IBM Gets Leaner and Meaner

Spin-off opens a new chapter for Big Blue

“No one ever got fired for buying IBM.” So was the saying several decades ago when IBM was synonymous with computing.

Fast-forward to 2020, and IBM is hoping the slogan will make a comeback.

On 8 October, IBM announced it will spin off the managed infrastructure services unit of its Global Technology Services division as an independent company. The new company, which IBM has dubbed NewCo pending the adoption of a formal name, will be created toward the end of 2021, making IBM two separate publicly traded companies.

IBM’s president, Jim Whitehurst, stated in a call for industry analysts that the company is still working out specific details including leadership for NewCo, but at this stage, IBM’s business consulting arm, Global Business Services, will stay, as will the Technology Support Services unit, its product support business for IBM solutions. This leaves NewCo to focus on managed services for multivendor infrastructure.

The severing of the IT services division from its cloud business is CEO Arvind Krishna’s biggest move since taking the helm nine months ago. IBM’s services business (that is, Global Business Services and Global Technology Services) currently accounts for about 60% of total revenue. By spinning off components of it, IBM says it will create an outsourcing services giant with an annual revenue of $19 billion a year and capable of competing with the likes of DXC Technology, T-Systems and Capgemini.

Outsourcing services have naturally come under huge strain during the pandemic as IT consultants have been unable to fly and less-complex cloud services have ballooned. Customer value in this segment requires supplier and ecosystem neutrality as well as a laser-sharp focus on efficiency through enhanced automation, all of which lack alignment with IBM’s cloud business. In addition, this market has been in a race to the bottom for several years. IBM’s services revenue, for instance, dropped 7% annually in 2Q20; the year before, it was down 6%. In fact, Global Technology Services hasn’t recorded year-on-year revenue growth since 2Q18.

Critics will argue that the spin-off is more about financial engineering and Wall Street than about customers. We have long believed that IBM is shooting for leadership of the hybrid cloud market, and highlighted its goals in 2018 when it spent $33 billion to acquire Red Hat in the most expensive software deal in history (see Open Season: IBM Buys Red Hat).

Since then, IBM has had to live in the shadow cast by the growth rates and dominance of its younger rivals in the hyperscale cloud services market, all of which are stepping up their efforts in areas of IBM’s strategy, such as DevOps, Kubernetes, hybrid cloud management, artificial intelligence and support tools, as well as jockeying to migrate mission-critical workloads to their cloud platforms.

IBM’s total revenue dipped 5% over the past year and has been negative in seven of the past eight quarters; in comparison, the various cloud providers have notched up 30% to 40% growth over the same period.

Positioning IBM for, in the words of Mr Krishna, a “maniacal” focus on open source, hybrid cloud and artificial intelligence makes it smaller but enables it to concentrate investment on a high-growth and innovative business that moves at a speed more suited to the competition and that isn’t at odds with the difficult conditions of the managed services market.

Most important of all, shedding the managed infrastructure services unit will enable a tighter integration and unification of IBM’s portfolio, a much-needed element in the company’s strategy. We have consistently argued that IBM suffers from a lack of a “flywheel” in its products that reinforces its portfolio, something that benefits the cloud providers, particularly Microsoft, immensely.

IBM’s products stretch far and wide, from systems to services, including a formidable research arm. In our view, this range often suffers from a lack of integration and unified vision, too much complexity and, above all, fragmentation, all of which have held it back.

Now with Red Hat, hybrid cloud, Watson and a brand that scores highly as a trusted provider of mission-critical operations at the heart of its strategy, the new leadership can be more confident in the flywheel emerging around its core strengths and differentiators in the market.

Similar spin-offs, such as the formation of DXC Technology out of Hewlett Packard Enterprise in 2017, haven’t exactly been home runs, and it will take several years before we learn the real impact of the move. However, on paper, this is an interesting play for IBM and one that will be watched closely. It certainly represents another major salvo fired in its pursuit of the cloud market and shows that its new leadership under Mr Krishna and Mr Whitehurst is capable of making hard-hitting decisions.

Much more scrutiny will now fall on IBM’s cloud business, which at times can be criticized for lacking transparency. And there can be no excuses for poor performances from now on. But a new leaner and meaner IBM will certainly help address some of its biggest challenges in the new era of cloud services and artificial intelligence.