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Why Amazon and IBM should change

Both companies should change according to their circumstances

Rich Karlgaard
Published: Dec 4, 2014 06:36:17 AM IST
Updated: Dec 4, 2014 01:03:46 PM IST
Why Amazon and IBM should change

Know when to hold ’em. Know when to fold ’em.” Thus sang Kenny Rogers in his 1978 hit, ‘The Gambler’.

Lesson of the song: Circumstances change. Good luck is bad luck when the loser draws a gun. Bad can be good, if you’re wise enough to drop out before you lose it all.

It was Amazon’s good luck that for years investors looked the other way at the company’s lack of profits. They bought the Amazon two-step: Free cash flow matters more than profits, and Amazon can slow down innovation and growth and turn on the profit tap anytime it wants. Got that?

But circumstances changed. Stocks became fully valued. Investors became more selective. Amazon’s growth slowed, and its free cash flow—at least for a quarter—disappeared. Until recently, a company with $80 billion in revenue with a brilliant founder/CEO but no profits seemed like a cool thing. Until suddenly it didn’t. Amazon’s stock in 2014 is down 28 percent. Think about it: Amazon is now fighting a multifront war against the likes of Apple over devices, Google over cloud services, Alibaba and Wal-mart over commerce, and FedEx and UPS over rapid delivery. And it’s doing so with a weak balance sheet and a negative cash flow. Not very cool!

Circumstances change.  So must Amazon. And now so must IBM—but for entirely different reasons. For years under CEOs Sam Palmisano and Ginni Rometty, IBM promised steady earnings growth, even in the face of declining sales. A quarter’s hiccup would be one thing, but IBM has had 10 straight quarters of revenue decline. What IBM did to keep up earnings was buy back its stock—more than $100 billion worth since 2002—and sell off lower-margin businesses.

Stock buybacks are, arguably, a smart strategy in predictable times. But not so smart when cloud and mobile technologies are threatening to upend older enterprise-technology companies like IBM.

Hindsight being perfect, IBM’s Rometty should have told Palmisano to stuff his earnings road map when she succeeded him as CEO. It was an outdated idea from an otherwise smart CEO, who, along with Louis Gerstner, literally saved IBM in the 1990s with a big, bold bet on global services. But the earnings promise was a road map too far. It was one of those things that worked, until suddenly it didn’t. And when it didn’t, it really didn’t.

My guess is that Rometty is so loyal to IBM and mentor Palmisano that she was slow to see the flaw of promised earnings growth amid declining revenues in an era of rampant IT disruption. But now she sees the mistake, and she steered IBM off that road last month. But you have to wonder about that $100 billion spent on stock since 2002. More acquisitions were, in fact, needed. IBM can be good at acquisitions. For instance, Kenexa, its cloud offering in human resources, was acquired in 2012 and is growing at 30 percent per year.

Giant Genius
One of my Forbes colleagues claims the San Francisco Giants were “lucky” this year. His claim is based on the Giants winning only 88 games and slipping into a wild-card spot during the regular season’s final weekend. That’s a misunderstanding. The Giants’ strategy is to build a team for the playoffs. During the regular season, they resist reaching for 96 wins if 90 or so will do. That way the Giants won’t burn out a pitcher. The Giants have had 335 consecutive home sellouts, so fans buy into this strategy.

This patience can be seen in the Giants pitching aces vis-à-vis the Los Angeles Dodgers. The Dodgers’ ace, Clayton Kershaw, was baseball’s dominant pitcher during the 2014 regular season. But he fell apart in the playoffs. The Giants’ ace, Madison Bumgarner, was merely good during the regular season but was dominant in October. It may look like luck. But it’s planned.

Know when to be patient. Know when to peak.

Rich Karlgaard is the publisher at Forbes

(This story appears in the 12 December, 2014 issue of Forbes India. To visit our Archives, click here.)

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