PC inventor leaves its past behind

14 Dec 2004

IBM’s decision to sell its PC business to Chinese manufacturer Lenovo was hardly a bolt from the blue. The news that the PC division was on the block had emerged the week before the announcement was made, and according to a story in the Wall Street Journal, the two sides had been in tentative negotiations for almost three years.

While IBM has sold its PC division to Lenovo, it could hardly be said to be exiting the PC business. Under the terms of the US$1.25bn cash and equity deal, IBM will acquire a 18.9pc stake in the Chinese company, while Stephen Ward, the general manager of IBM’s Personal Systems Group, will become CEO of Lenovo. For the next five years at least Lenovo will manufacture IBM-branded PCs and laptops and will be the preferred supplier of PCs to the US technology giant.

At face value it may seem surprising that the inventor of the PC and the No 3 PC brand globally will cease to manufacture its own machines. But the PC has been a 20-year roller-coaster ride for IBM. The success of its PCs in the early Eighties gave it bigger profits than any other company had ever posted. Yet by the early Nineties the same PC business almost brought it to its knees as it cannibalised the mainframe business that produced profits of more than US$4bn a year.

In 2003 most of IBM’s business units were producing a pre-tax profit of about 12pc, a figure that is expected to fall slightly to 11pc this year.

Despite revenues in excess of US$11bn annually for the past couple of years the PC division has barely broken even and has even had negative quarters that have brought overall profitability down.

“If you look at IBM’s progress over the past three to four years, it has been converting fixed costs to variable costs wherever possible,” says Brian Gammage, a PC-industry analyst with Gartner. “IBM will continue to sell IBM-branded PCs but someone else will manufacture them so it’s got rid of the fixed costs.”

There are numerous other advantages for IBM in a deal that has been broadly welcomed by analysts. The worldwide PC market is expected to shrink next year — primarily due to falling sales in mature markets such as the US and Europe — but sales are expected to continue to grow in emerging markets. Leading that charge is China and through the Lenovo deal IBM is getting its name on the PCs of the leading manufacturer in China. Lenovo, despite its strength in China, and to a lesser extent the rest of Asia, will benefit by getting routes to new markets — something it has failed to do on its own.

“IBM wants to move up the value chain and sees its future in higher-end consultancy and IT services as well as the higher-value hardware and software products, which appeal to its core corporate customers,” says Douglas Hayward, senior analyst with Ovum. “And, by way of this deal, IBM gets its name on the desktops of the world’s fastest-growing and potentially largest IT market — China. Seems like a win-win situation to us.”

Locally IBM has been quick to assure customers there will be no impact on business and that in the long run Irish customers will benefit. “This is a long-term strategic alliance by IBM that will strengthen our offerings in the PC market in Ireland,” said Peter O’Neill, sales and distribution director with IBM Ireland. “Current and future investments by clients in IBM ThinkPads and ThinkCentre PCs are backed by warranty and service and support from IBM and our business partners. In the short to medium term this means no change to our product line or availability, no change in our customer service teams or sales coverage. In the long term it will deliver continued high levels of innovation, more product choice to the Irish consumer, innovative financing options and the best customer service available. This is good news for Irish consumers and businesses.”

Gammage suggests that the new Lenovo could actually be a healthy competitor to Dell that has dominated the PC industry for many years. “The PC market has been characterised by one strong and profitable player, Dell, and no one else has been able to get its cost structure to the same level,” says Gammage. “After this deal Lenovo has the cost structure and because it is focused on volume products it has no expectations of double-digit margins.”

Only last month Gartner predicted that three of the top 10 PC manufacturers would exit the market by 2007. Gammage believes that only market leader Dell and Apple, because it focuses on a profitable niche, are dead certs to remain in the business.

Given the breadth of Hewlett-Packard’s (HP) portfolio, speculation will mount that it will be next to get out of this commodity market. Speaking after the deal was announced HP CEO Carly Fiorina said that its board had looked at breaking up the company three times in the past and “each time the board came to the same unanimous conclusion. So many of the growth opportunities that are going to drive the business going forward now depend on the power of this portfolio.”

Hayward disagrees strongly with this view. “We have long had severe doubts about this. IBM’s decision to quit the PC arena merely reinforces our concerns. In today’s marketplace you are either an Accenture or a Dell. It’s just become even more difficult to justify being both.”

Michael Dell for his part has questioned the merits of the deal. “We’re not big fans of the idea of taking companies and smashing them together,” he told News.com in an interview. Given that there is relatively little overlap between the IBM product lines transitioning and Lenovo’s consumer-focused products the merger should run smoother than a deal such as HP-Compaq where there were many competing products involved. That said it will be interesting to see if corporate buyers continue to hold faith with IBM’s PC strategy and which of the top 10 could be next to follow suit.

Pictured is HP CEO Carly Fiorina who insists that her company has no plans to follow IBM’s retreat from the PC marketplace

By John Collins