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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.
This solution was possible because the pharaoh was an absolute ruler. He didn't have to suffer critics who valued nothing but short-term results. By contrast, IBM must fend off carping investors whenever it wants to engage in a long-term strategy that involves the deferral of rewards. For IBM as for any public company (or for the closest political equivalent, a republic), forbearance is generally in short supply. Resisting the demands of critics requires wise, strong and charismatic leadership along with excellent luck and timing. Lately IBM seems to be running low on good luck, good timing, and good governance. Actually, it's not just lately. Data on the wealth of the IBM community of employees show that the company's revenue per employee peaked more than a decade ago, in Sam Palmisano's time, long before Ginny Rometty took the helm.
It might be argued that IBM's cultural malaise is even older than that. When Lou Gerstner reinvented IBM as a services company, he put it on a path that basically can grow only by adding employees. For years, Gerstner's strategy worked just fine because IBM's main business remained manufacturing. In manufacturing, growth in capacity requires capital more than labor. And in IBM's situation, when Gerstner took over growth in product revenue didn't even required much capital, because IBM had vast factories compared to the diminishing plant requirements fostered by the rapid miniaturization of computing circuitry. IBM could build a lot more MIPS in a lot less space with fewer people that it needed in the past.
When Gerstner took over, IBM's biggest challenge was boosting sales of its high-margin mainframes and other proprietary machines. The immediate solution lay not with sales to reluctant, cautious customers but to its own service bureaus. The services business played a dual role in improving the financial yield of IBM's manufacturing operations. When its services group bought new machinery, IBM's production lines enjoyed improved demand. When its services group could deliver results with used equipment, the residual value of machinery leased to outside end users by IBM's finance arm was bolstered.
As IBM built up its services operations, it was able to profitably offer end user customers a variety of very attractive server upgrade deals knowing that three years after a new machine was put on lease it could be de-installed and sold to IBM's services group at a price that made the whole kabuki work. The casualties, if any, lay among third-party equipment lessors who did not enjoy access to IBM's internal data centers, and equipment owners who had planned on the high trade-in values they enjoyed in bygone years.
The difficulties IBM now faces simply did not exist during the Gerstner transition. It took several years for IBM's services business to become so big that it could not keep growing. With maturity, its ravenous appetite for equipment both new and used diminished. At the same time, IBM's roster of employees, enlarged again and again as the company took on additional services engagements, became unwieldy, with payroll costs, even in India, that necessarily kept pace with IBM's services activity and its revenue.
At the same time, IBM neglected its hardware manufacturing operations, using capital that might have made that business segment more productive to buy back shares and perform other financial engineering feats. IBM was burning its furniture to keep the house warm, and in time, despite the vast amount of fuel it had couple decade ago, it was running out of assets to consume. All this was reflected in figures the company published to keep its shareholders informed, such as data on its revenue per employee, the size of its payroll, the sums it spent repurchasing shares, the slowing growth of its now massive services business and the loss of value of its manufacturing operations. Last year IBM had to pay $1.5 billion to dispose of its semiconductor manufacturing operations and that was only a fraction of the cost. IBM also took writeoffs of related assets that cost another $4.7 billion.
IBM had or could borrow the funds to pay for its suffering last year and this year. By every indication, it will be able to pay its bills next year, too. Thus it remains solvent, or at least seems to be as long as its shareholders are willing to tolerate the company's carrying more than $33 billion of goodwill and intangible assets on its books.
Like Egypt in the time of Joseph, IBM looks set to ride out some very lean years, largely because it amassed so much wealth in the past and its managers, whatever their flaws and limitations, have done a very good job deploying the company's assets. Nevertheless, without massive change in its services business, IBM is unlikely to return to the high profitability it enjoyed in the past. Basically, IBM must find a way to boost its revenue per employee. And it must do this forcefully and promptly.
This is precisely the problem Malthus said a nation would face when its population grew faster than its agricultural production (plus its ability to purchase food using other assets, such as the sale of minerals or the exploitation of value added by manufacturing). Malthus was a gloomy sort, or at least felt that the world's powers fell short when it came to balancing population and nourishment. IBM is anything but gloomy, and every quarter tries to assure its investors that all is well and getting even better.
Some facts, however, may fuel the doubts of skeptics. Critical observers of IBM may find themselves more in sympathy with sour old Malthus than chipper young Rometty.
Based on published data for its most recently completed fiscal year (courtesy of Wolfram Alpha), IBM's revenue per employee (RPE) at the end of last year was $219,200. Apple's was $2.12 million. Google's RPE was $1.299 million. Microsoft's RPE was $740,500. Amazon's RPE was $596,800. Intel's RPE was $523,800. Hewlett-Packard's RPE was $358,600. Oracle's RPE was $289,600. SAP's was $283,300.
IBM is the runt of this litter.
But IBM's revenue per employee is likely to improve this year, if the reports of widespread layoffs across the company pan out. The layoffs, however, will have to be pretty severe to move the needle in the right direction, because IBM's revenue, the numerator of the ratio of interest, is off about 13 percent so far this year. So, to bring its RPE up to that of, for example, Hewlett-Packard, IBM would probably have to shed more than a third of its employees. This isn't going to happen. It has been twenty years since Lou Gerstner said IBM was going to become a services company. IBM has achieved that, but it has been unable to turn its services into highly profitable standardized products the way Google has monetized searches or Amazon has transformed the shopping experience. In software, by serving the classes, in contrast to Microsoft's success with the masses, IBM has similarly missed the center of the segment's opportunity. And the manufacturing business that IBM has abandoned as hopeless lies at the heart of Apple's phenomenal success.
The solution, for IBM, may be to subcontract large portions of its services operations to companies like Tata, Wipro, Infosys or Satyam. That might enable IBM to RA 100,000 or 150,000 employees. If IBM becomes smaller and all its employees wealthier (as measured by attributed corporate revenue), its management just might be able to get it out of the financial hospice in which it currently resides and put it on the path to recovery. But, as Malthus in one of his dark moods might have said, perhaps not.
— Hesh Wiener August 2015