
The Fed suckered IBM into a failing cloud strategy? - lmg643
http://www.cringely.com/2014/07/25/fed-suckered-ibm-failing-cloud-strategy/
======
luu
Cutting costs isn't IBM's strategy to get out of the recession. Cutting costs
is IBM's strategy. I interned there in 2003, and it was already apparent that
they preferred to hire people overseas and let attrition reduce the ranks of
folks locally in order to reduce costs. From all the complaints, it was clear
at the time that was causing serious problems with R&D.

The joke around the office was that we'd replace one person locally with three
people overseas, losing the output of two people, since the three overseas
people were so clueless they'd need a local person holding their hands full-
time. I was doing microprocessor design at the time, and the community is
small enough that everyone know that Intel was getting good folks overseas.
But even at the reduced wages outside the U.S., IBM was cutting corners and
not hiring the best people.

Even locally, they try to reduce costs. A friend of mine who stuck around long
enough to make it into management told me that they try to keep salaries at
about the 40%-ile to save costs. On finding that out (as well as a few other
gems), he left. Until I heard that, I couldn't figure why brilliant friends of
mine often got raises that didn't even cover inflation. Don't they know that
people are going to leave because of that? They know, and that's their
strategy.

The thing about Bernanke comes out of left field. IBM didn't use low interest
rates to invest therefore "the companies that were expected to spend us back
to better economic health didn’t do so" therefore low interest rates didn't
make the recession less severe than it otherwise would have been? No comment
on whether or not those last two statements are actually true (I'm not an
economist and haven't studied the issue), but Cringley certainly doesn't make
a case for them.

~~~
flyosity
My wife worked at IBM for many years and every year, like clockwork, right
before the quarter was up, they'd shut down the power to entire IBM sites for
a day or two to save money. Everyone would be told to work from home. That's
how important cost-cutting is to IBM.

~~~
mathattack
Poundwise Pennyfoolish no? (Or is it Pennwise Poundfoolish?)

If productivity doesn't drop, why not telecommute 50%?

------
mathattack
First of all, Cringely is right on the first part. IBM, and many other
companies, are taking advantage of the low rate environment to borrow money
and buy back stock. This is capital structure optimization, and many companies
do it. He is tongue is cheek about the problems being the Fed's fault.

There are impacts to this policy. By borrowing to buy back equity, you are
increasing the chance of distress. You don't increase your cash position, but
you do increase the amount of interest payments you have to it. (Albeit less
due to the low rate environment) This means it is more difficult to bet on
anything that isn't a sure thing.

That said, perhaps this is the best way for shareholders to wind down a
company that can no longer innovate. At some point, large companies can cease
to be innovative, and cease to profitably handle acquisitions. Then what?
Especially if you're too big to be bought out yourself.

There are two options... One - Split yourself up and sell the parts to the
highest bidders. Two - Buy back the shares. Shrinking the outstanding
shareholder base will increase the per-share value even if the total corporate
value is flat. Rather than waste money on innovation (if you can't) or M&A (if
you overpay and underintegrate) better to give it back to the shareholders and
let them invest capital in companies that can grow.

Borrowing to buy back shares is just taking case #2 to the extreme, and
ultimately passing the buck to the long term bond holders.

~~~
scholia
See The Fed's Financial Repression At Work: How Big Blue Was Turned Into A
Wall Street Slush Fund, by David Stockman at Seeking Alpha
[http://seekingalpha.com/article/2324305-the-feds-
financial-r...](http://seekingalpha.com/article/2324305-the-feds-financial-
repression-at-work-how-big-blue-was-turned-into-a-wall-street-slush-fund)

It's a good piece, even if you don't share Stockman's view of the US economy
and its impending doom [http://seekingalpha.com/article/2324315-the-implosion-
is-nea...](http://seekingalpha.com/article/2324315-the-implosion-is-near-
signs-of-the-bubbles-last-days)

~~~
jobu
That first article is really good (the second reads like the breathless
ranting of a conspiracy theorist).

If other major companies are doing the same thing as IBM (seems likely), then
it's the best explanation I've seen for the stock market boom over the last
couple years. There has to be a way to incentivise these companies to create
_real, long-term value_ over short-term stock price manipulation.

~~~
mathattack
After a while they just get too big to do it. But that's ok. As long as
someone is willing to buy the bonds, there's nothing wrong with shuffling the
capital structure.

In theory, some people need fixed income instruments (say insurance companies)
so there is a market for it.

If the people with risk capital want to place it on smaller more innovative
companies, why not?

------
joshuaellinger
My wife is an ex-IBM and the cut-to-get-growth story rings true.

But it overlooks a core problem that IBM faces. The cloud is a competitive
platform for problems that previously required mainframes. They successfully
defended (kinda) against Oracle/Sun in areas like running large banks and
stock exchanges.

What happens to IBM when you can solve hard real-time transaction problems on
1000 loosely-coupled distributed computers instead of 1 large mainframe (made
up of a 1000 processors with shared state)? That day is either here or close.

My take is that they can't ignore the cloud but they can't win it either.
Tough place to be.

~~~
wpietri
In some ways, I think Cringely underestimates IBM's potential. (Or maybe he
correctly estimates IBM management's inability to see IBM's potential.)

One way Google kicked the ass of their competition was to radically their cost
of computing through smart use of commodity hardware. It seemed like a small
thing, but it gave them a lasting advantage, because nobody could afford to
deliver the same search features.

Given IBM's deep pockets and deep experience with hardware, I'd think there
must be some strategy there that would let them create cloud computing
infrastructure with radically lower cost than the competition. We regular
people are stuck with off-the-shelf colocation setups, off-the-shelf hardware,
off-the-shelf processors, and off-the-shelf software. IBM can afford to change
any of that from scratch. Any of it.

I just can't believe that, less than 10 years into the cloud computing era, we
have already happened upon the optimum approach.

~~~
cwyers
What deep experience with hardware? Yes, there was a company called IBM that
had a lot of hardware experience, and there is currently a company called IBM.
But most of the parts of IBM that have deep experience with hardware got sold
off to Lenovo.

~~~
bashinator
Z-series (mainframes) and Power systems (high-end UNIX servers). Yes, both are
in a shrinking market, but they've got significantly higher margins on both
sales and support than commodity x86. They're also what's keeping IBM's
domestic hardware manufacturing going.

------
tedsanders
The article says that because of expansionary monetary policy, "[Businesses]
tended to borrow money and invest in their own shares." To me, this statement
seems nonsensical. Here's why:

Fed policy affects things by changing the aggregates. But stock ownership can
never change in the aggregate. If you have extra money and you buy some stock,
for every dollar you spent buying stocks, someone else now a has a dollar from
selling you the stocks. A common myth is that money can go "into" an asset
class. It cannot. It's impossible for extra money to end up invested in stocks
in aggregate, because for every buyer there must be a seller. Individually,
you may have less money, but that's balanced by someone else having even more
money now. Stock sales will never change the aggregate money supply nor
aggregate investment nor total stock ownership. So what is cringely saying
here?

I'd appreciate if anyone could explain the logic. I don't want to pre-judge,
but my suspicion is that monetary policy is a subtle issue and that blaming
the Fed is fun, both of which lead to mistakes such as this one.

(In fairness, perhaps the author means to say that specifically IBM used low
interest rates to buy stock and not that businesses generally did this. That
is a charitable interpretation that makes more sense and deviates only a
little from what was actually written.)

~~~
lkrubner
About this:

"It's impossible for extra money to end up invested in stocks in aggregate,
because for every buyer there must be a seller."

If I buy a share for $1, and then a year later sell it for $10, then the new
buyer is putting $9 extra dollars into that asset class.

~~~
tedsanders
If person A buys a share for $1, then another person must sell a share for $1.

A year later, if person A sells a share for $10, then another person must buy
a share for $10.

At all times, someone is always holding the money created by the Fed. The
money never "went in" to stocks. Sure, the valuation of the stocks changed,
but the aggregate money supply and the aggregate stock ownership never
changed.

~~~
snowwrestler
The money supply is constantly changed by the Fed in response to demand for
cash, to maintain consistent inflation.

In 2008 when everyone started selling their stocks, the Fed had to create
massive amounts of money to match the appreciation of the stocks that were
being sold. Thus, because the money supply grew in that situation, people said
money was "coming out of" stocks. In reality it was value coming out of
stocks, and the money was being created by the Fed. So think of it as
shorthand for what's really happening.

~~~
tedsanders
Ah, but you're committing the very same fallacy! It's not possible that
"everyone started selling their stocks" in 2008. That statement makes zero
logical sense. Every seller was matched by a buyer. We might just as well say
that everyone starting buying stocks in 2008.

I think what often links stock prices with demand for money is risk
preferences. If stocks become more volatile (which they tend to do while
falling), investors deleverage. This deleveraging reduces the velocity of
money and thereby increases the demand for cash. If unchecked, this will cause
deflation and requires the Fed to create more money in response.

~~~
snowwrestler
Every seller was matched by a buyer but not at the same price. If a stock
starts selling at $100/share and after 1,000,000 transactions is selling at
$50/share, then some money came out of the stock despite the number of shares
not changing.

~~~
tedsanders
No, no, no. :)

Every seller is matched by a buyer at the same price!

I think you are making claims without thinking them all the way through. Let's
go through an example:

Imagine there is a company with 1,000 shares. Alice buys a share from Bob for
$100. This trade implicitly values the company at $100,000. Later, Carol buys
a share from Dave for $50. This new trade implicitly values the company at
$50,000.

The value of the company fluctuated by $50,000, but if you look at every
trade, an equal number of dollars and shares were exchanged on each side.
Alice lost $100 of money while Bob gained $100 of money. Carol lost $50 of
money while Dave gained $50 of money.

No money "came out" of the stock.

The aggregate stock ownership stayed the same: 1,000 shares were owned both
before and after.

The aggregate money supply stayed the same: $150 were in people's pockets both
before and after.

The only thing that changed was the market consensus of the price of the
company. The bottom line is that price changes of an asset class don't mean
money is being soaked or released. Individual ownership can change, but
aggregate ownership cannot.

Does that sound reasonable? I hope this conversation is helpful for people
reading this comment thread.

~~~
snowwrestler
You're missing a few pieces of the stock market. The total number of shares
increases over time, and some shares pay dividends.

Edit to add: My point is that the total value of the stock market fluctuates
over time. If every sale is zero-sum, how are such fluctuations possible?

------
forgottenpass
_The result of all this is that IBM management has lost touch with reality._

I see that the author needed some connective tissue between the bit about The
Fed and IBM's cloud plans but any IBMer/ex-IBMer can tell you they're out of
touch. The disagreement is about when they lost it.

Most, including this author, will point to whenever the domain they're experts
in was mismanaged to hell. But IBM will keep on trucking right past their
foray into "the cloud," constantly chasing the latest fads, and letting older
divisions wither and die because nobody in charge understand the tech domain
well enough to salvage them.

------
sailfast
The headline got me to click, but I fail to see how cheap interest rates makes
IBM's potential cloud failure the fault of the Fed.

You could argue low rates force the hand of some firms - the stock buyback
argument made sense in the article and had me following. How a strategic
decision like "Cloud is where we're going as a company" can be traced to the
Fed? That's where I lose the thread. What if they had decided on another
investment area? Would you be writing the same article? Would one write an
"The Fed suckered Amazon into a successful cloud strategy" article?

~~~
wpietri
I don't think it's the fault of the Fed. If somebody making $16 million a year
can't be held responsible for their choices, it's a sad world we live in.

But I do think cheap money has let IBM coast a little. Our business culture
has a theory, one I think mainly dumb, that if we tie executive rewards to
stock prices, they'll do good things for their companies. In this case, cheap
money lets them get paid without doing anything useful.

------
elmerland
The article has two good points about IBM buying shares back and not being
able to compete in the cloud market. However, I fail to see how the Fed
directly caused IBM to fail in their cloud strategy? Seems that IBM management
fail to spend/borrow money wisely.

~~~
lay_man
I read it as Cringely being sarcastic, esp when you read the last para taking
a potshot at Ginni.

------
PaulHoule
I dunno.

What I do know is that IBM seems to be the #2 advertiser on TV and in
magazines after that stupid gecko.

It is trying more and more to be like those Indian outsourcers like Wipro and
Infosys, but the difference is that Wipro and Infosys pay the CEO at Indian
rates and spend customer money on solving customer problems rather than
sponsoring tennis and golf tournaments.

------
smackfu
Why exactly does Cringley have such a hate on for IBM?

~~~
freditup
He seems like a sensationalist who has certain vendettas against specific
companies and entities. I'm not sure why he's taken seriously at all...

(As in, I really don't understand why he keeps getting posted on HN, not just
some throwaway insult)

~~~
smacktoward
Because he wrote the best book ever written on the rise of the PC industry,
_Accidental Empires_ ([http://www.amazon.com/Accidental-Empires-Silicon-
Millions-Co...](http://www.amazon.com/Accidental-Empires-Silicon-Millions-
Competition/dp/0887308554)). And then turned it into a TV documentary
miniseries, _Triumph of the Nerds_ ([http://www.amazon.com/Triumph-Nerds-Bob-
Cringely/dp/B00006FX...](http://www.amazon.com/Triumph-Nerds-Bob-
Cringely/dp/B00006FXQO)), which was best in class as well.

~~~
freditup
Hmm, perhaps you're right. But he seems to me to be in that category of
authors who takes small bits of evidence and draws much to large of
conclusions.

(And yes, I'm doing the same thing with this very comment)

------
chiph
Not only can they not make a profit on running cloud services, they can't make
a profit selling hardware to the people who do, either.
Something..something..selling the division to Lenovo...

~~~
Spooky23
They couldn't do that before either.

The people buying IBM x86 servers were people who were already snookered into
buying POWER or Mainframe systems.

------
lnanek2
IBM makes its money on the consulting anyway, they don't need to make money
off the cloud services. They just need to sell lots of $200+/hr consulting
services putting people on them.

~~~
hvs
Consulting (and services in general) is a low-margin business. You can only
increase revenue by tricking young college grads to work 80-hour weeks at low
pay.

~~~
scholia
Margins on services are much higher than margins on hardware. While they're
much lower than margins on software, margins on consulting services are also
much harder to attack.

~~~
johnward
When they are paying someone $40 per hour and billing that person at $300 per
hour there has to be a nice margin in there.

~~~
scholia
Sure, but software gross margins are typically above 80%. (And should be close
to 100% in a serve-yourself online software business, where the manufacturing
cost is zero.)

------
stonogo
IBM has stopped targeting excellence and started targeting EPS. You cannot
operate a business without looking up from your spreadsheets once in a while,
no matter how big that business is.

Earnings per share should be a natural byproduct of excelling in your market.

------
dev_jim
Cringely should stick to commenting on tech as opposed to the validity of
raising debt to do share buybacks in a low interest rate environment.

