Toward the end of 2004, IBM announced it would be selling its renowned -- even seminal -- PC division to the Chinese company Lenovo Group. Lenovo has agreed to pay IBM $1.25 billion for the business, $650 million of that in cash. Lenovo will get to use the respected IBM brand on its PCs for five years. In return, IBM will get an 18.9 per cent stake in what's being called "the joint venture."
Yet IBM's PC business generates about $10 billion each year in revenues, so onlookers might think this sale doesn't make much sense. But it does, once you look under the covers.
We know that IBM didn't have a huge worldwide market share for its PC products in recent years - five per cent by most estimates, far behind market leaders Dell and HP, and shrinking as time went by. Despite the fact that IBM continued to offer fine products with technical innovations, enterprise customers eschewed the brand in favour of lower-priced products from IBM's competitors. Apparently, customers didn't see the value-add in IBM's technology. The fact is, PCs are now a commodity, and a few extra bells and whistles aren't worth the added dollars.
In addition to losing market share, the PC business was bleeding money for IBM to the tune of nearly $1 billion in less than four years. This might make you wonder why Lenovo struck the deal. Why would it buy a losing entity?
In my opinion, the deal is all about shifting demographics. IBM's largest markets for its PCs are North America and Europe, which are saturated: virtually everyone in these regions who wants a PC already has one, or more. The action has shifted to developing markets in Asia, especially China.
With its enormous population and growing per capita income, China has been called the most important market in the world. The country is a glowing beacon for companies that want to sell high-tech products to consumers, corporations and government agencies. Many of these entities have yet to purchase their first PC and are hungry to do so. Yet as a market, China is a tough nut to crack, especially for outsiders. Even worldwide market leader Dell has dropped out of the Chinese PC market because of stiff competition.
Much of that competition comes from none other than Lenovo, which holds nearly a 25 per cent share of the market. Lenovo is far and away the market leader in China. When you add in the six per cent share held by IBM, Lenovo sells nearly one-third of all PCs in China. Now you can see why IBM would want a slice of Lenovo ownership. There should be good recurring revenue for years to come.
For its part, Lenovo, previously known as Legend Group, has aspirations to grow outside China. It will instantly do so with the IBM brand and worldwide presence of marketing and sales offices and experts.
Loss of innovationDespite its potential, I have misgivings about the deal. I mourn the loss of innovation as IBM no longer invests billions of dollars annually in new PC technologies. Although Lenovo pledges to continue R&D on new technologies, I foresee a curtailment as the company focuses on lowering costs to stay competitive in its markets. However, doing so might cause Lenovo to lose customers in precisely the markets it covets: those outside of China.
There also will be the inevitable culture clashes among the new company's employees. The deal shifts nearly 10,000 IBM employees to Lenovo's payroll, doubling the size of the Chinese company overnight. The new Lenovo is sending its senior executives to offices in New York state to be closer to IBM's corporate headquarters. While I can't say I know anything about how Lenovo is run, I'd venture to guess that it isn't "the IBM way." I predict a brain drain will ensue as frustrated IBMers find employment elsewhere.
Sadly, it's a sign of the times that PCs have reached commodity status, and IBM's sale of its PC business is just part of the industry life cycle. But it's better to get out now before losing another billion dollars.