International Business Machines (NYSE:IBM) is one of the world's most representative corporate social ecologies. If it were a city, its population would place it in the top forty cities of the United States and Brazil, the top ten of Malaysia, the top five of France and the top two of Romania or Norway. Its representation from 175 countries would make it one of the world's most ethnically diverse and highly educated.
In just over three decades, this corporate metropolis has expanded 20%, from 341,279 employees to 405,535, then contracted 30% to 278,039, only to grow again by 70% to a historic peak of 463,785.1 The strain this would put on any social infrastructure is unimaginable. Therefore, although economics may write headlines, it's important to push past just an economic evaluation. It was IBM's century-old social network that held it together, and this is what we must study to assess its future and decide on its value as a long-term investment.
As you will see, IBM's corporate ecology returned for Watson Sr. a compound annual growth rate of 16.7% over thirty-two years and for his son Watson Jr., 20.9% over sixteen years. This corporate society also returned 29.1% for Louis V. Gerstner; but in Who Says Elephants Can't Dance? he rebuffs the notion that the Watsons' belief system contributed to his success. The Watsons, in their humility, were always the first to admit that it was not them, but their employee-owners. Tom Watson Sr. put it simply in 1939, "no business can be run successfully on a one-man basis."2
In IBM, a corporation of more than four hundred thousand people, it is the corporate culture that matters.
Watson Sr.'s Legacy - Manage the Business, Build a Corporate Culture
When Tom Watson Sr. was hired in 1914, to lead what was then C-T-R, he told the board of directors, "If you want me to come in here and operate this business for the benefit of the business, I'll do it, but I will not have anything to do with the operation of it from a stock standpoint."3 He was determined to build a strong corporation first.
He was quickly tested on that. Almost immediately, he stopped dividend payments to invest in new product development and then he stopped a plan to pump and dump C-T-R stock (a legal practice at the time). IBM went on to survive nine recessions, the Great Depression, and four of the six top U.S. stock market declines in history, while delivering 16.7% CAGR to his shareholders.4
Watson Sr. believed that enthusiasm was the "basis of all great things." And he knew that standing alone in the field, hearing "no" every day was a discouraging environment. Therefore, he instructed his executives to help maintain their men's enthusiasm-demanding that they serve as their assistants. In a 1932 meeting of the company's best salesmen, he brought all his executives onto the stage and had them face this sales team. He told his executives they were looking into the eyes of those directly responsible for the success of IBM. It is hard to imagine the sense of pride that swept the audience that day. They knew that every IBM executive understood their first priority: their team.
Watson Jr.'s Legacy - Establish a Corporate Constitution, Decentralize Decisions
As a long-term investor, confidence comes from knowing that the corporate leadership has the experience to weather tough economic times. Long-term growth, though, requires the enthusiastic support of the employee-owners. IBM's founder discovered the best path for growth.
Unfortunately, he wasn't scalable.
By the 1940s, all of IBM's needs would no longer fit through Watson Sr.'s always open, but lone, door-now the biggest obstacle to its growth was the "old man" himself.
Watson Sr.'s nature was a personal one, but it could range from that of a father figure to that of a benevolent dictator. He was authoritarian, and his leadership style directly conflicted with the corporation he wanted to build-a society of thinking and acting individuals. And with all due respect to the fifty thousand IBMers of the time, IBM would have eventually died along with him if not for his son. Although by legal standards IBM was a corporation, it was still very much Watson Sr.'s personal property, and external forces were making internal change a necessity.
At the end of 1955, IBM employment stood at 56,000, net income at $56 million and revenue at $500 million. At the time, many wondered how it could grow further. But rather than taking another four decades to match those numbers, Thomas J. Watson Jr. would add, on average, 56,000 employees every four years, $56 million in net income every nine months and $500 million in revenue almost every year. By 1971, revenue per employee had grown by 212%, net income per employee by 310% and the number of stockholders by more than 2,000%.
Under his watch, IBM became the corporation his father had always envisioned.
To create this growth, Watson Jr. had called a "constitutional convention" in Williamsburg, Virginia where he decentralized IBM. He replaced IBM's beloved authoritarian figurehead with a set of basic beliefs-the world's first corporate constitution. Respect for the Individual replaced his father's concept of "Democracy in Business." He transferred the individual's loyalty not to himself, but to the IBM Corporation. He made every decision-even his own-subject to IBM's corporate constitution. As you can see, IBM-as a decentralized, decision-making organization governed by a set of basic beliefs-delivered even better returns.
He summed it up nicely when he said, "Strong beliefs win strong men and then make them stronger and as men become stronger so do the organizations to which they belong."5
IBM had changed. Under Watson Jr., it evolved from a monarchy to a belief driven organization, and from a centralized decision-making company to a company of thinking and acting individuals guided by those beliefs. Fundamentally, though, it was still the company of Watson Sr.'s vision: a place where the principles were fixed, and they were "lasting principles."6
Unfortunately, that vision would gradually fade.
Gerstner's Legacy - Centralize Decisions, Replace the Constitution, and Manage the Stock
On Lou Gerstner's watch, IBM became a financial organization. As he points out in Who Says Elephants Can't Dance?, to fix the problems that Akers had encountered he centralized decision making and replaced IBM's basic beliefs.
His return on investment would seem to support his decisions as good ones. But what he failed to understand was that the IBM culture was broken, not dead. In his book he wrote that the "most corrupted" of all the IBM Basic Beliefs was respect for the individual,7 which hit IBMers as if the President of the United States had written that we should no longer pursue a more perfect union. Surely a century-old corporation, like a two-century-old nation, is more than its founding words. But great leaders do not seek to abolish a people's constitution; rather they seek a return to its original intent. Mr. Gerstner would have found the answers in IBM's culture if he had dug deeper. He just needed the humility to be a student of the Watsons' IBM.
Gerstner believed that employee stock ownership helped his elephant dance. But did it? Employees motivated through stock options are being chained to their corporation; in contrast, those who invest willingly carry the owner's burden. The former should be considered a short-term investment, as this culture may not survive the next economic storm. IBM history documents that the latter will do everything they can to right their ship. And it was these employee-owners who carried IBM through the 20th Century.
As Watson Sr.'s legacy is found in his son's performance, so Mr. Gerstner's legacy can be found in the performance of his successors. They continue to be financial stock managers, not managers of the IBM business. Sam Palmisano's results-even after being a share buy-back behemoth-is best described as lackluster when compared to either his 20th Century peers or Morningstar's 2013 Ibbotson® Stocks, Bonds, Bills, and Inflation® (SBBI®) Classic Yearbook large company stocks benchmark.8
And Ginni Rometty's start is not stellar. With history as a reference she seems to have two choices: return to the company's roots and build a strong business or continue to sell off divisions-a business strategy left over from the eighties-and possibly suffer the same fate as John Akers.
The drive to manage the stock through ever greater earnings-per-share is the elephant-in-the-room. And if Lou's elephant ever danced, it does so no longer. His legacy is in every room where employees are evaluated, pay for performance is discussed or product investment decisions are made. Mr. Gerstner's financial culture has not delivered the long-term results of IBM's 20th Century sales culture.
Rediscovering IBM's Corporate Constitution
Can we expect a change? If so, traditionally this would be the year.
IBM's cultural birth date is May 4th, 1914-a century ago this coming weekend-when Tom Watson Sr. took charge. He built his culture from scratch with maxims such as "Democracy in Business," "We Are All Assistants" and "We Forgive Thoughtful Mistakes." His son strengthened it by reducing his father's principles to three simple-to-remember words: Respect, Service and Excellence.
It was these words that formed IBM's Corporate Constitution. It created the world's first corporate employee-owners-the IBMer. IBMers made business decisions as if they carried the owner's burden. Being an IBMer was never about stock options, social class, corporate hierarchy, educational stature, pay grade or time-in-service; rather it described a person of commitment, dedication and loyalty. It was a person in a win-win relationship with their company; and part of a corporate family. Of course there were leaders; but we discussed issues as peers and drove toward a common goal-a thriving, profitable and ethical company.
Until three years ago, IBM's centennial celebration would have been 2014. Tradition reflects this constant: Watson Sr.'s twenty-fifth anniversary was in 1939 at the New York World's Fair, attended by IBMers from 79 countries; Watson Sr.'s fortieth anniversary was in 1954, attended by 56,000 in 57 countries in 350 family dinners that started in Thailand and followed the setting sun; IBM's "Fifty Years of Progress" celebration was in 1964 at the New York World's Fair, attended by 12,000 employees from 32 nations; and finally, a Diamond Anniversary of seventy five years in 1989-a sober celebration during a difficult time most IBMers still remember. All these celebrations marked 1914 as IBM's beginning.9
In 2011, IBM celebrated its legal beginning, not its cultural. The celebration of 2011 and non-celebration of 2014, illustrate today's IBM-a corporation that honors technicalities and denies its past to which it owes so much.
Investing in IBM for the Long Term
Jim Collins' premise that the world's greatest corporations treat profit like food for the body-necessary but not the point of life-does not ring true within the twenty-first-century IBM.10 Instead, the company's core ideology has set a maniacal focus on earnings-per-share. In this respect, the company has become gluttonous; and as in the human body, gluttony has deleterious effects on long-term health.
Over the last one hundred years, IBM's culture has carried it and its stakeholders through eighteen recessions, the Great Depression, and eight of the U.S. stock market's twelve largest declines.4 You will have to evaluate if catering to short-term stock returns-constant earnings-per-share road maps-is in your long-term best financial interest.
This long-term investment decision is not just a shareholder decision though; it is one that must be made by each of IBM's four stakeholders: shareholders before buying stock, customers before purchasing products, college graduates before accepting employment offers, and societies before making tax concessions. It is these four stakeholders that form IBM's investment community. For IBM to grow again it needs all of its stakeholders to believe their interests are being addressed. This financial balancing act was a defining characteristic of a Watson-driven cultural model, and the ongoing financial road maps are a threat to it. All IBM's stakeholders were once united through great leadership and open communication. They are now an investment community divided against itself-with three of the investors fighting over bread crumbs.
After determining your personal long-term investment horizon, you must decide if you can confidently extend this chart to cover your time frame.
IBM's best long-term investment metric has always been the strength of its internal character and culture. Until its corporate society is once again an ecology where its corporate citizens can breathe freely and talk openly, there will be no on-going, self-sustaining, organic revenue growth.
Peter E. Greulich owns no IBM stock directly, but he owns generic mutual funds that do. His primary interest is in seeing his company grow again-to him, IBM is still "my company." He believes it is in the balanced distribution of profits that a corporation finds purpose and permanence, and thereby supports the continued expansion of capitalism. His book, A View from Beneath the Dancing Elephant: Rediscovering IBM's Corporate Compass, will be released later this month
1 Any reference to the number of IBM employees and data that is dependent on this number uses IBM annual report information and includes complementary employees. A complementary employee is an approximation of an equivalent full-time employee hired under a temporary, part-time and limited-term employment arrangement to meet specific business needs in a flexible and cost-effective manner.
2 Peter E. Greulich, The World's Greatest Salesman, (MBI Concepts Corporation, 2011), p. 113
3 Thomas Graham Belden and Marva Robins Belden, The Lengthening Shadow (Little, Brown, Boston, 1962), p. 100.
4 Source: © 2013 Morningstar. All rights reserved. Used with permission. From Morningstar 2013 Ibbotson® Stocks, Bonds, Bills, and Inflation® (SBBI®) Classic Yearbook
5 Thomas J. Watson Jr., A Business and Its Beliefs (McGraw-Hill Book Company, Inc., New York, Toronto, London, 1963), p. 73.
6 Peter E. Greulich, The World's Greatest Salesman, (MBI Concepts Corporation, 2011), p. 145
7 Peter E. Greulich, The World's Greatest Salesman, (MBI Concepts Corporation, 2011), p. 186
8 Source for large company stocks: © 2013 Morningstar. All rights reserved. Used with permission. From Morningstar 2013 Ibbotson® Stocks, Bonds, Bills, and Inflation® (SBBI®) Classic Yearbook
9 MBI Concepts Corporation, IBM Traditional Anniversaries
10 James C. Collins and Jerry I. Porras, Built to Last: Successful Habits of Visionary Companies (Harper Business, New York, 1994), p. 55.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.