IBM adjusts to harsh PC world

IBM's decision to form a joint venture with China's Lenovo Group underscores the challenges that manufacturers face in the modern...

IBM's decision to form a joint venture with China's Lenovo Group underscores the challenges that manufacturers face in the modern PC business, even for a company synonymous with the product.

In terms of shipments, for the last few quarters IBM has ranked a distant third among PC makers worldwide, behind Dell and Hewlett-Packard.

That said, though, its ThinkPad notebooks enjoy a strong reputation among corporate customers, who are impressed by their security and reliability features. And IBM's historical role in the development of the PC also gives its extra cachet with some customers.

So why would IBM seek a gradual exit from the PC business?

Quite simply, it's just too difficult for most companies to generate steady profits selling PCs, according to Roger Kay, a vice-president with market research company IDC.

Of the top-tier PC makers, Kay said, only Dell's direct-sales model and vigorous inventory management consistently brought it profits.

Components such as memory and displays are subject to wild fluctuations in price. PCs are also harder than ever to differentiate, given that most PC makers employ many of the same contract design and manufacturing firms in China and Taiwan.

Traditional hardware companies have spent much of the last few years looking for opportunities to expand their revenue outside the rapidly maturing PC market.

Dell and HP have developed consumer electronics divisions, but IBM has spent more time boosting its high-end server and software businesses, as well as expanding its already huge services arm with the 2002 purchase of PwC Consulting. IBM has cut costs in its PC division by outsourcing production and dumping its hard-drive business, but financial analysts looking for better margins have long called for IBM to sell off its PC operation.

Kay said that the deal with Lenovo gave IBM almost a decade's worth of cash earnings from the PC business in a single deal. At the same time, IBM will still be able to retain its important enterprise customers that have come to rely on ThinkPads as the basic computing device for their workforces. The company's primary argument against dropping PCs until now has been that it needs notebooks in order to provide a complete IT package for corporate customers.

As for leading Chinese PC maker Lenovo, the deal with IBM gives it a foothold in the lucrative US and European markets. While most of the exciting growth in the PC market is taking place in emerging markets in Asia, Eastern Europe and South America, corporate customers are attractive because products for that segment command higher margins than PCs for personal customers.

Kay also pointed out that Lenovo would be acquiring the second-largest notebook PC business in China, putting it in a dominant position in its home market.

But Stephen Baker, director of research at NPD Techworld, said IBM and Lenovo had an uphill battle on their hands trying to convince corporate customers that the ThinkPad of tomorrow would be just like the ThinkPad of today.

According to Baker, IBM is taking a big risk in allowing Lenovo to keep the ThinkPad brand name. ThinkPad customers have already demonstrated they care more about features and product design than price, and it may be difficult for Lenovo to reassure customers that the ThinkPad's reputation will endure on Lenovo's watch.

If the ThinkPad evolves into just another notebook or turns into an inferior product, then IBM will have damaged its reputation and brand among corporate customers, which could hurt the very software and server businesses that IBM is trying to enhance.

It's too early to know exactly how enterprise ThinkPad users will be affected by the new company, but smaller businesses will probably find themselves on the receiving end of a marketing barrage from Dell and HP as they try to capture accounts IBM will not have time to service, according to Sam Bhavnani of Current Analysis.

Both IBM and Lenovo will have to devote a great deal of their energy to convincing large corporate customers that life will go on for the ThinkPad customer. Bhavnani said these enterprises would demand to know whether they would still have IBM support in two years, or whether they could order a new batch of notebooks with their custom software image if they needed to expand.

One thing all of IBM's corporate notebook customers should expect to see, several analysts agreed, was a classic cycle of FUD: fear, uncertainty and doubt, much of it spawned by IBM's rivals. IT companies prey on user uncertainty whenever the industry undergoes an upheaval.

While IBM appears to be kicking off the latest round of consolidation in the PC market, it will probably not be the last hardware maker to rethink its approach. Analyst company Gartner recently predicted that three of the top 10 PC makers would exit the market by 2007.

With IBM, the number three PC company, and Lenovo, the number eight PC company, joining forces, the spotlight now switches to HP. Chairman and chief executive Carly Fiorina is still having a hard time convincing analysts that the acquisition of Compaq was worth the time and effort.

At a HP analyst meeting yesterday, Fiorina acknowledged that HP's board had considered a breakup in the past. If growth in the PC market stagnates in 2005, as predicted by Gartner and IDC, HP might find itself pondering the same set of options that led to the IBM-Lenovo deal.

Tom Krazit writes for IDG News Service

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