “Wipro Technologies”, Hoover’s Company Information, Hoover’s Inc.: Austin TX. 35 Bramhall, J. (2005) “Infosys Technologies Limited”, Hoover’s Company Information, Hoover’s Inc.: Austin TX. Do

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In 2002, Palmisano announced another makeover related to his vision of “on demand business”, by focusing on BPTS and other high-end service offerings. The market was, however, full of sceptics. Firstly, the company’s new strategy was far more demanding than before. Judging from Palmisano’s daring moves, the underlying plan behind the grand vision was not about selling more IT products and services. Instead, the aim was to move IBM out of the low growth computer industry. By leveraging its massive knowledge workforce, the company aimed to re-design and operate customers’ businesses including finance and accounting, customer service, human resources, procurement, and product design and engineering. In other words, Palmisano hoped that this would make the company indispensable to customers in all aspects of their business beyond back-office computing. Secondly, the lack of disruptive forces (such as the arrival of the internet in the 1990s) or phenomena in the market stressed IBM’s strengths and uniquely put the company in the centre of the business services game. To achieve this goal, it would take Palmisano much more effort to convince IBM’s customers that it was the best partner in the market. Moreover, he had to ensure the company’s comprehensive business outsourcing offerings were no threat to them. McDonald’s Corp, a long-term customer of IBM, already found the idea too radical and rejected IBM’s proposal in running the fast food company’s accounting and finance operations. William H. Davidow, co-author of the book The Virtual Corporation, published in 1992, and an early advocate in outsourcing, even warned companies not to take the idea too far and become hostages of outsourcers.36 Once again, Palmisano had to step into the shoes of his customers, just as his predecessor Gerstner did when he first took over the office in 1993, and ask if this grand vision would truly address customers’ burning issues or whether it was just another management fad. IBM managed to pull off a few successful BPTS engagements. One of them was Marathon Oil Corp. The customer wanted to trim costs in the finance department and be able to receive real-time performance information in the beginning. At the end of the engagement, IBM not only helped the company overhaul its processes, but also took over the finance operations and operated the processes for Marathon. Another key customer was Procter & Gamble (P&G). The company won the contract to operate its HR processes for ten years, valued at US$400 million and which included 3,500 jobs in both IT and customer services. Previously, P&G set up a number of performance goals to address efficiency issues. Prior to outsourcing the processes, P&G stated it could only meet nine out of 21 goals. In contrast, since IBM took over the operations, all performance goals were met. However, with only a handful of successes and customer testimonies under its belt, IBM was in full gear to expand its BPTS coverage in the other market segments including after-sales service for consumer electronics, insurance claims processing, and supply chain optimisation. The questions remained whether the time was right or whether the market was ready to buy into the IBM’s new value proposition.

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EXHIBIT 1: EVOLUTION OF THE IT INDUSTRY

Data from IBM (2005) “Understanding Our Company: An IBM Prospectus, 2004”, IBM Corporation: Armonk, NY.

1890 1950 2000

1890PUNCH CARDS AND MECHANICAL CALCULATINGPunch card tabulators allow large-scale accounting, completing the 1890 US Census in record time.

1900

1939VACUUM TUBES AND ELECTRO-MECHANICAL CALCULATINGThe Atanasoff-Berry Computer paves the way for more complex calculations in science and industry.

1940 1960 19701910 1920 1930 1980 1990

1952TRANSISTORS AND ELECTRONICSAT&T licenses Bell Labs’ transistor technology, leading to solid-state electronics and more powerful computing machines for governments and large enterprises.

1964MAINFRAME COMPUTINGThe IBM System/360 – the first general-purpose scalable and compatible family of computers – makes mainframe computing accessible to mainstream business.

1971MICROPROCESSORSIntel commercialises the first computer-on-a-chip, which powers devices from handheld calculators to the Pioneer to spacecraft; mini-computers emerge.

1981PERSONAL COMPUTERSThe IBM Personal Computer sets a standard, accelerating the adoption of computing by individuals, departments and small businesses.

1994THE INTERNETThe release of Netscape’s Navigator browser popularises the World Wide Web for business and transforms personal computing devices into powerful information portals.

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EXHIBIT 2: STAGES OF TECHNOLOGY INNOVATION AND DIGESTION

Data from Bartels, A. (2004) “IT Spending Outlook: 2004 to 2008 and Beyond”, Forrester Research Inc.: Cambridge, MA.

1956-1966Innovation & growth

1966-1976Refinement & digestion





Mainframe Computing Personal Computing Networked computing

IT In

vest

men

t to

GD

P ra

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Compound annual growth rate for period in IT investment to GDP ratio

5.8% 2.9% 7.1% 0.3% 5.3% - 0.3%

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EXHIBIT 3: IT PURCHASE DECISION MAKERS


87%

45%

4%

35%

9%22%

1999 2002

IT Department

BusinessExecutivesJoint Decision:Business and IT

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EXHIBIT 4: IBM’S REVENUE MIX IN RECENT YEARS


$0.0

$20.0

$40.0

$60.0

$80.0

$100.0

$120.0

1998 2000 2002 2004

EnterpriseInvestment / OtherGlobal Financing

Software

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EXHIBIT 5: IBM’S CONSOLIDATED STATEMENT OF EARNINGS FROM 2002 TO 2004

(US$ in millions except per share amounts)FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002Revenue:Global Services $46,213 $42,635 $36,360Hardware 31,154 28,239 27,456Software 15,094 14,311 13,074Global Financing 2,608 2,826 3,232Enterprise Investments/Other 1,224 1,120 1,064Total Revenue 96,293 89,131 81,186Cost:Global Services 34,637 31,903 26,812Hardware 21,929 20,401 20,020Software 1,919 1,927 2,043Global Financing 1,045 1,248 1,416Enterprise Investments/Other 731 634 611

Total Cost 60,261 56,113 50,902Gross Profit 36,032 33,018 30,284Expense and Other Income:Selling, general and administrative 19,384 17,852 18,738Research, development and engineering 5,673 5,077 4,750Intellectual property and custom development income -1,169 -1,168 -1,100Other (income) and expense -23 238 227Interest expense 139 145 145

Total Expense and Other Income 24,004 22,144 22,760Income from Continuing Operations Before Income Taxes 12,028 10,874 7,524Provision for income taxes 3,580 3,261 2,190Income from Continuing Operations 8,448 7,613 5,334Discontinued Operations:Loss from discontinued operations 18 30 1,755

Net Income $8,430 $7,583 $3,579

Earnings/(Loss) per Share of Common Stock: Assuming Dilution: Continuing operations $4.94 $4.34 $3.07 Discontinued operations -0.01 -0.02 -1.01Total $4.93 $4.32 $2.06

Basic: Continuing operations $5.04 $4.42 $3.13 Discontinued operations -0.01 -0.02 -1.03Total $5.03 $4.40 $2.10

Weighted-Average Number of Common Shares Outstanding: Assuming dilution 1,708,872,279 1,756,090,689 1,730,941,054 Basic 1,674,959,086 1,721,588,628 1,703,244,345 Data from IBM (2005) “IBM Annual Report 2004”, IBM Corporation: Armonk, NY.

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EXHIBIT 6: BUSINESS SEGMENT INFORMATION OF IBM CORPORATION AND SUBSIDIARY COMPANIES FROM 2002 TO 2004

(US$ in millions)

FOR THE YEAR ENDED DECEMBER 31:Global

Services

Systems and Technology

Group

Personal Systems

Group SoftwareGlobal

FinancingEnterprise

InvestmentsTotal

Segments

2004:External revenue 46,213 17,916 12,794 15,094 2,607 1,180 95,804Internal revenue 3,131 1,051 173 1,805 1,287 8 7,455Total revenue 49,344 18,967 12,967 16,899 3,894 1,188 103,259Pre-tax income/(loss) 4,657 2,265 162 4,541 1,494 -187 12,932Revenue year-to-year change 8.5% 9.4% 12.2% 6.1% -5.6% 11.0% 8.1%Pre-tax income year-to-year change 3.5% 23.9% NM 19.2% 26.4% 25.8% 18.1%Pre-tax income margin 9.4% 11.9% 1.2% 26.9% 38.4% -15.7% 12.5%

2003:External revenue 42,635 16,469 11,387 14,311 2,827 1,065 88,694Internal revenue 2,837 865 171 1,613 1,300 5 6,791Total revenue 45,472 17,334 11,558 15,924 4,127 1,070 95,485Pre-tax income/(loss) 4,499 1,828 -118 3,808 1,182 -252 10,947Revenue year-to-year change 16.0% 2.5% 3.3% 11.4% -0.4% 4.3% 10.0%Pre-tax income year-to-year change 23.0% NM NM 7.1% 23.8% 14.0% 29.2%Pre-tax income margin 9.90% 10.5% -1.0% 23.9% 28.6% -23.6% 11.5%

2002:External revenue 36,360 16,195 11,049 13,074 3,203 1,022 80,903Internal revenue 2,854 711 139 1,225 939 4 5,872Total revenue 39,214 16,906 11,188 14,299 4,142 1,026 86,775Pre-tax income/(loss) 3,657 538 57 3,556 955 -293 8,470Revenue year-to-year change 4.3% -10.8% -7.2% 2.7% -2.4% -8.6% -1.3%Pre-tax income year-to-year change -29.1% -74.1% 137.3% 12.2% -16.4% -7.6% -23.6%Pre-tax income margin 9.3% 3.2% 0.5% 24.9% 23.1% -28.6% 9.8%

NM - Not Meaningful

Hardware

Data from IBM (2005) “IBM Annual Report 2004”, IBM Corporation: Armonk, NY.

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EXHIBIT 7: IBM’S ON DEMAND EXECUTIVE GUIDE

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Source: IBM (2005) “On Demand Business: The Executive Guide”, IBM Corporation: Armonk, NY. Do

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