Can becoming an Apple Store for enterprises reverse IBM's decline?

The deal between Apple and IBM is based on the idea that IBM can still make a significant impact on the IT market. However, IBM's power has been diminishing for decades, and it's far from certain that CEO Virginia Rometty can reverse the company's decline.
Written by Jack Schofield, Contributor

The deal between Apple and IBM will convert "IBM shops" — as most Fortune 500 IT departments are correctly known — into Apple shops, selling and maintaining iPhones, iPads, enterprise-specific apps and cloud services. This is an obvious benefit to Apple, which targets consumers rather than enterprises, and has a patchy record for cloud services. Whether or not it's a significant benefit depends on the quality of IBM's execution, which remains to be seen.

The problem is that Big Blue ain't what it used to be, and even its CEO, Virginia Rometty, admits that it is going through a "rocky time". In short, it's going nowhere fast. Its sales have been down, on a year-on-year basis, for nine quarters in a row. Its annual turnover of $99.75bn is lower than it was in 2009 ($103.63bn) and barely above what it was in 2004 ($96.5bn). For comparison, Apple's sales have exploded from $8.28bn in 2004 to $170.91bn in 2013, and Google's from $3.19bn to $55.52bn.

Even Microsoft under Steve Ballmer doubled its sales from $36.84bn in 2004 to $77.85bn in 2013. If IBM had done as well as Ballmer over the past decade, it would be a $200bn corporation, and still bigger than Apple.

The reasons for IBM's awful performance are well known. First, it has spent decades getting out of businesses where it used to be strong. For example, it spun off the Lexmark printer business, it sold off its PC, storage and other businesses, and now it looks as though x86 servers are following PCs to Lenovo. Second, its proprietary mainframe business is in long-term decline. IBM has been milking its locked-in user base for more than 30 years, but it's hard to see where new growth would come from. Third, it has missed almost every revolution since the PC, where it belatedly entered the market in 1981. And while the IBM PC certainly changed the PC business, it was Microsoft and Intel that benefited, not IBM.

Rometty justified the company's strategy to the New York Times by saying: "We don’t want empty calories. So when people keep pushing us for growth, that is not the No 1 priority on my list."

Graph from IBM's annual report showing EPS targets
IBM's business is driven by the need to increase its operating earnings per share: see below.

Indeed, IBM's strategy is focused on finance rather than technology. Its stated objective, in its 2012 annual report, is to deliver "at least $20 operating (non-GAAP) earnings per share in 2015", up from a low of $1.81 in 2002. But one of the main ways it's doing that is by buying back its own shares.

David Stockman, a former Reagan government economist, has poured scorn on this approach. Recently, he wrote at Seeking Alpha: "For more than a decade now, IBM has been eating its seed corn. Since the beginning of fiscal 2004, Big Blue has posted $131 billion in cumulative net income, but saw fit to reinvest fully $124 billion or 95 percent of its earnings in its own balance sheet, which is to say, in buying back its own stock. […] In short, IBM has become a stock price inflation machine."

Stockman notes that IBM has also taken on debt to do this: "In 2004 IBM had $13 billion of net debt. Today the figure stands at just under $37 billion." It still has the cash-flow to buy companies to fill holes where it has missed out, but it no longer has the deep pockets of Apple, Google and Microsoft.

Many industry observers know that IBM once controlled the IT business, and its turnover was twice as big as everybody else's put together. Apple followers will recall that IBM was the Big Brother that Steve Jobs attacked in striking TV commercials: only plucky little Apple could stop IBM from having it all. Some may even remember Apple's failed attempts to sell itself to IBM in the 1990s. (IBM didn't think Apple was worth $7.3bn.)

That company no longer exists. IBM used to be the world's most powerful corporation but today it's only the third largest tech company, behind Apple and HP. Unless there's a turnaround, IBM is on track to be overtaken by Google and Microsoft. Maybe it can flog millions of iDevices to its mainframe-based users, but then again, maybe it can't. (Sure, enterprises will buy iPhones and iPads, but they are already buying iPhones and iPads. From Apple.)

So the original question remains: Can IBM execute? Looking at IBM's track record in smartphones, tablets, apps or even cloud services, it's hard to see much evidence that it can. What it can do, of course, is buy the skills and the software it lacks. It's already done that with purchases such as SoftLayer's cloud service, for $2bn, and Fiberlink ($375m), which it bought for its well-regarded MaaS360 cloud-based device management service. Others include Aspera, Cloudant, Trusteer, Green Hat and many more.

As part of its BlueMix initiative, IBM is also investing $1.2bn in cloud datacenters, and another $1bn in developing cloud software. But you have to wonder why it wasn't doing this five years ago. It's already lost a ton of business, including a CIA deal that went to Amazon. IBM has always been the high cost supplier — we used to say "you can buy better but you can't pay more" — and cloud prices are tumbling at a rapid rate. Is IBM really going to come from behind and out-innovate Amazon, Microsoft and Google?

IBM has had grandiose projects before, some of them with Apple. The two companies once planned to take the PC market from Intel and Microsoft by moving the industry to their PowerPC Reference Platform (PReP/CHRP), and they had joint ventures — Kaleida and Taligent — to change the software market. Apple failed to deliver and eventually dumped PowerPC chips to switch to Intel. Both Kaleida and Taligent were miserable failures.

It also remains to be seen whether the Apple deal will create conflict inside IBM. That happened before when IBM fell out with Microsoft over the OS/2 operating system, and decided to kill the Redmond upstart. But IBM's own PC division turned out to be one of Windows' keenest supporters, and IBM's incoming CEO, Lou Gerstner (corrected), abandoned OS/2 as soon as he could.

In this case, IBM has been trumpeting its support for open source, but the Apple deal is based on closed, proprietary technology. Of course, IBM's mainframes are also closed, proprietary systems, so perhaps IBM salesmen are already adept at talking open while selling closed. There's no doubt that there is an enterprise demand for iOS devices and apps, but there is also enterprise demand for Android and Windows Phone devices and apps, especially in companies that support users under BYOD schemes.

For IBM, the Apple deal is an opportunity. It may also be several opportunities foregone, because Android has by far the largest market share, and by far the largest range of devices. (See When it comes to Android vs. iOS in the enterprise, Android is the Borg.)

Does this mean a $100bn company with roughly 400,000 staff believes it can't compete with numerous small Chinese start-ups or even with Amazon in developing its own Android phone — and perhaps more customised devices, that Apple will never provide — for the enterprise market?

The old IBM would have wanted to own everything: cloud, software, apps, devices, maintenance and financing. The current one doesn't have the foresight, ambition or sheer guts of Jeff Bezos' web-based retailer. It's certainly possible that Rometty will be able to reverse IBM's decades of relative and sometimes absolute decline, but I wouldn't bet on it.

In 1990 (left), IBM's $69bn annual turnover made it much larger than HP+Compaq ($16.11bn), Apple ($5.56bn), Microsoft ($0.8bn - green) and Dell ($0.5bn). By 2013 (right), IBM had been overtaken by Apple and HP, with both Microsoft ($77.85bn) and Google ($55.52bn - yellow) still gaining. Taken together, Microsoft and Dell ($134.79bn) now outsell both HP ($112.30bn) and IBM ($99.75bn).


Graph from IBM's annual report showing EPS targets
IBM's operations, and its growing share price, are driven by the aim of increasing its earnings per share to $20 by 2015. High-margin software (light green) will contribute most, with hardware/financing (dark green) flatlined at best. From IBM's own projections, that goal looks hard to reach without adding a substantial new business, which presumably the Apple deal is meant to provide. Of course, the simplest way to increase EPS is to reduce the number of shares by buying them back. But in doing this, IBM has already gone into debt. What happens when the music stops? Image credit: screen grab from IBM's 2012 annual report.


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