Building New Profit Centres: The IBM Story

Today, IBM is mostly known as a software, consulting, and IT infrastructure company that holds one of the largest patent portfolios, generates healthy profits, and enjoys steady business growth.

But going back some 30 years, the situation was quite different.

In 1992, IBM was primarily a vendor of mainframe hardware and software, and its services business contributed only $7.4 billion to $65 billion in total revenue. The company was not profitable: a loss of $4.6 billion was reported that year.

Ron Scherer, writing for the Christian Science Monitor, commented that “it never used to rain on International Business Machines Corporation, the embodiment of corporate success. Now the company needs more than an umbrella—it is caught in a torrent of trouble.”

To extricate Big Blue, as the company is often referred to, from this torrent of trouble, the board brought in a new CEO, Lou Gerstner, the following year. Fresh at the helm, the new CEO looked for ways to reignite growth and turn a loss into profit.

Gerstner soon realized that IBM had significant know-how that was underutilized but could be used to exploit emerging market opportunities in services and technology supply.

IBM had always had a services arm, but this part of the business was mainly focused on installing and maintaining IBM products. What Gerstner understood was that the company’s expertise in servicing its own products could be harnessed to develop a broader services and consulting business that addressed growing demand for integrating technologies from various vendors with core business processes (fulfillment, logistics, etc.). IBM Global Services, the new services and consulting arm that Gerstner established, was vendor-agnostic. This marked a major departure from previous practices at IBM. Previously, the company would only work with its own products to solve its customers’ problems, but the new division was free to integrate third-party solutions if that was the best option. IBM moved from selling hardware and software licenses to selling solutions.

Another departure from established practice followed in the IBM Research Division. The output of IBM scientists and engineers was prolific and significant. Writing in Who Says Elephants Can’t Dance?, Gerstner’s own personal account of the IBM turnaround, he states that “IBM has more Nobel laureates than most countries do, won every major scientific prize in the world, and has consistently been the foundry from which much of the information technology industry has emerged.” The new leader fully appreciated his company’s capacity to innovate. But he also recognized a crucial shortcoming and concluded that the “IBM Research Division was far more fertile and creative than our ability to commercialize all of its discoveries. We are underutilizing a tremendous asset.” And this he set out to change.

As a first step, IBM started to sell licenses to its patents. But Gerstner then steered the company toward deeper monetization. IBM opened itself up to act as a subcontractor for other companies in the technology space, custom-designing and supplying microelectronics for other heavyweights such as Nintendo, Sony, and Apple. In this way, IBM generated revenue and profit from underutilized assets.

The repositioning of IBM under Gerstner appears to have been the natural consequence of his belief in “building great institutions around core competencies and unique strengths.” By recognizing, and then moving to monetize, its core competencies, IBM tapped into new sources of growth and revenue. By 1994, IBM was again profitable.

From Product to Service

When we hear Michelin, we think of tyres and—thanks to the eponymous guide—restaurants, but the fact that Michelin is also a pioneer in services is not widely known.

Founded in 1889 by André and Édouard Michelin, the company drove crucial innovations in tyre technology and design from the start. In 1891, Michelin took out its first patent for a removable pneumatic tyre. Later product innovations included the run-flat tyre and radial tyres.

As a tyre manufacturer and pioneer in tyre technology, Michelin’s engineers were interested in better understanding the performance of their tyres when actually in use by customers. To ensure access to such tyres, Michelin engineers in France arranged for them to be ‘rented out’ to some customers, with responsibility for maintenance resting with Michelin. By taking on responsibility for maintenance, the engineers created an opportunity to gather valuable performance data that could be used to further improve their product. This approach was first adopted in the 1920s on a very small, non-commercial scale, but it informed and inspired Michelin’s shift into services later on.

Seeing the potential in providing tyres as a service, Michelin launched Michelin Fleet Solutions in 2000. This organisation formalised the tyre-as-a-service concept first conceived by the company’s R&D team. Customers—operators of large fleets of trucks or buses—would no longer buy the tyres but rent them and be charged per kilometre driven. Tyre maintenance was provided by Michelin.

By selecting the right tyres for the operation and optimising parameters such as tyre pressure, Michelin could extend tyre lifetime and increase the fuel efficiency of its customers’ operations. Outsourcing ownership and maintenance to Michelin not only helped large fleet operators cut costs, but also allowed them to focus on their core business.

As a manufacturer, Michelin had accumulated a deep body of knowledge about tyres that it monetised by establishing a services business.

Subcontracting and Innovation

It is common knowledge that subcontracting is an option for contractors to augment their capabilities and bring in external expertise.

What is less known is that a contractor – subcontractor relationship can yield more than just immediate financial benefits for the subcontractor side.

Research suggests (e.g. Rachel Bocquet. Product and Process Innovations in Subcontracting: Empirical Evidence from the French “Sillon Alpin”) that taking on work for other organisations can positively impact product and process innovation.

 What is key is how the relationship is structured. Contractual mechanisms that guarantee incentives for innovation, mid-to-long term contracts, organisational structures that favour knowledge exchange and a collaborative approach are all factors that can help improve a company’s ability to innovate.