TFH Flashback: Let Them Eat Gates, February 1995

When times are good and commerce plentiful, it’s good to be the king. Times appear to be propitious for IBM, and chairman Louis Gerstner must get a proportionately good feeling when he looks in the mirror each morning to shave. (Unless he cuts himself, we suppose.) IBM’s first outside king seems to have gotten the IBM Empire back on track. We would even go so far as to say that Gerstner seems to be worth the unheard of $16 million it took to bring him over from RJR Nabisco on April Fool’s Day, 1993.

On second thought, we wouldn’t go that far. Apparently neither would Wall Street, which gave IBM’s stock a haircut on January 23 even though IBM reported its best financial results since 1990. S&P wouldn’t go too far, either, and still has IBM on credit watch.

Gerstner’s enormous benefit package has earned him the nickname Louis Seize around our offices. In the French tradition of double entendre, this not only refers to the value of the chairman’s salary, bonus and stock options the day he took over at IBM, but also plays upon the pronunciation of sixteen inÿFrench: “says.” As in Louis says, “You’re fired.”

That joke only works because Gerstner doesn’t really bear any resemblance to the ill-fated Louis XVI, the last true French monarch. No chairman of IBM has ever been as irresponsible as King Louis or his Queen, Marie Antoinette, though John Akers did not survive the revolution at IBM much better than the rulers of France did their Revolution. The French rulers were guillotined before an angry mob in 1793. (Let them eat steel.) Akers was also removed from power by an angry mob–in this case, IBM shareholders–though he did get to keep his head and got a respectable golden handshake to boot. (Let him eat well.)

Chairman Gerstner is by no means the first IBM ruler to remove those in the company’s upper echelons from power. Akers got rid of George Conrades, once the head of North American marketing. Other top IBM executives left as soon as it became apparent that Akers would be leaving and they would not have a shot at the chairmanship. But Gerstner has been the first chairman who holds the feet of his top brass to the fire. Two of them got burned in the week prior to IBM’s year-end financial results announcement.

Robert LaBant, who was responsible for the development and launch of the AS/400 product line, will be the last chief of marketing for North America. Gerstner quite correctly believes that IBM shouldn’t have a sales force that is overwhelmed by its own geography. There should be one international IBM sales force, and rather than concentrate on product line territories that are further cut up by geographical territories, IBM should focus on getting customers better and cheaper data processing. Ned Lautenbach, who ran what used to be called IBM World Trade (marketing for just about everything other than North America), now runs all of IBM’s sales operations.

Ellen Hancock, who was in charge of IBM’s networking and software businesses, is out, too. She is being replaced by John Thompson, who ran the AS/400 business for a few years. Thompson is a very strong advocate of object-oriented programming. He is also one of the major forces behind IBM’s attempt to create a universal operating system microkernal, called WorkPlace OS, which is widely rumored to have been stillborn in IBM’s software labs. (WorkPlace was supposed to eventually be at the heart of OS/400. It would have allowed OS/400 to run applications written for other operating environments such as OS/2 and AIX. We never believed it would work, nor did we believe that someone would pay $200,000 for an AS/400 and then run Excel on it even if it did work.)

Thompson, as the new czar of software at IBM, is now also responsible for OS/2. IBM has goofed so much with OS/2 that it is hard to imagine that it can ever move beyond its position as an also-ran in the desktop and server PC operating system market.

OS/2 may be a very visible problem for IBM, but it by no means its biggest software headache. IBM is addicted to the revenue streams that come from mainframe software. About two-thirds of IBM’s $11 billion in yearly software sales comes from monthly rentals of MVS, VM and VSE operating systems, DB2 and IMS data base management systems and various programs like the CICS transaction monitor. Thousands of mainframe users worldwide rack up tens of thousands of dollars a month in fees. But the number of mainframe footprints is shrinking. IBM is dropping software costs on very big systems, which encourages customers to consolidate their mainframe processing on the biggest possible machine. This further accelerates the decline in footprints and in software revenue.

Sales of midrange software can’t bail IBM out. The company is lucky to get $1.5 billion a year in AS/400 software sales, and it has to sell a lot of new systems to get that because AS/400 program licenses are bought once, just like PC software. And with the new user-based pricing for OS/400, IBM can expect revenue to be under pressure even if it sells a large number of new systems. IBM’s other software products in the PC, Unix and networking markets probably only bring in another $1.5 billion or so a year. IBM could grow here, but not enough to offset coming declines in the large systems software business.

As the top lines of IBM’s software businesses get squeezed, the company is spending gobs of dough to retrofit its software for new hardware. All of its mainframe software is being rejiggered to work with a new family of CMOS mainframes. BothÿOS/400 and AIX are being redone so they work with a new line of PowerPC chips. All of these environments have to be extended so IBM can make good on its promises to turn its mainframe and midrange data processing engines into true servers, machines that snap to attention every time an end user asks for data.

Aside from trimming personnel and cutting costs, Gerstner has done one thing that almost makes him worth his pay: IBM takes Microsoft very seriously now. When Thompson first took over the AS/400 business, he laughed at the suggestion that Microsoft’s Windows NT was a threat to the AS/400 business. But with Bill Gates coveting IBM’s commercial midrange business, Microsoft courting the top AS/400 software developers and Intel platforms getting more powerful and cheaper by the minute, we think IBM’s management is finally bracing for a protracted battle in the midrange.