The Steward of IBM

Originially Posted: Barrons on December 17, 2011
By: Leslie P. Norton

Here’s to the next hundred years,” declares Sam Palmisano’s Christmas card on the 100-year anniversary of IBM’s founding. The card exudes the same gusto that has rallied hundreds of thousands of IBM workers for the past decade. But the gregarious head of International Business Machines (ticker: IBM) won’t be around for the next centennial: Now 60, IBM’s mandatory retirement age, Palmisano will end his decade as CEO on New Year’s Eve. Already, he is introducing Virginia Rometty, the incoming CEO and IBM’s powerful global sales chief, as “the boss.”


“The CEO is not the brand! It is not you. It is not about you.” So proclaims the eighth, and longest-serving, CEO since IBM’s founder, Thomas Watson Sr. Palmisano might be the world’s least-bashful person, except when it comes to taking credit for his job. Then he’s quick to set you straight. That recognition properly belongs to his coworkers, he insists. In fact, he describes his long run as “10% of 100 years.”

“You are a temporary steward of a wonderful enterprise, so leave it in better shape than you find it,” Palmisano says. That, he has done in myriad ways. In the course of his tenure, Palmisano dumped most of IBM’s money-losing computer-hardware businesses, expanded into higher-margin businesses such as software and services, and moved decisively into fast-growing markets, including the developing world and digitized systems for cities. Barron’s has chronicled much of this journey, most recently in “Big Blue Muscles Through,” (July 25, 2011).

IBM’s earnings have sprinted 21% a year, on average, in the past 10 years, to $11.52 a share in 2010. They probably rose by double-digits again this year. Despite two recessions, including one that still haunts the economy, a host of good financial metrics are even stronger. Gross profits are up, margins have widened and IBM now owns the world’s most valuable brand after Coca-Cola. Had you invested in IBM in March 2002, when Palmisano succeeded Louis Gerstner as CEO, you would have doubled your money and outperformed the Standard & Poor’s 500 by three times.

The approach to Palmisano’s office at IBM’s Armonk, N.Y., headquarters is stately, with a soaring ceiling. By contrast, his conference room is small and simply decorated. On the windowsill is a photo of Palmisano grinning with Linus Torvalds, inventor of the open-source operating system Linux. A snowstorm threatens on this gray day. Then Palmisano bustles in. His eyes twinkle behind horn-rimmed glasses that give him an owlish mien. A couple of inches above six feet, wearing the requisite IBM dark-blue business suit, he appears thoroughly comfortable with himself.

During his conversation with Barron’s, he throws his body into his anecdotes and readily specifies where rivals fall short. When crowing over rival‘s (AMZN) efforts in cloud computing, Palmisano points one finger up and exclaims: “IBM has one deal bigger than all of Amazon’s cloud business. One bigger than anything they’ve ever done! One deal!”

He marvels at the accounting of the new Internet-related companies that, he says, are, among other things, prorating commission expenses, treating them like capital expenditures. “All of a sudden, somebody is going to wake up and say, ‘You can’t account for your sales expense from the balance sheet and prorate it with the revenue, like it’s project accounting in the construction industry,’ ” he says. “If we took all the expenses and put them on our balance sheet, then we could have some earnings!” A hundred-year-old company, he says, can’t do such things.

PALMISANO WAS BORN IN 1951 to an Italian-American family in Baltimore. His grandparents didn’t speak English, his father owned an auto-repair shop and his mother ruled the household with an iron hand and a supply of wooden spoons for rapping knuckles. In the ninth grade, with sagging grades, Palmisano got into a fight at a Catholic school. The priests immediately stuck him in a boxing program, and his mother sat him in front of her every night and inspected his homework. “No lawyers were called in! We didn’t sue the school. Do you think my self-esteem suffered? Did my mother have me see a shrink? No,” he relates, with impatience at current customs.

The future CEO played saxophone in the band, and also football. As center, one of the least glamorous positions on the team, Palmisano was the guy who handed the football to the quarterback. The center protects the offense and blocks people. Something weird has to happen for him to score. But it’s also one of the most important positions on the team. The center needs to be tough, aggressive and consistent.

After graduating from Johns Hopkins in 1973, and turning down a tryout with the Oakland Raiders, Palmisano went to IBM. He never looked back. He quickly established himself as a rising star, working as then-CEO John Akers’ executive assistant and serving two stints in Japan. Along the way, he got married, and he and his wife, nicknamed Missy, had four children, now grown.

But in the 1980s, IBM stumbled as PCs and servers replaced mainframe computers. The board hired Lou Gerstner, the only outsider ever to serve as CEO. He famously slashed the work force and started pushing the service business. Palmisano ran global services, PCs, then servers. He was a gifted salesman, dubbed “the Closer” by colleagues. He also paved the way for Big Blue to snare gigantic billion-dollar deals.

When Palmisano became CEO, he had already been pressing IBM to adopt Linux for its systems and push more heavily into services. The company bought PriceWaterhouse-Coopers Consulting. He streamlined management, dispersing the executive committee, and invited the entire company to participate in a “values jam” on the IBM intranet to assess strategic priorities. (One result: greater power to low-level managers to make fast decisions.) As he repositioned Big Blue into higher-margin businesses and built overseas operations, he held managers to high performance standards. Yet his affability and his ability to woo the customers kept him popular.

ALL THE WHILE, KEY INSIGHTS about how the world was changing drove the strategy. One was about outsourcing: As corporations grew more global, employees would no longer fight it out by product and geography. Companies could hand over more and more of the work they previously did in-house to outside specialists, because best practices and the Internet made that possible. The corporation, he wrote in Foreign Affairs, could now be “an array of specialized components: procurement, manufacturing, research, sales.”

Palmisano also saw that with cheap semiconductors, computational power was being put into things we wouldn’t recognize as computers. By 2010, there would be a billion transistors for every human being alive, and 30 billion RFID tags embedded throughout the world. That could make the world vastly more intelligent, if it wasn’t swamped by streams of data. Enter the concept of the Smarter Planet, which he introduced days after President Obama was elected. That lit a fire under IBM’s analytics division, which helps customers handle mountains of data for their strategic needs. “His view of the global corporation was five to 10 years ahead of its time,” says Bill George, the former Medtronic CEO who now serves on ExxonMobil’s board with Palmisano.

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The strategic shifts frustrated shareholders and the stock went nowhere. Palmisano huddled with his lieutenants and unveiled the company’s first road map in 2007, showing how IBM planned to allocate capital and detailing its long-term earnings targets. Analysts were cautious. “We said, ‘We think we can go from $6 to $11, and this is how we do it: Revenue, productivity, share buybacks,’ fatter margins,” Palmisano recalls. “To be credible means you need to have some granularity. We felt this is what you should do for investors: Give them a long-term view, not a view of the next six seconds.” The current road map shows how IBM plans to double earnings to at least $20 a share between 2010 and 2015.

Once the road map was in place, it began to change management behavior. “We had to get ourselves comfortable internally so we could be credible and specific,” says Palmisano. Every manager had a target and a five-year view. One consequence: The entire fall budget-planning session wraps up in six days. It once took two months.

Since IBM announced its road map, it has met or beaten its own forecasts every year. Today, Big Blue derives 23% of revenue from software, 58% from services and just 17% from hardware. Palmisano is exceptionally excited about the analytics division. Watson, the Jeopardy-playing computer, is one product. WellPoint (WLP) recently announced plans to use Watson to suggest treatment options and diagnoses to doctors. It can mine a ton of data, thus saving on excessive testing. “There are 10 million pages of new medical research issued every year,” says Palmisano. Watson can process 200 million pages of content in less than three seconds. “The biggest thing that will transform business is analytics,” says Palmisan, and he pegs the market at $16 billion.

One sign of success: imitation. Hewlett-Packard (HPQ), Dell (DELL) and Oracle(ORCL) are all pushing into consulting and services. The road map is also widely admired. Last week General Electric (GE) made some gestures in that direction when it talked about near-term, double-digit earnings-per-share growth and a long-term view of cash allocation.

“In the investment community, IBM is held up as a keen example of a great company, because they’re very prescriptive and very specific about their intentions,” says Greg Brown, CEO of Motorola Solutions (MSI).

It was on a CNBC interview with Warren Buffett last month that Palmisano first heard Buffett had bought $11 billion of IBM. He knew somebody had been buying IBM shares throughout the year, but never suspected Buffett, who is famously averse to investments in technology. But Buffett specifically cited the road map. “You’re the boss,” Palmisano told Rometty. “You call, and after you call, I’ll speak with him.”

A FORMER HISTORY MAJOR, PALMISANO doesn’t believe in the “Great Man Theory.” The notion of a charismatic leader, he says, “is quite the opposite of what is required to be successful in running a large industrial company that has been around for a very long period of time. The tablets don’t need to come down from Mount Sinai.”

In the next several months, Palmisano will remain chairman of IBM and make sure Rometty gets off to a great start, much as Gerstner did for him—coaching the new CEO through earnings announcements and meetings with investors, analysts and the board. Then he will leave as Gerstner did. He doesn’t know what his next move is; Gerstner had a lucrative career in private equity post-IBM. Palmisano also has pet projects, such as P-Tech, the New York high school that IBM is opening for 100 aspiring scientists.

Sergio Marchionne, CEO of Fiat (F.Italy), is Palmisano’s friend. “Leadership is an incredibly complicated thing,” Marchionne says. “The minute people try to pigeonhole and dissect it, you end up with nonsense. People need guidance and direction, and comfort that the size of the sandbox we’re playing in is defined. Sam gives you the comfort of knowing that you are, in some part, in some fashion, part of the tribe. The tribe will protect you if you perform, and are faithful to the values of the house.”

As leader of the tribe, Palmisano has been more than faithful to the values of this house.