IBM's Turnaround Under Lou Gerstner, Business & Management Lessons

Are you telling me that a biscuit seller is going to run the technology conglomerate that is already in ruins and counting its days? Are you kidding me?

Many were shocked when IBM asked Lou Gerstner, then CEO of RJR Nabisco to take the helm of floundering IBM in the early 1990s. A CEO who had no knowledge of computer machines, programming, software and importantly, who had no knowledge of IBM’s potential customer segments. Gerstner’s experience was also largely in selling to consumers, not in the business-to-business sales which IBM required. How did he turn around the largest computer company in the world with so many limitations? What lessons could we learn?

Let’s begin with a brief history. 

The Freefall -In the early 1990s, IBM had hit a new low and was struggling. IBM’s Stock price dropped from $43 in 1987 to $13 in the 1990s. The Wallstreet analysts, Experts at Silicon Valley and Technology pundits had predicted the end of IBM. Bill Gates expected that IBM would fold in seven years. Almost everyone was of the view that the computer industry was driven by rapid technological change and only a smaller, nimbler firm could adapt quickly and grow while the company of IBM’s size would struggle as it would be impossible to react quickly enough to meet the changing market conditions. They were all saying that ‘Elephants can’t dance or move like ants’. 

He? Who? -In the meantime, IBM’s board of directors were hunting for a suitable CEO who would change the company’s fortunes. A good lot of CEOs flatly refused to consider the opportunity. They were of the view that IBM had already entered into an irrecoverable state and helming it would be a damaging proposition for their careers. Scott McNealy, then CEO of Sun Microsystems commented that IBM’s best way forward was to hire someone lousy. 

IBM’s board of directors had chosen a list of suitable candidates for the leadership position and Lou Gerstner was at the top of the list. After several rounds of discussions, the hiring team felt that Lou Gerstner would be the right person to lead the company.

The majority of experts were aghast on hearing the selection. A non-technologist for a hardcore technology company? Were they hastening IBM’s decline? Media ridiculed Lou’s selection. 

The Rationality Behind Selection 

Fortunately, the IBM board’s criteria of a leader were widely different from what the commoners or experts thought. The board was not looking for a technologist, but rather a broad-based leader and a change agent. The board members believed that the company had a lot of smart, talented people who were also technically strong. So, they felt that the problems at IBM were not technical in nature. 

The Change Agent -What they wanted was a leader who could look at the company as a wholesome and introduce a new way of doing things, a new process, a new organisational structure or a new business model. A proven, effective leader who is skilled at generating and managing change. Any new change would definitely have to revolve around the most precious resource ‘The Humans’ and only by building personal relationships, a leader could motivate people to change their behaviour. The hiring team believed that Lou was capable of driving that kind of strategic and cultural change at IBM similar to what he had done at American Express and Nabisco. He is humble and a great listener of criticisms, opinions and suggestions. He never let criticisms affect his work and loved building relationships. 

Prior to joining Nabisco, Lou served as president of American Express and dramatically grew its business, from 8.6 million to 30.7 million cardholders. In RJR Nabisco, he had unified the two separate cultures that had been brought together through a merger. 

BE A FOLLOWER TO BE A LEADER 

We keep hearing pieces of advice that if you want to be a successful leader, ensure that you are seen as a leader and not as a follower -We are instructed to adopt behaviours that people associate with leaders -A distinctive body language(Dominant, assertive), a unique identity, a different thought process. Many motivational books recommend ‘Find your own style and be you are’. 

“The one who follows the crowd will usually get no further than the crowd. The one who walks alone is likely to find himself in places no one has ever been.”

By pointing out examples of Steve Jobs and other similar personalities, the thought of ‘Being different to be a leader’ is widely being spread. We are constantly encouraged not to fit into the class of followers. We are told to live by example; set our personal goals and standards, and stand by it and position our place in the world so that others can be inspired to do the same. 

Being One Of Them -The truth is, without followers, there won’t be any leader. Leadership is not about himself or herself. It is about his or her followers. A leader’s job is not to inspire others to emulate him or her but to inspire others to become a better version of themselves and in turn, they could inspire more people. A leader has to seemingly appear like one of the followers -like an ordinary person similar to them but capable of producing extraordinary results which would give confidence to them to improve themselves.

Why? -Humans are a social animal and we are naturally driven to be part of a community in order to reproduce and survive. We have a strong bias towards people of our community. People in an organisation willingly follow a leader only if they feel the leader is just like one of them. Being a member of their social community helps in building trust between the leader and the followers -Trust, the first major step in building a lasting relationship with the followers. Without relationship, a leader cannot execute any changes or new plans.

Leadership is about engaging with your followers and building relationships with them.

Being a part of their community means a leader is the one who is working for the interests of the group rather than individual interests. It is not about him or her, it is about followers. It is not about how Lou Gerstner would benefit, it is about what is best for the company and its people. Gerstner was not working to become a larger-than-life hero or an unreachable icon but to make the company great again and help the people to lead comfortable lives. He was humble and modest, qualities of a follower. 

How to be a follower? -The first step Lou Gerstner took after joining was to spend time with as many IBM people as possible. He lived among them and then lived like them. Without any preconceived notions, he patiently listened to them. 

Lou, being among the followers helped him to understand the problems faced by the company and people, the unofficial organisational structure, their attitudes, the process deviations, the organisational culture and so on. He understood what kind of challenges he has. He patiently gathered suggestions and ideas and the ways to execute them. The constant communication helped him to understand the employees better which helped him further in influencing them at a later time. 

01. THE STRATEGY

OBSERVING CUSTOMERS, THEIR SHIFTS IN ATTITUDES AND CHANGE IN CONTEXTS

When the computer industry first appeared in the 1950s, the business model was to deliver customers a total integrated package of hardware, software, storage devices, operating systems, all bundled into one pricing. The vertically integrated company manufactured its own semiconductor chips, built its own computer, developed its own proprietary operating system software, developed its own application software that would run only on its computers and marketed, sold & serviced by its own people. 

Ignoring the Customer’s Pain -This above-integrated solution provided a seamless experience to the customer but on the other hand, the customers were stuck with the model and the vendor. If there was a problem with one of the parts, the customer had to throw the entire stack plus he or she had to put up with the vendor’s pricing of the parts and the inconsistent service in some cases. So, customers were forced to stay loyal to a company for a long time with the solution they chose in the first place. 

The Disruption -Then a revolutionary product entered the computer market -the microprocessor, an affordable, cost-effective product -Many chips on one single chip -Suddenly, it could be used to produce all kinds of computers. Combined with the economics of mass manufacturing, the manufacturing of computers became cheap. Small companies like Apple, Microsoft, Compaq popped up and disrupted the market. Gradually, the competitors grew from a few handfuls of companies to thousands. Vertical integration was no longer the norm. 

The customer chose the type of chip, the PC manufacturer, the operating software and the applications in his PC. Companies were getting specialised only in one field -Some sold only application software, Microsoft sold operating systems and application software, few companies sold only the hardware. Marketing, sales and services were taken over by the retailers and dealers. It was no more part of the company. See the image below. 

(Image Source: Association of Computing Machinery, acm.org)

As the new order took place, the old vertically integrated companies struggled due to their size and vast network. A lot of people shifted from IBM’s mainframe computers to PCs. As the volume of PC users grew, a lot of programmers shifted their attention to develop applications for PCs which further increased the pool of potential customers. At the same time, the new order gave an opportunity for a number of new companies to grab the limelight -Compaq, who manufactured only PCs became the fastest Fortune 500 company to reach $1 billion in revenue. Dell and Novell too joined the list soon. Microsoft was also making stronger waves. It was a time of being specialised only in one field. 

THE OTHER VERTICAL INTEGRATORS

NCR, like IBM, was one of the biggest vertically integrated companies till the 1980s. The company recognised the winds of change. They abandoned their proprietary chips, hardware design and moved their entire computer line to run on commonly available microprocessors. They modified their software (which was originally designed to run only on proprietary computers) to run on off-the-shelf microprocessors. They split their company into individual segments focusing on the specific needs of customers. 

UNISYS, a multibillion-dollar company in the old vertical industry, also recognized the disruption. They were once proud designers of good quality computers. They abandoned the manufacturing of computers and shifted their focus to software and services.

NOVELL, a small company was initially launched along the lines of vertical industry. They built their own network hardware and software. The software ran only on their own network. To adapt to the changing environment, they abandoned the hardware business and shifted their focus only on developing and modifying the software to run on inexpensive computers. They became the ‘first mover’ in the networking industry and became a multi-billion dollar company within a decade. 

SPLITTING IBM? 

It appeared that the logical solution to IBM’s problem was to split the company into individual operating units to match the horizontal industry structure. Industry experts, Silicon Valley consultants, IBM executives, the board directors were also suggesting the same. Gerstner’s predecessor, John Akers, had already taken initial steps to break up the company and the IBM’s board of directors were also of the view that Gerstner would take those plans forward. 

Lou Gerstner felt that splitting the company appeared like a knee-jerk reaction to what competitors were doing without understanding what created fragmentation in the industry. He was of the view that businesses exist to meet the unmet needs of customers and any decision had to be guided from the perspective of customers. There’s another factor too -IBM’s knowledge of customers. IBM’s people were selling their integrated solutions to Chief Information Officers of the companies. They were familiar with this customer base. If IBM had to be split, the company had to deal with individual customers which they were not familiar with. It posed a major challenge.

‘The Why’ Behind The Behaviour Change -A disruptive product or service happens because the existing businesses failed to meet the needs of their customers or ignored their needs. Before taking any major decision, Gerstner felt that it was important to understand the reasoning behind the customer’s new behaviour of encouraging fragmented vendors and perceive what kind of needs were ignored by the industry so that IBM can make the right decision. 

How to understand the customers? By observing, talking and spending time with your customers. 

Lou Gerstner spent time with customers to understand why they supported a horizontal industry structure. His research gave the following inputs

• IBM’s price was very high due to their high-profit margins and the customers were left with no option but comply. They badly wanted to break IBM’s monopolistic grasp on industry economics. 
• IBM was promoting mainframe’s centralised computing whereas client companies were inclining towards delivering computing power to individual employees. Gerstner observed that IBM was not moving quickly enough to meet the needs of distributed computing. 

Many small companies came to fill-in this need. It was clear that customers were not actually looking for specialised companies or fragmented suppliers. They actually wanted to bring some competition into the marketplace to loosen the grip of vertical integrators like IBM and to seek suppliers for distributed computing. 

THE POSITIONING STRATEGY -KEEPING COMPANY TOGETHER

From his research, Gerstner observed that the horizontal industry structure still posed a problem for some of their customers. It didn’t fully solve the problem. Earlier, companies like IBM helped in integration but now customers had to be the integrator of the technology into the usable solution to meet his or her business requirements. Many of them literally struggled with it as they were unfamiliar with the new developments in technology, hardware and software. They battled hard to make everything work together which took away their time from their own businesses. Adding to their woes, there was an utter lack of uniform standards throughout the computer industry which complicated their situations further. Customers also began to realise that they were, in fact, paying a higher price for the product in certain cases due to the fragmentation. 

It was clear that business customers still preferred somebody to provide an integrated solution but at a lower cost. Unfortunately, all those small companies were in no position to deliver an integrated solution. Every company offered add-on solutions which were not meeting the needs of customers. There was not a single company who was ready to understand the customer’s needs, problems, future ambitions and offer a working solution. 

Gerstner felt that IBM due to its sheer size, broad-based capabilities, talented people, far and wide geographical access, advanced research facilities was well positioned than any other company to provide an integrated solution to the customers, apply complex technologies to solve business challenges and offer support services which the competitors completely lacked. It would be insane not to use this massive and unique competitive advantage.

By splitting the company, IBM would become another disk-drive company or another operating system company or another PC company. The differentiation would be lost. IBM’s existing strengths could not be leveraged. None of the customers was looking for a company that looks similar to other companies. 

So, Gerstner wisely chose to keep IBM together rather than splitting it. And the decision turned out to be a masterstroke. 

LOWERING THE PRICE

From his consumer research, Gerstner learned that customers strongly felt IBM’s products were too expensive. In the 1990s, a bleeding IBM badly needed profits to survive and the company saw that the best way was to milk as much as possible from their existing mainframe products. He noted that fearing the loss of revenues, IBM never lowered the prices of existing mainframes. The conventional wisdom at that time was also not to lower the prices as it would affect the bottom-line. Even experts were of the same opinion. 

Gerstner saw that the other vertical integrators like Hitachi, Fujitsu, and Amdahl were selling their products 30–40 per cent below IBM’s price and they had already taken away a chunk of IBM’s market share.

What should IBM do? Gerstner believed that every decision had to be thought from a customer’s perspective -He was of the opinion that pursuing anything that's against consumer interests will eventually push the business to the brink of bankruptcy. His research clearly showed that customers were not happy with IBM’s prices and they felt that they were stuck with their company due to their initial choice. If IBM did not lower the prices, it would slowly be destroying its own valuable asset -the customers. 

To arrest the dramatic fall in sales of mainframes and to restore the customer’s faith and trust in the brand, Gerstner took a bold step of cutting down the price of the hardware and software. Everyone was shocked. 

This was an important decision which arrested IBM’s slide. 

INNOVATION, SIMPLIFICATION

Gerstner firmly reiterated that the company had to make the product within the price, a customer was willing to pay. As he lowered the prices of mainframes, the profit margins took a beating. One of the possible solutions was to innovate. He asked his team to work on simplifying the software and introduce innovations in the hardware in order to make the price reductions feasible. Fortunately, for Gerstner, one of the research team already had a solution -Moving mainframes from bipolar to CMOS architecture but the earlier leadership was against introducing it due to the fear of cannibalising their existing mainframe business. Lou Gerstner came to know that CMOS architecture would allow substantial reductions in price without losing gross profit margins. It was a blessing for him. 

Soon, IBM shifted its mainframes to the new architecture and thus improved its competitiveness. Gerstner’s team continued to work on manufacturing efficient systems to meet the needs of customers at a lower price while the competitors like Hitachi continued to develop bigger and bigger bipolar systems, focusing only on improved performance and finally they ran themselves out of the business. 

Within a few years, CMOS technology helped IBM to drop the price of mainframes from $63,000 to $2,500. This strategy saved IBM and its sales grew by 41% in 1994 and 60% by 1995. The company was finally on the path of recovery. 

02. FOCUS ON CUSTOMER ENGAGEMENT

After joining IBM, Gerstner spent as much time as possible with people in the company to understand the problems. The employees, leaders, executives spoke about every business issue -software issues, mainframe issues, microelectronics licensing, and so on. But Gerstner felt they didn’t address a couple of essential details -Customers and the internal culture -The two foremost critical parts of a business engine. The technological divisions at IBM developed products based on what they thought about could be built with their available technology and knowledge, or what they wanted to build, with little concern about customer needs or priorities. 

Gerstner wondered how IBM had completely lost its touch with customers?

The Decline -One of the core principles of IBM founder Watson was ‘Superior customer service’. But as time passed, IBM became almost a monopoly in the mainframe business and ‘customer service’ was relegated to the lowest levels of importance. The sustained success of System/360 mainframe with high-profit margins led to a commanding market position and made IBM employees complacent. They had nothing to worry about marketplace happenings as it rarely affected them. Gerstner writes that servicing became one-sided and instead of paying attention to changing needs, attitudes of customers, helping customers to solve their problems, helping them to expand their thinking, customer service became largely administrative. The employees lost their passion and were actually going through motions while servicing the customers.

Bureaucracy also affected the customer experience and service -It delayed new product approvals and launches as they were stuck in a maze of checks, approvals and validation that slowed decision-making. IBM’s new launches took almost five years of development time whereas the competitors were launching new products every eighteen months. It was widely joked at IBM, “products are not launched at IBM. They escape”. 

Customer Engagement -In this information age, the survival of business solely depends on how well a brand engages with its customers. It has become a top priority for most businesses. The customer engagement results in positive customer experiences which may encourage brand promotion through word of mouth. Highly engaged customers buy more, promote more, and demonstrate more loyalty. 

Gerstner felt that IBM’s lack of focus on ‘customer engagement’ was a major reason why the company was struggling. It was essential to motivate executives to interact with customers at every possible opportunity and build a relationship with them. For that to happen, the customer-facing employees, designers, marketers, sales, need to spend time with their customers, observe and listen. The more time they spend with customers, they would learn the shifts in user attitudes and understand their changing needs which could help in re-inventing the product. 

OPERATION BEARHUG

From his observational research, Lou Gerstner noted that customers found it hard to deal with IBM people in case of service requests and also lamented about the company’s poor responsiveness. He felt that it was important to change this perception and at the same time, he had to instil the importance of customer-centric organisation. 

Gerstner requested every member of the senior management to visit a minimum of five of IBM’s biggest customers during the next three months and spend time with them. The executive should observe and listen as much as possible. He or she should solve whatever the problems the customer have as quick as possible and show them that IBM cared for them. At the end of the visit, the executive had to send a one or two-page report to Gerstner. It was a major step in changing the culture at IBM and also customer perception of IBM. For his part, Gerstner showed his seriousness by studying every report and providing feedback. 

The ‘Operation Bearhug’ helped IBM in improving the service, making better business decisions, simplifying the communication between IBM people and the customers, earning the customer’s trust, and building a healthy relationship. 

03. INTERNAL CULTURE

Next, to understanding customers, internal organisational culture plays a vital role in building a sustainable competitive advantage for a business. The concept of ‘outstanding customer service’ had to be interwoven within the culture. It had to be a part of their everyday activity. 

Culture is not about only customer service but also about teamwork, cohesion, excellence and responsible behaviour as a whole company. IBM had lost some of its original cultural aspects over a period of time. The monopolistic nature of their mainframes business and IBM founder’s core principle of ‘Respect for the Individual’ played a major role in stifling the organisational culture. 

The ‘Respect for the individual’ became a culture of entitlement. It nurtured the idea of not doing anything to earn respect and at the same time, implanted the rigid belief that it was one’s right to get rich benefits and lifetime employment by virtue of being hired. 

The monopolistic nature of their business also had insulated them from the recession, price wars and technology disruption which further led to a decline in organisational culture. 

Hands-On Managers -Every middle and senior-level executive of IBM had brightest individuals as assistants to do many of their tasks, activities and chores. The middle-level managers were completely dependent on their assistants. They could not even provide any useful information or any status updates without getting back to their assistants. Gerstner saw that those executives were not actively involved in the work and this resulted in complete detachment from the day-to-day needs and operations of the business. This further affected the right mentoring and shaping of their assistants to suit the organisation needs. Gerstner believed that every executive had to get on to the field, be hands-on and involve himself fully in business operations. He quickly abolished the existing system and encouraged ‘hands-on’ management. 

Decision By Committee -There was a centralised ‘Management Committee’ which took major decisions of the business. It was a group of six members and met twice a week to view a lot of presentations. Gerstner saw that these people were not fully involved in the business and had no face-to-face understanding of the customers or market. The centralised control ultimately diffused responsibility, accountability and leadership. He felt that a committee’s job was not to take decisions but make suggestions. He got rid of the decision-making power of the committees and decentralised some of the decision-making so that more people could take responsibility and become leaders. 

Fearless Environment -Fear and uncertainty prevailed in all levels of the IBM organisation which demotivated employees. Gerstner’s primary job was to create a fearless environment. 

He endorsed an environment where people would not hesitate to talk freely and share their ideas -An environment where they could even question CEO’s ideas, plans and action. He appreciated when people didn’t hide bad information and shared it immediately and he encouraged other executives to follow the suit. He encouraged people to make mistakes as part of experimentation and learning but requested them to move fast rather than being slow. He believed in failing quickly and cheaply without spending too much money and time.

For Gerstner, hierarchy meant little to him. If there was a problem to be solved, he would put people in meeting regardless of hierarchy. He encouraged people to have a lot of candid, straightforward communications without thinking about hierarchy in meetings. 

04. RE-ENGINEERING THE ORGANISATIONAL STRUCTURE

IBM’s organisation structure was divided into individual geographical units with duplicate infrastructure in each country with decentralized control. As time passed, these geographical regions became individual ‘fiefdoms’ and tried to protect their turf. They began to compete against other IBM units. 

Lou Gerstner experienced the effect of IBM’s disconnected global network when he was head of American Express. As AE cards were used in different countries dealing with different currencies, the company needed IBM’s support to replicate the support systems in every country the product was in use. Unfortunately, there was no coordination among any of the geographical units. The American Express company had to again reestablish and build a new relationship with the local IBM unit in each and every country. They had to share their needs, requirements again and wait for their solutions. Being one of IBM’s largest customers in the US had no value to IBM management in other countries. Sometimes, products used in the United States were not available in other markets. It was really frustrating for international customers. IBM’s local unit was not leveraging the competitive advantage of the organisation. Customer data could not be tracked across the company. The local units cared only about their profit and loss and not bothered about Global relationship. 

Gerstner, having experienced difficulties of IBM’s network as a customer, and to proliferate the importance of being a customer-centric company, he felt that the organisational structure had to redesigned to meet the needs and requirements of customers.

He began to organise the company around global industry teams based on the customer bases -Banking, Insurance, Distribution, Manufacturing and finally, Small and Medium size businesses. Groups would be in charge of all budgets and personnel. No more geographical fiefdoms. A customer would receive the same service in all the locations and his support systems would be easily replicated with minimum effort so that he or she could focus on their core business. 

05. THE COST STRUCTURE OF KEY ACTIVITIES

When Gerstner joined the company, IBM was bleeding cash. Somehow, the cash burning had to be stopped as early as possible. Though the sales of mainframes were down, their profit margins were down, the total expenses of the company didn’t go down. Competitors were spending 31 cents to produce $1 of revenue while IBM was spending 42cents for the same end. 

To stabilise the company, one of the top priorities was to cut down the expenses drastically. Gerstner cut down the employee count. Even then, the expenses dropped only marginally.

Gerstner discovered that the inefficiency of systems and processes at IBM were the real culprit. The accounting systems, fulfilment systems, distribution systems, inventory systems, HR systems were built in the early mainframe days and failed to adapt adequately to meet the needs of changing business scenarios. The systems didn’t facilitate cross-communication between different business units and posed a major challenge for integration. 

The Operational Efficiency -Gerstner initiated a massive programme to reduce the expenses. He gave a clear target of approximately $9 billion. He also set a shorter timeline of ninety days to see the results. He asked his team to start with core activities that dealt with the outside world, beginning with customers. 

He gave employees the freedom to choose their activities, goals and expected results in consultation with their senior executives or managers. He promoted the ‘bottom-up’ approach. 

The employees began to make improvements in hardware development, software development, integrated supply chain, customer relationship management, and services. The hardware development time drastically reduced from four years to an average of sixteen months thereby saving a lot of money. The reduced inventory costs and integrated supply chain also saved billions of dollars for IBM. 

Then they shifted their attention on internal processes -HR, procurement, finance, real estate, information technology. They developed an optimized, cheaper, well functioning ‘Internal information system’ to communicate and run the businesses. 

Date Centers -IBM had hundreds of data centres and networks scattered around the world, many of them were largely dormant or being used inefficiently. IBM saved billions of dollars in reducing the data centres from 155 to 16 and by way of consolidating 31 internal communication networks into a single one.

Real Estate -IBM’s real estate had 240 employees and tens of millions of square feet in prime areas of the city and many properties were underused. Gerstner sold unused and irrelevant properties, cut down the staff drastically and outsourced some of the real estate activities as it was not IBM’s core business. IBM saved $9.4 billion by way of selling and re-structuring the real estate. 

06. CREATING LEADERSHIP TEAM 

A great leader is one who leaves the company in good hands after the end of his tenure. In other words, he or she plays a major role in developing the next generation of leaders in the organisation. Gerstner created a wonderful leadership team which helped in every step of IBM’s turnaround. 

Hiring Right People -Jim Collins writes “When facing chaos and uncertainty, and you cannot possibly predict what’s coming around the corner, your best “strategy” is to have a busload of people who can adapt to and perform brilliantly no matter what comes next. Great vision without great people is irrelevant”. Before devising the strategy, hiring the right people and building the team is the foremost thing. The first step Lou Gerstner took was to identify and include the right people in the executive team -The people with a right ‘Can-do’ attitude, passionate about winning, whose work is to solve a problem and who were looking for short-term victories and long-term excitement.

Insiders vs Outsiders -Gerstner felt that hiring outsiders to run the company might work in smaller organisations but would be an impediment in larger organisations as it would affect execution. External leaders might be equipped with better knowledge & experience and might have better solutions. But when it comes to execution, there would be resistance from within the company. Motivational levels would be low. 

Gerstner believed that for companies like IBM which has a complex organisational structure, developing internal talent for key management positions had several advantages. The insiders who had spent years in the company would be having an intimate knowledge of the company’s operations, policies, culture, people and customers. This would enable quicker execution of ideas. Moreover, IBM had many talented and qualified people with unique skills and expertise to choose from. 

The Leadership Traits -While choosing people for the leadership team, Gerstner read every candidate’s reports, observed how they interacted with customers and how they were candid in communicating with their seniors, evaluated the clarity of thinking, noted the courage of their convictions, assessed the willingness to accept feedback, gauged how accessible they were to their subordinates, probed how far they were willing to help colleagues and checked whether they were ready to abandon their ideas and ready to shift direction in case of data anomalies. 

With the help of the leadership team, Gerstner would not have succeeded. 

07. TRADEOFFS

Vertical integration, redefining the organisational culture, lowering the price of mainframes and operational efficiency was not enough to help in IBM’s turnaround. There was another critical element that helped IBM’s future — ‘Trade-offs’. 

Gerstner says that Strategy is not only about what to do but also about what we should not do. As time and resources are limited, Gerstner believed that a wiser way to do business is to invest time, effort & money only in the activities that would help an organisation to achieve its goals and are compatible with the brand’s vision and core values.

“It is better to do one product well than two products in a mediocre way” -Reed Hastings. 

THE STRATEGIC FIT

IBM had some subsidiary companies. Gerstner felt that some of those subsidiary companies had no strategic fit with IBM’s activities. They had nothing to contribute to IBM’s overall strategy. Similarly, those companies could not achieve an organisational fit with IBM as their administrative systems, processes, corporate cultures, customer demographics did not match the parent’s company’s systems. 

Federal Systems Company, one of IBM’s subsidiary, had a history of important technological breakthroughs for various national security and space programs. The company’s activities had no strategic fit with IBM’s and it was also a perpetual low-margin business and did not fit into the overall high expense model of IBM’s commercial side of the business. 

Gerstner and his team sold all those businesses similar to Federal Systems Company that didn’t offer any strategic fit and organisational fit. 

THE SUNK COST TRAP

Gerstner saw that a technical team was developing an operating system for the last few years to counter Windows OS. The company had already invested tens of millions of dollars in product development. The team felt that IBM’s OS/2 was a better product than Windows. They were emotionally attached to the product as they had already invested a lot of time, money and effort. 

Lou Gerstner had no emotional attachments towards any of IBM’s new products as he was new to the company and took no part in its earlier decisions. So, he was capable of applying an impersonal logic to the future of the product, unlike the people who devoted a lot of time in developing the product. Gerstner felt that the ‘operating system’ war was over already as Windows had grabbed almost ninety per cent of market share. He saw the company was investing in a losing activity. Moreover, people had developed a habit by using Windows OS and breaking that would not be an easy task. A new operating system is no more a vital competitive edge. 

John S Hammond writes “Sunk cost is a kind of a trap which will force a person to make choices in a way that justifies past choices”.

Gerstner advised the team to stop developing the software further so that the team could focus on products that would help IBM achieve a global competitive edge. 

APPLICATION SOFTWARE 

IBM made and sold hundreds of business applications, for customers in industries like manufacturing, financial services, distribution, travel, insurance and health care. The company had invested $20 billion in application development. Unfortunately, the returns were poor. The application software field had stiff competition and the market was dominated by small entrepreneurial companies with each firm focusing only on their specialised core capabilities. Gerstner questioned the need for developing application software but was told that the application software was critical to an integrated solution. 

Gerstner perceived that one of IBM’s core values ‘superior customer service’ depended only on the functionality of hardware and the middleware software. He felt that the ‘application software’ had no role or minimal role as many client companies were fine in installing third-party applications. Gerstner saw that IBM was strong in middleware software and the company had almost no competition in that field. He felt that ideally, IBM should focus its resources, investments on improving middleware software rather than developing application software. 

Network Partners -Gerstner also saw ‘application software development’ companies like SAP, PeopleSoft, JD Edwards were in a great position to generate a lot of business for IBM if they did not see IBM as their competitor. The customers often bought or chose the applications first, then they solicited help from software provider to tell them which hardware would support it. Those companies had stopped recommending IBM products and were pushing their clients to IBM’s competitors. 

It was clear for Gerstner that IBM had to stop developing application software in order to grow and become a market leader. He put an end to the ‘application’ software development and diverted the resources, money to middleware software development which went on to improve the competitive edge of IBM’s products. 

Do one thing better and do it better than anyone else -Lou Gerstner.

THE PC DILEMMA

For fifteen years, IBM had been trying to grab a prominent share in the PC market but failed miserably. The company made no profits from the billion-dollar investments in the PC industry. Though the company won a lot of awards for technology and design, Gerstner saw that PC sales were a loss-making business. Intel and Microsoft threw the market wide open for many small companies. It was becoming a commodity business. 

Gerstner saw no major gain of competitive advantage in manufacturing own PCs as the standard available desktops would still provide a good consumer experience at a lower cost. So, he felt that the wise decision would be to exit the PC business. Thus IBM got rid of the PC business. Similarly, the company exited from disk-drive business and DRAM business. 

By means of trade-offs, Gerstner manifested the seriousness of leadership in turning around the company. It also made it clear what activities an employee had to prioritize and focus. This further helped in building a strong internal brand culture. 

With all those efforts, IBM turned profitable. But further challenge awaits. 

08. THE GROWTH STRATEGY

The track record of many companies that were pulled back from the near bankruptcy is rather gloomy. Most of the companies have folded or either merged with some other company after a brief recovery. Gerstner’s ambition was to make IBM a leader again. For him, companies must go to the market to win and not to participate. Participating is a self-defeating attitude resulting in mediocrity. He didn’t want IBM to win the market and become a leader. So, what strategies did Gerstner devise to make IBM lead again?

SERVICES

Gerstner and his team observed that business customers were increasingly frustrated with the new industry structure that required them to integrate piece parts from many different suppliers. The technology developments, new software versions, proprietary architecture and new hardware launches were paralysing their decisions. For Gerstner, this showed that the future of IT would be SERVICES led, not technology led. The clients would value vendors who would offer integrated solutions and who would help in integrating technology into their core businesses. It appeared that IBM’s capabilities and vast network presented a strong case for leading the ‘services’ market. Further research showed that the services business would be a huge revenue growth opportunity for IBM. 

Gerstner envisioned that If IBM, not only going to play the role of integrator but also provide end to end solutions from architecture to applications to hardware & software choices at the client end, then the company would be poised to influence a customer’s buying behaviour. In that scenario, IBM had the potential to become an influential service business in the industry. Gerstner took efforts to make ‘Services’ as a major driving force inside IBM. 

Though IBM services business was formed in 1992, it was not given much importance. In 1996, with the Gerstner’s insistence, the company formed the ‘Global Services’ division and made a business of $7.4 billion. By 2001, the business grew to $30 billion. 

A NETWORKED MODEL

One of the ways to survive business disruption is to constantly observe the technology developments and adapt our business model. In the mid-1990s, Gerstner saw that the telecommunication industry had undergone dramatic changes. It provided high-speed broadband connections to the workplace, home and school. Millions of people logged into the internet. The faster internet speeds were changing the way business and society functioned. The concept of PC network was just emerging. 

Gerstner felt that the ‘network model of computing’ would soon govern the PC dominated world. It was an expensive, risky bet which turned out to be a lucky one. In the networked world, he believed that the network would not be revolving around PC but it would be just one of the components connected to the network. A network might include different computing devices like TVs, Game Consoles, High-end Servers, Hand-held devices, Appliances, cars and so on. Based on his prior experience at the American Express company, he theorized that a lot of companies might conduct business over a high-speed network. In that scenario, the massive flow of data could be handled only by large scale systems and not by desktops. He rightly assumed that soon, there would be a huge demand for computing infrastructure products which only IBM is capable of building. 

Thus IBM’s network business was born -The division addressed the opportunities and challenges of customer’s networking infrastructure and laid the foundation for the integration of new technologies into customer’s core business. 

SOFTWARE BUSINESS

In the early 1990s, IBM was known as a hardware company even though the company sold databases, systems management software and transaction management software to its business clients. One of IBM’s core strengths was Middleware software that told the computer hardware what to do. This software worked only on IBM’s computers. Though the company had many software assets, it never viewed them as a unique business opportunity. 

Gerstner pondered the idea of selling IBM’s software to all other vendors. He reasoned that it would dramatically increase the number of users which would result in increased transactions and profits. It would mean more opportunities to integrate applications, processes, systems, users and institutions -More ‘Services’ business opportunities. The research and development cost would be easily monetised over a larger volume of sales. 

Thus Gerstner planted the seeds of IBM Software business which grew to $13 billion by 2001. 

CONCLUSION

Many industry experts criticised IBM for selecting Lou Gerstner. But he never allowed all those criticisms affect his focus on turning around the company. He would have easily opted out of IBM CEO race. But then he would not have entered into the hall of fame. He created history and his success lessons are taught all over the world. He matches all the characteristics of Jim Collin’s ‘Level 5 leadership’ -Humble, Consistent determination, incredibly ambitious. But his ambition was first and foremost for the success of IBM and not for himself. Be selfless, and be Customer-centric in your business. 

References: Content predominantly from ‘Who Says Elephants Can’t Dance’ By Lou Gerstner, mbaknol.com, To be a good leader, start by being a good follower -HBR article by Kim Peters and Alex Haslam, Only the paranoid survive by Andrew S Grove, mtab.com, clarabridge.com, iveybusinessjournal.com, Forbes.com. Bloomberg.com, What Is Strategy-HBR article by Michael Porter, The Five Forces Of Competitive Strategy-HBR article by Michael Porter, The Hidden Traps in Decision Making — HBR article by John S. Hammond, Ralph L.Keeney, Howard Raiffa, Good To Great by Jim Collins.