Technology is a pretty brutal sector of the economy. Billion-dollar behemoths can have the rug pulled out from beneath them by a couple of kids in a garage. Today's biggest and best supercomputer is liable to be as good as the smartphone (or smart brain implant, perhaps) of tomorrow's children. Scale doesn't really matter. If you can out-innovate the leader today, you can out-scale them tomorrow.
Yet, somehow, IBM (NYSE:IBM) is still here. Most of the tech companies you think of as "old" are younger than your parents, or got into the tech game decades after their founding. Since its earliest days, way back in the late 1880s, IBM has been all about developing and profiting from technology. The company's been on top of the tech world for so long that it's now paid dividends for almost 100 years -- three payments in 1913, and then quarterly distributions since 1916.
How has IBM stayed so consistent and so profitable for so long? It all comes down to three basic principles:
- The market matters more than the machine.
- Don't be afraid to try something new, even if it threatens you.
Cutting-edge technology will only take you so far, as I've already mentioned, but it can take a company pretty far while it retains a technological edge. IBM's foundational technology, from which its predecessor, the Computing-Tabulating-Recording Company, derives the middle part of its name, was Herman Hollerith's tabulating machine:
Pretty old-school, isn't it? This little gizmo cut the time it took to process the United States census from eight years to one year, with the national population total of 62.9 million reported after only six weeks of work. Hollerith's Tabulating Machine Company was soon recognized as the best and most defensible business of the four merged to create C-T-R in 1911, which established IBM's identity from the start as a provider of technological solutions for businesses (and sometimes for governments).
The man behind the machines
The man who recognized the importance of the machines would be the one who laid down IBM's three core principles: Thomas J. Watson, brought aboard as general manager in 1914 and made the company's president less than a year later.
Watson might have been many things -- a good manager, an innovative thinker, a controversial amateur diplomat -- but first and foremost, Thomas J. Watson was a great salesman. Before arriving at IBM in 1914, Watson built his reputation by brutally outmuscling competitors at the head of National Cash Register's (NYSE:NCR) Rochester, N.Y., sales office. A great salesman has to know his audience, and Watson understood that the best customers of IBM's best product would be larger data-driven businesses, at least to the extent that businesses could be data-driven in those days. Thus he instilled from day one the corporate culture that prized customer relationships as much as technology.
That's not to say that Watson was anything near a Luddite. He understood that a technology company is only as good as the minds it contains, and when he arrived from NCR, he also brought along a personal mantra: "THINK."
Legend has it that Watson coined the mantra in a sales meeting, interrupting something tedious to point out: "[T]he trouble with every one of us is that we don't think enough. We don't get paid for working with our feet -- we get paid for working with our heads." Watson emphasized this by writing the word THINK on the meeting room blackboard.
"We get paid for working with our heads."
Watson needed his employees to use their heads, and they did -- the company's revenues doubled in the first four years of his leadership. In the 1920s, IBM expanded again into time recording products and continued to advance the technology behind its punched-card tabulators, which would set standards for the format that remained in place until digital computation swept punched cards into history's dustbin decades later. During this time, IBM firmly established itself as a technology powerhouse, and the company opened its first modern research lab in Endicott, N.Y., in 1932.
Watson's commitment to producing cutting-edge technology for deep-pocketed enterprises was soundly validated when the company won a contract (all but unopposed) to supply tabulating equipment for the newly instituted Social Security Administration in 1935. Called "the largest accounting operation of all time," the timely contract ensured that IBM would be a major U.S. government supplier for many years and gave the company a financial foundation from which to grow.
Out with the old
By the end of the second World War, real computers -- bulky, clunky, hard-wired, and very limited, but still computers -- began to appear. Although IBM was essentially a "tech" company, the pre-transistor era experienced far slower rates of progress than the period following the transistor's invention in 1947. The company had relied on punched-card technology for so long that it was hard to imagine moving on to something newer and unproven. Watson didn't see the company through the dawn of the computer era, but his legacy lived on in his son, Thomas J. Watson Jr., who assumed leadership after his father's death in 1956.
In many ways, the son would surpass the father. He oversaw the development and sale of the 701, IBM's first commercial scientific computer, four years before assuming company leadership. On his ascent to the corner office, Junior restructured the company with a greater focus on research and development and reaffirmed IBM's commitment to large business and government clients at a time when the market for computing products was starting to expand dramatically.
A year after becoming CEO, Watson Jr. made innovation a mandate by barring further development on vacuum-tube machines in favor of solid-state circuitry. The 701 used vacuum tubes. Within Watson Jr.'s first two years at the helm, IBM saw the end of antitrust actions against its dominant data-processing machines, designed the first example of artificial intelligence, created the first high-level programming language, and built the world's first hard disk drive, shown below:
Watson Jr. took over a company with nearly $1 billion in annual sales and, just as his father before him, doubled IBM's revenue in his first four years at the helm. By the end of those first four years, almost no trace remained of the company's tabulating-machine origins. Despite this dramatic change, IBM held true to its roots while embracing Watson Jr.'s intensified push for innovation. IBM under Watson Jr. freely made its old products obsolete, notably in the 1960s with the launch of the System/360 mainframe line and in a 1969 decision to split hardware and software sales. Watson Jr. retired in 1971 after a heart attack, leaving behind a company more than nine times larger (and 12 times as profitable) as the one he'd inherited in 1956. He also left a research-driven culture that has now produced five Nobel Prize winners, all awarded in the years after Watson Jr.'s retirement.
A near-fatal detour
IBM's lowest ebb as a public company must have come in early 1993, when it was fresh off a $5 billion annual loss (the worst in history at that time) and facing the near-certainty of another terrible year. IBM had created the PC standard and had then gifted the richest slices of that standard to Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC), which made the two most essential elements of what quickly became reverse-engineered commodity hardware. IBM was making boxes. Anyone could have made those boxes, and many competitors did so at a lower cost.
IBM had rushed to market with off-the-shelf parts, and the companies making those parts got rich. The company had strayed from its mission of building technological solutions for businesses and came as close as it ever has to eliminating its dividend. Despite cutting the payout by 80% in 1993, IBM held on -- thanks to the timely hiring of Louis V. Gerstner as its new chief executive.
Gerstner is best-known for shifting IBM away from unprofitable consumer electronics and back into high-margin business technology services, returning the company to a business model frequently used in the Watson Jr. era. Gerstner also renewed the company's focus on cutting-edge research, which has given the world a succession of increasingly impressive forms of artificial intelligence -- first Deep Blue, and later Watson, the Jeopardy!-playing supercomputer named for IBM's first great executive.
The market was always businesses and the focus was always on innovation, but IBM almost failed by straying from those core principles during the PC era. Its renewed success today is perhaps luck as much as anything. Would the company be where if it hadn't hired Gerstner in 1993? Still, luck can only take you so far. Today, IBM is best known as a software and services company. What will it become in the future? Shareholders can rest easy knowing that the company should be consistently strong, as long as it remembers its core principles.