Vertical Integration and Strategic Outsourcing

December 7, 2006

IBM Global Services (IGS) represents IBM's diversification strategy of vertical integration and strategic outsourcing. 

IBM IGS was established in 1996, but IBM did not fully integrate IGS until 1999. During this period, the computer service industry (CIS) experienced rapid growth, which is expected to continue until 2001 and beyond. With tremendous growth potential in the CSI, IBM predicted and relied on IGS to be their main source of revenue. IBM shifted their business focus from mainframe or hardware maker to computer service provider. In 1999, Louis Gerstner, CEO of IBM, announced that more than 50% of their revenue would come from IGS within the next five years. 

With this goal or vision in mind, IBM has been adding resources to improve the quality of its product to keep its marketing position through acquisitions and alliances with other computer services firms. In achieving its goal of becoming a total, integrated solution service provider, IBM has acquired Mainspring, an ebusiness consulting firm, and Informix, a database application and consulting company. It also made alliances with Ariba, a provider of business-to-business applications, and i2, a services and supply chain management and ebusiness consulting firm.

By acquiring and allying with these companies, IBM is quickly increasing its resources in expertise, technology, and skilled labor it needs to broaden its range of service offerings to its customers. IBM's vertical integration of IGS enabled it to fully increase its revenue. In the fourth quarter of 2000, IBM reported IGS grew 5 percent and ebusiness services revenues grew more than 70 percent just over one year.

The customer base grew tremulously once IBM achieved its total integration and became the biggest totally integrated computer service provider in the industry. This also put a great demand on its resources, especially in skilled labor. Competition was fierce in the industry. It costs a computer service company lots of money to attract and maintain its skilled workers because of the shortage. To help relieve the pressure, IBM is reaching out to other services firms to perform certain tasks, such as data processing and data management. Outsourcing also helped IBM to achieve its market presence and share, for it can offer a wide range of services. IBM was very successful in its outsourcing strategy. Today, IBM is the world's largest and most-experienced outsourcing provider.

Transferring competencies, leveraging competencies, sharing resources, and using production bundles are the competitive strengths that IBM possesses to pursue its diversification strategy.

IBM was the largest computer hardware manufacturer before changing its core business to computer services provider. Its R&D surpasses all its competitors in the computer industry. IBM holds the most patents both in U.S. and Europe. The success of its R&D department helped IBM tremendously during its diversification process. Using its well-established R&D department, IBM was able to introduce numerous innovations in the computer service segment as it did in the hardware segment.

Strong R&D and its enormous size gave IBM a great leverage over its competitors. No one in the industry can match IBM's resources and R&D process. Its richly available resources helped IBM to diversify itself and make a profit in a short amount of time.

Although IBM focuses its resources and strategy on IGS, it still dedicated a portion of its resource to develop and improve on the existing mainframe computer segment. IBM hardware and computer services were sharing its resources, such as skilled labor and R&D, to give IBM the ability to provide total solutions to its customers. 

Computer service customers no longer want to purchase just the hardware or service separately. They are seeking for a computer service provider that can provide the total package of hardware and services.  Having their own hardware and computer services enables IBM to bundle their services and offer total integrated solutions to their customers. 

Shifting to computer services provider was a big move for IBM. This is their recovery strategy, prompted by big losses from their hardware making venture. I think IBM would not be better off if it "stuck with the knitting" and remained a computer maker. Every research study and survey showed the great growth potential in the computer industry, and the losses in revenue from the computer making business were the indication that IBM's business strategy was no longer working. It would be wrong if IBM ignored all the indications and stayed in place while its competitors moved forward and made billions of dollars in the new computer service segment.

There is not really a way to measure how much "worse off" or "better off" IBM is because of its diversification. We know now that IBM's diversification strategy is working. Its revenue is increasing and it is meeting Wall Street's expectations. However, no one knows for sure what would happen if IBM chose to remain a computer maker. They might keep losing money in their computer making business and eventually be forced to diversify, or they might come up with new innovations that would help them to recover.