NANSHA, CHINA – NOVEMBER 17: Ginni Rometty, Executive Chairman of IBM speaks with Karen Tso, Anchor … [+]
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How so? Every company these days is in a pitched battle for investors’ very limited attention. What makes the difference between the few that trigger investors’ fear of missing out (FOMO) and the rest?
Simply put, companies that exceed investors’ growth expectations spur investor FOMO. Companies that disappoint those expectations get left behind. A corollary of being left behind is envy of the small number of winners — which spurs a struggle for faster growth.
Sadly growth does not happen just because the CEO wants it. Instead growth goes to companies with the most effective and speediest Observe, Orient, Decide, and Act (OODA) loops.
What’s an OODA loop? Picture two fighter jets in midair. The pilot that sees the enemy first, positions the jet to attack, aims to where the enemy will be and fires their rocket first will be the survivor. The same principle — with many differences in execution — applies in business competition.
Many large companies like IBM simply can’t win the OODA loop race against fast-moving startups. A source close to the company told me in a March 15 interview that IBM bows down to a deity known as “the stack” — which drives IBM to sell each customer “a combination of hardware, software, consulting and the ability to finance it all.”
Sadly for IBM’s stack-worshipping executives, the cloud has enabled customers to free themselves from Big Blue’s octopus-like grip. Whenever a visionary IBM executive realizes that Big Blue has to overtake these upstarts with a better value proposition, IBM’s stack worshippers slam on the breaks.
Until IBM can reverse that situation, I would avoid the stock.
An IBM spokesperson declined to comment on why IBM’s revenues and stock price have declined. He said IBM expects revenue to grow after it spins off the business that’s dragging it down — resulting in “mid-single digit revenue growth following the separation of its managed infrastructure services business by the end of 2021.”
(I have no financial interest in the securities mentioned in this post).
IBM’s Lost Decade
IBM’s stock has severely lagged the NASDAQ
IBM’s revenues and profits have also declined. In 2010, IBM revenues were about $100 billion — they’ve dropped every year since at a 3% compound average rate of decline to $73.6 billion in 2020, according to macrotrends. Big Blue’s net income is also down — at a 9.3% compound annual rate of decline from $14.8 billion to $5.6 billion in 2020, according to macrotrends.
IBM can’t blame a declining market for its shrinking sales. After all, global IT spending rose from about $3.4 trillion in 2010 to $3.7 trillion in 2020, according to Statista.
In the latest quarter IBM kept on shrinking. According to CNBC, its January 21 Q4 2020 report marked the fourth consecutive quarter of falling revenue and featured no earnings guidance for 2021.
More specifically, IBM’s revenue fell 6% on an annualized basis and at $20.37 billion was $400 million below analyst estimates according to Refinitiv. Adjusted earnings of $2.07 was 28 cents a share above estimates.
IBM blamed external factors. IBM’s CFO Jim Kavanaugh told analysts, “The challenging environment we have seen since March continued with the shift in clients buying behaviors and priorities. Giving the level of macroeconomic uncertainty, more clients tended to move toward shorter duration engagements impacting our software revenue.”
What does the future hold for Big Blue? CNBC noted that despite a lack of formal earnings guidance, IBM expects revenue to grow this year and for the company to generate “$11 billion to $12 billion in free cash flow.”
CEO Arvind Krishna is aiming IBM at top-line growth. As he said, “I want to measure the company on revenue growth.”
One analyst does not see much revenue growth in 2021. According to Morningstar Equity Analyst Julie Bhusal Sharma, IBM will post 1% revenue growth — the achievement of which hinges on a proposed 2021 spin-off of its “largest and worst-performing segment, global technology services.”
Sharma argues that once this happens perhaps investors will notice “IBM’s other segments’ better growth and profitability profiles.”
How IBM Worships At The Altar of ‘The Stack”
IBM’s stack model worked well before the rise of the cloud — but it also created an attractive target for rivals seeking to unlock Big Blue’s grip on customers with more powerful technology that costs customers much less.
My source — an executive with well over a decade at Big Blue — points out how valuable the stack model was to IBM. “Most software sales were accompanied by a hardware and consulting order that was five times larger. IBM encouraged this to the point that it was virtually expected that every software sale came with services,” he explained.
The tip of the spear against the stack was cloud computing — which boosted the effectiveness and lowered the cost of every element of corporate computing. What was great for customers was terrible for IBM — reducing its revenues and slashing salesforce commissions.
How so? “The shift to cloud computing disrupted every layer of the stack. Customers bought compute cycles from the cloud rather than hardware. Software no longer needed installation, only configuration, affecting the consulting business. Software revenue was recognized by monthly subscription, upending sales commission and incentives. And, of course, the entire cloud model was OpEx wiping out the financing business,” he said.
IBM’s consulting business could not cope well with the shift to cloud computing because its people lacked the skills needed to compete there. As my source explained, “The consulting teams tried to reframe their value proposition to software best practices and driving competitive advantage through technology, but most consultants were software installers without the deep business or industry knowledge to help customers drive change.”
While some IBM executives realized that the cloud was the future, its Fortune 100 clients that made up the bulk of its revenues were not yet moving to the cloud. IBM delayed “significant investment and change in business priorities out of fear of cannibalizing the stack,” he said.
As executives hoped it would prove to be a fad, cloud computing eroded IBM’s margins and reduced the magnitude and frequency of customer purchases. IBM executives leading those shrinking business lines put lipstick on the pig by “attaching ‘cloud’ to every division name and job title.”
In 2014, my source recounted a meeting at which IBM required its managers to listen for two hours to IBM’s vision for the “business cloud which would quickly catch up to and overtake its cloud rivals.”
But IBM was just kidding. “During the breaks I overheard one of the executive presenters consoling a manager from the hardware team by saying, ‘Don’t worry all IBM needs is a quarter or two of good stack revenue and we’ll be back!’ It was quite revealing that even as late as 2014, well into our revenue slide, senior executives still didn’t realize the severity of the business disruption,” he told me.
IBM’s Sluggish Product Development Process
The core of the problem is that without an industry-leading product development process IBM can’t catch up — indeed efforts to acquire its way to relevance have fallen short.
Five year ago, I wrote about IBM’s ponderous approach to developing new products. In a nutshell, IBM executives imposed requirements on product development teams — such as requiring that products can be used by vision-impaired individuals regardless of whether there is strong demand for the feature or that software can run on mainframes.
While these requirements may have been important to some customers, such internal mandates slowed down IBM’s ability to respond to more urgent and broadly felt customer needs
A case in point was IBM’s loss of market share in the market for identity management services. Identity management service provider SailPoint’s CEO Mark McClain, who previously worked at IBM, told me, “Big technology companies [including IBM] acquire companies that make point products. [IBM] product managers focus on making the acquired products compatible with other [IBM] products such as database software and middleware. Their product managers don’t spend enough time listening to customers and if a customer wants new features, they struggle to get the engineering resources to respond.”
My IBM source echoes McClain. He describes IBM’s product development process as “sluggish” compared to those of other software companies.
The reason is that IBM’s internal process requirements take precedence over urgently bringing compelling new products to market. “Everything takes just a bit more time and executive approvals than necessary. Every team is distributed across time zones and low-cost countries. Executives who are fighting to stay relevant exacerbate IBM’s weakness working across departments. [IBM expects departmental vice presidents to collaborate by sharing success] but no one wants to share.”
It’s not all doom and gloom at IBM. My source said in the past. IBM would acquire companies and “Blue Wash” the acquired products — forcing them to conform with IBM’s standards. This process “often consumed several quarters and crushed the product’s innovation road map and standing with the analyst community.”
He’s glad IBM has preserved the management independence of two recent acquisitions —Weather.com and Red Hat — whose branding “has been retained with the small addition of ‘…an IBM company’ to the logo.”
Until IBM can accelerate its product development process to bring products to market that customers value more highly than those of faster-moving upstarts, there is no reason to believe that Big Blue will grow fast enough to be a good investment.
