Maybe The Stock Market Isn't So Dumb - IBM Reaps A 6% Loss On A $156 Billion Investment

| About: International Business (IBM)

Summary

A stock is no more valuable than the trust and confidence its four investors - customers, employees, shareholders and society - place in that corporation’s leadership.

To measure the short-term thinking - and results - of IBM’s Chief Executive Officers, an analysis needs a proper baseline.

For almost eight decades, IBM’s culture knew the path through any economic wilderness. IBM should consider a return to its proven 20th Century roadmap.

IBM’s return on investment is the result of managing its stock rather than its business.

Since IBM (NYSE:IBM) last split its stock in May of 1999, it has reduced the number of outstanding shares by 46% - from 1.8 billion shares (split adjusted) at the end of 1998 to just less than 1 billion shares in June 2014. As shown on the chart below, this started with a share repurchase of $7 billion in 1999, has averaged more than $10 billion per year, peaked with almost $19 billion in 2007, and resulted in an overall IBM investment of $156 billion over fifteen years. This has all been done as IBM says in its annual reports since 2007 to "return value to the shareholders by reducing shares outstanding." Has it?

Using IBM's 1999 market value as the yardstick to measure return on investment, the answer would seem to be a resounding no; IBM's market value is 6% less. The answer would seem to be that these repurchases are keeping IBM's stock from - to use a layman's descriptive but applicable term - tanking.

Recently, there has been a flurry of articles suggesting there is a shift in thinking - that maybe it isn't in the best interest of investors, corporations or our society in general, that business leaders are rewarded for only maximizing shareholder value. Steve Denning, a Forbes contributor, does a great job summarizing this growing sentiment in his article, The Dumbest Idea In The World: Maximizing Shareholder Value.

In the case of IBM, the stock market seems to be ahead of everyone.

Maybe other corporate CEOs should take notice.

Even with an investment of $156 billion, IBM's market value has decreased by 5.99% in the last fifteen years.

The baseline for IBM is 1999

This was the last year that any IBM Chief Executive Officer would write in their annual report that market value was probably, "the most important measure of progress to investors." As Mr. Gerstner points out in his book Who Says Elephants Can't Dance?, "People truly do what you inspect, not what you expect." CEOs are people too. Since 1999 many believe that investors have only been inspecting IBM's earnings-per-share to determine its success or failure. This is a mistake. For almost fifteen years, IBM's long-term investors - customers, employees, shareholders and society - have been considering more than this single perspective offered up by the short-term-thinking inhabitants of IBM's corner office.

History has failed to evaluate the effects of IBM's cultural change. The watershed event that signaled the end of IBM's culture - to most IBM employee-owners of the time - was July 1, 1999. On that day, Louis V. Gerstner could have offered a choice between the existing defined benefit pension plan or his proposed cash balance plan. Instead he set off the cultural equivalent of a 9.5 magnitude earthquake that sent a tsunami of employee-owner opinions against his new cultural walls: former Gerstner Guerillas turned to guerilla warfare to fight him; employee-owners realized his new culture did not support right over might, and IBM was no longer a corporate home. Instead of fixing his problem in the last few years as IBM's chairman of the board - an individual with the most Wall Street credibility since Watson Jr. - he spent his last days at the corporation writing a book to proclaim not only financial but cultural success. IBM's 20th century culture died in 1999. History should record it as so.

IBM's cultural changes since 1999 have affected the trust and confidence - the true determinants of market value - of IBM's four investors: customers, employees, shareholders and society. IBM Chief Executive Officers have been compensating ever since with share buybacks. This meets the classic definition of insanity - doing the same thing over and over again and expecting a different result.

The beginning of the end of a sustaining culture

In the late '80s, many outside IBM were writing of the company's no-layoff policy, but insiders always knew it as a full-employment tradition. IBM hired smart people, and though some may have thought IBM would keep all its people as it sank, 99.9% of us believed that if really hard times hit, only the best-and-brightest should remain. Individual employment depended on performance. IBM was, by Jim Collins' definition in Good to Great, a rigorous society - a place where the best people need not worry about their positions, where the best people could concentrate fully on their work. Our cultural memory revered a CEO who constantly learned what and what not to do, and it recalled one very simple lesson: keep faith in your fellow employee-owners.

A Century of IBM Chief Executive Officers

In 1984, John Opel set an unreasonable market expectation. He predicted his $45 billion IBM growing to $100 billion by 1990 and then $180 billion by 1994. To put this in perspective, IBM's revenues in 2013 were $99.8 billion - clearly Opel's expectations three decades ago were not without their hubris. He brought IBM to a financial precipice and slipped out the back door unscathed.

His successor, John F. Akers, compounded a financial misstep with a cultural one. He dismantled Tom Watson Jr.'s processes that ensured cultural universality, elasticity and growth through employee-owner feedback; Open Doors, Opinion Surveys, Feedback Sessions and Executive Interviews became distant memories. Nor did he learn, as Watson Sr. did, by wandering amongst his troops. Because of this he lost touch with, and faith in his people. He accused us all of "standing around water coolers." He lost his courage. He moved to dismantle our corporation. Fortunately, he was fired.

Cultural hubris brings the end

So a new CEO arrived. Louis V. Gerstner's expertise, by his own admission, was in strategy and financial controls. There is no doubt that he restored our corporate financial health and made some important initial strategic decisions that we all cheered; but neither is there any doubt that he was unable to be a humble understudy to IBM's eight-decade old culture of success.

Who Says Elephants Can't Dance? is the story of Gerstner and his generals - a view from the few atop that fails to capture a single perspective of the few hundred thousand beneath. He fails to tell the story of the salesman winning a big deal, the systems engineer restoring a customer's system into production, or the product managers listening to their customers. And the culture that produces long-term results isn't the one under the control of a sovereign isolated behind corporate walls, but a culture that flourishes in the lives of those outside. There, the culture of the Watsons was still strong. We still remembered their three words: respect, service and excellence. We worked every day to exhibit them, not only in our corporate lives but personal as well. We pushed forward believing in each other - because that was our heritage.

Could the culture of the Watsons - which took six decades of personal interactions, selfless acts and the tribulations of five of the seven steepest stock market declines in history - be replaced in a few years? Can financial processes be so improved that - starting in Lou's first full year - 50% fewer full time employee-owners proudly delivered year-over-year revenue gains of 2.1%, 12.3% and 5.6%? That takes three hundred thousand people putting their shoulders to the wheel. The Watson culture that Gerstner never tried to understand - and just like Akers he never wandered within - underpinned his success.

Watson Sr.

In his book, barely thirty-five pages out of three hundred discuss his replacement culture. The three simple words that imbued eighty years of tradition, he ridiculed and then attempted to overwrite with eight principles. But his principles departed with him. They were quickly replaced by Sam Palmisano's five traits and nine competencies. And today, no IBMer can tell you what defines their culture; well, not what defines it positively.

Mr. Gerstner failed to restore the Watsons' proven cultural controls. He even failed to implement cultural controls of his own. He left behind a corporation where constant cultural change and chaos reigns. It is a catastrophe. But he wrote his memoir, claimed not just financial but cultural success, and was the second Chief Executive Officer in IBM history to escape unscathed. So far, history has allowed it to remain so.

Unfortunately, as a culture forgets the reasons behind its traditions, myths take their place.

A myth takes flight - earnings-per-share roadmaps

But now, IBM's 21st century leadership has replaced an eight-decade, believe-in-each-other, full-employment tradition founded in strong business practices with an earnings-per-share myth - a two-decade long, resource-action insanity. It is a myth based on short-term, shareholder-only interests; buttressed with earnings-per-share talking points. In this company, the short-term shareholder, CEO and board of directors profit at the expense of long-term shareholders, customers, employees and society. And it is having its cultural effect: it is a practice that even the best-of-the-best fear; it is a quarterly constant that only spares those with the right last name or high-level connection; it is a destroyer of lives, not because of poor performance, but because a person is in the wrong place at the wrong time.

The best this new myth has delivered is inconsistent revenue growth.

IBM's culture is now a Jim Collins' ruthless culture - hacking and cutting, or wantonly firing people without any thoughtful consideration.

Or as you will see, a Thomas J. Watson Sr. observation of today's IBM might be, "There is little believing left."

The founding of a better way

I am ashamed of it. I am ashamed of that record . . . We just didn't hang on to our courage and our belief in IBM and in IBM men.

Thomas J. Watson Sr., 1932, The World's Greatest Salesman

In 1921 Thomas J. Watson Sr., founder of IBM, was the source of his corporation's problems - just like Opel he set an unreasonable expectation. He forecast a tremendous year for his company - one with one hundred percent growth.

Unfortunately, the economy didn't cooperate. The Recession of 1921 (sometimes referred to as the Depression of 1921, because of its length and severity) caught him by surprise. In a single year (Moody's Manual of Investments: IBM's Comparative Consolidated Income Account and other sources), revenues declined from $16 million to less than $11 million; earnings per share dropped from $9.13 to $2.53; revenue per employee fell by a more than thirty percent; net income plummeted from $1.2 million to $331,000 - one-third lower than when Watson took over the company seven years earlier; to pay dividends a cash surplus tumbled negative; and employment, that had been an unwavering three thousand employees for years, fell by ten percent.

Yes, in 1921, IBM had layoffs.

Watson's corporation was on life-support so he moved beyond just workforce reductions. He implemented salary cuts, stopped the production of new products, and eliminated the research and development department. According to Thomas and Marva Belden in The Lengthening Shadow, "Salaries were cut 10 per cent, Watson's included . . . men were laid off, skilled and expensive labor going first. Of fifty men in the development department only four were retained, and they were sent to work elsewhere. Watson made the difficult and, he decided later, mistaken decision to stop producing new printers. . . . Watson had strained his credit to the limit."

IBM survived, but it would take eight years - even through the resurging economic backdrop of the Roaring Twenties - for it to claw back to $16 million in revenue, and it would take a decade and a half to realize Watson's original goal of $30 million. The experience scarred the IBM CEO.

So in 1932 when he stood on the speaker's platform before his best salesmen at the 1931 One Hundred Percent Club - two years into the Great Depression - he recounted his shame from that time. He spoke of lower profits, but that he also realized how hard those years were on his customers, company and those he employed. He shared the mistakes he learned from errors in judgment that he came to understand because he wandered amongst and listened to his employee-owners. He spoke on the dangers of losing faith in your co-workers. He told them that his 1921 mistake had prepared them for survival as they now journeyed through the greatest economic downturn of the 20th century. He embedded in IBM's cultural memory that it had been here before and it would face such downturns again, but because of his experience in 1921, IBM would always know what to do: believe in each other.

A tradition put to the test

Watson's team fought the Great Depression successfully for more than three years. Dividends had been resumed in 1916, and it wasn't until January 1933 that this run fell into jeopardy - the internal financial forecast at that time was a year with "reduced or no dividends." Unknown to the IBM financial team, they were forecasting the Great Depression's darkest moment - its economic trough - just three months away. It looked as if this economic beast was going to finally best them.

Watson could have repeated his actions of 1921 and resorted to layoffs, eliminating research and development, reducing salaries or yes, even stopping dividend payments to ensure corporate survival. But to Watson none of these were options - especially stopping dividends - as, over the years, the IBM stockholder had changed. They were no longer of the elite. They were individuals of small means purchasing single shares to then buy food and shelter with the quarterly dividends. More than half of them (2,200 of 4,000 total stockholders) were women - IBM had become a "widows and orphans" stock. It was not an option for him to throw up his hands - as he had done in 1921 - when business got bad.

So in 1933 Watson stood in front of his One Hundred Percent Club salesmen again. He told them that they had a great service to perform - that revenue was needed. Uncharacteristically, he invited non-Hundred Percenters, and to them he said bluntly, "Do something different." In at least his fourth session of the day, he told his factory foremen, "You have to keep in mind that your duty is to those men [salesmen] out there." He instructed them to deliver higher quality products and to hire more men of character.

IBM called his team to true service during the Great Depression.

He needed his IBM team with him. So finally, possibly talking about himself as much as his team, he told those who had been with him through five previous recessions and were now fighting this greatest of depressions, "There never was a good sailor developed in fair weather. It is during the storms when the seas are running high and the going is rough that you develop your sailors. That is how you develop men." He was determined to avoid layoffs, keep production lines running, continue to provide superlative customer support, and pay a dividend. He was calling on his team to help.

And they came through: his team delivered over the next decade an average annual revenue growth rate of 18%. His faith in IBM and his employee-owners was justified, and a tradition confirmed.

Watson Sr. didn't believe in backdoor exits. There could be no such departures for anyone building a corporation that would "go on forever." And as he told the board of directors when he took the job of President of C-T-R Company - IBM's predecessor, "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."

Finding the right roadmap into the next century

Everything that is new is usually nothing but the promising child of time-tested older achievements - an ideal continuation of tradition.

Elisabeth Gürtler

Change is inevitable. While learning from the past we should not be held hostage to it. And while IBM's past is the story of a great culture that could not keep a company from suffering during tough times, it bound its people together to soften the pain of those economic downturns, and lessened the impact of a leader's lack of clairvoyance. It then stood ready, after either of these ran their course, to rocket the corporation forward: as it did during the Great Depression and during Lou Gerstner's early years.

A new leadership needs to restore trust. They need to decentralize and once again delegate control through a corporate constitution composed of three simple words: respect, service and excellence. When they do, shareholders can once again expect consistent revenue growth. They will see the return of turn-around leadership to replace the current jettison-now management.

For almost two decades, IBM has been without any cultural controls or an experienced leader that spoke and acted as a fellow employee-owner. When will IBM's 21st century culture again be strong enough to span the coming century's greatest economic recessions, steepest stock market declines and poor leadership choices?

When it, once again, has a CEO who wanders amongst his or her fellow employee-owners, establishes cultural controls that last beyond their time in power, and has the humility to say of today's myths, "I am ashamed." Then the purpose behind a century-old IBM tradition will again be understood, and trust and confidence in IBM's leadership restored.

Then IBM's revenue growth and market value will recover - without buybacks.

Peter E. Greulich is an author, publisher and public speaker. He has written two books on IBM and three essays on Thomas J. Watson Sr.'s leadership during the Great Depression. His latest book, A View from Beneath the Dancing Elephant: Rediscovering IBM's Corporate Constitution is a sweeping historical look at IBM that puts a spotlight on its current human relationship practices. It is a different perspective from Louis V. Gerstner's Who Says Elephants Can't Dance. It is a view from beneath - the perspective of an IBM employee-owner.

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.

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