IBM tightens ship at PC unit in quest for profits

That is the question facing IBM's PC division as it struggles to wring costs out of operations and squeeze more profits in.

The answer sums up a major re-engineering of the PC group, as it reaches for its first quarter of profitability in about two years.

CNET News.com first learned of the cost-cutting measure in July from an internal memo that Dave Thomas, at that time general manager of IBM's PC division, sent to about 17,000 employees.

Robert Moffat, who officially replaced Thomas on Friday, explained where IBM is shaving pennies and millions.

Supply-chain changes, linked to IBM moving its PC business toward direct sales, account for half of the $1 billion reduction in costs, he said. Procurement cuts account for another $250 million. Nip-and-tuck changes, such as staff cutting and consolidation, make up the remaining $250 million.

"Our supply chain was not executing the way it can--the way it was designed to execute," Moffat said. "That was hurting our results and hurting our customers, which is probably the most important piece of that."

Moffat, who has spent much of his time at IBM in operations, sees better management of procurement, manufacturing and distribution as the way to cut costs and boost profits.

"The first management change I made, I brought Adalio Sanchez into (manufacturing)," he said. "Adalio is a proven general manager, and he is a proven manufacturing person. I have already seen the effects of making that change."

Sanchez had been responsible for one of IBM's most profitable and successful product lines: ThinkPad portables.

Many of the changes made by the PC division, which sells desktop computers, portables and servers, are small but efficient modifications, according to Technology Business Research analyst Bob Sutherland.

"They have been doing some smart things with their subcontractors, their suppliers," he explained. "They would hand them a design with all the components in there, and the subcontractor would say, 'We can replace this capacitor and save X amount of money because we're already buying that for some other work we're doing.'"

Other changes involve using common components in motherboards for different products, such as portables or servers, or using one motherboard across a single product line. The latter is the case for IBM's NetVista PC line launched in May.

"We have one (motherboard) that runs across multiple form factors, which means the same (software) can go into any form factor that large enterprise takes," Moffat said.

With NetVista, IBM also consolidated design, using essentially the same system for consumer and commercial markets.

"This is going to save them a ton of money," said International Data Corp. analyst Roger Kay. "It's more efficient than Aptiva and PC 300, which are radically different designs for the consumer and commercial markets."

Risk and reward
But these kinds of changes, which in some ways mimic operations at Dell Computer, also carry a liability. The shortage of a single component can hurt the availability of multiple products, as it did in the second quarter with ThinkPad notebooks and Netfinity servers.

Because a supplier failed to deliver an adequate supply of a single capacitor common to motherboards used in both products, IBM faced a crucial shortage that might have prevented the PC division from turning a profit in the second quarter.

The company lost $250 million in sales during that quarter, with ThinkPad shortages affecting sales well into the third quarter.

IBM's strategy differs drastically from that of Compaq Computer, which after deciding it could not take the time to revamp its manufacturing and distribution operation, bought the pieces it needed from bankrupt distributor Inacom.

Compaq, the volume leader at retail, also continues to sell PCs and portables in stores. IBM, by contrast, at the beginning of the year largely pulled out of retail in the United States and Europe. In the Asia-Pacific area, it continues to sell in stores.

"We did exit selling our products through the retail market," Moffat said. "That was very simply an economic decision. The supply chain could not be optimized to allow us to make the levels of profitability that are required in that marketplace."

IBM decided to focus more on direct sales, which meant generally lower overhead and addressed the problem of unsold inventory sitting on retailers' shelves. It also hit on a fundamental profitability problem for IBM: For example, Aptiva consumer PC sales, which accounted for less than 10 percent of PC revenues, made up nearly 30 percent of losses before IBM's retail withdrawal.

The short-term cost of abandoning retail was a hit in sales. During the first quarter, Aptiva sales plummeted 45 percent and commercial PC sales more than 30 percent.

In the long term, IDC's Kay said, IBM will reap profits from this change.

"When they talk about saving a chunk of money at IBM, call it supply-chain management, but it's also at the other end," he said. By removing all the headaches involved with stocking shelves and protecting dealers against price drops and other ills, he said, "you save a bundle and become more competitive with Dell."

In the second quarter, direct sales accounted for 24 percent of PC division sales, in line with IBM achieving its goal of 35 percent by year's end.

More in store
Sutherland, the analyst at Technology Business Research, predicted that other changes are coming, with IBM passing more manufacturing operations to subcontractors rather than absorbing the cost itself. He pointed to last month's $90.3 million sale of an office and warehouse facility to Meridian Group, a real-estate investment company.

Tenants include electronics manufacturers Selectron and Manufacturers Services. IBM has sold a similar facility in Brazil and two in Italy.

"You're going to see something like that, where they just transfer people over to the subcontract manufacturer," Sutherland said. "If, for example, you can sell a manufacturing facility to Selectron, and they take over the facility, Selectron can maximize that facility and manufacture other things. The knowledge base is still there, but they can write it off their books."

A source close to IBM said Moffat has made no move in that direction yet and for now is continuing strategies already in motion.