SECTION 3: Business Model Open Innovation. IBM Case-study (from Closed to Open, and further development.)

IBM Overview: IBM before 1992 and the crisis from 1945 to 1980
International Business Machines Corporation (IBM) was founded in 1911 and got its name in 1924. It merged different technologies (such as Herman Hollerith’s Electric tabulating machine and Willard Bundy’s time clock ) and their respective companies. From 1914 it had been managed by Thomas Watson, Sr. and in 1956 command of the company was assumed by Thomas Watson, Jr. . From the creation of computers in the WWII to the ‘80s IBM was the top player in the computer business. It exploited the Closed Innovation model and grew to be the most successful company in its industry.
IBM’s research was totally internal and the path to market for the output of its research had to be entirely within the firm. Research and Development were separated, so to encourage the researchers to pursue their own intellectual agenda. This lead to many scientific discoveries, including five Nobel Prizes and six National Medals of Science. Moreover, IBM first manufactured “core memories”(a first form of electronic memory) and revolutionized the computer market with its “System 360”. This new class of computers soon became the dominant design, and IBM realized an extensive vertical integration. IBM offered customers a complete solution for their needs and it had extremely high switching costs, as typical of Closed Innovation.
From 1980 to 1992
As computer sciences became more diffused, knowledge became more accessible as well.
In the ‘80s IBM still had a huge market advantage on its competitors. Nevertheless, it couldn’t protect its intellectual monopoly anymore.
In fact, start-up companies such as Digital Equipment Corporation invented minicomputers, freeing academic computer science and engineering departments from central computing organization, competing in research with IBM and opening a new market.

As an answer to this, VC industry started getting interested in the business and many new companies became profitable in the minicomputer market(Data General Prime, Datapoint,Pyramid…). Hence, mobility of engineers, who were trained at IBM and left the firm to start new companies, increased. Three out of the four erosion factors of closed innovation model were, then, realized and this highly affected IBM, whose business model could be classified as a type 3( “cheesbrough” ).
To increase the relevance of its researches and reduce the time to market, IBM reorganized its R&D department.
Other than the central funding allocation, IBM instituted Joint Programs, which reflected the joint cooperation of research and development(previously separately managed). As a result of this, IBM regained some competitiveness, but reduplication of functions and rivalry among the departments spread. Furthermore, of the many ideas created by IBM only few were really useful for the firm(“We were inventing great technology, but it wasn’t converting into new business for IBM” Ambuj Goyal, IBM manager).

1992: IBM crisis
By 1992 IBM business was facing huge competitive pressures on different fronts.
First of all, the mainframe market was maturing and IBM’s high market share meant that revenues were going to decline.
Moreover, in the PC industry IBM had fallen behind other more specialized competitors, such as Compaq and most of the profits were accrued to software based companies such as Intel or Microsoft instead of PC manufacturers.
Server and workstation businesses, while profitable, were facing severe competition and software business was in disarray.
The erosion of IBM’s leadership was clear and semiconductor business was declining as well, despite the high R&D spending.
In December 1992, IBM had the single most significant loss of its corporate history, losing $4.96 billion after taxes (highest loss in U.S. Corporate industry at the time). As a direct consequence, it had to make the first major layoff of its history, which amounted to almost twenty-five thousand employees.
In 1993 Lou Gerstner became CEO. Gerstner was the first IBM’s outside CEO and found himself in the toughest situation, having to decide whether to split up the company, to get more specialized and increase flexibility and market reactivity, or to have a huge turnaround process, trusting in IBM’s possibilities as a big corporation.

IBM turnaround: a new Business Model.
Gerstner vision and challenges
Lou Gerstner, as he explains in the book “ Who says that elephant can’t dance”, took in IBM the “most important decision of his life”. In fact, he decided not to break up the company, but to keep it together as an integrated corporation.
Many small companies were moving into the computer market, offering diversified solutions and creating add-on applications and hardware.
Customers needed an integrator of all the different solutions offered, able to use the existing technology to create value and IBM was uniquely positioned for the role.
To achieve that, it was first necessary to change IBM’s culture.
Gerstner decided to tie employee compensation to the performance of the whole company, rather than to that of their particular divisions. Moreover, he started rewarding teamwork and let every employee make three “personal business commitments” to fulfill broader IBM ones.
Also, he disbanded the Management Committee and created an 11-member Corporate Executive Committee (CEC), only focused on policy issues that cut across multiple units.
With these initiatives, internal competition and ostracizing would be reduced and company culture would start to change.
At the same time, it was necessary to completely innovate IBM’s business model, reengineering how the company did business and looking for new revenue sources, while reducing costs and selling non-essential assets. The whole logic IBM based its business upon had to change.

IBM Business Model Open Innovation

“During its closed innovation period, IBM deployed all its technologies exclusively within its own systems and services. [...] you could only buy the chip inside an IBM component. That IBM component was sold exclusively as part of an IBM subsystem, which was only available as part of an IBM system. […] IBM systems were sold only through IBM’s own distribution, and serviced, supported and financed by IBM exclusively”. (Chesbrough, 2013)
This vertically integrated and strict logic perfectly represents IBM mindset before its adoption of an open innovation approach.
It is only in 1993, that IBM started changing its logic and its business model, opening up to customers and competitors, reducing the vertical integration, managing IP in an offensive (rather than defensive) way, beginning to use open source software, and reforming its revenue and cost stream structure.
In the following pages, it is offered an analysis of IBM’s open BM innovation, following the BM canvas

Customer segment
IBM remained focused on the large corporate and governmental organization, but the logic switched from “in order to do anything, we have to do everything” to “ do whatever the customer needs us to do and work with what the customer already has”.
As a result of this, IBM’s innovation became customer driven and its targets started including what previously were competitors.
For instance, IBM in 1994 signed its first OEM agreement with an external customer: Apple Computer( further information on the matter at the “Key Activity” section).
This was a direct consequence of the adoption of a logic of service and of the impossibility to control and contain its technological edge for significant periods. IBM realized it was operating in an “abundant knowledge landscape”: the possibility to influence the future standards and protocol of the industry was much more appealing than defending its advantages for limited time periods.
What really changed, then, were customer relationships, and the channels IBM used to get to its targets.
Customer relationship
As stated before, customer relationships acquired a new relevance to IBM’s business, since customer themselves became drivers of innovation.
An important case to analyze, is the First Of A Kind (FOAK)program, which first started in 1995.
The FOAK “brought together IBM Researchers and clients to test new technologies on real business problems and growth opportunities”, as stated on IBM website. Through the collaboration with its customers IBM would be able to co-create new innovative solutions and export them to its business(possibility to use it in other circumstances), while the customer would get a solution to its problem[figure 3.1 p 44 OI]. Additionally, IBM would gain the ownership of the IP created by its staff and a “chance to expose its internal research staff to cutting-edge problems at its customers’ sites”.
As a result of this project, IBM has reorganized its research staff too, enlarging its duties. Researchers would be “knowledge brokers” other than “knowledge generators” and research managers would be assigned to a relationship manager with one of IBM’s businesses.

Another important example of the new role of customers for IBM is provided by the relationship between IBM and Citicorp.
During a meeting with a senior technical official at Citicorp, in fact, Mc Groddy (IBM former research chief) was shown the value chain of the company[ figure 5-1, p 103, OI] and he was challenged to state how much of the value chain he were helping him with.
That made clear that IBM needed to “do whatever the customer needs us to do and work with what the customer already has”, as the new IBM logic affirmed, and “create new products and services at the middle and top of the value chain” (Chesbrough, 2003).
This was one of the factors that contributed to IBM’s transformation from hardware producer to service provider( without abandoning its historical businesses).
Customer relevance has increased through the years, with many open source project and activities directed to acquiring customers’ tacit knowledge( see “ IBM today and make example”).

Channels
Channels connecting IBM with its targets were innovated as well. In fact IBM discovered Internet. This became a key resource for the enterprise, but it was also used to create a deeper connection with the customers. In time, internet would be used as a basis for the IBM cloud organization and to realize the various open source project the company leads. Moreover, having IBM strengthened its interaction with competitors and customers, it started to share researches and innovation processes with them. This led to an institutionalization of the relationships and to the creation of new ways to get in touch with them.
Value proposition
The value proposition of the company remained to deliver a complete solution(“ you won’t get fired if you buy IBM”). Nevertheless, IBM realized that, in order to create more value, it had to transcend its own R&D and to identify the best technologies outside, developing the ability to connect that technologies into effective solutions. It had to implement a logic of service and get beyond the NIH syndrome.
As stated before, IBM decided to tackle the middle and top if its targets value chain.
The relationship between this innovative logic and the process of opening that IBM was undergoing results clear by looking at FIG 5.2 p 109 oi
Key activities
IBM Key activities changed radically after the 1992 turnaround.
First of all, IBM adopted a service philosophy.
It realized that its expertise could be the basis for a service business, taking care of customers’ needs.
IBM stopped offering its own solutions only, but started suggesting competitive products as well, even helping to maintain the solution after purchase. The focus was, now, on delivering the most value possible to its customers. As stated by Chesbrough in its “Open Innovation Services”, a logic of service often leads to a greater efficiency and value creation, this is highly demonstrated by IBM’s own experience.
After having created a service philosophy, Gerstner broke out the service unit as a separate company: IBM Global Services.
Given the high volume of customers and its financial solidity, IBM Global Services could pursue economies of scale and invest in long-term profitability. Also, creating a different companiy helped to spread a certain internal culture, through training, HR processes and other initiatives.
IBM also innovated its key activities in the Software business.
In fact, Gerstner dismissed the OS/2. His colleagues were “unwilling or unable to accept” that OS/2 was a “resounding defeat” and that, despite its technical superiority it “was draining tens of millions of dollars, absorbing huge chunks of senior management’s time, and making a mockery of IBM’s image.” In 1994, then, IBM ceased the development of the OS/2 and engaged in a massive, multi-year effort to make IBM’s middleware section more open and network enabled. After less than 10 years(2001) Gerstner declared that IBM would spend $1 billion on open source software: Linux was officially affirmed in IBM. This marked the definitive end of IBM’s AIX system, but this also opened a new path in IBM’s story. In fact, IBM creates value through Linux and donates development tools and patents to increase its diffusion. Value is then captured through value added services and software “up the stack”.
Another new Key activity was represented by external OEM agreements.
In 1993 IBM signed its first OEM agreement with an external customer(Apple Computer) in which it agreed to sell its 2 ½ inch drive. The company decided that it would benefit more in selling extra 2 ½ inch drives than it would gain in the laptop market and by 1997 more than half the IBM’s production of 2 ½ drives was for other companies. Later on, a similar thing happened with MR- heads.
On the one hand, this lead to the opening of new markets (as Chesbrough states is typical of business model innovation in a logic of service, “Open innovation Services”, El Bulli case study) and on the other hand, it helped increase the volumes, reducing the costs per unit and realizing economies of scale.
It was important for IBM to acquire internal discipline, since it now could not win for the superiority of its chips but because of its own value added only.[ fig 5- p 109 OI]
Also, IBM established a research alliance with Toshiba Corp. Chartered Semiconductor Manufacturing Ltd. of Singapore and other firms to share the high costs and significant risks of developing leading-edge semiconductor processes. This is one of many example of cooperation in research that IBM implemented from 1992 on.
Eventually, IBM key activities started including IP management. IBM had a huge patent portfolio and engaging in outbound and inbound activities, it could monetize its knowledge, while acquiring new one at the same time.
With the closed innovation model, IBM was adopting a defensive approach towards its own IP, but in a world of diffused knowledge and in an open innovation approach IBM started playing offense too, by licensing-out many of its patents. This is still a significant source of revenue for the company.
Key Resources
Since Key activities of the company so drastically innovated, Key resources changed as well.
First of all, IP became a Key resource.
Many technologies developed by the R&D department couldn’t be used by the company, they might as well be sold out.
Recently, IBM has created a dedicated group to this issue. Lasser(the vice-president of the group ) stated that while almost 80% of the research department’s output went into IBM’s core business, 20% had no practical application for the firm. Her job was to develop alternative business model for this 20%. This could free up resources and management to look at new opportunities and enable IBM to make some profit from an otherwise unused idea.
Defensive approach would want IBM to preserve design and innovation, while the offensive approach IBM adopted fit more with a dinamic knowledge environment. “If IBM expects its product market advantages to come under attack quickly, then it might prefer to obtain direct compensation from infringing competitors and monetize its IP more broadly and rapidly instead”(Chesbrough, 2003).
Additionally, open source and Internet became IBM’s fundamental assets.
As Cawley(Vice president strategy at IBM) stated, IBM currently spends about $100 million on Linux, half of which are spent on “things that IBm needs, such as drivers for particular hardware or software to connect with it”. Other companies, spend about $800 million a year for their OS. Moreover, this is a great source of revenue for the company, with the add-on software and the related services that are offered.
Internet for IBM is the means that enables open source software and a tool to manage and coordinate enormous amount of information and to access external technology and knowledge.
In the earliest ‘90s IBM developed the “cloud” concept and it still is the center of its organization. Of course, open cloud projects and platforms are now being created but the innovation in the basic logic come directly from that turnaround. Gerstner predicted that, to succeed, the company would need to become an e-business company and to implement the software and service( web hosting) aspects of its business.

Revenue stream
As soon as Gerstner decided to keep IBM together, a hunt for new revenues started.
Finding new key resources and activities was a direct consequence of this process.
First of all, it is possible to analyze the influence that licensing-in and licensing-out had on revenues.
IBM first got the idea to license-out its patents by looking at Korean firms. They wanted to acquire “patents, technology, know-how, trade secrets..” and by acquiring it from Japaneese firms, they were growing fast.
As a result of this, Gerstner decided to start licensing-out. There was a strong internal resistance to this move, but IBM’s financial distress meant that the only alternative would have been to undergo another round of layoffs.
With time, this resulted being an incredible smart move and IP selling is, now, one of the biggest source of revenues for the company.
In 2001 only( less than 8 years after its crisis) IBM was making $1.9 billion in royalty payments(17% of EBIT), while spending only $600 billion on research.
Moreover, IBM developed its own patents database( connected to all of USTPO patents), adding additional feature to make the patent easier to locate. Being IBM one of the major players in the IP business it would significantly increase licensing and royalties. Additionally, IBM would acquire data on the IP demand and improve its business. Recently, IBM cooperated with the Internet Capital Group and spin-off its patent database into a new company: Delphion.
Eventually, IBM has become a foundry for young companies seeking to enter the industry of semiconductors. In fact, IBM has leveraged its portfolio to enter in cross-licensing agreement with most of the major industry players( e.g. Intel), receiving payments and accessing others companies IP in exchange for its own. By using IBM as a foundry, new companies also buy IP insurance policy. In many cases, the ownership of extensive IP gives IBM a significant competitive advantage in supplying complex products. In fact, products come with IP assurance that protects from infringement actions of other companies.
Switching to a logic of service and providing IT solutions was another great source of revenues for IBM. Not offering 100% IBM solutions only allowed the company to increase the volumes(and revenues) while reducing marginal costs. Now it is a major revenue source for the company( in 2008, IBM Global technology services and Global business services accounted for 1.3/1.8 points of profit margin increase)also thanks to the new BM(type 5) that IBM Global Services realized.
Open source became a major revenue source. In fact IBM monetized its open source focus by offering related services and support. In time, IBM’s Investments on Linux paid off remarkably. For instance, in 2000 IBM invested $1Billion and dedicated 1500 engineers to Linux, but by 2003 IBM was already getting returns of about $2billions per year and had revitalized its mainframe business as well. Today, open source is a fundamental IBM revenue source.

Cost stream
Such as for the revenues, IBM cost stream changed together with its activities.
First of all, many non-essential assets were sold to increase liquidity. Much of the corporate fleet was sold and New York HQ was put on the block. There was an auction of many pieces of the company’s art collection and IBM’s federal system company[ which handled governmental relationships
Moreover, the use of Open Source allowed IBM to save $700/750 millions per year to develop its own OS.
Also, cooperation in research project and production activities reduced the high costs and the risks taken by the company.
Eventually, external OEM agreements allowed IBM to increase its volumes and to reduce the costs per unit.

NB: ho deciso di rappresentare la BMI di IBM secondo il BMcanvas perché é uno strumento con cui ho maggiore familiarità. Se dovesse reputare più opportuna un’analisi con il component business model di IBM(che visto il case study, in questione immagino possa essere appropriato) posso provare. In tal caso vorrei chiederle un consiglio su come individuare il “partner network” di IBM all’epoca, che non mi risulta semplice.