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A letter from the Chairman

Dear IBM Investor: As I write to you, the global economy is experiencing profound disruption. There is a great deal of understandable and appropriate anxiety about where we are headed in the near and medium term. Many approaches are being offered to stimulate economic recovery and growth. And it is clear that IBM’s industry, as well as many others, will look very different a few years from now.

You need to know, in this time of turmoil, that your company is well positioned to continue delivering strong results, as we have been doing and did again in 2008 — achieving record revenue, record pre-tax earnings, record earnings per share and record free cash flow. Even more importantly, we are also positioned to lead in the new era that lies on the other side of the present crisis.

In this letter, I will explain why. I will describe how this moment of historic change presents an opportunity for IBM, not only to assert leadership in our industry, but to play a central role in changing how the world literally works. Our confidence is grounded in the strategic transformation of IBM over the past several years and the focused execution of nearly 400,000 dedicated and innovative women and men around the world.

IBM is now a very different company than it was just a few years ago. As a result, we entered this turbulent period strong, and we expect to exit it stronger.

A New Era – and a New IBM

What explains our strong performance, when so many of our competitors and other companies across business are struggling during a deep economic slowdown? The answer lies at the beginning of this decade, when the IT industry and businesses everywhere were confronted by three fundamental shifts in the world:

1. THE REALITY OF GLOBAL INTEGRATION. I don’t mean simply the widely shared recognition that the world was becoming “flat,” but the way in which that was happening, and what it meant for the goals and the very forms of organizations. The lowering of trade barriers, the rise of the developing world and the emergence of the World Wide Web combined to unleash the flow of work on a truly global scale. Therefore, the key questions facing leaders of all kinds became: How will we get that work to flow to us? How will we differentiate ourselves in a global economy? And how will we capture the new growth opportunities that are emerging around the world? Increasingly, new business models — in fact, a new model of the corporation itself — began to take shape. At IBM, we called it the Globally Integrated Enterprise.

2. THE EMERGENCE OF A NEW COMPUTING MODEL. This new model, which was replacing the PC-based, client/server approach, was networked, modular and open. Just as important, it was no longer confined to IT systems alone. Increasingly, the digital infrastructure of the world was merging with the physical infrastructure of the world. And that was creating a new platform for the global economy and society. We are now living in a world that is:

– INSTRUMENTED: Computational power is being put into things no one would recognize as computers: phones, cameras, cars, appliances, roadways, power lines, clothes — and even natural systems, such as livestock and rivers.

– INTERCONNECTED: All of this is being connected through the Internet, which has come of age.

– INTELLIGENT: We now have the computing power, advanced analytics and new computing models (such as “cloud”) to make sense of the world’s digital knowledge and pulse, and to turn mountains of data into intelligence.

3. INNOVATION AND INTEGRATION. Because of this new global arena and new technology model, business leaders expanded their horizons — driven both by competitive pressures and the remarkable array of new capabilities. No longer content with cost savings from off-the-shelf technologies and solutions, they were seeking to innovate — and not just in their products and services, but also their business processes, management systems, policies and core business models. To accomplish that, they sought to integrate advanced technology far deeper into their operations.

At IBM, we saw that these shifts would reshape the economic, technological and competitive landscape, and open up enormous business opportunity. So we made some important decisions, and we got to work.

GLOBAL INTEGRATION: We made major investments in our teams and capabilities in emerging markets around the world. This is helping us achieve superior growth in emerging markets — not only in the so-called BRIC countries of Brazil, Russia, India and China, but in dozens of countries across the developing world. At the same time, we accelerated the global integration of IBM’s operations. As a result, our supply chain, research labs, software development and service delivery today are truly global in scope. We have made substantial progress toward remaking IBM into a Globally Integrated Enterprise, with more still to do.

TECHNOLOGY: We transformed IBM’s mix of products, services, skills and technologies — exiting commoditizing businesses like PCs and hard disk drives, and making more than 100 strategic acquisitions this decade. We also shifted our internal R&D. Of the more than 4,000 U.S. patents IBM received in 2008 (our 16th straight year of patent leadership), more than 70 percent were for software and services. IBM’s portfolio today is built around networked, modularized and embedded technologies, such as service-oriented architecture (SOA), virtualization, business intelligence and analytics. As a result, we are well positioned to build the kinds of IT infrastructures and solutions that will be of the highest value to our clients.

BUSINESS: The kind of value our clients sought required a partner with intimate knowledge of their industry, and with the ability to turn that knowledge into company-specific operational and management systems. You can’t do that on a global scale from corporate headquarters. So we not only amassed considerable industry expertise, but also made major changes in how we deploy it. We shifted skills and decision-making closer to the marketplace and the client. At the same time, we transformed our vast services delivery capability. We applied automation, standardization and the kinds of engineering and management principles that were long ago adopted in manufacturing and supply chains. The results are showing up in our margins and in our best-in-class levels of service delivery client satisfaction.

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