Looking beyond the current stock price, when you scratch below the surface, it is not hard to see some serious warning signs; very low organic and acquisition revenue growth, a culture of entitlements, executive tenure, a continued lack of internal innovation and an obvious inability to recruit and retain the most talented entrepreneurs.

Why should IBM take note of this letter? I offer this from a perspective derived from my own experiences.

For more than 30 years, I have been fortunate to be a first-hand participant in the formation and growth of some of the most successful technology companies.

I began my career in 1981 with AT&T where I focused on the technical side of the data networking products. I later joined a then little-known start-up called Oracle where I founded and ran its Unix Product Line organization. From there, I co-founded and successfully sold an Internet-based software start-up. In 1992, I joined Apple to run its Unix and object technology engineering divisions and then joined Siebel Systems – where I spent a decade of my career – and ultimately ran its Products division including the OnDemand and SMB organizations. When Siebel Systems sold to Oracle, I decided to redirect my focus.

Today, I am a venture capitalist with InterWest Partners investing in early stage SaaS, analytics and mobile companies in the B2B markets. These companies include: AppMesh, Aria Systems, CubeTree – acquired by SuccessFactors and then SAP, Doximity, Get Satisfaction, Marketo, SignalDemand and Workday.

With some luck, these companies may take their place as significant players in the information technology industry.

In every case, I have found one consistent theme: great companies live and die by the talent they recruit and retain, the brands they create and the culture they foster from within.

Talent is the Asset

“The most valuable assets of a technology company walk out the door every night.”

Anonymous

Gerstner refocused IBM in the early 90’s. Since then, IBM has executed a revenue growth and innovation strategy primarily through acquisitions. Some of IBM’s most notable product successes have resulted from such acquisitions (e.g. Cognos, PriceWaterhouse Consulting, Tivoli, etc.).

More recently, IBM’s acquisitions of Coremetrics, Lombardi Software (a former InterWest investment) and now Kenexa have continued that strategy.

Yet, how many people responsible for those innovations and innovative companies – the founders, senior executives and/or employees of the acquired companies – have chosen to stay long term with IBM and become key IBM innovators and executives? How many senior executives from these acquired companies are now senior IBM executives in any area: Engineering? Marketing? Sales? Service? Support?

In my discussions with various IBM managers, it is my understanding about 1.5% of the company’s 400,000+ employees are considered “executives”. About .5% are VPs. IBM VPs who come from acquired companies represent a very small fraction of this percentage.

As Apple has demonstrated, the ability to continuously innovate is a critical success factor to support the longevity and relevance of technology companies. Yet, in IBM’s case, how many innovations have resulted from an acquired company’s staff after the acquisition? I don’t have the specific data but I do not believe it has been many.

A recent comment from an executive whose company was acquired by IBM:

“It takes many, many years to be promoted.  Acquisition executives have either no chance or no interest.  The lifers will continue to lead.”

When I have interviewed “IBMers” for positions in my portfolio companies, many have struggled with identifying their personal accomplishments within IBM and what changes and innovations they have developed and/or drove.

IBM’s culture to seemingly promote via tenure v.personal innovation and performance, in my opinion, is a culture more closely associated with academia, governments and unions, not innovative and successful technology leaders.

Recruiting

What percentage of today’s top computer science and engineering graduates from the best computer science schools go to work for IBM? Which of these students are familiar with and use IBM products? If they do initially go to work for IBM, how many of them stay for a career?

I invest in start-ups and relatively small private companies.  So, I may have a biased perspective but I believe these are the companies where today’s top college business and technical graduates want to work. Even in today’s fragile economy, gone are the days when young people are looking for a company where they can work for 30 years and retire.

Graduates from MIT, Carnegie Mellon, IIT, Caltech, Harvard, Stanford, etc. want to work in innovative companies such as Box.net, CornerStone OnDemand, FaceBook, Google, MobileIron, Salesforce.com, Twitter, and many other start ups and small but significant public companies where they can be involved in developing innovative new technologies and businesses across the entire IT spectrum.

None of the young people, in business or technology, I meet and work with every day use anything IBM produces, at least not directly.

Yet, they all know and use products and applications from companies such as Amazon/AWS, Apple, Box.net, Facebook, Google, Salesforce.com.

If they are technical, they rely upon open source solutions such as Cassandra, CloudDB, Hadoop, Ruby on Rails, and MySQL. Mention IBM brands/products like DB2, Cognos, Rational, Tivoli, etc. and they may have heard of them but they have never used them and have seldom seen them in use.

These people are the future technology/business leaders and decision-makers of the world. They, and others who work with and/or follow them, will shape the future of technology and how it is applied in the world.

My portfolio companies compete for talent against the most innovative companies on the planet. It is telling that to my knowledge we have never lost anyone we have wanted to recruit to IBM.

 

Brand and Account Control Erosion

IBM should also be concerned that the CIO and IT in general are experiencing diminishing control over the technology that employees use within the enterprise – with the exception of pure infrastructure, but even that strangle-hold is loosening.

New technology solutions – SaaS (Box.net, Marketo, Salesforce.com, etc.), Mobile (BYOD), etc. are eroding IT’s dominant control over employees and the technologies they use. IBM has always aligned with IT, not end users.

As the “consumerization” of IT continues, in my opinion, IBM might consider modifying its strategy such that it creates mindshare with the direct end user. Otherwise, its brand will have significantly less importance in the enterprise and the account control tactics it has used historically will fail to produce the desired results.

Today, I see no such strategy from IBM.

 

Innovation Through Acquisition

Most industry pundits who follow IBM would agree that the near-death experience IBM faced in the 90’s resulted directly from poor financial controls, an entitlement culture (e.g., pensions), betting too long on old technology (e.g., mainframes) and not betting enough on new technology (e.g., software).

The infamous business strategy originally put in place by Gerstner that primarily relied upon acquisitions for innovation – coupled with strong financial controls  - continued under Palmisano. And, if the recent announcement of Kenexa is any indicator, it appears to still be firmly in place under Rometty.

According to some IBM insiders I have spoken with, today IBM is “run by Finance.”  The issue with this is that a ruthless focus on financial controls encourages anti-innovation and anti-risk.

For that reason, IBM has focused on acquiring companies that have reached a certain revenue size and that, by definition, ignores innovative technologies that might be significantly disruptive to IBM competitors.

To be fair, IBM has occasionally acquired some very small companies, and has purchased companies just for technology.  But, those have been rare, and commercializing those acquisitions, even established companies, have been inconsistent in their results.

And, of course, all these acquisitions are put under leaders that are IBM “lifers”, not the actual creators or managers of these innovations and companies.

According to a current IBMer:

“The old guard don’t know what they’re buying and the acquired staff have learned to achieve in a different way, and on different things, than IBM management does.

As far as I have been able to see, supporting acquisitions to drive revenue and margin growth is the biggest contribution Palmisano made to IBM.

However, acquiring innovation seems to be, by far, the lesser of objectives.  The most important objective is acquiring current revenue and the basis for near-term revenue.  The second is to fill a hole in a product roadmap. It’s too bad, because thoughtful acquisition and integration could lead to much higher ROI.”

In the past, IBM has had a successful track record of introducing major new technology innovation through its investment in IBM Labs – I can personally think of the relational database, Ted Codd and DB2 as having a direct influence over my life, for example. Most recently, Watson came out of a significant effort inside IBM Labs to develop exciting new search, predictive analytics and voice recognition technology.

If IBM’s innovation strategy is to continue to experiment from within and acquire proven innovation from outside, that is both rational and reasonable. However, to make that work, the Company needs to retain the outside innovators who have significant expertise in areas likely to be outside the scope of existing IBM management. For example, people who have deep expertise with new business models, go-to-market techniques and business development.

If only the “IBM old guard” is making important decisions around development priorities, delivery models and go to market creativity, then the newly acquired company talent will have little impact upon those decisions. This will naturally sub-optimize the outcome of those acquisitions for IBM and may likely lead to the departure of the staff of the acquired companies as they become frustrated.

 

Execution

From my more than 30 years of experience, I believe that the data shows that the best technology companies execute the best. IBM’s current culture does not appear to reward execution – well, at least not the type of execution I am familiar with.

Here is a statement from an executive whose company was acquired by IBM:

“IBM senior management is great at making speeches: ‘We need to [some obvious goal]’ and therefore stated with the expectation that it’s someone else’s job to figure out specifically what to do.”

Other conversations with former senior executives from acquired companies lead me to believe that there is little motivation on the part of IBM development to make fundamental operational improvements to improve near-term development objectives for acquired companies.

Apparently, the same holds true for go-to-market teams.  According to my sources, these groups are focused on near-term results.  So, they do not invest sufficiently in sales enablement and technical enablement for newly acquired product lines.

IBM management makes a trade-off of using the same staff for either supporting knowledge transfer or supporting near-term transactions.  The heavy bias is always toward the latter. So, the near-term numbers will commonly be made by acquisitions, but longer-term, it’s much more challenging to sustain growth in new markets or with new channels (including IBM channels).

As such, IBM is focused on near-term execution with acquisitions, and does not appear to establish the basis for sustained value extraction from the acquisition.

Obviously, acquisitions have to pay for themselves, with a combination of taking advantage of IBM’s strengths and to reduce certain costs, but perhaps the time horizon needs to be a little longer.

In addition, the “I” for the ROI should include not only the initial price of the acquisition and some select retention agreements, but also, perhaps a near-term drop in revenue (due to a focus on sales training and channel recruitment) and some additional IBM legacy staff to be trained.

The data shows that IBM is good at retaining almost all acquired staff for a short while using strong financial incentives. This is very good for helping to make the near-term numbers. However, to sustain the revenue, the acquired staff should be motivated to stay longer-term, to continue to provide the foundation for revenue growth.

Suggested Reforms

So, now that I have been critical of IBM, I would be remiss if I didn’t offer several relatively straightforward suggestions to consider:

Hire and Retain Great Talent

Universities - I would consider developing and rolling out a program to recruit the best and brightest from the best schools with a combination internship/scholarship. I personally designed one between my portfolio companies and Caltech and would be glad to share it, if IBM is interested in a framework to consider.

Acquired Companies – Develop and roll out a program to retain the best and brightest from your acquisitions.  Give them multi-million dollar budgets to create products/solutions/businesses and have them report directly to the CEO each quarter on their accomplishments. The CEO could then mandate which of these will be commercialized and hold the GM accountable for delivering.

Reward Execution

From a number of conversations I have had with different IBM personnel, the following is the best proposal I heard to improve execution from within IBM.

“I would propose that she (Ginny) reorganize the company, fundamentally, into real business units that included development, support, sales, marketing and manufacturing (where applicable).

I would use that opportunity to reach into the acquired management pool to leap-frog them into positions of responsibility and accountability.

I’d modify the risk-reward system to provide big pots at the end of a successful rainbow with equity/cash, but on the other end of the spectrum, terminate employment for the GM’s who missed their objectives and not just move them to another make-work role to reward them for their years of continued service.”

IBM continues to score well on being a good place to work and makes headlines of being a well-led company.  Use that in your favor to recruit out of college and industry – direct and indirect through acquisitions – and give them the ability to innovate.

Recharge the IBM innovation engine.

When Ms. Rometty looks back several years from now, when she steps down, it would be great to see her leave behind a financially strong company recognized equally as well for its technology and business innovation.

By making these simple changes, I believe IBM can use its substantial resources to sustain its financial momentum to lead the technology industry for another 100 years.

I wish you much success.

Sincerely,

Bruce Cleveland

General Partner

InterWest Partners

 

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