Understanding IBM’s business model and its consequences for our client relationships, workforce strategy, management systems and economics is key to understanding why and how we have transformed the company over the past few years. And that, in turn, is the basis for our optimism about IBM’s ability to capture the most attractive marketplace opportunities now emerging.

Although IBM began life as a maker of clocks, scales, electromechanical tabulators and other industrial equipment, it has never defined itself in terms of particular products or technologies. Even when the company emerged as a leader in “computation,” it was constantly developing new kinds of computational technology and new ways of applying it — from automating the new U.S. Social Security system with punch card tabulators in the 1930s; to pioneering electronic banking, retailing and airline reservations with the mainframe in the second half of the 20th century; to setting a standard for and driving the commercialization of personal computers in the 1980s.

The one, near-fatal exception occurred during the late 1980s and early 1990s. For the first time in IBM’s history, the company failed to adapt to changes in technology, competition and client needs, despite the fact that IBM itself had created many of the disruptive technologies of that time. The company remained heavily dependent on its highly successful innovation of the prior era: the mainframe, and all of the businesses, distribution channels and economics that hinged upon the mainframe’s continued dominance. However, the rise of alternative, lower-cost technologies, a new computing architecture, the proliferation of niche competitors and changes in client buying patterns combined to overwhelm the company and led to large market-share and financial losses.

The hard-learned lessons from that period are directly relevant today, in at least two respects. First, the IT industry is again undergoing fundamental change on many levels simultaneously, which will once more create winners and losers. Second, many of the actions IBM took to recover from its near-collapse put it in a strong competitive position for this new era, a position that the company has substantially strengthened in recent years.

IBM, forced to adjust to new realities, did so across the board. This included entering and building significant businesses in enterprise software and services — markets which together grew from 49 percent of industry revenues in 1995 to 59 percent in 2004. For IBM, software and services today constitute 16 percent and 48 percent of the company’s total revenues, respectively.

IBM’s gross profit margins in the mainframe era were unsustainable. So the company recalibrated its economic and cost structure to be competitive, while maintaining margins sufficient to fuel our high-value innovation business model. It created distribution and go-to-market channels to reach new decision makers and to increase sales coverage. It migrated all of its hardware and software platforms to high-performance technologies. And it shifted from proprietary to open architectures.

These capabilities have been dramatically enhanced and augmented in recent years. Today, IBM’s strengths in business consulting, systems integration, IT and business transformation outsourcing, open enterprise software and high-performance hardware provide the company with a strong hand to capture the most promising opportunities that lie ahead. These opportunities involve doing new kinds of work for clients — work that is deeper and more complex, and for which traditional IT companies have not typically competed.

From its start, the IT industry has been characterized by the cycle of innovation and commoditization — and with it, high risk and high reward. Companies that create new, high-demand technologies and services enjoy, for a time, barriers to entry and superior margins and pricing power, for the simple reason that there are few or no other providers of that technology or service. However, alternative technologies or capabilities inevitably emerge, decreasing or eliminating the innovator’s advantages. In short, that segment of the industry commoditizes. There are still attractive opportunities to be pursued, but with much less profit potential.

This innovation-commoditization cycle has never been more pronounced than it is today, and it forces distinct choices for both competitors and investors in the IT industry. Winners can be the innovators — those with the capacity to invest, manage and leverage the creation of intellectual capital — or the commodity players, who differentiate through low price, economies of scale and efficient distribution of other parties’ intellectual capital.

Perhaps the greatest risk is to get squeezed in the middle — being attacked by low-price competitors, while lacking the expertise and intellectual capital to keep up with the most aggressive innovators.

Understanding, anticipating and managing the forces of innovation and commoditization are essential to increasing shareholder value and mitigating risk. This is a core aspect of IBM’s business model, and it has allowed the company to create value for clients and investors for nearly a century.