|MIXING RED AND BLUE: LENOVO AND IBM’S PC DIVISION
An unknown Chinese company buying the mighty IBM PC division would have been unheard of once, but in December 2004 that is what happened when Lenovo paid $1.75 billion for the IBM personal computer business, which included desktops, laptops and notebooks. Lenovo began life under the Legend company name, which was founded in 1984 by 11 scientists at a Chinese university. The business began as a distributor of foreign computer brands such as IBM and Hewlett-Packard in China: Legend first manufactured personal computers in 1990 and had grown into the leading PC maker in China with a 27 per cent market share. In 2003 the company changed its name to Lenovo to avoid confusion with other companies of the same name around the world. The new name is a mix of ‘Le’ from Legend and ‘novo’ which is Latin for ‘new’.
IBM became famous for being market leader in main-frame computers but saw mega-growth begin once it launched its first PC, priced at $1565 and backed by superior software, which gave it a major competitive advantage over rivals such as Apple. As competitors caught up in terms of software, PCs for the home became little more than commodities. IBM responded by focusing on large corporate clients where profit margins were more attractive. IBM reinvented itself again under the redoubtable Lou Gerstner in 1993 as IBM Global Services, which markets information technology outsourcing, consultancy and services (e.g. customer relationship management systems) and computer maintenance to companies.
Shortly before the change in direction IBM came close to collapse as its mainframe computer business, the star of the 1980s, faltered. Global Services has been the growth engine for IBM ever since, and now records annual sales revenues of over $46 billion, which account for over half the group total. It is also a high-margin business, which has enabled IBM to remain profitable in the face of stagnant demand for its computer hardware (PCs, mainframes and microprocessors), the sales of which were $30 billion in 1993 and $31 billion in 2004. In line with this move away from hardware, Gerstner also invested in the software side of the business; this has grown, albeit largely as a result of company acquisitions. At the time of the sale it accounted for about 40 per cent of group profits.
IBM has also built a fairly successful microprocessor business, although it has not met with the success accorded Intel. Its Power family of microprocessors has been successful within the corporate computing market and its collaboration with Sony and Toshiba resulted in the development of the Cell processor. This has nine ‘brains’, seven more than Intel and AMD’s dual-core processors, giving superior performance. It is used to power the PlayStation 3 games console, and IBM Power processors are also at the centre of Microsoft’s Xbox and Nintendo’s Revolution consoles. IBM’s Powerchips are also at the heart of its successful Unix servers, the workhorses of most corporate data centres.
Current IBM chief executive Sam Palmiscano, who took over in 2002, further strengthened IBM’s presence in consulting and services by buying Price water house Coopers Consulting for $3.5 billion. This made IBM the world’s largest management consulting company. In PCs, however, the situation was different. At the time of the sale, IBM was a distant third in market share. It had around 6 per cent of the global PC market, behind Dell with 18 per cent and Hewlett-Packard with 16 per cent. Internally, its share of group revenues had fallen to 12 per cent and was barely profitable. Growth in global sales of PCs was minimal.
Palmiscano’s vision of the future was that in addition to selling hardware (mainframes and microprocessors), software and IT services, IBM would help its customers re-engineer their business processes and offer to run such activities as call centres, logistics and financial administration (e.g. invoicing). Big Blue would be a seller of ‘business process transformation services’ (BPTS) consisting of management consultancy, business process outsourcing and engineering services—a market estimated to be worth $500 billion worldwide.
IBM has placed great emphasis on emerging markets and has met with considerable success as the emerging world invested in large IT projects in industries such as financial services and telecommunications that build the foundations for future growth.
By buying the PC division of IBM, Lenovo hoped to create a third force to challenge the dominance of Dell and Hewlett-Packard. Fuelled by its success in China, where it is market leader with around 30 per cent market share, the purchase propelled Lenovo from ninth position globally into the position of a global player with 7.7 per cent market share, and with 60 per cent of its sales overseas.
Much of Lenovo’s success in China has been based on winning the loyalty of distributors. While overseas PC companies developed a reputation for squeezing distributors’ margins when times were hard, Lenovo played fair by maintaining them. The result is a wide network of computer retailers, not only in large cities such as Beijing and Shanghai, but also in small provincial cities where China’s growing middle class is beginning to buy PCs. This has meant that Lenovo’s market reach far outstrips that of its competitors. Lenovo also built a reputation for operational efficiency, allowing it to compete effectively on price, while designing machines specifically for the needs of the Chinese market.
Lenovo’s Chinese headquarters are in Beijing but, following the acquisition, its headquarters for international operations are in New York. The company’s chairman, Yang Yuanqing, moved his base from Beijing to New York and an American from Dell, William Amelio, was appointed the chief executive officer. The deal allowed Lenovo to use the IBM brand name on its machines for five years. In the USA, the IBM name continued to be used, in the UK the company’s Thinkpad notebooks are branded Lenovo, while in China IBM, Lenovo and Thinkpad are all used.
Regarding after-sales support, IBM Global Services was contracted to provide maintenance and support for PC products outside China. The idea was that IBM’s current customers—mostly large corporations—would see no change. This was a major concern: when Hewlett Packard merged with Compaq it lost 20 per cent of its customers in the first year. For Lenovo, preserving business stability was a prime short-term goal.
The IBM salesforce was incentivized to sell Lenovo machines in the same way as it has been with IBM-branded computers. The only overlap was in China, where the IBM salesforce joined its former rival.
Lenovo’s first objective was to duplicate its success in China in emerging markets such as India, Brazil and Mexico. Its second target was small and medium-sized businesses, where IBM did not have a strong presence.
By 2009, all was not well at Lenovo. With the company losing ground to rivals, most notably Acer, its Taiwanese competitor which bought Gateway in 2005 and Packard Bell two years later, Lenovo had slumped to fourth place with about 7 per cent of the market, while Acer had grown to around 12 per cent. Two of Lenovo’s problems were poor machine reliability and a reluctance of American businesses to buy Chinese computers. Another criticism of Lenovo was its late entry into the netbook market where Acer built a strong presence. Maintaining a strong position in China but losing market share in the rest of the world was not the scenario envisaged at the time of the acquisition. The result was that Yang Yuanquing moved to become CEO, with Amelio, whose focus had been on production, leaving the company. Liu Chuanzhi, the company founder who stepped aside after the IBM deal returned as chairman.
Based on: Landon, S. (2005) Is Big Blue Fading Again?, Financial Times, 9 May, 19; Nuttall, C. (2005) IBM is the Only Certain Victor in New Console Wars, Financial Times, 16 May, 17; Landon, S. (2005) A Global Power Made in China, Financial Times, 9 November, 12; Landon, S. (2005) Your Rules and My Processes, Financial Times, 10 November, 13; Ritson, M. (2005) Lenovo is All Over the Place, Marketing, 8 June, 22; Anonymous (2005) A Tough Sell for Lenovo, Business Week, 12/19 December, 32; Einborn, B. (2007) Lenovo’s American Sales Keep Falling, businessweek.com, 1 February; Waters, R. (2008) Emerging Markets Let IBM Ride Out Turbulence, Financial Times, 21 July, 23; Balfour, F. and B. Einhorn (2009) Lenovo CEO Is Out. Chinese Execs Return, businessweek.com, 5 February.
1. Why did IBM sell its PC division? Relate your answer to the BCG and General Electric Market Attractiveness–Competitive Position models
2. Why was buying the IBM PC division an attractive proposition for Lenovo?
3. What were the challenges facing Lenovo in trying to make the acquisition work?
4. Do you think Lenovo will be successful in the long term?
This case was written by David Jobber, Professor of Marketing, University of Bradford.