History does not repeat itself, but it does rhyme.
A quote frequently attributed to Mark Twain
Although as an International Business Machines (NYSE:IBM) social analyst, historian, and thirty-year employee-owner, I do not believe history repeats itself, there is a definite rhyme to be heard between the twentieth and twenty-first century IBMs. For over one hundred years, IBM CEOs have decided how to invest the company's profits, and the various paths chosen by these CEOs have yielded differing results.
The question the long-term IBM investor should ask is: "Does 2014 rhyme with 1914 or 1984?" Depending on the year and rhyme you hear, you may decide to invest--or not.
Investment brochures commonly include the words, "Past performance is no guarantee of future results." My articles should probably include the following statement: "A study of the past is an imperfect lens to forecast the future."
1914: A leadership investing to achieve purpose and permanence
Mere money has no brains, no part in management. All it is entitled to is security and a fair interest on the investment... I don't believe that any man can own a business. It belongs to the customers, to the workers, to the community, to the public.
George F. Johnson, President, Endicott-Johnson Corporation
Thomas J. Watson Sr., who was a close personal friend of George F., displayed a similar philosophy in the early 1900s. He sought between his four stakeholders--customers, employees, shareholders and society--a balance in the distribution of corporate profits, consensus on that balance through open communication and a gains distribution philosophy that, after placing the customer first, always adapted with the times.
Watson returned a compound annual growth rate (CAGR) of 17.1% over four decades. During that time the company had to contend with nine recessions, the Great Depression and four of the six steepest stock market declines in history. His record through these times of great economic adversity justifies further analysis.
When he assumed control of the C-T-R Company in 1914, it was the haphazard union of three unrelated manufacturers of scales, tabulating and time recording machines. It had not been successful since Charles R. Flint first combined the three companies in 1911. C-T-R was deep in debt and facing a two-year-long recession. According to The Lengthening Shadow by Thomas and Marva Belden, C-T-R's $10 million in stock had a market value of under $3 million--less than half the company's long-term indebtedness.
Though the shareholders were unhappy, Watson knew his customers needed products of higher value. So he stopped dividend payments to invest in the business. The shareholders and board of directors fought his decision, but with Flint's support the customer was put first, and C-T-R took the first step down the path to becoming IBM.
During the Great Depression, Watson came to believe a stock purchase was an investment in him and his team. In 1933, facing the Depression's lowest point, his financial team advised that they might have to reduce or eliminate dividends. To protect the company Watson Sr. could have stopped dividends as he did in 1914 or utilized layoffs as he did in the Recession of 1920-21; but instead, while he continued to invest in new products, he called on his salesmen to grow revenue and hold the line on expenses--this time, the dividend came first. He wrote later that year that he looked forward to a day when he could pay his employees more, but for now they had a great service to perform. Why did he change his view?
As he described to his salesman at the 1933 One Hundred Percent Club (a yearly gathering of his best-of-the-best salesmen) IBM's shareholders were no longer of the elite: more than half (2,200) of the 4,000 shareholders were women. IBM shares, in the midst of the greatest economic downturn of the 20th Century, had become a widows and orphans stock. Dividends put food on the table and shelter over a child's head. As warehouses filled with tabulating machines, these were not easy times to be IBM's president--there were rumors that certain members of the board considered removing him.
But because of his leadership, dividends were paid and revenue kept growing.
Then World War II started. Watson held all profits from war munitions to 1.5%, placing those funds in a reserve for the widows and orphans of IBM veterans. But he still had to fulfill his promise of the Depression and reward his employee-owners for the sacrifice they made during those times of famine. To do this, over the next three years he reduced his commissions from 5% to 0.5%. This money was used to create the IBM employees' retirement plan that would survive for six decades.
When speaking of plans such as this to his shareholders, he said:
We look upon these benefits to our employees not as an expense, but as an investment in our human assets. It is easy for us to send you statements of our material assets, but those material assets are worthless until our human assets, the men and women in IBM, put them to work.
By always putting the customer first, investing in the stakeholder who needed it the most at the time, and practicing true service, Tom Watson Sr. not only provided an amazing return for his shareholders, but IBM also became synonymous with customer service, dedicated employee-owners and a corporation that worked to stabilize its supporting democratic political system.
Purpose and permanence, for the twentieth century IBM, was in a strong, well-informed and symbiotic ecosystem of stakeholders.
1984: A leadership adrift
When John F. Akers assumed control of IBM, he inherited a market expectation that could never be met. His predecessor, John R. Opel, had promised that IBM would be a $100 billion corporation by 1990, and $180 billion by 1994. When Business Week published an article on February 18, 1985 (IBM: More Worlds to Conquer) about this goal, it used the word "hubris." And it was.
Akers found himself in the middle of an investment and employment tsunami. He stopped the investing and hiring, and started reducing and redeploying the IBM workforce, but then he was blindsided by the 10th largest stock market decline in history. Even though IBM grew by more than 50% over the next six years, it missed Opel's revenue target by $30 billion; and in the ensuing three years, IBM would lose $15 billion. John Akers would return to shareholders, over his eight years, a negative 4.0% CAGR.
As many IBMers--but few analysts--remember, IBM set this expectation by playing a financial game. Most of the company's revenue at the time came from its leased hardware install base, which it converted to a purchase model over a few short years at a fraction of its true value. In a fire sale, the company exchanged a perennial, one-dollar gold piece for a devalued, one-time, two-dollar paper note. IBM's revenue growth was temporarily hyper-inflated; but it was also financially hyper-extended.
And even though Opel did his successor no favors, Akers did little to help himself.
A loss of faith and confidence
Akers' greatest failing was not his financial missteps but the body blows he delivered to the IBM culture. By considering breaking the corporation into Baby Blues--smaller, and what the market believed would be more nimble companies to drive higher shareholder value--he presented the company to the market as a corporate junk yard primed for auction.
Then in April 1991 some executive meeting notes were released to the press. It included a memo from John Akers stating that too many employees "were standing around IBM water coolers." Some blamed the person who leaked the memo, but most blamed the CEO for thinking it. IBMers all knew that if IBM failed they would lose their paychecks, pensions, stock portfolios, and work families. No one was standing around. Mr. Akers had lost sight of how vested every IBMer was in their corporation. He added on top of the corporation's financial ills, a cultural sickness.
But in less than two years the stock market started one of the greatest bull runs in history, and 46% fewer full-time IBMers delivered 28% more revenue. This filled not his sails, but the sails of his successor, Louis V. Gerstner. If Akers hadn't lost his trust and confidence in his employee-owners, Who Says Elephants Can't Dance? would have been his book. But instead, because he sought primarily short-term shareholder interests and carried a leadership style that demoralized an eight-decade old culture, he was fired.
What of 2014?
If 1914 says "go long" and 1984 says "go short," with which one does 2014 rhyme?
Virginia M. Rometty inherited a financially strong corporation, but in many ways she faces an IBM that Watson Sr. found in 1914: three companies (this time, software, hardware and services organizations) that are many times at odds with each other: dispirited organizations ravaged by resource actions; an inability for employees to remove aggressive, arrogant and authoritarian middle-managers; a lack of individual recognition commensurate with individual efforts; and a first-line management team that is given no financial ability to control its own fate.
IBM is in cultural trouble. It knows this but refuses to acknowledge it and take action. In its 2010 Corporate Responsibility Report, its marketing organization turned a negative into a positive--making a Global Pulse Survey result of 65% employee satisfaction sound good while ignoring its 30 point drop since 1986; and failing to publish or address the most negative aspects. That is an interesting approach for a responsibility report. Instead, in the same report, IBM announced it will begin, "implementing a more contemporary approach" to employee surveys. It is to be replaced by some as yet unidentified new methodology. Unfortunately, there are few methodologies short of not asking that can put a positive spin on employee morale. So, they best not ask.
Sam Palmisano did Mrs. Rometty few favors; but even during times of corporate plenty, she has continued the body blows to IBM's culture: the resource actions of Gerstner and Palmisano continue, extracting the final vestiges of value from IBM's retirement plans continue, and--ever so reminiscent of Akers--blaming poor revenue on her salesmen rather than on IBM's leadership, continues.
She and her board of directors must re-establish a culture that will carry IBM through a new century. That may seem a bold statement, but it was one hundred years ago in May that Watson Sr. established the same goal for a small company called C-T-R. They can begin by building a new trust and confidence in the twenty-first century IBM. That starts with a return to the example set by its founder: building a strong, well-informed and symbiotic ecosystem of stakeholders.
If a cultural change is made, I remain hopeful; because IBMers have always been adaptable.
Which path to choose as a long-term investor?
No one, it is true, can look ahead and foretell with unfailing accuracy what the future will bring, but that is not necessary, for just as historians judge the past in the light of the present, we can envision the future out of our knowledge of what has taken place in the past and what is going on about us now.
Thomas J. Watson Sr., founder of IBM
Virginia M. Rometty has two choices: complete the 2015 earnings-per-share (EPS) roadmap no matter the cost, or find a better path. Sam Palmisano's legacy is the wrong direction: pulling in IBM's traditional centennial anniversary by three years, transferring wealth from the U.S. and U.K. pensions to fund IBM's bottom line at the expense of its culture, and setting expectations through financial roadmaps that have transformed IBM into a financial corporation rather than a sales, technology and cultural leader. It is a misguided leadership that seeks profit as an end in itself, and not a reward for services rendered; that seeks an earnings-per-share driven product portfolio, and not a customer-driven one; that values the short-term at the expense of the longer-term interests of its people, products and shareholders.
No, no one can predict the future. IBM's, as during the time of Watson and Akers, rests on the shoulders of its CEO. If every day she wakes up thinking about all four of IBM's stakeholders--customers, employees, shareholders and society--and the equitable distribution of profits between them, then she should receive compensation commensurate with the position she holds. If she wakes up, though, continuing to focus on one investor's short-term interests, history would say IBM has the wrong leadership.
Let's end this article, as we started, with a quote from Mark Twain--the greatest of American philosophers:
It is not worthwhile to try to keep history from repeating itself, for man's character will always make the preventing of the repetitions impossible.
History does not repeat itself; but in the long term, corporations do yield the fruit of their leaders' character--and therein is history's rhyme. What is IBM's 2014 character? Is it that of 1914 or 1984? Answer this question for yourself and, if investing for the long term, invest wisely, as I believe there is rough sailing ahead.
Then again, I have an imperfect lens; and it is just one perspective.
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Article Update: What Has Happened To IBM's Sales Culture?
From my last article, there were several requests for revenue-per-employee comparisons between IBM and its major competitors. Here is a 2013 snapshot without any historical perspective. Again, one metric will not determine the success or failure of a corporation, but it does add an arrow to your shareholder long-term, investment-decision quiver--an apt metaphor for a bubble chart. Seeing IBM relative to its competition should raise a multitude of other observations.
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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.