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PUTTING ITS MONEY WHERE IT'S MALTHUS
In 1798 Robert Malthus triggered a perpetual debate about the damaging effects of demographic pressure. An Essay on the Principle of Population asserted that, unchecked by canon, custom or calamity, a nation's fecundity will outpace its ability to produce or procure food. A similar phenomenon can weaken a company. IBM's revenue per employee has fallen since 2004, two years into Sam Palmisano decade-long reign. IBM's subsequent leader, Ginny Rometty, hasn't been able to reverse this dire trend; consequently, IBM's corporate culture is losing vitality as its employees become financially undernourished.
For IBM, as for other cultural aggregates since biblical times, it's not just about recognizing the problems posed by absolute or relative poverty, but about developing and implementing an effective coping strategy.
In ancient Egypt, according to the Old Testament and the Koran, a worried pharaoh turned to a prophet named Joseph to interpret disturbing dreams. In the dreams there appeared seven fat cows and subsequently seven very lean ones that ate the first seven. In another sequence, seven healthy corn plants were followed by seven sickly ones that consumed the first seven. When the pharaoh, following a courtier's suggestion, asked Joseph, who was a prisoner at the time, what the dreams meant, Joseph said that the pharaoh had been given a timely and valuable warning: Egyptian agriculture would be blessed with seven very good years but after which it would suffer seven years of crop failures and potential famine. The pharaoh reckoned that careful management of the bumper crops might enable his empire to ride out the lean years . . . if he could find a way to do that.
There was nobody near the top of the political heap in Egypt that the pharaoh could rely on to competently manage the Egyptian economy through a 14-year cycle. So the pharaoh took a chance. He appointed Joseph, an untested character and an imprisoned alleged criminal to boot, his chancellor. Joseph was charged with developing means to store a portion of Egypt's annual harvests and, after seven years, if hard times hit, to manage the distribution of the previously stored grain.
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NERVES OF STEEL
As 2014 drew to a close, the Wall Street Journal, which undoubtedly can recognize an outfit in decline, said IBM shares would be the year's worst performing component of the Dow Jones Industrial Average. IBM was the biggest loser of the DJIA in 2013, too. The last company to do so poorly was Bethlehem Steel in 1995 and 1996; it was kicked off the DJIA in 1997. In 2001, Bethlehem went bankrupt, and two years after that it was dismembered. If IBM doesn't change quickly and dramatically, it is a goner.
Goodwill impairment may be the ruin of IBM. So, perhaps it's time for Big Blue's customers to understand just what it means. When one company buys another for more than the market value of its net assets (meaning assets minus liabilities), the difference between the net value and the acquisition price is called goodwill. When both companies are publicly held and the acquiring company pays more to buy its target than the price the stock market had previously concluded was its worth, the difference is easy to discern as goodwill.
For instance, if IBM bought a publicly held company with a total market capitalization of $1 billion and paid $1.5 billion to clinch the deal, IBM would put on its books assets totaling $1 billion plus a half billion dollars denoted as goodwill. Things can get a bit more arbitrary if the acquired firm is privately held, but accountants will arrive at a figure they stipulate is the market value of the company and call the amount by which the purchase price exceeded that value goodwill.
In the past, the acquiring company would slowly write down the value of goodwill, taking as long as 40 years to complete the process, slowly digesting the acquisition the way a python digests a large meal. But accounting rules change and in the USA, since 2001, companies are not permitted to amortize goodwill. They are, however, required to review the goodwill on their books. If a company decides that one of its acquisitions is no longer worth its former value because it could not be sold for at least the original acquisition price, the acquirer is supposed to declare a diminution of the goodwill on its balance sheet. The result would bring the acquired company's declared value in line with its actual or presumed market worth. The sum lopped off goodwill is called impairment.
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TWO CALVES AND CALVES NOT
In Semitic mythology, Jews at the foot of Mount Sinai embraced an invisible God rather than one represented by a golden statue of a calf. From that pivotal moment, the followers of Moses and eventually the other people of the book, Christians and Muslims, vested their faith in software rather than hardware. A couple dozen centuries later, the resultant monotheistic civilization controls the bulk of the word's wealth and power. This year, one of that civilization's great industrial institutions, IBM, shifted the burden of its strategic trust from physical hardware to intangible software and cloud computing.
For many customers, and probably for most of them, IBM's evolution is late rather than early. Users of IBM i technology have long since learned that Big Blue re-hosts their computing environment from time to time. In the past there has been some disruption (but not the same amount for every user) and a lot of progress (but not always as much improvement in price/performance as performance for legacy workloads). If IBM changed the i's hardware platform again or even embarked on a course that promised changes every few years, committed users would adapt. They would embrace gains from whatever progress directly helped them. And some would grumble. Change might lead to defections, but for lively i shops, lack of change would present an even greater temptation to exit the IBM i universe. The System/34, System/36, and their families faded away when they were frozen, not while the equipment was evolving.
Mainframe customers are often more tightly bound to their hardware than i users because quite a few run ancient applications or use venerable patches that depend on the specifics of IBM's instruction set and its implementation. Some of the oldest code run by mainframe shops is cloaked in mystery, its origins uncertain, its documentation little more than folklore, its behavior when run on a new platform capable of surprises. Nevertheless, mainframe shops have flocked to less costly IBM-compatible systems whenever they have had a chance, from the long-ago days of Amdahl and Hitachi PCM processors to the more recent FLEX and Hercules platforms. Amdahl and Hitachi built IBM-like hardware and wrote IBM-like firmware. FLEX and Hercules emulations run on X86 hardware. Users generally got all their code to work and only abandoned or avoided the non-IBM alternatives when Big Blue scared them off. So, if IBM introduced a new hardware generation and promised support for all or nearly all legacy code, as it has in the past, offering in return improvements in functionality, power and particularly value, users would stick with their big iron. As is the case with the IBM i, progress can keep the mainframe alive, while paralysis would kill it off.
The IBM Power platform that is used for AIX and Linux as well as the IBM i operating system changes a bit with each generation, more or less the way X86 and ARM processors do. Generally speaking, instruction sets get richer, functions that have become more important to users get additional improvements and characteristics that are connected to fundamental properties of chips, such as cell geometries, change as transistors and their interconnections become smaller.
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A lot of things are going wrong at IBM. Frustrated investors, disgruntled employees, and anxious customers are trying to figure out why. They share the absurd belief that proper understanding could mitigate Big Blue's malaise. For an individual, knowledge might cure pain caused by ill-fitting shoes; but not the agony of terminal cancer. For a vast organization like IBM, myriad woes are a concomitant of existence. Why? The myth of Pandora provides an explanation. Tricked by Zeus and trapped by her nature, Pandora unsealed a container and unintentionally beset mankind with perpetual afflictions. IBM can prevail, but not without struggle.
Knowing that existence brings difficulties doesn't change the nature or severity of the problems. In Greek myths, immortals and mortals alike encounter challenges. If a protagonist overcomes a threat, the tale of that victory is a single case. The general nature of existence remains the same; vicissitudes persist. This is the case with IBM, too. It can meet and overcome specific problems, or fail to do so, but neither a single victory nor any group of victories will change the inhospitable climate of the world in which it competes.
But before I explore the possibilities available to IBM, I would like to make sure we all know in a basic way the story of Pandora and how it was erroneously changed by a 15th century Dutchman named Desiderius Erasmus, to the detriment of our appreciation of Hesiod, a poet who lived several hundred years before Christ, and of the engineering skills of the Classic Greeks.
Like Eve in the Old Testament, Pandora is a woman who brings the wrath of God down on the human race. Also like Eve, the first woman in the Bible, Pandora is the first woman in Greek mythology. Pandora was created by Hephaestus under the direction of the great god Zeus. She was beautiful and various lesser gods gave her many attractive characteristics plus a couple of flaws, such as the double-barreled gifts for persuasion and mendacity. Unlike Eve, who was created as a gift for Adam, Pandora was devised to punish men. The bride of Epimetheus, dull brother of the sharp Prometheus, she was given as a gift a sealed container and warned not to open it. But Pandora would succumb to curiosity, as Zeus knew she would, and open the vessel, releasing its noxious contents. That act gave Zeus his revenge on mankind for adopting the fire that Prometheus gave to humans, defying the will of Zeus who had wanted fire to belong only to the gods.
The container opened by Pandora was not a box but a pithos, which is the Greek term for a very large jar or urn. During the Iron Age the Greeks learned how to make these sturdy containers and used them to store oil, grain, and other things that were kept under a sealed lid. Large ones were a couple meters tall and, when full, could weigh one or two tons. Some stories about the supremely witty philosopher Diogenes say he lived in a pithos, although other accounts of his life have him sleeping in a barrel.
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WHEN OXFORD WAS OBNOXFORD
It was December 1208 or 1209. New Year's Day in England was March 25; the month after December 1208 was January 1208. Somebody bumped off a young woman who lived in Oxford. The villagers blamed university students, and, led by their mayor, hanged two. The remaining academics blew town right away, many moving east from their ford on the River Thames to a bridge over the River Cam. That is how Oxford University gave birth to Cambridge. They were the sole universities in England for 600 years, providing an organizational model for many academic institutions and some commercial companies.
The University of Oxford got its start a couple hundred years before the establishment of its rowing rival. The village, well outside the reach and largely beyond the influence of London, became a home for schools, not yet colleges, engaged in training theologians for the holy and lawyers for those less so. They were chartered and influenced by the Roman Catholic Church, but nevertheless retained some independence. They were governed by canon law rather than civil law, a fact that made the hanging of two clerks, as students were known in those days, even for alleged participation in a murder, extralegal.
At the time, however, there wasn't much the Church could do to intercede. England's King John had a falling out with Rome. England was under an interdiction for five years beginning in 1208. John, who didn't accept the Church's choice for Archbishop of Canterbury, was excommunicated by Pope Innocent III.
The last thing college masters, nominally supervised by bishops, wanted was to fight the political establishment. They had a lot to lose, including the tax exemptions and other legal perquisites. Eventually, John caved, apologized to the Pope in writing and thus ended the sanctions. By 1213 the hubbub in Oxford had settled down to some extent and the University of Oxford enjoyed a rebirth. A couple years later John make another important compromise when he signed the Magna Carta, sharing power with other nobles and putting England on a path that would eventually lead to democracy.
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WHO SAYS ELEPHANTS CAN'T DIE?
Fifty years ago, the American computer industry had eight major participants. IBM had about two-thirds of the market; seven dwarfs shared the rest, and none of them is particularly important anymore. That is the nature of enterprise. Many companies prominent in the Dow Jones Industrial Average back in 1966 have faded. Looking back a century, only General Electric can be found in both the 1914 list and today's roster. IBM was in the Dow from 1932 to 1939, when it was replaced by AT&T. IBM didn't make the DJIA again until 1979 and now it might not get a 100-year run. The way things are going, it might not even get half that far.
The last time IBM looked like it was headed for the glue factory was in the early 1990s. The company's board brought in Lou Gerstner and within a few years it was clear that Blue was going to be big again. Gerstner's reinvention of IBM as a services company gainsaid the naysayers. By the time Gerstner left IBM in 2002, observers declared IBM saved. Under Sam Palmisano, Gerstner's successor, IBM continued to forge ahead, propelled by growth in services, boosting the software business and taking IBM out of two classes of hardware that had thin profit margins: small computers and disk drives. But all was not rosy.
Toward the end of Palmisano's reign, some old issues that many observers thought were dead came back like zombies to haunt IBM. The client business, which IBM had abandoned, took off like a rocket. It didn't rise because of traditional personal computers. Instead, it blossomed as smartphones and later tablets began to perform many of the tasks that initially made PCs so popular and then learned compellingly attractive new tricks. Smartphones and tablets incorporated sensors along with geolocation apparatus and merged these technologies with the communications capabilities that made PCs so popular. The sensors enabled the clients to adapt to their motion, orientation and ambient conditions. The navigation subsystems enabled client gadgets to know where on earth they were located. And the communications features that expanded to include not only old text messaging and email but also telephony and videophone capability enabled app developers to give smartphones and tablets myriad amusing, informative and transformative capabilities.
All this stuff not only boosted Apple, which more than any other company has invented the new world of smart, interactive clients, but empowered Google, the master of mobile monetization, and fueled Amazon, the wizard of shopper-friendly systems. The transformation of information processing into a collection of intensely interactive processes and services has stunned large, powerful and talented companies that only a few years ago were feasting at the dot com diner.
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IBM ENDS 2015 POORLY, ENTERS 2016 ON THE BRINK OF CATASTROPHE
IBM ended 2015 reporting a fifteenth consecutive quarterly decline in revenue (down 9 percent) and a fall in profit (off by more than 19 percent). It guided shareholders to expect substantially less profit next year, $13.50 per share compared to $14.92 for all of 2015. When the stock market opened the day after the results were announced IBM shares lost several percent in value, gaining back a portion of their losses as equity markets subsequently enjoyed a respite from days of declining stock prices.
The details in IBM's quarterly report only exacerbated the discontent of investors. Analyst comment was mixed, with optimists and pessimists tip-toeing around what is arguably the most worrisome issue for IBM shareholders: The value of the company's shares has been held aloft by the faith of one investor, Warren Buffett. If Buffett's Berkshire Hathaway decided to sell its losing investment in IBM, many others would likely follow, and the price of IBM's shares would then plunge.
Among the items that contributed to a dimnution of faith in IBM, as measured by its share price, was the imminent failure of its formerly great storage business. Big Blue's storage revenue dove. Investors and observers who took CEO Ginny Rometty at her work when she said she was going to unload poorly performing businesses within IBM were forced to contemplate the possibility that IBM might be preparing to sell or liquidate its storage business. During the most recent quarter accounted for a third of the company's hardware sales, and the business was conducting at a a substantial loss. Revenue from mainframe and power servers rose, but not enough to keep IBM's total hardware segment from diminishing about a half percent in revenue. The upshot: IBM reported more than a 10 percent decline in pre-tax profit for the quarter, yielding enough upside to restore its losing hardware business to break-even for the year.
Software, which has become the main engine powering IBM's profitability, suffered a revenue decline of about 11 percent and a fall in pre-tax profit of more than 20 percent. The company's services revenue also declined, and it reported mixed profitability.
While IBM seems to have persuaded Warren Buffett to hang tough, it hasn't done a very good job of getting other investors to envision an eventual rebound in the company's fortunes and with that rebound an upturn in the value of IBM's stock. Investors seem to believe the prospects for other tech companies such as Facebook, Amazon, Alphabet and Netflix are far better than the outlook for IBM. Ginny Rometty's goal in 2016 will be to prove them wrong if they fail to include IBM shares in their list of favorite financial vehicles.
IBM FOURTH QUARTER 2015 PERFORMANCE BY SEGMENT
|Global Technology Services||8,126||234||8,359||1,486||17.8|
|Global Business Services||4,297||118||4,415||708||16.0|
|Total for All Segments||22,015||1,994||24,009||6,177||25.7|
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