IBM—Innovation, Investments Fuel a Transformational Journey

By Charles King, Pund-IT, Inc.  January 24, 2018

Ocean-going ships offer one of the most commonplace images for describing large enterprise behavior. You know the drill, including allusions to the difficulty of stopping or turning aircraft carriers or oil tankers “on a dime.” Plus, there are the difficulties businesses face from iceberg-like challenges whose dangers are mostly invisible or unknowable.

Such time-worn analogies often collapse into cliché, but the underlying concept has value. Why? Because though a ship may appear to travel in a straight line, the piloting process is one of non-stop motion, making countless adjustments related to constantly shifting tides, currents and circumstances. The task is also anything but rigid. Laid-in courses can be altered to account for changes in plans, and an experienced ship’s company can usually respond to expected and unexpected emergencies.

These points are worth remembering when it comes to analyzing corporate behavior and performance, especially when considering long term trends and transformational issues. They also factor into two recent IBM announcements—its Q4 and full year performance in 2017 and its 25th year of patent leadership.

IBM’s journey to date

Like other successfully sea-worthy vessels, large businesses are built for both durability and flexibility, with future-focused strategies and chains of command. That said, few corporate leaders thirst for the perils of the open sea. In fact, it seems entirely likely that some long-gone CEO penned the old Spanish/Catalan blessing/farewell, ‘”Que no haya novedad” (“Let no new thing arise”).

During the past decade or so, IBM faced and survived problems that threatened, damaged and sank some other well-positioned companies. Those challenges began with the 2007 sub-prime mortgage debacle and following global depression, events that postponed the orderly transfer of leadership from previous IBM CEO Sam Palmisano to its current chairman, president and CEO, Ginni Rometty.

Rometty took on her new role in 2011, after global economies had stabilized and began moving back from the abyss. That’s not to say her gig was a cakewalk. Fundamental changes in technology usage, particularly the rise of cloud computing and swift, massive adoption of wirelessly-delivered content and mobile endpoints, including smart phones, were shifting the ground beneath traditional IT vendors and inspiring the rise of new, highly creative competitors.

To their credit, some vendors anticipated many of these changes and began actively preparing for and pursuing new lines of business. That included IBM which, in 2012, outlined five strategic imperatives—cloud computing, analytics, security, social business and mobility—it believed offered sizable new business and commercial opportunities. The company also introduced innovations, like its Watson cognitive platform, and strategic investments, such as its acquisition of Softlayer for enterprise-focused cloud computing to support related efforts.

Competitors’ challenges

Some IBM competitors fared less well. HP, for example, which had suffered years of leadership turmoil, appeared to enjoy some badly-needed stability by naming BoD member and former eBay CEO Meg Whitman as its CEO. Interestingly, Whitman took on that role about a month before Rometty’s appointment as IBM’s president and CEO. But the pair’s experiences, and those of their respective companies could not have been different.

While IBM steadily executed shifts in its corporate and go-to-market strategies, along with associated, sometimes painful changes in its solution and services portfolios, HP stumbled from one crisis to another. Those included ongoing litigation with former key partners (Oracle), multi-billion-dollar write-downs of massive and massively failed acquisitions (like EDS and Autonomy) and “spin-mergers” that involved the sale of majority interests of underperforming HP businesses (including enterprise software and services) to third parties.

Facing continuing declining sales and margin pressure, Whitman orchestrated the split of Hewlett-Packard into two fully separate businesses—HPE (enterprise, consisting of the company’s data center assets, solutions and professional services) and HP (containing its emblematic PC and printing/imaging solutions). By doing so HP/HPE essentially exited the ranks of vendors offering integrated desktop-to-data center solutions, leaving the market to Dell and Lenovo. The new HPE positions itself as a direct competitor of vendors, including IBM and Oracle, though it relies on third parties to provide key software assets and professional services.

IBM’s 2017 Q4 and full year performance

This is not to imply that IBM’s and Rometty’s path was straight ahead and untainted by delays, misadventures and even breakdowns. Like most other corporate transformations, the experience included painful decisions about underperforming businesses and employees.

In some cases, entire business units, including IBM’s customer care call centers and its System x (Intel-based servers) group were sold to third parties. In others, product and service lines were consolidated, reduced or eliminated, resulting in substantial headcount reductions. Those were offset to a degree by expansive hiring in new, more promising areas. But the process of winding down old and spinning-up new businesses impacted IBM’s sales and financial performance, leading to 22 straight quarters of falling revenues.

That provides the context for last week’s IBM Q4 and full year (FY) 2017 earnings call which found the company delivering its highest revenue growth (nearly 4 percent) since Q2 2012. That also handily beat Street revenue estimates by nearly half a billion dollars, making Q4 the ninth in a row the company outperformed analysts’ expectations.

The “hows” of IBM’s achievement were even more impressive than the numbers themselves. Since their introduction a bit more than half a decade ago, IBM’s strategic imperatives have grown to constitute nearly half (46 percent, or $36.5B) of IBM’s revenues over the trailing 12 months. More importantly, the group’s revenue growth in 2017 (11 percent overall, and 17 percent in Q4) handily outpaced the company’s other BUs.

Of course, some imperatives did better than others, and in different ways. For example, though IBM Cloud’s $17B in 2017 revenues trailed the $20B the company’s analytics efforts (including its Watson cognitive platform) drove during the year, its 24 percent growth in 2017 (plus 30 percent growth in Q4) was far more robust.

In addition, IBM Cloud now accounts for over a fifth (21 percent) of the company’s annual revenues, or more than double what it contributed just four years ago. More importantly, IBM remains one of the strongest leaders in cloud services, particularly among enterprise customers. Competitors, including AWS, Microsoft Azure and Google Cloud are pivoting their businesses to engage those same large clients where IBM is already a preferred vendor.

Finally, IBM continues to deliver on longstanding commitments to shareholders. Consider that even as annual revenues declined from about $98B in 2013 to $79.9B at the end of 2016, IBM raised its annual dividend from $3.70 to $5.50 per common share. That outstrips all the company’s direct competitors and highlights why IBM remains a darling among income-focused institutional investors.

Patent leadership and return on innovation

Let’s take a look at another recent announcement—the January 9th press release about IBM achieving its 25th straight year of patent leadership (with a record 9,043 patents in 2017). How the company has maintained its patent leadership for a quarter century isn’t always obvious. However, if you take a close look at the IBM Research organization, you realize the group manages both its budget and its scientists’ energies to emphasize areas that demonstrate or promise significant commercial and market opportunities.

This year’s list (which is heavily weighted toward cloud, AI and security) is a good example of how IBM makes this work. All three are aligned with the company’s core strategic imperatives. It’s also interesting to consider how IBM’s funding of R&D relates to its patent leadership. Back in July, Recode published a list of companies that were top spenders in R&D. Not surprisingly, more tech vendors were in the top 20 than from any other industry.

However, if you compare that list to the new list of 2017 leading patent holders, you discover some interesting juxtapositions. Among big spenders, Amazon easily topped the Recode list by investing $16.1B on R&D in the previous fiscal year which was nearly 3X more than 13th place IBM (with $5.4B). But while IBM clearly led in 2017 patent generation (with 9,043 patents–nearly 1,000 more than last year), Amazon Technology’s 1963 patents qualified it for 14th place.

In fact, topping IBM’s 2017 patent total would require adding together the R&D efforts of the top four big spenders on the Recode list: Amazon, Alphabet, Intel and Microsoft which together generated 9,884 patents in 2017. That handily beat IBM’s 9,043 total but as Recode reported, the quartet collectively spent $55B in R&D in the previous fiscal year—over 10X the $5.4B IBM spent on R&D during the same period.

This is obviously not an apples-to-apples comparison since the time periods covered by the two reports don’t fully overlap. But it does offer food for thought about the industry- and market-leading returns IBM continually reaps from its innovation investments. The fact is that 25 straight years of patent leadership offers a company a lot to brag about. But achieving that while spending a small fraction of what major competitors are putting into R&D is simply remarkable.

Final analysis

Returning to my initial nautical allusions, what is the status of IBM’s voyage under the leadership of Ginni Rometty? In short, after successfully weathering years of rough economic seas and constantly shifting competitive tides, its performance during 2017, and particularly Q4 offers hope that the company has entered quieter, more predictable waters.

However, the vessel we see today is somewhat different than the IBM Rometty took command of in 2011. Frankly, the company is considerably more weatherly in rigging, shape and capabilities, meaning it is better able to provide for its own and its customers’ requirements to undertake entirely new adventures, and survive and thrive despite whatever chance and circumstance place in its way.

In addition, while the organization’s appearance may have changed, the continuing leadership of IBM Research shows that the company’s innovative bones remain fully intact. That qualifies as good news for today that also bodes well for the quarters, years and voyages to come.

© 2018 Pund-IT, Inc. All rights reserved.