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HCS 4140 – Organization Behavior and Structures

December 2, 2017

IBM’s Decade of Transformation: Turnaround to Growth

In 1990, IBM was the 2nd most profitable company in the world, with a net income of $6 billion
on revenues of $69 billion, and completing a transformation that would lead it into the next decade of
continued success. However, the trend plunged suddenly: between 1991 and 1993, IBM lost a
staggering $16 billion, and a recovery was uncertain. In this paper, I examine the factors that lead to
IBM’s success in the 1960s and 1970s, and its troubles in the late 1980s and early 1990s. Additionally, I
consider the actions CEO Louis Gerstner took in order to stabilize IBM’s financial woes and to reestablish
its position of leadership in the industry. Lastly, I evaluate the organizational challenges that arise within
large, established companies, and the power dynamics that take place within the industries in which
said companies participate.

IBM’s success during the 1960s and 1970s

At an individual level, the leadership and management skills of president and CEO Thomas
Watson Jr. were instrumental in the unequaled success that IBM experienced for almost 30 years
beginning in the late-1950s. He had the vision, passion, and charisma required to focus IBM’s
organization on innovation and success. As soon as he took the helm as CEO, Thomas Watson Jr.
reorganized the company toward an adaptive cultural structure: taking risks, trusting his instinct, and
going against Thomas Watson Sr.’s conviction that electronic computer technology would be of no
consequence. His boldest move – one which set the stage for IBM’s success for almost 30 years (figure 1)
– centered around making the largest ever private investment in a commercial project. Under his
direction, IBM eventually invested $5 billion dollars to develop a modular integrated circuit mainframe
computer system named System /360 – a revolutionary design that became the basis for all future
computer systems. Additionally, establishing written cultural values and working toward the
development of a strong organization culture, along with his strong commitment to corporate social
responsibility, transformed IBM into a national cultural icon.
Environmentally, IBM’s success was fueled by an ever-growing need for technological
advancement in government, military, space exploration, academia, and private enterprise throughout
the globe, beginning after WWII and as a result of the Cold War. However, it must be noted that, as
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much as the environment was fueling IBM’s success, Thomas Watson Jr.’s vision was driving the
advancement of the computer technology, as well as of the manufacturing and business processes.

figure 1: IBM’s revenue (bars), profit (line), and trend lines – adjusted for inflation as of 2006 (by Gabriel Moreno)

IBM’s problems during the late 1980s and early 1990s

There were numerous factors which contributed to IBM’s problems; but overall, they centered
around organizational culture and structural issues. In 1971, after suffering a heart attack, Thomas
Watson Jr. was forced to step down as CEO. Following Watson’s departure, IBM suffered from lack of
leadership – management focused IBM’s energies on the continued success of the System /360
technology and on its further development – eventually coming to depend heavily on a leasing revenue
model which prevented the organization from maintaining the level of focus on adaptability required to
navigate the competitive landscape. Organizationally, IBM became overburdened: rid with divisional
rivalry, inadaptability, over-complexity, and inability of decision-making due to an overly democratic
process. Furthermore, the functional organizational structure that had been one of IBM’s strengths
during Thomas Watson Jr.’s leadership, had become inadequate in the competitive landscape that
surfaced beginning in the late 1970s.
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Environmentally, the need to supply low-cost technology solutions to private enterprise, and
later on to individuals, opened up a large industry segment that at first fell significantly under the profit
margin levels that IBM’s management found lucrative. The computer technology segment became a
vibrant competitive field, with many small companies vying for market share in specialized technology
solutions, including software, hardware, and services. Said new segment developed into the
microcomputer and personal computer sectors. In time, the cost, quality, and performance factors
required to drive the industry segment higher, found a consumer demand that slowly but surely eroded
the long-standing position that IBM had held within the technology industry. Soon after, things began
to turn negative very quickly for IBM. To make matters worse, comments made by, then CEO, John
Akers, made their way through the organizational ranks and out to the newspapers: “People don’t
realize how much trouble we’re in,” vented John Akers during a company training event in April 1992.
Employee and investor confidence tumbled, and soon, the company’s finances followed (figure 2).

figure 2: IBM’s decade of trouble during John Akers leadership – revenue (bars) and profits (line) adjusted for inflation as
of 2006 (by Gabriel Moreno)

Gerstner deals with the crisis

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By early 1993, IBM investor confidence was extremely low. After failing to find a suitable CEO
replacement from within IBM’s ranks, and from within the technology industry, the board of directors
was forced to look for leadership outside of the technology industry. It eventually found it in Louis
Gerstner – previously at Nabisco. Although Gerstner was meant to guide the process of splitting the
company up and selling it in parts, he quickly came to the conclusion that IBM could be saved, and he
rallied the support necessary to convince the stakeholders to focus on a recovery process.
Gerstner had come from several high-level positions within the consumer sector, and he
brought with him the mindset that “the customer drives everything the enterprise does.” Unlike his
recent predecessors at IBM, and against the currently established organizational culture, Gerstner
focused on learning about the technology industry and its customers. “Gerstner logged thousands of
miles visiting customers, analysts, and industry experts” (Applegate 5).
Once he had decided on helping IBM recover, Gerstner surrounded himself with people who
would help him deliver on his goal; he did what he felt was necessary to steer the company in the right
direction and to execute the difficult process of transforming the strong organizational culture that IBM
had become.
Financially, he set out to streamline the business processes, and he delivered the mandate to
divisional heads, to report to him on their businesses and their customers; furthermore, he called for
studies to be performed across the competitive field and used the results to establish a process by
which each business unit could be either fixed, closed, or sold.
Organizationally, he changed the structure in a way that would allow him, and a team of key
executives he had organized, to oversee the work being performed across the organization in the U.S.,
and abroad. He incentivized strategically so as to drive the cultural change he felt was necessary, and
he laid off the necessary number of employees to get IBM’s costs in line. With remarkable speed,
Gerstner was able to stop the intense downward financial trend, and to turn a small profit by the 4th
Quarter of 1993 in the amount of $382 million. By year-end 1994, stockholder confidence was high
and profits had risen $5 billion (figure 3).
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figure 3: IBM’s recovery during Louis Gerstner leadership – revenue (bars) and profits (line) adjusted for inflation as of
2006 (by Gabriel Moreno)

Once Gerstner and his team had stabilized IBM’s financial standing, the next challenge was to
position the company for growth. In order to do so, Gerstner would need to hone in on a solid vision
for IBM, moving forward – he would need to find “the next big thing” in technology. Lastly, he would
need to organize the company in a way that would provide the flexibility and process required for it to
behave as a new venture, as a growing business, and as a mature business, all at the same time.
IBM’s vision for the future became centered around the theme of “One IBM”, an organizational
and cultural model that would allow IBM to provide a consistency of technology and integration
services to its customers, no matter where in the world the customer may be found – for many of IBM’s
most important customers, who were multinational enterprises, the concept of “One IBM” would
become a critical differentiating factor.
Remarkably enough, IBM did find the “next big thing” in technology in what Gerstner came to
call e-business, a concept that no other company at the time had thought about. In e-business,
Gerstner recognized that the Internet infrastructure – along with the necessary “middleware,”
hardware, and software – would form the basis of future business-to-business transactions.
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Lastly, through and extensive and difficult process of analysis and implementation, Gerstner and
his team developed a framework by which IBM would have the possibility of discovering and selecting
lucrative new businesses, of developing them, and of integrating them into the organization as the
businesses matured – it came to be known as the Emerging Business Opportunity (EBO) process.

Organizing for growth

There is consensus that large, established companies, find it difficult to build successful and
sustainable new businesses: “Established firms tend to use existing capabilities and find it more difficult
to develop new capabilities. They have developed routines that serve them well; however, these
routines are also core rigidities that prevent, at times, innovation. Thus, routines often lead dominant
firms in an industry to dismiss or reject the value of new products or services” (Fogel 297). Disruptive
Innovation Theory (Christensen, et al.), places the aforementioned difficulty at the center of conflict for
large, established enterprises. The research has shown that “a company’s propensity for strategic
change is profoundly affected by the interests of customers who provide the resources the firm needs
to survive. Incumbents listen to their existing customers and concentrate on sustaining innovations as a
result.” Furthermore, “Incumbents’ focus on their existing customers becomes institutionalized in
internal processes that make it difficult for even senior managers to shift investment to disruptive
innovations” (Christensen).
While performing a historical financial analysis on IBM, I pondered upon the factors that led to
IBM’s troubles in the late 1980s. It dawned on me that for such a large established firm, it is a lot more
difficult to be price competitive, in part, due to the financial strain built up into the enterprise
throughout its history. Case in point: in 1994, Apple Computer Inc. posted a total revenue of $9.2 billion
dollars; while, in 1993 IBM posted a net periodic pension cost of $722 million for the U.S. Plan alone,
with an equal cost for all Non-U.S. Plans combined. Considering IBM’s U.S. pension plan alone, that
amount equaled approximately 8% of Apple Computer’s total revenue for the year. The cost
competitiveness advantage that young companies had in the 1980s, compared to long-standing
enterprises such as IBM, became evident.
A principal challenge Gerstner and his team had to contend with moving forward, had to do
with the intrinsic propensity for IBM’s business units to focus on short-term performance and their
inability to nurture new business lines, as has been postulated by the Disruptive Innovation Theory.
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Through various initiatives, Gerstner and his team also discovered that another factor hindering
IBM from developing new businesses was the lack of entrepreneurial experience and an
entrepreneurial subculture. Based on that research, Gerstner and his team developed a process
framework through which the organization could discover strategic business opportunities, to develop
them, and to integrate them into the ongoing established business processes.
What came to be called the Emerging Business Opportunity (EBO) process, could be said to be a
progression of the organizational restructuring that Gerstner recognized had been required for IBM to
compete in the fledgling technology industry of the late 1980s. He had already tackled some of the
basic cultural restructuring challenges since his arrival at IBM, and what was needed next was a
progression toward a fit perspective approach to cultural organization for emerging business lines, in
order to contend with the competitive environment of the times. “For example, a culture that values a
traditional hierarchical structure and stability would not work well in the computer manufacturing
industry, which demands fast response and a lean, flat organization” (Nelson and Quick 261).

An appropriate approach for each type of business

As Gerstner and his team clarified the factors that were involved in the development and
integration of an emerging business, they came across the work described in a book titled The Alchemy
of Growth, which breaks down business types into “horizons” (Applegate). Based on those writings,
Gerstner and his team recognized that, moving forward, the organization would need to select the
appropriate approach for each type of business model: mature, high-growth, and emerging business
opportunities. What is noteworthy about such an approach, is that for each type of business, an
organization is able to build a model for the selection of appropriate factors by which it can become
adaptable enough to perform simultaneously as a new venture, as a growing business, and as an
established business (table 1 compares the different approaches established).
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FACTOR EMERGING BUSINESS HIGH-GROWTH BUSINESS MATURE BUSINESS

Organizational ● New venture, ● Product-Market-Geogra

● Divisional (Functional)
Structure team-based structure phy business units

● Expand new products

and markets ● Streamline and
● Build and launch new
integrate operations
business venture ● Build capabilities for
Critical Tasks growth ● Customer loyalty
● Strong risk/uncertainty
system
management ● Strong strategic
planning and execution

● Reward performance
against milestones
● Provide career ● Reward profitable ● Reward profit and
Incentives development and growth and increased operating performance
visibility market share targets
● Provide opportunity to
lead

● Entrepreneurship and ● Operation execution

Culture ● Strategic planning
learning and control

● Business leaders, with

Accountability ● Business leaders ● Business leaders
corporate oversight

● Builds/launches new
ventures
Leadership ● Has access to industry
Attributes and finance networks
● Maintains ongoing
contact with customers
● Identifies/exploits
strategic opportunities
● Builds capabilities for
rapid growth
● Generates cash
● Exploits strategic
position
● Plans for future growth

table 1: Comparison of IBM’s business type approaches, based on the Lifecycle Approach to Business Innovation (Applegate
Exhibit 7)
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Conclusion
The story behind IBM, with its exceptional success, with the factors that made it an American
cultural icon, along with the dramatic fall and recovery of its business financials in the late 1980s and
throughout the 1990s, has become the basis for influential business management theories and case
studies. IBM’s story is a remarkable example of the effects that organizational structures, organizational
cultures, and management practices have on a the largest, strongly established, global enterprises. In
this paper, I have examined the factors that contributed to IBM’s success, as well as those that
contributed to its troubles and recovery in the late 1980s and early 1990s.
Personally, I am impressed by the astounding speed in which a company the size of IBM could
recover from a precipitous fall in its financials, and to reorganize as quickly as it did under the
leadership of Louis Gerstner. This sentiment is echoed by Steve Lohr in his New York Times article:
“Even I.B.M.'s critics are impressed by his skill as a manager in moving quickly to cut expenses and to
streamline operations.”
Having the opportunity to research the historical financial record and having access to
established models and theories that seek to explain the dynamics taking place in competitive
industries, especially during times of increased competition and instability, have become incredibly
useful. In my opinion, they help bring to light the, otherwise obscure, interplay between individuals,
groups, organizations, and the business environments in which they operate.
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REFERENCES

Apple Computer, Inc. Annual Report -- 1994. Apple Computer Inc., 1994. Web. November 24, 2017.

Applegate, Lynda M., Austin, Rober, and Collins, Elizabeth. "IBM's Decade of Transformation: Turnaround
to Growth." Harvard Business Review.9-805-130 (2009) Web. Sep. 15, 2017.

Barnaby J. Feder. "Frank Cary, Past Chairman of I.B.M., is Dead at 85." New York Times. January 6, 2016.
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Bill George. "How IBM’s Sam Palmisano Redefined the Global Corporation." Harvard Business Review
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Pugh, Emerson W. Building IBM: Shaping an Industry and Its Technology. Cambridge, Mass: MIT Press,
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Christensen, Clayton M., Raynor, Michael E., and McDonald, Rory. "What is Disruptive Innovation?"
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Nelson, Debra, and Quick, James. OrgB4. Fourth edition. ed. GB: Cengage Learning, 2013. Web.

IBM Annual Report -- 1994. International Business Machines (IBM), 1994. Web. Nov. 24, 2017.

IBM Annual Report -- 1995. International Business Machines (IBM), 1995. Web. Nov. 24, 2017.

IBM Annual Report -- 2001. International Business Machines (IBM), 2001. Web. Sep. 30, 2017.

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