IBM Invented the PC. Then It Sold the Business.
In 1981, IBM built a personal computer, and then it did something strange.
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IBM Invented the PC. Then It Sold the Business.
Episode guide
In 1981, IBM built the personal computer that created the category, and then it published the design. Within a few years, "IBM-compatible" was the name of the entire market. By 2004, the company that invented the PC was the third-largest seller of them, holding under six percent of the market, with a division that produced $12.8 billion of revenue for $162 million of pretax profit.
This episode reconstructs the decision IBM's chief executive, Samuel Palmisano, and its board reached in December 2004: sell the personal computing division — the ThinkPad, the factories, the sales force — to Lenovo Group of China for about $1.75 billion. It walks through the strategic review that began in 2002, the internal arguments against the sale as Palmisano later described them, the opposition inside Lenovo's own shareholder base, and the American national-security review that turned into a formal investigation.
Then it follows the outcome: the margin IBM said it would gain, the gain it actually booked, the American company that kept its PCs instead, and the brand that became the world's largest PC business on somebody else's balance sheet.
What to listen for
- Why the decisive figure was a ratio, not a loss: $162 million of pretax profit against $12.8 billion of revenue, set beside roughly $9 billion of profit from the rest of the company.
- What the dissent actually argued — brand reach, purchasing power, and pull-through into corporate accounts — and why none of those three can be printed on an income statement.
- How Lenovo's own shareholders opposed the acquisition unanimously, and what changed their arithmetic.
- Why the sale was reviewed as a national-security question, and what happened to Lenovo computers inside the US State Department two years later.
- What the disciplined counterfactual claims, and the one live experiment that tested it: Hewlett-Packard.
Evidence in this episode
IBM put PCs in front of ordinary buyers in 1981, and its name became the generic term for the category — users spoke of "IBM-compatible" machines, or "IBM clones." By 2003, IBM's worldwide PC share had fallen to 5.8 percent, down from 8.8 percent in 1996, against Dell's 16.7 percent and Hewlett-Packard's 16.2 percent. In the first nine months of 2004, IDC put Dell at 18 percent, HP at 16 percent, and IBM at 6 percent. 1
On December 3, 2004, The New York Times reported that IBM had put the business up for sale, in serious talks with Lenovo and at least one other potential buyer, at a price likely between $1 billion and $2 billion. IBM's spokesman, Edward Barbini, said the company had a policy of not confirming or denying rumors. The report framed the retreat as the end of an era for an industry IBM had helped invent, and noted that the money in PCs now went to Microsoft and Intel. 2
Investors liked the idea before they knew the terms: IBM shares rose $1.32 to $97.08 on December 3. Analysts were split. Merrill Lynch's Steven Milunovich called a sale "a moderate positive for IBM," citing improved margins against reduced revenue, and added that "at times PCs have provided a significant part of revenue growth." Prudential's Steve Fortuna said the PC business "is absolutely not strategic to its long-term core strategy." 1
IBMs Form 8-K filed December 7, 2004 carries the announcement and the prepared remarks of chief financial officer Mark Loughridge. The terms: at least $650 million in cash, up to $600 million in Lenovo stock, and about $500 million of assumed net liabilities — roughly $1.75 billion in total consideration — with IBM taking an 18.9 percent stake in Lenovo. Loughridge told investors IBM expected a pretax gain of $900 million to $1.2 billion at closing, and that without the PC business IBM's gross margin would improve by roughly three points and its pretax margin by about one point. 3
Loughridge's strategic framing was that the industry had bifurcated into a high-value, solutions-led model and a low-cost model that required enormous economies of scale, and that the PC segment "continues to take on characteristics of the home and consumer electronics industry." IBM's approach to PCs, he said, had been "to optimize the PC division's profitability, rather than focusing on market share." The presentation listed prior divestitures including hard disk drives and displays, and about $9 billion spent since 2002 acquiring more than 30 companies. 3
The joint announcement described a combined PC business with about $12 billion of annual revenue and 11.9 million units on 2003 results, third-largest in the world, with worldwide headquarters in New York, principal operations in Beijing and Raleigh, North Carolina, and roughly 19,000 employees. About 10,000 IBM employees would join Lenovo — more than 40 percent of them already in China, fewer than 25 percent in the United States. Stephen M. Ward Jr., who ran IBM's Personal Systems Group, would become Lenovo's chief executive, and Yuanqing Yang its chairman. 4
Palmisano's own words on the day: the announcement "further strengthens IBM's ability to capture the highest-value opportunities in a rapidly changing information technology industry," and the PC segment "continues to take on characteristics of the home and consumer electronics industry, which favors enormous economies of scale and a focus on individual users and buyers." 4
IBM's 2004 annual report shows what the division was worth inside IBM. External revenue for the Personal Systems Group was $12,794 million, up 12.4 percent, and its pretax income was $162 million — against $4,541 million from Software and $4,657 million from Global Services on total company revenue of $96,293 million. 5
Palmisano gave the fullest account of the internal decision years later. IBM's long-range technology assessment in 2002 concluded the PC business would no longer present much opportunity for innovation, at least in the corporate market; he then led a lengthy strategic review and decided to sell while the unit was still profitable. The arguments against a sale were, in the article's words, intense: PCs pulled in sales of other IBM products in corporate accounts, the cost of electronic parts for IBM's larger computers would jump without the PC division's purchasing power, and the corporate brand would suffer without the one IBM product touched by millions of people. "I've heard every one of the arguments, every one of them," Palmisano said. "But if you decide you're going to move to a different space, where there's innovation and therefore you can do unique things and get some premium for that, the PC business wasn't going to be it." He also said he deflected overtures from Dell and from private equity firms, preferring a sale to a Chinese company because the Chinese government wanted its corporations to expand globally, and aiding that goal strengthened IBM's standing in China. 6
Forrester analyst Ted Schadler, on PBS NewsHour the week of the announcement, said IBM was exiting because the business was no longer central to its strategy: "PCs are a commodity today; it's driven by price, not driven by value, so the margins are thin." He noted IBM had other suitors, and that for under $2 billion Lenovo was buying 10,000 employees, the brand, and a base of 14 million US corporate desktops. 7
Lenovo's founder, Liu Chuanzhi, described the other side of the decision. He said the deal was likened to "a snake swallowing an elephant," that most people were negative, and that when he asked a room of executive MBA students how many believed the acquisition would succeed, only two hands went up — both belonging to Lenovo employees. He named three risks: whether clients would buy from the new owner, whether employees would stay, and whether Chinese and Western management would clash. 8
Speaking publicly about the decision a year later, Liu said Lenovo's major shareholders had opposed the acquisition unanimously — they thought the risk and the difficulty were too great, and cited the low proportion of mergers that succeed worldwide. He described the decision as one made after doing the arithmetic: IBM's PC business carried a gross margin around 24 percent against Lenovo's 14 percent; assembling a PC cost IBM about $24 against Lenovo's $4; and the PC division paid roughly $200 million a year back to IBM headquarters in management charges. He also said IBM had restricted the unit to large corporate accounts rather than consumers, and that IBM's PC executives insisted the new company's headquarters be in New York rather than split between two cities. 9
The national-security dimension was not resolved by the announcement. The New York Times reported on January 31, 2005 that the Committee on Foreign Investment in the United States had escalated its review into a formal 45-day investigation. A former Clinton trade official, William A. Reinsch, said, "I don't think anybody has stood up and said with a straight face that PC's are a critical military technology." Michael R. Wessel of the United States-China Economic and Security Review Commission said the deal "falls right into the middle of all that," and that these transactions would be scrutinized. Palmisano said the reaction had caught IBM somewhat by surprise. 10
The review cleared. IBM and Lenovo announced on March 9, 2005 that CFIUS had completed its review ahead of the statutory deadline, clearing the way to close. 11
Lenovo's shareholders approved the transaction on January 27, 2005, and the deal closed on May 1, 2005. IBM recorded a pretax gain of approximately $1 billion. The same announcement described a $350 million strategic investment in Lenovo by Texas Pacific Group, General Atlantic and Newbridge Capital, and named Robert W. Moffat Jr. and Henry Chow as IBM's non-voting observers on the Lenovo board. 12
IBM's own financial statements for 2005 test the promise: the company recorded the divestiture on April 30, 2005, reported total revenue of $91,134 million against $96,293 million in 2004 — a decline of 5.4 percent — and reported gross profit margin of 40.1 percent against 36.9 percent, an improvement of 3.2 points, driven primarily by the sale of the PC business. 13
Lenovo overtook Hewlett-Packard as the world's largest PC maker in the third quarter of 2012, according to Gartner's preliminary figures — 13.8 million units against HP's 13.55 million — although IDC's data still placed HP first. Gartner attributed Lenovo's gain to aggressive pricing and noted Lenovo was the only top-five vendor to increase US shipments that quarter. 14
IBMs later PC history continued. In 2014, Lenovo also acquired IBM's x86-based server business for $2.3 billion, taking another hardware line off IBM's books. 15
In May 2006, the State Department told Congress it would not use Lenovo computers on a classified network after Representative Frank Wolf objected to a $13 million order for 16,000 machines, about 900 of which had been intended for the embassy network. Wolf called the purchase a national-security concern. Michael Wessel of the US-China Economic and Security Review Commission objected again, on the grounds that Lenovo is partly owned by the Chinese Academy of Sciences, an arm of the Chinese government. 16
The experiment that tested the counterfactual was Hewlett-Packard. HP kept its PC division: in October 2011 its new chief executive, Meg Whitman, reversed her predecessor's plan to spin off the Personal Systems Group. "HP is committed to PSG, and together we are stronger," she said. The division had generated $40.7 billion of revenue in 2010. Michael Dell argued publicly that a spin-off or sale would be a mistake, calling PCs a growth market. By the end of 2011, IBM's market value was $217 billion — more than four times HP's. 617
Tim Bajarin, an analyst who had consulted on IBM's first laptop, went to Beijing with other analysts after the announcement and was, in his own words, highly pessimistic — he expected IBM's best people to stay rather than join an unknown company, and he expected the cultures to clash. Ten years later he wrote that Lenovo kept its top executives, held onto IBM's major customers, and turned the integration into a business case for how such a takeover should be done. He also recalled that the US government initially challenged the idea of a Chinese company gaining access to IBM's US government contracts. 18
References
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- 5IBM, 2004 Annual Report
ibm.com
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- 8Knowledge at Wharton, Liu Chuanzhi on Rebuilding the Lenovo Brand
knowledge.wharton.upenn.edu
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- 15Wikipedia, Acquisition of the IBM PC business by Lenovo
en.wikipedia.org
- 16Computerworld, U.S. State Department to limit use of Lenovo PCs
computerworld.com
- 17Computerworld, HP to keep PC division, rejects spin-off idea
computerworld.com
- 18
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