Dynamic Capabilities

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Dynamic Capabilities at IBM: Driving Strategy into Action
(White Paper Draft)

J. Bruce Harreld Senior Vice President IBM

Charles A. O’Reilly III Graduate School of Business Stanford University

Michael L. Tushman Harvard Business School Harvard University

August 10, 2006

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2 Abstract In the past 15 years, the IBM Company has undergone a remarkable transformation from a struggling seller of hardware to a successful broad range solutions provider. Underlying this change is a story of foresighted strategy and disciplined execution—of connecting knowing to doing. In strategic terms, the IBM transformation illustrates the ideas behind dynamic capabilities, showing how the company has been able to sense changes in the marketplace and to seize these opportunities by reconfiguring existing assets and competencies. We review the literature on dynamic capabilities and, using IBM as a case example, show how their strategy process permits them to both explore new markets and technologies (e.g., life sciences, pervasive computing) as well as to exploit mature products and markets (e.g., mainframe computers, middleware).

3 Dynamic Capabilities at IBM: Strategy in Action In the early 1990s, many Wall Street analysts had written off IBM as a company; its stock price was the lowest it had been since 1983. By 1992, more than 60,000 jobs had been lost and, in spite of John Akers’ (the CEO until 1993) efforts at transformation, the company was failing. When Lou Gerstner took over in 1993, the services unit was 27 percent of revenues and the software unit didn’t even exist. In 2001, services and software were $35 billion and $13 billion businesses respectively and combined represented 58 percent of total revenues. IBM’s market cap had increased from $30 billion in 1993 to $173 billion. The share price over that period increased 7X. Since then, with Sam Palmisano as CEO, IBM has continued this remarkable transformation so that today, IBM has revenues of $91 billion, more than 70% from software and services.

During the past decade, the company has transformed itself from primarily a provider of computer hardware to a broad-based supplier of information technology services and solutions. From an employer with more than 400,000 employees in 1986, IBM went to a company of slightly more than 200,000 in 1994 and today has grown to 330,000. They have gone from a laggard in the personal computer business in 1980 to a 40 percent market share in 1985 to exiting from the business in 2005. From a company that provided little in the way of consulting services in 1990, IBM has become the largest services company with more than 190,000 employees in their Global Technical Services and Global Business Services units. During a 20 year period, IBM has gone from success to failure to success; from a technology company to a broad-based solutions provider to, perhaps, an exemplar of the new world of open systems and on-demand capabilities. Unlike other great technical companies such as Xerox, Philips and Polaroid that failed to

4 capture the benefits of their innovation, IBM has been able to leverage their intellectual capital into businesses as diverse as life sciences, automotive and banking—and make healthy profits along the way.

How did this happen? While the broad story of IBM’s rise, fall, and transformation has been well-documented elsewhere1, there is a part of this story that is essential and not widely appreciated—a story about strategy and execution and how the IBM strategy process links the two. It is an illustration of how a current buzzword in strategy, “dynamic capabilities,” is made real and used to help the company succeed in mature businesses, like mainframe computers, as well as move into new ones, like digital media. It is a lesson in how theory and practice combine to develop new insights that are useful for business and generate new thinking about strategy.2...
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