System failure that brought down IBM: Technological change overtook the computer giant and now its culture needs to change. David Bowen and Mary Fagan report

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MAYBE John Akers, chairman of IBM, should grow his hair and wear wild ties. Sir John Harvey-Jones did, and used his industrialist-hippy look as a signal that he was trying to change the culture at crisis-ridden ICI.

IBM is in crisis too, and has been trying to change. So far, though, the Harvey-Jones tendency has been restricted to outposts of the vast empire. Nick Temple, chief executive of IBM UK, has been spotted with his shirt tails hanging out; Alan Willsher, a Briton in charge of the new Individual Computer Products International, was interviewed wearing a plaid jacket and yellow tie. But at the heart of IBM in Armonk, New York, the dark blue suit rules. Thomas Watson, who made the company mighty, insisted that all dress soberly - and they still do.

Five years ago, a book called IBM: How the world's most successful corporation is managed was published. It followed another subtitled The world's most successful marketing organisation. Now, after last week's announcement that it lost dollars 4.96bn ( pounds 3.28bn) in 1992, it is the world's most unprofitable company. The reason is simple: the men in blue have been unable to change fast enough.

For a famously moralistic group, IBM had an inauspicious beginning. It was originally formed as a combination of three companies, called Computing Tabulating and Recording, by a sometime arms dealer, Charles Flint. The man who brought it to greatness was Thomas Watson, who went to work for Flint while he still had a prison sentence hanging over his head: as a salesman for NCR, Watson had been over- enthusiastic in crushing the rivals in his patch, and had been indicted in an anti-trust suit.

But he was apparently converted to high ethics and insisted that the salesmen at CTR - or International Business Machines as it was named in 1924 when he became chairman - behave in an 'honest, fair and square way'. As well as wearing dark suits and white shirts, they had to behave themselves at all times - at home or work.

Even when salesmen let their hair down, they did it in the IBM way. They enjoyed themselves at company-owned country clubs; they indulged in theatricals, a tradition that still lives on in company songs. Watson set up training schools, stuck up slogans (saying THINK) and, most unusually, instituted a lifetime employment policy.

It is no coincidence that these ideas resemble the Japanese management style. When Tokyo's Ministry of International Trade and Industry was casting around for 'best practice' to copy in the 1950s, it studied American textbooks and found much mention of the celebrated IBM way. If IBM was not the father of Japanese corporate success, it was at least an uncle.

IBM's real strength, however, was selling, and it was this that made it the dominant supplier of punched-card tabulating machines - early data processors. During the Second World War, it quadrupled in size as its machines were used to control logistics. It also produced its first electro-mechanical computer, 51 feet long and eight feet wide.

Watson's son, Tom jr, took over in 1952 and pushed IBM into electronic computers. R&D spending was tripled and IBM started to close the gap on the original computer maker, Univac. New ranges pushed its sales to dollars 2.3bn by 1964. That year, the 360 range was launched. This was the product of the biggest privately financed programme ever, and made IBM unassailable in large computers. Having invested in an IBM, which was incompatible with anything else, it was a brave manager who dumped it for another system. As the use of computers exploded, IBM became ever mightier.

David Wu, analyst with SG Warburg in New York, says that even in this phase, IBM was not driven by technology but marketing. 'It beat Univac because it paid more attention to customers,' he says. 'It always had the best service.' It did not, however, stick too closely to Watson's ethical guidelines: salesmen sold FUD - fear, uncertainty and doubt - to dissuade customers from buying from less secure companies.

The 1960s and 1970s were IBM's heyday. In 1973, its sales went through dollars 10bn; in 1978, dollars 20bn. By then it was run by IBMers - grey men viewed as safe pairs of hands who would maintain the strange combination of aggressive marketing and cosy paternalism that made the company so different. This image is not quite fair. Frank Cary, who took over in 1973, tried to stir it to such an extent that the wits decided IBM stood for I've Been Moved.

In retrospect, it is clear that even then IBM was not doing enough, and that it was allowing itself to be overtaken by the quick march of technology. Its base was the mainframe, the cumbersome central computer. But by the late 1970s there was already a shift to smaller, more powerful machines. Mainframes' share of the market fell from almost 80 per cent in 1974 to less than 30 per cent 10 years later. First minicomputers and then personal computers took up the pace, and the leviathan did not keep up. 'IBM forgot what made it successful - listening to customers and looking after them,' says Mr Wu.

Its culture and organisation were geared to a huge workforce selling expensive and profitable machines. Even now, a dollars 1m mainframe can generate dollars 800,000 of profit. But the trend of the last 10 years, accelerating hard in the last five, has been towards machines that are bought off the shelf and are increasingly standardised.

Ironically, IBM contributed to this shift. When it decided to join the personal computer market in 1981, it did so in a big way. It set up huge factories and soon established its PC as the standard machine. But instead of using its own researchers to develop the core processing unit and software, it bought them in from two specialist companies, Intel and Microsoft. As a result, other companies were able to 'clone' IBM computers using the Intel chip and MS-DOS operating system. It soon became clear that clones could be as good as an IBM - and they were cheaper.

In some industries, size will always win because the economies of scale are so great. Not so in computers. 'Component prices don't differ that much because there is so much competition between suppliers,' says Michael Spiro, financial director of Elonex, a London- based PC manufacturer. 'We can undercut IBM because our overheads are much lower.'

In addition, he says, smaller companies are nimble. 'The bureaucracy at IBM is so much heavier: in our company we can decide on the spend and just do it.' Light-footedness has become increasingly important as the pace of change has accelerated, driven largely by Intel's introduction of ever more powerful chips. IBM is fighting back with the Ambra, its own clone made in factories that are supposed to benefit from the small-company culture. But it has probably missed the bus.

It has also been undermined by machines and software that can be linked to other makes. Slowly but surely, companies have realised they are not locked into one brand. The only profitable computer firm in Europe, ICL, was early to jump on this 'open system' bandwagon.

As computer hardware became more and more a commodity, the real power moved to software suppliers. On Friday, the market capitalisation of IBM was overtaken by that of the once-tiny Microsoft.

IBM's bosses realised in the mid 1980s that they had a problem. Even as net profits soared above dollars 6bn a year in 1984 and 1985, they started to cut their overheads. John Akers, who took over as chairman in 1985, junked the lifetime employment policy and brought the headcount down from 407,000 to 300,000. Last month, he announced that another 25,000 jobs would go this year, and analysts say there will be more.

Mr Akers has also acknowledged that IBM, whose turnover last year was dollars 65bn, is too big. He has broken it into more than a dozen companies, which are supposed to operate at arm's length and even compete.

IBM says its empire has become a federation of autonomous parts. The parallel with the metamorphosed Soviet Union is self-conscious - but while the company may like to highlight the new freedom, others think only of the difficulty of changing an entrenched culture. 'Everybody's looking over everyone's shoulder,' says John Logan, executive vice-president of the Aberdeen Group, a Boston-based consultancy. 'When no one is quite sure of the rules, the blue-suit methodology just doesn't work.'

The massive loss, the result of a dollars 7.2bn charge for restructuring, is unlikely to be repeated, and Mr Wu believes IBM will move into the black in the fourth quarter of this year. There will still be a demand for mainframes for the biggest computing tasks of all, and it will be able to make money as a large, but not dominant, producer of personal computers.

IBM will never again enjoy hegemony in the world of computers. But it can, analysts say, become the world's biggest supplier of computer services, using its unrivalled network to help companies build the systems they need. That would be like General Motors giving up cars for traffic-guidance systems, and it can only be done if IBM is prepared to throw away the baggage of its past. Is Mr Akers the man for the job? Many believe he is too much of an IBMer and that he should be replaced. If he wants to prove them wrong, he could start by throwing away his suit - and getting the name of Harvey-Jones's tie shop.

IBM'S LOSS last year of dollars 4.96bn ( pounds 3.28bn) was the biggest corporate deficit ever, just ahead of General Motors' 1991 loss of dollars 4.45bn. But if inflation is taken into account, both slip some way down the list.

According to the Guinness Book of Records, Argentina's state oil company, Yacimientos Petroliferos, takes the prize with a loss of dollars 4.6bn in 1983, but given the country's hyperinflation this figure should be treated with caution.

The National Coal Board, now British Coal, is a strong contender. In the year to March 1985, when the miners' strike was running, it lost pounds 2.2bn. Allowing for price increases, that is certainly above IBM's loss, while British Steel's 1979-80 loss of pounds 1.8bn also puts it in the race.

(Photographs omitted)