Two years ago, IBM Corp. was stumbling. Its financial performance in the first quarter of 2005 was well below expectations, and the culprit was its big technology services unit, a business under increasing pressure from lower-cost Indian outsourcing firms.
“It wasn’t just the miss, it was that revenues were slowing in services,” Samuel J. Palmisano, IBM’s chief executive, recalled in an interview.
Since then, IBM has made impressive progress. It has increasingly moved up the ladder to offer higher value corporate packages of research, software and services. This is also higher-margin business, where specialized skills matter more than price.
IBM has also hired aggressively in India to narrow the cost advantage of its offshore rivals in traditional technology services such as operating data centres for customers and upgrading and maintaining their software.
IBM has been reorganized from a classic multinational company with country-by-country operations, working in isolation, to a more seamless global enterprise with centres of expertise in industries and technical skills, scattered around the world, each a hub in a global network for delivering services.
The changes, according to Palmisano, amount to “a huge reinvention” of the company.
Its experience offers a textbook case of a company successfully navigating the twin challenges of globalization and rapid technological change, at least for a two-year stretch.
So far, it seems to be working. Profit margins at IBM have risen steadily, and it reported record earnings and cash flow in 2006. Wall Street expects the trend to continue when IBM reports its quarterly figures on Wednesday. The consensus estimate of analysts has earnings increasing 13% from the year-earlier quarter, to about $2.15 billion (Rs8,677 crore), or $1.47 a share, on a 5% rise in revenue, to nearly $23.1 billion.
Despite the recent improvement, IBM still faces daunting long-term challenges—particularly in its services business, which last year contributed 52% of the company’s revenue and 37% of pre-tax income.
The Indian companies in the technology services business continue to enjoy a sizable cost advantage. The leading Indian outsourcing companies, such as Infosys, Tata Consulting Services and Wipro, have average operating profit margins of more than 20%, according to a recent analysis by Sanford C. Bernstein and Co. The margins at IBM, according to Bernstein, are less than half that—though a bit higher than the average for the next six largest US technology services companies, including EDS, Accenture, BearingPoint and Computer Sciences.