Thursday, July 1, 2010

How Did IBM Avoid Becoming Extinct?

In the 1990s IBM appeared headed for extinction. Today it is again a leading technology competitor. In an award-winning paper, Charles O'Reilly of the Stanford Graduate School of Business and his coauthors tracked how, by being ambidextrous, Big Blue avoided going the way of the dodo bird.

STANFORD GRADUATE SCHOOL OF BUSINESS—It's almost axiomatic that business is a Darwinian struggle. But what that means is far from clear. Do businesses, like living creatures, survive because they learn to adapt to a changing environment? Or, like dinosaurs, are they unable to change and thus die out when the climate shifts, only to be replaced by newly evolved creatures better suited to the new environment?

In a paper just awarded the Accenture prize as the best business paper of the year, the business school's Charles A. O'Reilly III sees some truth in both arguments, but ultimately he comes down on the side of those who hold that businesses can indeed change and adapt to new conditions. And while that may sound purely theoretical, O'Reilly and his coauthors, Bruce Harreld and Michael L. Tushman, both of the Harvard Business School, analyzed how IBM, which looked headed for extinction in the 1990s, learned to adapt and regained its place as a dominant competitor in the technology industry.

For O'Reilly, the Frank E. Buck Professor of Management, "ambidexterity" is the key to organizational evolution and survival. "It is the ability to simultaneously compete in mature markets where factors are customer intimacy, operational excellence, and incremental improvements, and to compete or explore new markets where the key factors to success are different, including flexibility and rapid adoption," he says.

The paper makes a number of arguments that appear, at first glance, to be counter-intuitive. After all, doesn't business theory tell us that focusing on core markets and core customers is exactly the right thing to do? And when it comes to developing new lines of business, doesn't it make sense to bring in new blood, people who aren't bound by years of functioning in the company's culture?

The authors say no to both premises.

Their paper, "Organizational Ambidexterity: IBM and Emerging Business Opportunities," appeared in the summer 2009 issue of California Management Review.

IBM's Dilemma

The paper recounts how, in September 1999, Lou Gerstner, then CEO of IBM, was angered when he learned that, in the face of financial pressure, one of his business units opted to discontinue a promising new initiative. Why, he wondered, was IBM not capitalizing on new technologies? An internal company study had revealed that Big Blue had failed to capture value from 29 separate technologies and businesses that the company had developed.

For example, IBM developed the first commercial router but Cisco dominated that market. As early as 1996, IBM had developed technologies to accelerate the performance of the web, but latecomer Akamai had the vision to capture this market.

A detailed internal analysis of why IBM missed these markets revealed six major reasons the company routinely missed new technology and market opportunities. The first three were:

• The existing management system rewarded execution directed at short-term results and did not value strategic business-building. • The company was preoccupied with currently served markets and existing offerings. • The business model emphasized sustained profit and earnings per share improvement rather than actions oriented towards higher price/earnings.

Each of those three failings paradoxically related directly to much of IBM's success in mature markets. Or, as the authors put it: "The maniacal focus on short-term results, careful attention to major customers and markets, and an emphasis on improving profitability all contributed to the firm's ability to exploit mature markets — and made it difficult to explore into new spaces. The alignment that made the company a 'disciplined machine' when competing in mature businesses was directly opposite to that needed to be successful in emerging markets and technologies."

As a result of this analysis, the company founded its Emerging Business Organization (EBO) initiative in 2000. Between 2000 and 2005, EBOs added $15.2B to IBM's top line. Significantly, that growth came during a wave of mergers and acquisitions throughout the technology industry. While takeovers during this period added 9% to IBM's top line, EBOs added 19%.

IBM now puts experienced managers at the top of the new business units, a sharp departure from past practice. The logic of the earlier strategy was that younger leaders would be less imbued with the "IBM way" and more likely to try new approaches. But those leaders often failed.

Explains O'Reilly: "A manager has to be well connected (internally) enough and credible enough to get help from the rest of the organization. A newcomer couldn't get that help." What's more, senior managers now know that if they want to get to the very top at IBM they have to spend time running those new businesses, a development that ensures a flow of top-notch management talent into the EBOs.

Some organizational researchers question whether businesses can adapt and see IBM's recovery as an anomaly. However, O'Reilly and his coauthors see it differently.

"The IBM EBO process is simply one illustrative example for how multilevel selection can operate to help an organization adapt over time. Other long-lived companies such as GKN [Aeronautics], J&J [Johnson & Johnson], and Goodrich have accomplished similar feats using variants of multilevel selection. For example, Corning, founded in 1851, relies on its capabilities in glass and optical physics to provide it with a competitive advantage," they wrote. "The Ball Company was founded in 1880 as a maker of wooden buckets. Today, it is a dominant player in metal and plastic containers for companies like Pepsi and Budweiser."

If one looked only at smaller businesses and startups, both of which have high mortality rates, it might appear that most organizations cannot adapt. After all, a new business can only afford to place one bet; that is, it must focus on the opportunity most likely to pay off. But that's misleading, since a larger or more mature business has the resources to do more than one thing at a time. In other words, to be ambidextrous.