Economist David Stockman, who is probably best known for being President Reagan’s budget director back in the era of voodoo economics, has been particularly outspoken about IBM as a poster child for bad policy on the part of the U.S. Federal Reserve. How this would be isn’t immediately obvious but I think is worth exploring because IBM is far from the only company so afflicted. There’s an important effect here to be understood about corporate motivations and their consequences.
So I’ll begin with a story. Almost 40 years ago there was a study I worked on at Stanford’s Institute for Communication Research having to do with helping farmers in Kentucky be more successful by giving them access to useful government data. The study was sponsored by the United States Department of Agriculture (USDA) and it gave portable computer terminals to farmers along with access to databases at the USDA, National Oceanic and Atmospheric Administration, Department of Commerce, etc. The idea was that with this extra knowledge farmers would be able to better decide what crops to plant, when to plant them, when to harvest them, etc.
It didn’t work.
The farmers, even those farmers who made greatest use of the data, were no better as commercial farmers than the control group that had no special information or communication resources.
But this doesn’t mean they didn’t benefit from the data. Those farmers who used their terminals most found the data useful for speculating on commodities markets. These were hedging strategies to some extent but the best traders took them much further, significantly supplementing their farm income. They weren’t better farmers but they were better businesspeople.
It was an unintended consequence.
Now back to IBM. With the Great Recession of 2008 the Federal Reserve under then chairman Ben Bernanke lowered interest rates almost to zero in an attempt to make the recession less severe by spurring business spending to lead a return to growth.
This didn’t work, either. The recession dragged on and on but the companies that were expected to spend us back to better economic health didn’t do so. Traditional monetary policy said that given really cheap money companies would invest in their businesses.
Instead they tended to borrow money and invest in their own shares. At least that’s what IBM did.
And it’s easily understandable why IBM did this. Their cost of money has been about one percent. The dividend yield on IBM shares has been around two percent. On the basis of dividend savings alone it made sense to buy back and retire the shares as long as interest rates remained low. This Fed-driven stock arbitrage (and not IBM’s actual business) has been in large part behind the strength in IBM shares over the past several years.
There are several problems with this policy, however. For one thing, interest rates eventually go back up. They haven’t yet but eventually they will and at that point IBM may find itself selling shares to retire debt.
Another problem with this policy is that it decouples IBM’s stock from the reality of IBM’s operating businesses. Sales go down, operating profits go down, but earnings go up because there are fewer total shares. The longer this goes on and the more used to such unreality you become as a company the harder it is to get back to minding the business, which for the most part IBM hasn’t done.
The last problem with this policy is that money spent buying back shares does nothing to help the business, itself. Here’s an interesting video featuring former Intel CEO Craig Barrett where he explains around 41:25 into the video why it is, exactly, that companies can’t cut costs to get out of a recession — that they have to spend their way out. “Invest their way out,” Barrett says.
IBM, totally ignoring Barrett’s advice, has primarily tried to cut its way back to prosperity and it doesn’t work.
The result of all this is that IBM management has lost touch with reality. They no longer know what to do to save the company. I’m far from the only person saying this, by the way. Check out this clip from CNBC. It used to be only I was saying this stuff, now many pundits are catching-on.
Which brings us finally to IBM’s cloud strategy. Remember IBM’s future is supposedly based on mobile, cloud, and analytics — mobile being the Apple/IBM deal I wrote about last week. Just in the last week or so IBM CEO Ginni Rometty has started to back away from cloud as the basis of IBM’s future and for good reason: it can’t work.
Cloud is an industry where prices are dropping by half every year and will continue to do so for the conceivable future. It’s an industry where the incumbents not only have very deep pockets, the biggest of them aren’t even reliant on cloud for their survival. Amazon is the cloud leader, for example, yet if their cloud business went under you’d hardly see it as a blip in the company financials — it’s such a small part of Amazon’s business. So too with Google.
But what about IBM? Unlike these other companies, IBM has to actually make money on their cloud investments because they’ve told the world that will be the basis of much of their income moving forward. Except it won’t, because cloud computing has become a commodity and IBM has never been successful in a commodity business.
And then there is Microsoft. Microsoft, too, has said that it’s future is reliant on cloud success (Windows Azure). Microsoft has more money than IBM and a more motivated work force. Microsoft will do whatever it takes to win in the cloud. They’ve done it before, investing tens of billions to build, for example, the Xbox franchise which may possibly still be in the red. IBM doesn’t have that kind of patience, motivation, or deep pockets.
IBM will sell cloud services to their existing customer base at prices above the market right until those customers come to understand that IBM’s cloud isn’t any better than the others. Then the companies and governments will switch to cheaper providers and IBM will abandon the sector just as they have so many others (PCs, on demand, and now X-series servers, too).
But now we know it wasn’t Ginni’s fault for failing to understand her own business, It’s all the Fed’s fault for failing to anticipate an unintended consequence of its own policy — that people would generally rather eat ice cream than make it.
Unfortunately economics is a field where people tend to believe what they want to believe – even professional economists. They tend to leave out human nature. The only economist I know who’s been proved consistently right over the years is Paul Krugman, and he was denouncing the low interest rate policy in 2008.
Paul Krugman has been consistently right over the last few years ? Mon diu ! What a gross mis-representation of the truth ! Krugman is living proof that the Nobel Prize has become a
politicized and meaningless award. No one has been more wrong concerning the major issues of macro economics than Paul Krugman aka ‘Mr Shister’. Some of his demands for higher spending are downright ridiculous if not absurd.
Economics is a field where evidence to validate theory is heavily dependent on government policy, therefore particularly vulnerable to motivated reasoning based on political ideology.
Krugman is a brilliant economist who has become a lighting rod for conservative criticism, because he is widely known, outspoken, politically liberal, and unhesitating in outing conservative wrongheadedness. He has indeed been consistently right about the recent U.S. economy, but he is not alone — many professional economists share his views, but are not as well-known to the public.
David Stockman is not a professional economist. His education was at Harvard Divinity School and his professional experience was in politics and business. He apparently now is considered an economics pundit because of his experience during the Reagan administration as point man for trickle-down/supply-side/voodoo economics.
ICE CRAM
As I look back along IBM’s relatively recent history and projected near future, it seems like IBM is abandoning or divesting itself of real, productive technologies and markets to embrace faddish, nebulous concepts.
In the recent past IBM got rid of its PC business, yet Lenovo appears to be a sustainable, economically productive business. In the near future I can see IBM selling off its chip business, where it still creates new designs and process technology to support the advance of the industry.
Meanwhile, IBM holds onto services based in India that are ineffective and inefficient and spouts a lot of guff about cloud services. Chasing dreams is one thing, but rejecting real businesses to don the emperor’s clothes is another.
You miss the point of IBM’s divestments. It’s not that money cannot be made from these products. It is that IBM cannot make money from them. Hence dumping the PC business, which was a smart thing to do. Unlike poor old HP that bought one 🙂
Didn’t we go through this once before? It seems the ‘cloud’ is just a euphemism for centralized computing, which we all decided we hated for it’s unresponsiveness.
The cloud is not centralized computing.
It is in part about scalable infrastructure. You pay for what you are currently using. I might need 10 servers, but then scale to 20 servers during known peaks or some other measurable metric.
Cloud is really more interesting to developers and deployment people than it is to customers.
Scott
“Cloud is really more interesting to developers and deployment people than it is to customers.” True. The big computer companies have been trying for a long time to generate recurring sales of devices and services. You can’t do that when one pocketable PC can do it all for 10 years.
Yes, also known as On Demand. I think the article above, while correct about share buy backs, is woolly about Cloud. Cloud is anything anyone wants to make it. For example, Microsoft’s vision for Cloud (SaaS) is different to IBM’s which originated with their “On Demand” strategy of ten years ago. In other words IBM has been executing a Cloud strategy longer that anyone else except perhaps Salesforce.Com.
More propaganda from cringely.
Last line, s/cram/cream
I would rather eat ice cream than ice cram. 🙂
“…people would generally rather eat ice cram than make it.”
I hate eating ice cram, let alone making it. Now ice _cream_ – that’s another matter.
And please, remember that corporate bodies are singular, or at least try to err consistently: “…IBM has to actually make money on their cloud investments…” – “has” (singular) followed by “their” (plural). I’m no grammar nazi bu there are limits 🙂
Good one Cringely, I have to agree. If we are correct, then IBM will have issues as inflation and interest rates climb.
[…] The Fed suckered IBM into a failing cloud strategy? […]
From an investing perspective, established companies that use their access to cash to buy back their stock are not the companies you want to be long in.
The basic operational objective of an established company, like IBM, is to turn money into more money. IBM has massive infrastructure already in place, both in terms of capital assets like buildings, desks, and phone lines, and also in terms of operational procedures; IBM knows how to locate and hire talent in multiple markets, how to integrate people into teams, groups, and divisions, and how to structure internal communication on a scale of tens of thousands of people. IBM doesn’t need to spend massive piles of cash on creating these structures in the way a startup does. For IBM, these structures exist. What IBM needs to do, to succeed as the size business they are, is utilize the existing corporate infrastructure to meet current client needs (which they’re decent at), and anticipate future client needs by positioning themselves to have solutions ready when those future needs materialize.
Current products serving current client needs generate revenue in substantially the same timeframe as the related expenses. Balancing those revenues and costs is an operational problem. At IBM’s scale it’s a rather large one, but doing the operational balancing of controlling current costs while selling current product isn’t hard in the creative, technical sense. A great many companies are very competent at this, and competent operations managers and directors are relatively easy to come by. Decently run, this part of IBM will generate relatively modest amounts of cash until their products become obsolete; badly run, it’ll generate a modest loss in the same timeframe. This isn’t the part that relates to stock buybacks.
The latter part, the anticipating, is where the access to cash comes in. What’s important here is how much money IBM has access to, what they’re choosing to do with it, and what that choice says about their core competencies. In IBM’s case, they have access to $$Billions$$ at an interest rate of approximately bupkis (~1%), and they’re choosing to use that cash on a stock buyback that also returns approximately bupkis (~2%). Making money on the difference between 1% and 2% is the business of banks, not of technology giants. IBM using its massive access to cash to buy its own stock amounts to announcing to the world at large, “Hey, we’ve totally forgotten how to do our own business, so we’re getting into the finance business instead. But unlike a pure finance company, we have this other thing we do that’s going to become obsolete in relatively short order. By not investing in our core competencies to create new product, we are willingly putting our company on a path to do a controlled flight into terrain on our own core competencies.”
There are a lot of companies to invest in, and not all of them are flying into the ground. This is true whether what you’re investing is your money or your professional skills and time. Given a choice, the companies that invest in improving their product offerings, instead of buying back their stock, are a better long-term bet for you to invest in as well.
Great article Bob. Makes complete sense that a business (IBM) will do the least possible even if it means that they make the smallest return on their investment.
Interesting column, and I always enjoy your commentary. Sorry to be nit-picky — just playing grammar police for a moment — you wrote, “it’s future” when you meant “its future.”
From one Peter to another: Get a life.
Very insightful, and a sad example of what so much of American business has become today – no production of any meaningful service, let alone a physical product. Just moving money around to make more money.
Any idea how much IBM has borrowed to fund their stock buybacks?
A sad decline…
I knew Fed ZIRP was a loser in 2009. But too many people in the ruling class are in a position to spend the freshly printed dollars before they have been inflated. So the policy goes on.
Normal people don’t feel or see any improvement in the economy since 2008 but the stock market keeps ripping upwards.
What does this story have to do with Condoleeza Rice?
Re: The Farmer Analogy. Bob said “They weren’t better farmers but they were better businesspeople. It was an unintended consequence.” I’m not so sure we should separate the issue of being better farmers with being better business people. They made farming their business. Farmers have long used the commodity markets as a way to sell their crops at current prices before they are planted, so that they can predict their income and avoid the possibility of selling after harvest at then current (future) prices that may be depressed due to an over supply of the crops they’re selling. It was a form of insurance, provided by the risk-taking traders who benefited only if the prices rose. It actually makes more sense than having the government subsidize farmers by buying all they’re excess crops and stockpiling them until they rot, just to support the price.
I read Bob’s line as a reference to the farmers being more skillful traders on the market, but NOT with their own crops.
That’s a big difference. Farmers would speculate and play the market to maximize profit, but with their own crops. The best of the traders stopped worrying about their own crops and began speculating to maximize profit, period. They ceased to be mainly farmers selling crops to make a living and became no different that a broker sitting in Chicago or New York.
Re: IBM, Bob said “They no longer know what to do to save the company.” I’m not sure that is, or even should be, the goal. Suppose I start a company with 300 shares and sell 100 shares each to two other people so we are partners in the business. The next day, I win the lottery and loose interest in the business. So I buy back the shares, and we’re all back where we started. The business was lost.
The VERY FIRST priority of a business is TO STAY IN BUSINESS. Otherwise, why bother.
I have been involved with a company that sells digital information products using the Internet. They are using a new concept to make more money than is usual in this type of business. Once they sell a low cost product to a customer, they use various unique strategies to sell higher cost products to some of their existing customers.
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This strategy has two components. First, they have developed a series of products that give more value to their customers. Second, they have developed innovative methods of selling these higher value products.
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This is the type of strategy that IBM should be using, instead of messing around with short term financial engineering ploys.
> around 41:25 into the video
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Sheesh, are we supposed to go drag sliders around like animals? Let’s tack this here &t=41m25s on that URL there
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https://www.youtube.com/watch?v=isOcxsxX4qY&t=41m25s
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Much better, as comrade Jello B. would agree ( https://www.youtube.com/watch?v=W8tvCTXNkeI 😉
I don’t see why “the cloud” isn’t a viable business model for IBM. The cloud doesn’t have to mean only the low level infrastructure; it can mean value-added services integrated on top of that infrastructure. Apple has a sticky ecosystem for consumers; why can’t IBM become the sticky mobile-cloud ecosystem for enterprise, in the way Microsoft is now the desktop-server ecosystem for enterprise?
By the way, the Fed’s monetary policy was successful as far as could be expected, but the problem was a lack of demand, not a lack of supply. Rationally run businesses will not invest in additional capacity if there isn’t demand. Fiscal stimulus was needed to to make up the difference, and while fiscal policy also worked as well as could be expected, stimulus was too small because of politics. A rationally run government would take advantage of low interest rates to borrow and invest in infrastructure as stimulus, but again, politics.
Did anyone notice or experience the Cringely website malfunction last week? For some reason, my two posts, late in the afternoon of July 25th, showed up as the only two posts, and remained so for the next 9 days. At least that’s how it looked to me,when accessed from different locations and ISPs. When fixed today, I discovered my posts were actually among the very last of the posts on July 25th. Explanation?
There was a malfunction in the spam blocker plugin, ‘Akismet’. It sent all the comments following the first two into spam. It took several days to sort through all the spam for the ‘real’ comments, as Bob gets about 300 spam comments a minute, lol.
Apologies for the inconvenience or if your comment never showed up!
In the future, please feel free to reach out to me directly if you notice anything abnormal on the blog. My direct email is: jennie@weblamb.com
As this was a technical problem, many other posters may be curious about it. Thanks for the email address, which I will certainly use for any personal problems with my posts. However in this case, my two posts were actually among the last ones on July 25th. It’s the posts that came before it and those that may have been posted during the subsequent 9 days, that went to spam or failed to show up for some reason. Could it be that I was already on a “safe senders” list perhaps?
Yes, I noticed the website malfunction, too.
What I’m wondering is whether, for the 9 day period, each poster only saw their own post, or just mine?
During that period, I saw only two posts by ronc — and I still don’t see my reply.
It would have been just yours.
The issue has been resolved, please feel free to reach out to me directly next time if you notice an issue @ jennie@weblamb.com
I don’t think earnings will go up when a company buys back shares. The shares aren’t retired, they belong to the company, so the company should retain the earnings to those shares. Why else would the company buy those shares back?
Also, I noticed Barrett used the term ‘market capitalization’ to refer to the market VALUE of a company. Capital is cash in hand, or cash you have spent on something. Stock price is what people think your company is worth. If your stock price doubles and the market value of your company goes up by a zillion dollars, you don’t suddenly have a zillion more dollars you can invest. Bad, bad terminology.
Charles Pergiel,
According to my rapidly fading memory, when a company buys back some of its own stock, these shares become classified as treasury stock. As such, they are no longer eligible to receive dividend payments and they reduce the shares of stock used to calculate earnings per share.
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A company might want to have a stock buyback to increase the value of earnings per share. Even with flat earnings for the company, a stock buyback can increase earnings per share. An increase in earnings per share makes the options granted to company executives more valuable. This is one reason for the type of financial engineering used by some companies. It is unfortunate that some executives are more concerned with their own well-being than that of the company, its customers, and employees.
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Market capitalization does indeed refer to the market VALUE of a company. The term ‘capital’ can refer to many different things. If you look up definitions in a dictionary, they may list several different but related meanings for a particular word.
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Should have mentioned that an increase in earnings per share (of stock that is issued and outstanding) usually leads to an increase in the market value of each share of such stock. Also, it is usually an increase in the market value of such stock that makes stock options issued to a company’s executives more valuable, or even entitles them to the stock options in the first place.
I have no inside knowledge nor any particular details, but I have a feeling that the EPS target which they are trying to hit isn’t so much of a goal as it is a requirement; otherwise Really Bad Things might start happening to the company. And while it is true that such increases may lead to more value for the company’s executives, it may also be true that Really Bad Things will start happening to them personally if these targets aren’t met. It may be less a matter of greed than it is of short- term economic survival for them, in other words.
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But I wouldn’t give them too much benefit of the doubt here. And whenever shortsighted “mind the share price, or the EPS, or whatever” thinking starts taking hold in a big way, Really Bad Things usually start happening in the long-term anyway, even if things still look pretty good in the short-term..
Re: “It is unfortunate that some executives are more concerned with their own well-being than that of the company, its customers, and employees.” It’s up to the stockholders, through the BOD, to align executive self-interest with that of the company. But let’s face it, the employees, executives, and other expenses are tools used by the company to extract money from customers. Ultimately, happy customers are needed to keep the machine running.
Yes, but unfortunately a lot of public companies start thinking of their stock as “free money” (especially if the stock price goes up dramatically for whatever reasons; Wall Street usually has a hand in this), to be used for acquisition purposes and loan collateral and such. Which Wall Street encourages them to do, because in the end that usually allows The Street to gain almost complete control over that company. And they will then gladly put it through the wringer, possibly destroying billions of dollars of value in the process, if that allows them to put even a small fraction of that money into their own pockets. Damage done; move on; rinse and repeat.
” it wasn’t Ginni’s fault for failing to understand her own business ”
Why would that surprize you? I worked for the PC Company in the early through mid 90’s.
Armonk didn’t understand that business either.
Death March 2015 continues. Just this week a friend and former colleague told me that he was informed by his boss that IBm was getting ready to cut another 15,000-20,000
Last one out, turn off the lights……
It’s only a bet – if share Prices rise, Rometty will win – and earn a lot on selling shares in 2016…
What’s left of IBM will be purchased by an Indian company (Tata) for the enormous esteem the name still commands in that country. It will be focused on selling services to other companies within the Tata empire and its yearly losses will be happily absorbed as simply the cost of owning such a prestigious property. In other words, Big Blue will become a White Elephant.
@boris pure speculation or something else?
Friends at Fishkill Fab are crying… they are the next profitable biz unit to face sale.
The so called “Markets” based on Wall Street is nothing but “Las Vegas of the East”!!! It is for gamblers looking for a quick way to get rich!!!
Any company that depends on the Wall Street’s valuation of its stock as an indicator to drive its business strategies and operational directions is asking for trouble.
A company that depends on its revenues and profits need to look ahead for its Product or Service Development Life-cycles and look at the valuation of its stock by Wall Street. Once stock is issued through ISP, it should should only generating revenues and profits. Which in turn generates dividends to the stockholders who put their faith in the company to provide income.
The generation of revenues and profits depend on making its products/service should only be the focus of any company. Which in turn depend on attracting Customers through satisfying/generating Customer Needs that have not been fulfilled by its Existing Products and its Competitors Products to set its strategies.
That is what successful companies such Apple (end user information use), Boeing Commercial Airplanes (travel), IBM (large-scale information processing) etc. have set their business strategies by looking at global customer needs, and ignore Wall Street valuation of issued stocks. These companies buy-back the stocks that have been issued to increase the dividends to the “Real Stock Holders” and ignore the “Stock Traders” that move in the murky waters of Wall Street.
All that’s true, but isn’t Wall Street’s evaluation based on the ability of the company to enrich it’s share holders?
All dinosaurs die eventually. Incompetent people in leadership help speed it along.
I wonder if Team Ginni realizes that some of those people that get resource-actioned end up at places like Amazon and the federal government working on the cloud, and they work together to help cut IBM out of the picture.
Nah!
There’s a special place in Hell reserved for all these people like Lou, Sam, and Ginni.
Retired guy here. Retired at 49 selling a small software company just after 9/11.
An observation. When you see a female CEO in a large tech firm, it is the beginning of the end. Women, even if they are brilliant, are not risk takers, dice rollers and most importantly NOT visionaries. This is the male preserve.
Women are brought in when there is an established playbook and the game is defense and administration of a conquered field – conquered by males. When I see a female CEO (think (BM, HP, GM. Yahoo etc. ) you know that the vitality is gone and it is a matter of spinning out cash and doing the bump and grind until the company is absorbed into another entity. Don’t expect any revolutionary or disruptive technologies from organizations led by females.
Now, females can do well in founding or heading up organizations marketing to women or developing products for same. Think Martha Stewart, Body Shop, Mary Kay, etc, etc. But hard nuts – nope.
I’m inclined to agree, with the possible exception of one generalization: “Women, even if they are brilliant, are not risk takers”. Seems to me women take extreme personal risk when it comes to prostitution and motherhood, much greater risk than just losing investors’ money. They also participate in what I would consider unnecessarily risky hobbies, just as men do.
Actually Female CEO’s seem to be picked right before the sh*t hits the fan. This is on Ginni, she’s had time to change course and get out of the bubble that management has put themselves in. It is not because she’s female.
Isn’t it weird how men are viewed as individuals and women viewed as women? There are plenty of failing male CEO’s out there.
just read your book. as a former ibm’er until mid 2013 (30 years/17 as overseas assignee), i am sad to see the value of this once great company deteriorate and do hope that the board is strong enough to leverage the right governance to save the company. ultimately, it is the board who can change this overnight and i would be willing to fund a copy of your book for each board member to read if you have not done so already. for me it was more than just a company – it was filled with great people.
as a recognised performer in all jobs since joining (why would they invest in overseas assignment for 17 years if that wasn’t true?), i was “managed out” by a coward who knows nothing about people management. he is nothing more than a sheep who does as he is told and operates without one solitary shred of courage. in addition, his previous boss, a peruvian bully who shall be known as paddington (no offence to peruvians or paddington), should be placed in jail for his antics over the years – no integrity and rules by fear. only saving grace is that his job was cut in half for failure to perform. i also remember another who was accused of insider trading and this was never denied – not by the individual; not by the corporation. he was still retained. we used to chuck idiots like these out the door even on the basis of perception of impropriety. now, ibm promotes and protects them and has done for the last decade. idiots on parade.
i hope the board steps-up the pace and cleans house at the top and sorts out the remuneration and incentive system.
one of the good features in my separation agreement was the fact that i am allowed to speak my mind, but ibm also retained that privilege in exchange. the difference is that i haven’t anything to hide and those who read this will recognise the lack of capital lettering in my style. . .
all that said – i want ibm to succeed.
Looking over its history, was there ever a time when IBM fully understood anything?
I can think of no other company management that has a whole is less patriotic and more greedy than the management staff at IBM under Mrs. G. There is one thing that needs to be remembered and never forgotten. You cannot operate as a one trick pony very long.. Gini cannot continue to make cuts and cook the books very long.. It is only greed that has allowed 9 quarters of insanity to prevail over simply having a solid business practice. When it’s all over Gini will walk away with several million dollars.. hard working IBMers will walk away with nothing but the memory of what was a great company.
I was employed at IBM for 15 years and met with an executive recently who told me that any Power sale that includes Linux installed is counted on the books as a cloud sale. That is a hardware sale and shows these folks will do anything to falsely show Wall Street and investors the company is selling increased cloud solutions as their new growth strategy. A typical flawed strategy for IBM that will not work.
Another flawed strategy is IBM’s Roadmap 2015. Cutting costs like resourcing thousands of loyal employees to help achieve the EPS target Sam P promised years ago. Cutting to prosperity never works. Time for the board to clean house.
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