Competitive Intelligence

IBM’s PC Sale to Lenovo Long Overdue & a Great Entry Point to the China Market

IBM hit the headlines revealing that it is to sell its personal computing division to China's Lenovo Group for $1.75 billion. IBM will take an 18.9% stake in Beijing-based Lenovo under the terms of the agreement, which also sees Lenovo become the preferred supplier of PCs to IBM, and IBM becoming the preferred services and customer-financing provider to Lenovo, with headquarters of the combined company moving to New York.

The Chinese company, which has aspired to enter international markets for years, will be able to use IBM's strength in branding, technologies, sales networks, and financing worldwide to achieve its dream, while IBM spins off what has become an increasingly non-core business and builds a closer partnership with a company from China. It is believed to be a perfect match by IBM China Chairman and CEO Henry Chow because of international influences and China's manufacturing strength.

For many, this has seen the end of an era with the IBM news but the decision should not come as too much of a surprise to anyone. In keeping with the company's recent strategy of getting out of less profitable businesses and focusing on higher margin services and software-led operations, the move also creates a powerful capitalization strategy for market-entry into the fast-growth China market for services and software that are sure to accompany PC sales.

IBM's recent acquisitions have focused on software and services markets, including its $3.5 billion acquisition of PricewaterhouseCoopers and $2.1 billion to acquire Rational, both in 2002. Despite good growth from its PC business in recent months, its share of the market is small, compared to bigger rivals such as Dell and Hewlett-Packard and is also not a big income generator for the company.

We'll see how these two powerhouses of the PC market will do competing in ever-lower margins with a branded seller from China:

Combined, IBM and Lenovo will stand at third place among PC makers with a projected 7.7 percent of the market and combined sales of $12 billion last year, behind Dell Inc. and Hewlett-Packard Co., which respectively command 16.7 percent and 15 percent of the market.

Even for the industry leaders, though, the business remains one of low margins and low return on investment. In IBM's case, the first nine months of 2004 saw a profit of less than $100 million measured against $9.4 billion in revenue.

Similarly, HP's Personal Systems Group, which represents the company's total sales of laptops, desktops, personal workstations and handhelds, saw a $210 million profit on $24 billion of revenue.

Despite the low ROI, which was seen as a factor in IBM's decision, HP remains committed to the PC market, said Deb Nelson, the company's vice president of marketing worldwide for the Personal Systems Group.

"It's a two-horse race" between HP and Dell, Nelson said. The IBM/Lenovo deal "is a change but not a significant one on the overall market," she added.

"We're not surprised by this move," Nelson said. She agreed that the PC business is one in which low profits are the norm, but she stressed that in HP's case, the PC is just the entry for sales of HP products.

Although HP is also a competitor in the server and support market, as IBM is, Nelson said that fielding PCs "brings a lot of other benefits" aside from unit desktop or laptop sales.

Nelson pointed to a "portfolio" of other items HP markets, such as printers, cameras, MP3 players and servers. These, she said, have higher margins but are sold using HP's PC line as an anchor. In fact, Nelson said, digital entertainment was the focus of the company's August product launches as well as its print and advertising campaigns.

Whether IBM's deal with Lenovo will affect HP's market share in the United States (Lenovo has a long lead over the field of computer manufacturers in China, so much so that Dell decided to abandon the PC field there earlier this year), Nelson said it could induce "some uncertainty in IBM customers," which would be an "opportunity" for HP.

Lionel Menchaca, a spokesperson for Dell, declined to comment directly on the IBM/Lenovo deal. He noted that Dell does not break out profit numbers for desktop and laptop sales, but did note that they were both "profitable." He added that 50 percent of the company's $47 billion of revenue for the past four quarters was due to desktops and 29 percent was attributed to laptops, with the remaining 21 percent coming from servers and storage. Dell has historically been able to retain larger profit margins on its products due in part to its direct-sales model over the Internet.

Menchaca added that Dell is not focused on acquisitions, preferring instead to grow the company "organically." However, Dell has been no stranger to purchasing companies to get a foothold in a market. In 1999, the company made its first acquisition, of storage vendor ConvergeNet, for $340 million. And in 2002, Dell bought services company Plural Inc.

eWEEK's Jim Louderback had another take on the strategy:

IBM spent the last few years commoditizing everything below middleware, including the OS and the PC. That explains the fascination with Linux. A commoditized and free OS not only makes Microsoft's key market position obsolete, it also makes the PC itself simply an off-the-shelf component. The consultants at the core of IBM have been recommending non-IBM hardware for years...

In fact, IBM should have gotten out of the PC industry a long time ago. It's been years since the company made memory, hard drives and Token Ring cards—why did they stick it out with PCs? According to ex-CEO Lou Gerstner, it's been "painful and costly for IBM." But he truly believes that the company could have competed. As he said in his 2002 memoirs, "If we had focused on the marketplace and done our homework, there's no reason the IBM PC business today would be looking up the leaderboard at Dell."

Well that time has passed. The corporate desktop looks a lot like a terminal, circa 1985. Interchangeable parts are defined more by what they connect to rather than what's inside. In other words, it's the services they run that are far more important—and they'll run just as well on a Dell.

Most of the PC excitement is happening at home, where Dell, Gateway, HP and others are jockeying for a piece of the media server market. From where I sit, those legacy PC vendors have already lost. Those devices will look a lot more like TiVo or iPod than your standard PC. But IBM hasn't been credible at home since its failed PC JR, so that's no great loss.

My final verdict - an excellent move by IBM, with manifold benefits and little obvious downside.

- Arik

Posted by Arik Johnson at December 13, 2004 05:01 PM | TrackBack