Have you ever heard the phrase, “The first step to recovering from a drug problem is admitting that you have one”? Well, I would argue that this is the first step to recovering from any problem.
When you’re considering investing in a company, it’s important to look at its track record. Look hard. Ask yourself: How does this management team react to crisis?
Hopefully, not like IBM. At IBM, politics often outweigh good sense. Consider IBM’s situation in 1988: The company was floun- dering. Profits were down and costs were sky high. It became evi- dent that the company would have to let some people go in order to survive. The problem was that IBM didn’t want to saythat it was letting people go. For some reason, that was very important to IBM—not to say it.
Instead of admitting that it had a problem, IBM came up with a plan: The company would offer every single employee voluntary retirement, rather than laying anyone off. Give people several
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years salary, an acceleration of their pension plans, and other perks, and IBM figured enough employees would leave of their own accord. The company wouldn’t have to fire a soul.
The plan landed on the desk of a top IBM manager I know very well. He was horrified. The manager went to John Akers, the CEO, and said, “I think it’s a very bad idea to make this available to everybody. We’re going to lose our best people.” Akers disagreed.
The good people, in Akers’s opinion, would never leave.
Well, the announcement was made and who do you think took the offer—the employees who could get another job in a heart- beat, or the people who’d been struggling to appear useful for years? Take a wild guess. Over 80 percent of the people who took IBM up on voluntary retirement were among the highest-rated employees the company had. IBM lost a whole layer of terrific management, because when crisis hit, it was too embarrassed to admit that it was letting people go.
Bring In an Expert
The companies I respect most aren’t afraid to admit they have a problem. They’re not afraid to bring in an expert to fix the area in which they’re falling short. I see this as a sign of strength, not weakness.
Take, for example, Michael Kinsley, editor of the high-profile political Web magazine, Slate, whisked away when Microsoft needed help in the new media arena, or Jim Allchin, the designer of Banyon’s networking operating system, brought on board when Novell was killing Microsoft in networking. Trouble with the next- generation operating system? No problem. Microsoft hired David Cutler and a dozen of his VMS design team members from Digital Equipment, the leading competition. From Mike Maples, brought in from IBM to lend some much-needed structure, to Jon Shirley and Bob Herbold, operations gurus from Radio Shack and Procter
& Gamble, Microsoft has never been afraid of bringing in sea- soned veterans from the outside to help turn things around. Not only does recruiting top executives from other companies help Microsoft by infusing management with outside expertise, but it also weakens the competition by removing key leadership.
By bringing in a veteran like Bob Herbold, Microsoft, then a relatively immature company, was able to benefit from Herbold’s years of experience at powerhouse Procter & Gamble. Before Her- bold’s arrival, Microsoft was determined to do everything in- house. For example, when it needed an internal information system to manage its accounting, rather than outsourcing the job to an expert, Microsoft programmers were asked to write a pro- gram from scratch.
Herbold changed all that. He realized that it was ridiculous to have Microsoft’s programmers spend thousands of hours creating a system outside their realm of expertise, rather than buy a system from a specialist. He decided to hire SAP, the number-one vendor in enterprise management systems, to design a system for Microsoft, using NT Server.
In addition to saving Microsoft money, the outsourcing had an unexpected benefit. Microsoft had been trying to convince the business world that its NT Server operating system, meant to com- pete with Unix, was powerful enough to run a multi-billion-dollar company. It was a hard sell. While most customers believed NT Server could run management software for a small company, the general feeling was that the big guys would be better off with a Unix or minicomputer system. By hiring SAP to create Microsoft’s enter- prise management system on NT Server, Microsoft served as its own test case, demonstrating NT’s power beyond a doubt. The project enhanced Microsoft’s relationship with SAP and encouraged SAP to upgrade its commitment to designing for the NT system.
Thanks to Herbold, Microsoft has embraced outsourcing in other areas as well. The move has resulted in streamlined opera- tions, reduced cost of goods, cheaper operating costs, and enhanced profits.
Like Microsoft, Dell Computer has benefited from a bit of managerial poaching in times of trouble. When Michael Dell found his company floundering in notebook computers, he evalu- ated the competition and identified Apple’s newly released Power- Books as the best-designed products in the laptop category. Dell then recruited about a dozen of the top people from Apple’s PowerBook team, including the lead designer, John Medica, to create a new Dell laptop.
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The overhaul cost Dell dearly in the near term. Medica’s team viewed Dell’s old laptops as unmarketable, resulting in the cancel- lation of all existing notebook projects. The long term was a dif- ferent story entirely. About 18 months after the overhaul, Dell launched its first highly successful notebook series, which has been gaining significant market share ever since. Michael Dell later replicated the strategy in servers, with equally startling success.
On the flip side, there was IBM. When the PC revolution hit, IBM blundered. IBM was a mainframe company, and its manage- ment just didn’t get it with PCs. And no wonder—they had a main- frame guy running their PC division. He failed. Guess what they did? They hired another mainframe guy. And when that guy failed, they hired anothermainframe person. He failed, and they hired still another one. Eventually, IBM put someone with a nonmainframe background in charge of PCs. He was from a cookie company.
While this fiasco was unfolding, during the late 1980s and early 1990s, I was blasting IBM in my coverage as an analyst. I happened to know a portfolio manager who was one of IBM’s biggest share- holders. His fund had so many shares of IBM that the CEO of the company met with this guy directly,one on one.
One day the shareholder came to me and said, “Mike, you keep blasting IBM. I know you think they’re doing a horrible job of run- ning their business. I’m meeting with John Akers, the CEO, in a few days. What should I tell him he needs to do to improve things?”
I just shook my head. “Look,” I said, “it’s so simple. But I guar- antee you Akers won’t do it.” The guy got excited. I mean, he had millions of shares in IBM. He was dying to know what the “simple”
thing was. I told him: “What IBM should do is buy this very little company called Dell and turn IBM’s entire PC business over to Michael Dell, its founder.”
Now you’ve got to understand, Dell Computer was practically a gnat at the time. It had only about a $500 million market cap; IBM had something like a $100 billion. It would have been a very small acquisition for IBM, and Michael Dell was a PC genius. I told the shareholder that if IBM put Michael Dell in charge of its PC division and put IBM’s assets at his disposal, it would dominate the PC indus- try within a few short years.
Well, to make a long story longer, the shareholder went into his
meeting with Akers. Needless to say, he was practically laughed out of the office. There was no way IBM was going to turn its PC busi- ness over to a kid. (Dell was 27 at the time.)
The rest is history. If IBM had been willing to swallow its pride and utilize Dell’s passion and knowledge of PCs, it could have led the PC gold rush. But it was too stubborn to admit that it needed an outsider, especially such a young one from such a small com- pany. That was in 1992. Today Dell Computer Corporation, the former gnat, has a market cap that’s almost equal to IBM’s.
Compaq
While IBM was making a mess of things, Compaq wasn’t doing too well, either. The company only had about 4 to 5 percent of the American PC market, and instead of increasing, its share was start- ing to level off. Because Compaq was doing really well outsidethe United States, the slowdown was somewhat obscured. No one really knew that Compaq was in trouble.
It wasn’t an analyst who figured it out—it was Ben Rosen, who had backed Compaq financially in the beginning and was now chair- man of the board. Rosen watched the industry religiously, and he saw that other companies, like Gateway, were making more profit per computer than Compaq, even though Compaq had greater buy- ing power, better engineering, lower royalties, and a higher price per machine. He realized that something was very wrong.
Rosen didn’t know what that something was, but he decided to find out. He started what’s referred to in the industry as a skunkworks project. (A skunkworks is a secret assignment, outside of normal company operations, led by a few hand-picked employ- ees.) Rosen assembled a team of engineers and asked them to build a computer comparable to a Compaq machine, but to build it completely from industry-standard parts.
The Compaq skunkworks operation project wasn’t known to anyone. Even the CEO was kept in the dark. After a few months, Rosen’s team completed its assignment, and one thing became blindingly clear: Compaq was in trouble. Not only had the skunkworks team been able to build a Compaq-like machine, but it had done so with off-the-shelf parts, with no buying power what-
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soever, for much less than what it cost Compaq to build a compa- rable unit. The CEO was fired.
Selling to Grandpa
The problems at Compaq and IBM were different, but their root was the same: Both companies were living in the past. Compaq and IBM had been big players in the 1980s, and the two companies were operating under the misconception that the personal com- puter industry was driven by engineering, much as mainframes and minicomputers had been. They failed to realize that the industry had transformed itself—it was no longer driven by the best engineering, but by the best distribution and the best price points. Today’s computer customer didn’t need the best machine—he or she needed a decent machine that was afford- able. The customer wanted a Saturn, but both Compaq and IBM were hell-bent on selling a Rolls-Royce.
Luckily for Compaq, it had Rosen in its court. His skunkworks project showed the company the light, and on June 15, 1992, Compaq introduced a completely new line of products. Based on industry-standard parts, with prices cut by more than 30 percent in one fell swoop, the new line shook the industry.
Instead of following suit, IBM decided to wait and see how things played out. That indecision cost it dearly. During that sum- mer, Compaq took a huge chunk of IBM’s market share and even- tually passed it as the PC industry leader.