THE BLOG

IBM: A Lesson for American Business

02/12/2015 03:52 pm ET | Updated Apr 14, 2015

Over the past couple of decades, some companies, like Xerox, have succeeded in transforming their core business strategy in response to radical changes in technology, while others, like Kodak, have failed. Right now, IBM is on the bubble, and it has been hiding its distress with financial engineering. In the process, it has essentially become becoming a poster child for what's wrong about the drive to maximize of short-term shareholder value.

IBM has neglected to invest in operations, especially research and development, needed to expand into new markets and develop new lines of business. Meanwhile it has been buying back enormous blocks of its own stock to prop up share price. It isn't working. In 2014, 15 percent of its market cap, despite having the largest number of patents of all companies in the IT sector.

The Motley Fool put it most scathingly. Despite a roaring bull market, IBM's shares have fallen 14% this year, "making it the worst-performing stock on the Dow" thanks to what Big Blue has laughingly euphemized as "a marked slowdown in September of client buying behavior." Would it have been that much more painful to say "a sharp drop in sales?" And yet this happened even though IBM was frantically buying back $12 billion worth of its own shares. A company obsessively devoted to short-term shareholder value has "destroyed more shareholder value than any other company in the Dow," according to Steven Denning in Forbes.

What's going on at IBM is a clinical study of a disease at the heart of the American economy. We've gotten lazy about creating genuine, new value and instead we're focusing on ways to preserve our equity by manipulating its price. Since 2000, IBM spent $108 billion buying back its own stock, paying out $30 billion in dividends as it borrowed massive amounts of money to finance these buybacks. It has essentially been leveraging the appearance of growth and profit--as our entire economy was doing before the collapse of 2008. Yet while the Dow rose 47 percent over the past three years, IBM lost 15% of its value even though outstanding shares in the company have dropped from 1.16 to 990 million.

All the while, IBM's revenue has stayed about the same as it was in 2008.

IBM has talked a good game in terms of business strategy. It has promised to regain its luster in four ways: through emerging growth markets, cloud computing, business analytics and an initiative called Smarter Planet. It abandoned that last one, and has found new revenue only in cloud computing, which offers brutally low margins and stiff competition. The company expected to grow revenue by $20 billion during the past four years, but instead it has lost $9 billion in sales. Even merging markets haven't really panned out: China has decided to rely on its own technology rather than source components from companies like IBM.

It isn't clear how much IBM's failure to transform and grow its core competitive advantages could have been better managed, but it can't have helped to be mandating cost cutting through compulsory work force reductions, regardless of performance. It has also been shifting "technical expertise from high-paid U.S. staff to lower-wage staff overseas."

What IBM faces shouldn't be trivialized: technological disruption is a mortal threat to any enterprise built on technological innovation. Adapting to it is no small, easy matter. Yet, it has lost sight of its own future. Andrew Ross Sorkin sums it up in the Times: "IBM's success in recent years has been tied more to financial engineering than actual performance." The Motley Fool concurs: "Despite IBM's woes over the last three years, it has not increased spending on Research & Development to boost its growth endeavors."

Here's the outcome of all this in a nutshell: recently, IBM failed to win a $600 million contract with the CIA to handle all of that agency's cloud computing, even though its offer was actually 30 percent less costly than Amazon's winning bid. Let that sink in: book-seller Amazon beat IBM for a major technological, government job. IBM is a giant with enormous background in mainframe computing and government contracts. Here's what's most frightening. IBM's bid was rejected on "technical grounds."

I have no idea whether IBM can turn itself around now, whether it's stock will rise or fall. I see in its story a larger lesson about the maximization of shareholder value and how it distracts an executive team from the real job of business: to create new customers by luring them into the fold with new solutions and new products. When that happens, stock prices, given enough time, will rise accordingly. Patience, grasshopper. The shares will reflect a company's real value, eventually. First things first.

Peter Georgescu is the author of The Constant Choice. He can be found at Good Reads.