As PC Industry Slumps, IBM Hands Off Manufacturing of Desktops

Wall Street Journal; New York, N.Y.; Jan 9, 2002; By William M. Bulkeley;

Sic:334111Sic:334119Sic:334611Sic:511210Sic:334413Duns:00-136-8083

Edition:

Eastern edition

Start Page:

B.1

ISSN:

00999660

Subject Terms:

Personal computers

Divestiture

Companies:

IBM CorpTicker:IBMDuns:00-136-8083Sic:334111Sic:334119Sic:334611Sic:511210Sic:334413

Abstract:

IBM has steadfastly resisted pressure from Wall Street to get out of the PC business entirely. IBM has maintained that PCs are an essential

product offering in making big-system sales to corporate and other "enterprise" customers. Until now, IBM has produced most of the PCs it sells.

Robert Moffat, IBM's general manager of PC operations, says outsourcing manufacturing will help assure IBM's continued presence in the PC

market by reducing its costs. "This is a reaffirmation of our commitment to the PC business," he says.

IBM lost its dominance in the PC market after 1990, the year Microsoft Corp. introduced the Windows 3.0 operating system, which ended up

supplanting OS/2, the one IBM had bet on. IBM lost its leading PC market share to Compaq Computer Corp. in 1994 and has struggled to make a

profit in the business for at least a decade.

Full Text:

International Business Machines Corp., the company that invented the dominant variety of personal computer, is giving up on making desktop PCs in most of the

world.

In agreeing to sell its PC manufacturing operations in the U.S. and Europe to contract manufacturer Sanmina-SCI Inc., IBM is staging the latest retrenchment to

stanch PC-related losses as its market share has declined. IBM will continue to handle the design and sales of desktop PCs and also to produce laptops.

The outsourcing move underscores how far Big Blue's PC fortunes have faded since 1981, when it introduced the first desktop PC based on Intel Corp. chips.

Others quickly cloned IBM's PC and it became the industry standard. Today, IBM-compatible PCs command 95% of global PC sales.

Under terms announced yesterday, IBM will sell PC-making operations in Research Triangle Park, N.C., and Greenock, Scotland, to Sanmina-SCI, which will

make the machines for IBM under a three-year, $5 billion contract. Exact terms weren't disclosed. (In a separate big outsourcing deal, NEC Corp. yesterday said it

would sell two telecom equipmment factories amid the global technology slowdown.)

Though it currently loses money on PCs, IBM derives about 15% of its revenue, or $12 billion a year, from the unit that makes them. IBM's flashy and

well-regarded ThinkPad laptops, also part of that unit, make money. Most of IBM's revenue and profit come from computer services, software and large computer

sales.

But in desktop PCs, the Armonk, N.Y., company hasn't been able to match the low costs of market leader Dell Computer Corp. IBM often takes a loss on PC

sales to hold onto its corporate customers, and it has all but ceded the consumer PC market. "Since these guys created the market, this is a little embarrassing," says

Roger Kay, an analyst with International Data Corp. "But I think they got over that long ago."

IBM has steadfastly resisted pressure from Wall Street to get out of the PC business entirely. IBM has maintained that PCs are an essential product offering in

making big-system sales to corporate and other "enterprise" customers. Until now, IBM has produced most of the PCs it sells.

One of the analysts favoring a complete exit, Andrew Neff of Bear Stearns, praised the outsourcing move. But Mr. Neff still contends that continued involvement

with PCs is doing nothing for IBM's "multiple," the value the stock market gives to each dollar of corporate earnings.

Robert Moffat, IBM's general manager of PC operations, says outsourcing manufacturing will help assure IBM's continued presence in the PC market by reducing

its costs. "This is a reaffirmation of our commitment to the PC business," he says.

IBM lost its dominance in the PC market after 1990, the year Microsoft Corp. introduced the Windows 3.0 operating system, which ended up supplanting OS/2,

the one IBM had bet on. IBM lost its leading PC market share to Compaq Computer Corp. in 1994 and has struggled to make a profit in the business for at least a

decade.

IBM will continue to produce ThinkPad laptop computers at its plant in Guadalajara, Mexico, and will still manufacture some desktop PCs in China for Asian

markets. Employment in the PC division, including engineers, salespeople and customer support workers, will be reduced to about 8,700, after 980 manufacturing

workers are transferred to Sanmina-SCI. IBM said Sanmina, based in San Jose, Calif., agreed to keep the workers at current pay scales for a year.

Sanmina-SCI, the world's No. 3 contract manufacturer of electronic products, is a major producer of PCs for Hewlett-Packard Co. and makes circuit boards for

other PC makers. SCI, which Sanmina acquired last year, got much of its early growth by supplying circuit boards to IBM for the first PC.

IBM is currently No. 4 in the world-wide desktop computer market, behind Dell, Compaq and Hewlett-Packard, with a 5.4% share for the first nine months of this

year, according to International Data Corp.

Mr. Moffat declines to estimate the cost savings of outsourcing. "Assuming the industry performs the way I expect it to, I expect we can have a break-even to

profitable business on a sustainable basis," he says. Even last year, he says, IBM overall had a profit from the PC business, taking into account profits from related

services and financing.

Mr. Moffat, who was put in charge of the PC operation 18 months ago, says he had been weighing whether to outsource PC manufacturing, but the sales decline

throughout the industry over the past year forced the decision. "This is an industry the bottom fell out of," he says. "Even when the industry recovers, mid-single-digit

growth is what I would forecast."

IBM's PC sales fell 16% to $9.07 billion for the nine months ended Sept. 3, about in line with the industry. The personal systems unit reported a pretax loss of $136

million for the period. In the past, Mr. Moffat says, such a sharp sales decline would have caused IBM to lose "billions." But expenses had been cut 30% from

year-earlier levels, the result of transferring the dedicated PC sales force to the main IBM sales organization and moving some managers elsewhere in the company.

Some observers expect the computer industry to resume double-digit growth next year. But Mr. Moffat says as the world's major economies "stare at saturation,"

IBM is expecting growth rates of 5% to 7% for the PC industry. The company continues to believe it must sell PCs as part of its strategy for providing technology

infrastructure for large organizations, he says.

IBM can't compete with Dell in a price war because of higher engineering, service and sales costs, Mr. Moffat says. Although IBM sells to consumers through its

Web site, it has de-emphasized the consumer market since halting retail-store sales in 1999. Instead, it aims to attract corporate and government customers by

developing software and technology that make its PCs more attractive than rivals'.

For example, last year, IBM unveiled a security chip that makes it easy to encrypt data on laptop computers but that can't be hacked. The chip resulted in a recent

"single-source contract with a government agency" for thousands of laptops, Mr. Moffat says, declining to identify the buyer.

And IBM has won a contract to replace 40,000 PCs at Eastman Kodak Co., in part because of software it has developed to hide a record of a PC's software on

the hard drive. The software makes it easy to restore if the computer crashes or is infected by a virus. "People look to us to provide added value they don't expect to

get out of Dell," Mr. Moffat says.

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IBM's PC History

1981: IBM starts shipping IBM PC

1983: Compaq unveils compatible portable and IBM unveils PCJr home

computer

1985: IBM pulls PCJr from the market

1994: Compaq becomes No. 1 in PCs

1998: IBM loses $992 million in PCs

1999: IBM abandons retail PC business

2002: IBM stops making desktops in U.S.