FIVE
Lenovo
IBM Lends a Hand

When was the last time you saw a successful acquisition or merger in the computer industry?

—Michael Dell, founder and CEO of Dell, Inc.

ON DECEMBER 7, 2004, Lenovo, China’s top computer company, astonished the world with the announcement that it was acquiring IBM’s personal computer division for $1.75 billion. It appeared to be an exceptionally bold move for a relatively young Chinese company and a sign of its determination to extend its global reach. Fang Xingdong, the chairman of Blogchina.com and a well-known pundit on information technology issues, called it “a magnificent acquisition.” He added, “The new Lenovo becomes a major global player in the PC industry overnight.” Fang predicted that Lenovo would be getting “IBM’s first-rate products, technology, brands, market, channels and management.”¹

A little more than four years later, on February 5, 2009, Lenovo seemed to be hovering on the edge of catastrophe. The company announced a quarterly loss of $96.7 million, and it confirmed the departure of CEO William Amelio, a former Dell executive who had taken the job only three years earlier. Lenovo’s chairman, Yang Yuanqing, replaced Amelio with the company’s founder, Liu Chuanzhi, who took over the duties of chairman. Yang and Liu both concentrated their efforts on stabilizing the company, and Liu had to be asking himself whether Michael Dell didn’t have a point: Mergers in the computer industry can turn out to be far more complex and unpredictable than they first appear.

Only a year after its dramatic quarterly loss, Lenovo recorded an $80 million profit for the same quarter and was back on track as the world’s fastest-growing computer company and fourth largest manufacturer of PCs. Turning Lenovo around, however, had required abandoning IBM’s vision of the industry and effectively abandoning the American market approach for a model that was specifically Chinese. For Liu Chuanzhi, Lenovo’s journey to becoming a major player on the global technology scene had been a dizzyingly informative ride.

Written in the Stars

In Chinese astrology, 12 animals symbolize the zodiac. The first is the rat, known for its intelligence, nimbleness, cunning, and aggressively entrepreneurial spirit. It may have been a coincidence, but in 1984, a year of the rat, the world witnessed the launch of a group of extraordinarily enterprising Chinese companies, including Haier, TCL, Chint, Vanke, and Lenovo.

The company that was to become Lenovo got its start on November 1, 1984, when the Computer Technology Institute of the Chinese Academy of Sciences authorized about $25,000 for its 11 computer scientists to set up a private company calling itself the New Technology Developer, Inc. Liu Chuanzhi, who had just turned 40, was one of the original founders. Born in Shanghai and raised in Beijing, Liu graduated with an engineering degree from Xian Military Communication Engineering College in 1966. During the Cultural Revolution, he was sent to a state farm to do manual labor, but within two years, he had managed to join the Computer Technology Institute.

His work focused on magnetic storage. At the time, it was hard to see much of a commercial future in China in such an esoteric field. There were no products or markets for the designs he was working on, and the Cultural Revolution had cut investment in research and development to a minimum. Liu recalled:

No new houses had been built since the Cultural Revolu -tion, so people just crammed into buildings as the population grew. Three other colleagues, scientists who were ten years older than I was, lived with me in a 12-square-meter room the size of a bicycle shed. I can’t even call it a house. The walls were just a single layer of brick. It was impossible to stay warm.

In 1984, China had just begun to engage in market reforms, and a new emphasis was put on turning R&D into useful products. The new venture that Liu helped found was given a mandate to commercialize the Computer Technology Institute’s research and hopefully to generate enough money to improve living conditions for its scientists. If possible, it would also help to pay for improving the Institute’s scientific research.

Liu soon found himself riding a bicycle across Beijing, looking for promising business opportunities. To finance the salaries for its employees, the new company experimented with selling electric watches, roller skates, sportswear, and refrigerators. On one occasion, Liu put up $17,500 in a deal to buy color TVs, which turned out to be a scam. The fraud briefly shook Liu’s confidence and nearly sank the struggling company, but soon afterward, Liu’s luck improved. IBM asked the company to represent it in China, and as it turned out, IBM was a hot product. The sales from IBM alone generated enough revenue to keep the fledgling company afloat.

The Institute’s own software soon provided an even bigger windfall. Ten years earlier, the Institute had started working on an innovative computer circuit designed to translate a computer’s English text into Chinese characters. The scientists who had worked on the project were assigned to the new company. They developed a prototype on a card that could easily be plugged into a computer’s main circuit board. In April 1985, the company launched its invention on the commercial market as the Legend Chinese Character Card. The name Legend means “association” in Chinese, and one of the card’s most attractive features was its ability to immediately come up with Chinese characters relating to anything typed on a keyboard. The program would then suggest multiple choices as possible translations. The Legend Card was an instant hit and became an essential add-on for PCs imported into China. It was soon bundled with most new PCs entering the market. The company generated substantial sales, and the card’s success made New Technology Developer the distributor of choice for anyone importing computers into China. In 1989, the company changed its name to Legend.

Growing Pains

In 1990, Legend introduced its own branded PC in China and became a computer producer as well as a distributor of foreign imports. The initial focus was on business clients, but Legend soon found that its lack of financial backing made it difficult to compete head-on with foreign PC makers. In 1994, the stress of trying to keep Legend afloat led to Liu being hospitalized. As it turned out, the forced vacation gave Liu an opportunity to rethink Legend’s strategy. When he left the hospital, Liu decided that in addition to having the company focus on the office market, he would create a consumer PC division, targeting individuals who wanted computers for personal use. Liu pioneered the home PC concept in China to the Chinese market. PC 1+1 stood for “one home, one computer” or “one child, one computer.” The idea was that the computer was something you could use for your own amusement and enrichment, and that it was not a machine limited to office work. The separate division was headed by Yang Yuanqing, who was 29 years old at the time and had joined the company as a salesman in 1988.

Taking the Lead

Chinese PCs were usually a generation behind the West, and Liu decided to change that. Teaming up with Intel, Legend launched its first Intel Pentium PC in China just as Pentium PCs were going on the market in North America. Legend was soon able to boost its sales volume dramatically by selling Pentium-chip–powered PCs at much lower prices than the competition. Before long, the company began overtaking foreign brands in China. By 1996, it was clearly a market leader. In addition, Legend had previously focused on desktop computers, but it introduced its first laptop in 1996. The company was beginning to show a knack for balancing innovation and cost. Ease of use was another advantage. One of Legend’s cheapest models allowed inexperienced users to get on the Internet by just pushing a button.

By 1999, Legend was ahead of its competition with a 21 percent share of the market in China and 8.5 percent of the Asian market. In 2000, Liu decided to spin off his distribution business for imported PCs and services. The new company was called Digital China. In 2001, Yang Yuanqing, who had headed the consumer division, was appointed CEO of the entire company. By then, it controlled 30 percent of China’s PC market.

In 2000, however, the consumer market was beginning to reach saturation. Legend’s growth, which had been compounded at 30 percent over the previous six years, also flattened out. Domestic PC makers found themselves caught in price wars, while foreign PC makers, including Dell, were gaining ground against domestic players. The growth potential in China was beginning to look limited. Yang was still determined to make Legend a top Fortune 500 company within the next ten years, but consumer PC sales, which had been driving the company’s growth, remained static. In an effort to continue growing, the company tried to diversify.

Diversification Fails

By the year 2000, more than 100 million Chinese were using the Internet, which created a vast range of new business opportunities. From 2000 to 2003, Legend was swept up in the dot-com fever and invested heavily in Internet companies. In August 2001, Legend spent $35.37 million to acquire 40 percent of the outstanding shares of Yestock Information Technology Co. Ltd. It hoped to cash in on e-commerce trading in securities over the Internet. In December 2001, it invested in New Oriental Education & Technology Group, Inc., a company focusing on providing online training. In partnership with AOL Time Warner, it invested in an Internet company called FM365. The total investment in Internet businesses exceeded $100 million.

Legend also briefly explored moving into IT services. The technology research firm Gartner predicted that the IT services business in China would increase 3000 percent from 2000 to 2007. The forecast was based mainly on the expectation that all levels of government would eventually need to go online to increase services and transparency. In 2000, China had initiated a program to encourage business enterprises to set up corporate websites. As demand increased, Legend added IT services to its diversified portfolio, although its total investment in IT services added up to only around $13 million.

In 2001, the penetration rate of Chinese mobile phone usage was 11.2 percent, less than half of the standard rate in Western countries. Legend saw the potential and invested nearly US $11 million in a joint venture formed with Xoceco to manufacture and sell cell phones.

When the Internet bubble finally burst in 2003, Legend’s investment in Yestock decreased to 90 percent of its former value, and its ventures into online training and FM365 had to be closed with losses. The company had spent $25 million on FM365. IT services also continued to lose money. By the end of 2004, the company’s share in China’s PC market had dropped to 24 percent, a significant decline from the 30 percent it had held just three years earlier. The diversification strategy had obviously been a failure. Noncore businesses including the Internet and IT services were spun off. Legend determined to return to its core business: personal computers.

An International Strategy Proves Problematic

In an interview with McKinsey in 2001, Liu Chuanzhi appeared undecided over whether to sell under his own brand or take the OEM approach. Legend’s past performance in China had been driven by the company’s ability to leverage competitive advantages, but once the company was selling overseas, the advantages offered by the market in China would no longer be relevant. Liu felt that the situation called for caution.

Taiwan, which already had considerable experience in electronics manufacturing, had tried to break into western markets for computers using its own brand names and had failed to compete successfully with established foreign brands, and Liu was afraid that Legend would run into the same kind of resistance. The safer approach might be to remain an original equipment manufacturer or to team up with a Taiwanese company and try to build a brand together.

While Liu was deciding whether to adopt the OEM approach or form an alliance with a Taiwanese company, he had begun selling PCs in Hong Kong under the Legend brand. To test the international waters, the company had arranged in September 2001 to sell its PCs through more than 50 outlets owned by Fortress, Hong Kong’s largest consumer electronics and household appliances retailer. Hong Kong had traditionally been dominated by international brands such as IBM, Compaq, and Dell. Legend did not have much impact on the market. The next year, Legend tried to expand into Spain and a few other regional markets. The loss of market share in China forced Legend to make a strategic retreat from its efforts at foreign expansion.

When the company tried to establish its brand overseas, it soon became apparent that other companies had already registered the name “Legend.” Something needed to be done. “We needed to have an English brand name that could be used without restriction in all countries,” Yang explained. Although still focused on the China market, Yang realized that the IT business would eventually have to go global, and going global required building a brand name that could be used everywhere.

In 2003, Legend changed its name to Lenovo. The new name combined the first two letters of Legend with the Latin word novo, meaning “new.” The idea was to reflect both the spirit of innovation and novelty. In April 2004, Lenovo formally changed its name to Lenovo Group Limited. “The board of directors believed the alignment of the English brand name and the company name would help to raise the recognition and popularity of the brand,” Yang explained. (The name in Chinese remained unchanged.) However, despite the hopes it had pinned to its international strategy, international sales dropped to less than 2 percent of total revenue in 2003. Then an acquisition that promised to be a game-changer suddenly appeared on Lenovo’s radar at precisely the moment when it needed it the most. The target was nothing less than IBM’s PC division.

IBM Reinvents Itself

IBM had introduced its first personal computer for business in 1981, which quickly became known as the PC. Computers in business had until then tended to be massive machines tightly controlled by technicians under the watchful eye of a company’s headquarters. The introduction of the Apple 2 computer and the Radio Shack Model 1 had interested amateurs at first, but it soon became apparent that a small computer could be useful for businesses at the corporate level as well as to individuals in their daily lives. As the market for personal computers expanded, IBM’s decision to put its own desktop computer on the market effectively legitimized the personal computer for business. The IBM PC was largely assembled from off-the-shelf components bought from other manufacturers. But for most business executives, the IBM brand name was all it took to make the desktop computer a credible business machine. Few executives knew much about computers at the time, but everyone knew that IBM had a solid reputation. For corporations, investing in hundreds or thousands of computers, choosing IBM was a no-brainer. Even if equivalent computers made by other manufacturers were cheaper or performed slightly better, IBM would still be there tomorrow, and that counted for a lot.

To make its new computers work, IBM turned to a youthful Harvard dropout named Bill Gates and his pal, Paul Allen, who cobbled together an operating system based on some work that they had bought from another programmer. The original system was called QDOS, for “Quick and Dirty Operating System.” Apple soon equipped its operating system with a graphic user interface that allowed folders and files to be visually organized on a screen. Apple had based its system on work being done by Xerox’s Palo Alto Research Center. Xerox never pushed the concept itself, but when Apple incorporated it into its Macintosh computers, the graphic interface became an instant hit. Microsoft, the company founded by Gates and Allen, modified their system, renamed Windows, to give it a visual interface as well. Because most people in business wanted an IBM PC, Microsoft Windows ended up dominating the market. Computers that could run Windows and its accompanying programs became known as IBM-compatible PCs.

In contrast to Apple, which designed its chips and operating system exclusively for its own computers, Microsoft’s Windows could run on any Intel-based computer chip that followed the same architecture as an IBM PC. As copycat vendors, led by Compaq, began to sell their own IBM-compatible PCs, an entire industry developed. Chip makers such as Intel and AMD and software companies such as Microsoft and Lotus drove remarkable growth of PC usage both in business and at home. However, the real money in the PC industry moved to software and the chips or integrated circuits that made the PCs run.

IBM was itself assembling parts bought from other manufacturers. The difference was that IBM’s machines usually cost more than the competition’s and often underperformed competing computers that sold in their price range. Assembled PCs were gradually becoming a commodity. The transition helped Dell, which offered to tailor its computers to the no-frills, basic needs of each of its customers. By eliminating the extras that might make a computer more versatile but were likely to go unused in most offices, Dell thrived at operating on razor-thin margins. It generally sold its computers directly to customers on order. Because it could eliminate superfluous components, it was able to undercut most of the competition, and it soon became the market leader in PC business sales. IBM was either unwilling or unable to match the Dell model, and it incurred losses that were becoming a drag on its other businesses.

GETTING OUT OF THE PC BUSINESS?

After several attempts at restructuring failed, IBM considered getting rid of its PC business altogether. Lou Gerstner, who headed IBM at the time, remarked that nothing was unthinkable at Big Blue. IBM had dumped a number of businesses when their profitability was threatened by market erosion. These included various timekeeping devices, card-sorting machines, videodiscs, typewriters, and printers. As management professor Mark J. Zbaracki put it, “IBM’s strength historically has been reinventing itself.”

IBM had sensed early on that the global IT industry was moving into a new phase, and the company’s strategists predicted that the emphasis would soon shift to software. Profits from hardware manufacturing would decline from 58 percent in 2000 to 42 percent in 2005, while profits from software development would increase from 29 percent to 41 percent. In this period, IBM sold its hard-drive business to Toshiba and its disk-drive business to Hitachi. The company also shed its display and network processor businesses. In 2002, IBM acquired PriceWaterhouseCoopers’s services. By adding other software companies such as Tivoli, Rational, and Informix, IBM successfully transformed itself into a services, software, and consulting company. IBM’s PC business was put up for sale.

IBM TRIES TO MAKE THE SALE

In 2000, shortly after Samuel J. Palmisano was named IBM’s president and CEO, IBM’s efforts to find a way out of the PC business took on a new urgency. IBM approached a number of PC makers in hopes of selling the company’s ailing unit. The price sought by IBM was a major obstacle. IBM wanted $3 billion to $4 billion, and it had difficulty finding anyone willing to pay that amount for a business that was already in trouble and had a questionable future. In 2001, IBM approached Legend for the first time.

IBM’s then CFO, John Joyce, went to Beijing to discuss a potential sale in 2002, but Legend rejected the offer. IBM’s PC business had lost nearly $400 million the previous year. That added up to almost four times Legend’s total profits for the entire year. To make its offer more attractive, IBM performed radical surgery on its PC division, slashing costs and outsourcing manufacturing.

In July 2003, before beginning formal talks with Legend, Palmisano arranged a private meeting with a senior Chinese government official in charge of economic and technology policy. Palmisano explained that IBM was interested in helping Legend create a global enterprise. IBM would contribute its expertise in technology, management, marketing, and distribution. Building a truly international Chinese-owned company would demonstrate China’s desire to invest abroad instead of merely serving as a manufacturing hub for the rest of the world.² The Chinese official replied that this was exactly where China wanted to go, but unfortunately, times had changed. Chinese authorities might have orchestrated such talks a few years earlier, but they were now reduced to the status of observers. IBM needed to negotiate with Legend on its own. IBM never really knew whether the official had interceded on its behalf or not, but the discussions resumed with Legend suddenly expressing a renewed enthusiasm for going global.

THE TALKS CONTINUE

Liu was now open to a deal, but he still insisted on caution. Mary Ma, Legend’s CFO, flew to New York to follow through on the discussions, but Liu warned her not to fall in love with the deal. As it turned out, Ma was very impressed with IBM’s radical restructuring of its PC business. She returned as an enthusiastic supporter.

During the summer of 2004, at secret talks in Raleigh, North Carolina, Yang and Palmisano agreed to go beyond the idea of a simple sale and purchase of assets. Instead, the two companies would form a strategic alliance. Legend—which would now be known as Lenovo—would become the preferred supplier of PCs to IBM and would be allowed to use the IBM brand name for five years. IBM would continue to sell Lenovo PCs through its sales force and distribution network. Big Blue would also provide marketing, services, and financing for Lenovo PCs.

In an interview in Fortune magazine, Liu said that he had finally come to see the IBM offer in a different light. He explained:

We gained confidence that many of the risks we’d feared could be distributed or controlled. We worried about losing customers, so we worked out an agreement that would allow us to continue using the IBM brand, to keep the IBM salespeople, and even to keep the top IBM executive as CEO. That gave us confidence we could give customers the same level of service and quality after the acquisition.³

What Lenovo Bought

On December 8, 2004, Lenovo announced that it would acquire IBM’s PC division for $1.75 billion. Lenovo would pay roughly $650 million in cash and $600 million in securities and would assume debt of an extra $500 million. According to the terms, IBM would get an 18.9 percent stake in Lenovo. The new company would have an annual sales volume of 11.9 million units and sales of $12 billion, based on the two company’s 2003 sales. The deal instantly transformed Lenovo, which had been a distant ninth-place contender, into the world’s third-largest PC maker.

It also quadrupled Lenovo’s PC business, which turned Lenovo’s dream of globalization into a reality. Now, Lenovo had sales volume and could also continue to use the IBM logo on its products for five years. IBM’s famous ThinkPad laptop and ThinkCentre desktop brands would belong to Lenovo forever. Together with sales channels, management, R&D capabilities, and global corporate clients, it would have been hard to imagine an arrangement more favorable to Lenovo. The mystery was why IBM had been willing to agree to half its original asking price, especially since its cost cutting had begun to make the PC unit more profitable.

IBM’s Interest in China

IBM had, in fact, received attractive offers from other interested bidders, including an American company, the Texas Pacific Group. But from the very beginning, Lenovo was the only option that IBM pursued seriously. “There were simpler transactions that we could have done,” Palmisano admitted. “What we wanted was not a divestiture, but this strategic relationship with Lenovo and China.” The New York Times reported that IBM had decided to play its “China card”:

The sale of I.B.M.’s personal computer business to Lenovo for $1.75 billion … is “a three-dimensional deal,” according to Mr. Palmisano. The sale provides I.B.M. with a path to leave a business that is large but not profitable. It is also the latest step in I.B.M.’s shift toward services, software and specialized hardware technology from mainframes to microprocessors for computer game consoles, all of which promise higher profits than the fiercely competitive PC business.

Yet the most intriguing, and potentially most important, dimension of the deal for the company is that it is I.B.M.’s China card. The new Lenovo, folding in the I.B.M. personal computer business, will be China’s fifth-largest company, with $12.5 billion in sales in 2003, and the Chinese government will remain a big shareholder. I.B.M. is eager to help China with its industrial policy of moving up the economic ladder, by building the high-technology engine rooms to power modern corporations and government institutions with I.B.M. services and software.⁴

The real reason that IBM wanted the deal with Lenovo was that IBM wanted a way into China. Palmisano saw it as building a bridge to China’s future. To IBM, the payoff would come when closer ties materialized with the Chinese government and the Chinese public. As Palmisano explained:

We don’t have any special deal with the Chinese government or any other government really. It’s a much more subtle, more sophisticated approach. It is that if you become ingrained in their agenda and become truly local and help them advance, then your opportunities are enlarged. You become part of their strategy.⁵

Echoing that line of reasoning, IBM announced in March 2005 that it intended to develop its Chinese business as a “China IBM” rather than an “IBM China,” and that it was planning to provide integrated solutions for China’s healthcare system. This came to fruition on May 1, 2009, when IBM announced the opening of a Healthcare Industry Solution Lab in Beijing. IBM would work with hospitals and rural medical cooperatives to make healthcare “smarter.” The healthcare reform initiated by the Chinese government called for a $124 billion investment by 2011, to make healthcare services safer and more affordable for China’s 1.3 billion citizens. IBM would provide part of the solution.⁶

Integrating Very Different Cultures

IBM was keen to make the transaction work in order to demonstrate the company’s long-term commitment to China’s growth. However, integration required creative solutions because the companies were very different:

IBM’s PC business had higher overhead, while Lenovo was lean.

IBM’s PC business was three times larger than all of Lenovo.

IBM’s PC business had higher production costs, while Lenovo’s labor costs were $3 per desktop PC, the lowest possible.

IBM’s PC was a strong global business, while Lenovo was the No. 1 player in China.

IBM excelled with high-end corporate clients, while Lenovo did well with retail customers and small businesses.

IBM had the best notebook technology, while Lenovo had great desktop technology.

Given the drastically different but complementary cultures and business practices of the two companies, it was unlikely that Lenovo’s management could handle the integration on its own. To make the transition smoother, IBM decided to keep an 18.9 percent stake in the new company and retain executives to run the combined company. Besides allowing Lenovo to use the IBM brand, IBM continued to sell Lenovo PCs through its sales force and distribution network. In doing so, IBM risked its brand image and prestige and made a substantial commitment in human resources. It was an impressive demonstration of the company’s confidence in Lenovo.

IBM volunteered Stephen M. Ward Jr., the head of the former PC division, to be the CEO of the newly combined company. Lenovo’s outgoing CEO, Yang Yuanqing, would become chairman. Initially, Yang wanted dual headquarters, in New York and Beijing, but Ward preferred to have a single one in New York. After a few days, Yang came around to Ward’s point of view. “Steve made a lot of sense,” Yang said. “Putting the headquarters in New York told our global customers that we’re a global company.” Later, it was decided that the headquarters did not need to be in any specific city. Senior leadership meetings were held in various cities around the world, depending on which location made the most sense at a particular moment in time. Board directors and executives evolved into a true blend of East and West.

Ward’s task was to ensure a smooth transition and integration of the merged business following the acquisition. He spent most of his time on customer retention and integrating the organization. The accomplishments following the merger in May 2005 were impressive on all points:

Customer Retention. Lenovo shipped record volume and had nearly even market share compared with Lenovo and IBM’s combined pre-acquisition shares.

Profitability Growth. EPS (earnings per share) grew by 1 percent quarter-over-quarter, and Lenovo succeeded in turning the IBM PC division from a loss-maker to profitability compared with its prior year’s performance.

Strong Cash Position. Lenovo had nearly $964 million in net cash reserve as of September 30, 2005.

Successful Integration. Lenovo had managed successful integration into a global organization, and it was on track to successfully meet its target for integrating both organizations.

With integration accomplished, Lenovo accelerated its strategy for the next phase: expanding profits. In 2005, Lenovo had a net profit rate of less than 2 percent, while its direct competitor, Dell, had a much higher rate of 6 percent. To improve profitability, the company had to improve efficiency and cut costs. Ward’s background at IBM made him hesitant to launch into a drastic reform. To increase its growth rate, IBM would need to expand into emerging countries and the consumer market, and Ward lacked experience running a business in an emerging market. With retirement approaching, Ward and the Lenovo board agreed that it was time for him to step aside. On December 20, 2005, Lenovo announced that William Amelio would be appointed the new CEO, effective immediately.

Yang had only praise for Ward’s handling of the integration of the two companies:

Steve Ward successfully helped to create a single, global PC company from two distinct organizations. As a result, we have created significant value for our shareholders over the past year, and Lenovo is in a strong position to make continually better progress against our goals. We appreciate Steve’s contributions to Lenovo and his continuing support.

When Lenovo approached him for the job, Amelio was Dell’s senior vice president for the Asia-Pacific and Japan regions. Before Dell, Amelio had worked in senior management for NCR and AlliedSignal from 1979 to 1997. He had held a number of senior positions with IBM, including general manager of worldwide operations for its PC business. Amelio had sales experience in the emerging market and seemed to be an ideal candidate for the top job.

In January 2006, Amelio unveiled his strategy for Lenovo:

We must first keep a laser sharp focus on our cost and expense structure to continue to drive operating efficiency. Second, we must drive product competitiveness with innovative, high quality, appropriately priced products that address key growth areas. Third, we must leverage our success in China and the success of the dual transaction/relationship model in support of our products. I’m looking forward to building on the strong momentum Lenovo has delivered to date.⁷

Following the IBM PC acquisition, Lenovo divided its sales system according to two functions: relationship and transaction. The relationship model, based on the Think brands that had been acquired from IBM, targeted large corporate customers that needed tailored solutions, fast delivery, and quick responses to service demands. The transaction model, based on Lenovo’s successful practice in China, targeted small and medium businesses and individual consumers. For the transaction model, the selling points would be a large distribution network, service, and low pricing. Lenovo believed that it had developed a successful model in China that could now be duplicated in other parts of the world.

Expanding into emerging countries was a necessity. According to International Data Corporation (IDC), in 2006, Lenovo PC shipments in Europe declined by 12 percent, and in the United States, its growth was 5.3 percent below the industry average of 6.7 percent. The growth was almost all in China, which was getting 30 percent more shipments than anywhere else. As a first step in its effort to replicate its success in China, Lenovo chose Germany and India to test its transaction model in both mature and emerging markets. The experiment worked in both markets and produced significantly higher growth in 2006.

Amelio did a great in job integrating, streamlining, and improving IBM’s former PC business, but when the economic crisis hit hard and fast in 2008, Lenovo’s profits went into a tailspin, leaving Amelio very little time to refocus on China, the emerging markets, or consumer products.

What Went Wrong?

In May 2006, when Lenovo’s results for 2005–2006 were announced, Amelio declared:

Lenovo is a great business with innovative products and a disciplined operating plan. We are sharply focused on taking the steps now that we believe will make us successful and more profitable over the long term: improving our operating efficiency, building brand awareness, and expanding our dual business model.⁸

The statement raised questions about the coherence of Amelio’s long-term strategy. The mystery is why the company had decided to change its primary focus from innovative product offerings to one that concentrated instead on brand awareness. The shift marked a departure from Lenovo’s initial strategy, and it posed a dilemma: Where would growth come from without innovative products? The dual business model stayed in the third place.

In 2007, Amelio removed the IBM logo from ThinkPad laptops. The market’s reaction was less than enthusiastic. To promote the Lenovo brand, Amelio began pouring money into marketing. He clinched an advertising deal with a soccer star, Ronaldinho, who had previously played for Brazil and Barcelona. Ronaldinho became a Lenovo Worldwide Brand Ambassador in 2006. To that questionable coup, Amelio added sponsorship of the Winter Olympics in Turin in 2006, sponsorship of the AT&T Williams Formula One racing team in 2007, and sponsorship of the Beijing Olympics in 2008. Amelio concluded his three-year tenure at Lenovo on an optimistic note in a press release:

Over the past three years, we’ve implemented a successful international strategy. Lenovo has joined the ranks of the top global PC companies. Our brand is recognized around the world. We have developed a solid reputation for quality and innovation, and our customer service is second to none. I’m pleased with what we have accomplished as a team.

In a 2007 interview, Amelio reconfirmed his priorities:

Improving supply-chain efficiency outside China is one of Lenovo’s four strategic objectives, along with moving away from IBM’s business model of selling mostly to large corporations; cutting prices and improving performance in PC manufacturing outside of China; and lastly, building a Lenovo brand that is not in IBM’s shadow.⁹

Amelio’s intention was to move away from the relationship model, which focused on corporate customers, but he had failed to build an international transaction/consumer model. Compared to Lenovo’s 5,000 stores, which the company referred to as “touch points” in China, Lenovo’s distribution network outside China was too weak to boost sales of entry-level laptops, which had become increasingly important in the market. Worse, product launches for the new laptops were experiencing potentially fatal delays.

Innovative product offerings were not high on Amelio’s list of priorities. During his tenure, the PC market turned increasingly to laptops, not the expensive models favored by corporate clients but entry-level models, priced to appeal to individual consumers on tight budgets.

It took until 2007 for Yang Yuanqing to lose patience and decide to personally create a global consumer business group to push for consumer models. In March 2008, Lenovo introduced a new line of PCs linked to the word Idea as a brand concept. These included IdeaPad laptops and IdeaCentre desktops. Lenovo had its first global consumer-oriented PC, and the initial impulse to build it had not come from Amelio.

It was also becoming increasingly apparent that there were no innovative products and no appropriate channels that could possibly benefit from Amelio’s costly marketing hype. It was too late for Lenovo to play catch-up with Acer and HP and other competitors that were already responding to market trends with ultra low-priced netbooks. Acer’s market share rose from 9.4 percent to 11.8 percent, and HP’s increased another 3.1 percent to 19.6 percent in 2008.

With the global recession, corporate customers were cutting back on spending. Computer makers like Dell and Lenovo that had depended heavily on corporate customers for sales were losing market share. Lenovo’s global PC market share fell to 7.2 percent in 2008 from 7.5 percent a year earlier. In the fiscal quarter ending on December 31, 2008, Lenovo reported a loss of $97 million, down from a net profit of $172 million during the fourth quarter a year earlier. Sales dropped 20 percent from $4.49 billion a year earlier to $3.59 billion.

Amelio’s effort to turn Lenovo into a globally recognized brand had seemed like a good idea at the time. What was lacking was a compelling product line to justify the market hype: With uncompetitive products and an inadequate sales presence at the local level, the money spent on branding simply increased costs without adding to sales.

Lessons Learned

The fact that Lenovo went back to relying on Chinese managers and shifted its focus back to China, emerging markets, and individual customers does not mean that the original acquisition was a bad idea. Legend had wanted to go global in 1988, but it only considered being serious about it in 2003, when it had become clear that diversification had failed and that there was not enough room for continued growth in China. Everyone knew that going global would require considerable time, and the IBM deal still looks like an ideal choice. The deal gave Lenovo everything the company needed to be a global enterprise: brands, customers, executives, R&D, channels, and a global sales force. IBM was straightforward and highly sophisticated in building the relationship with Lenovo and China. The payoff for IBM was not the onetime deal with Lenovo but the ever enlarging software, consulting, and services business in China itself.

The integration of the IBM PC business and Lenovo still rates as a success despite the decision to change the CEO and chairman. The management shakeup at the beginning of 2009 was driven at least in part by the global economic crisis and the company’s dependence on corporate customers.

It is fair to say, though, that if Lenovo had stayed focused on its original strategy and executed it well, the company might not have experienced as much stress as it did during the crisis, which helped to emphasize the challenge of integrating two drastically different corporate cultures. Executing a new strategy is far more difficult when time-consuming cultural issues constantly need to be dealt with.

Looking to the Future

In January 2009, Lenovo announced that it was cutting its workforce by 11 percent, or about 2,500 employees, worldwide during the first quarter. The company sought to reduce expenses in support and staff functions, such as finance, human resources, and marketing. Executive compensation would be reduced by 30 to 50 percent, including merit pay, long-term incentives, and performance payments. The cuts produced savings of approximately $300 million. Lenovo also relocated its call center operations from Toronto, Ontario, to Morrisville, North Carolina, which produced additional savings.

As part of the reorganization, the company consolidated its China, Asia Pacific, and Russia divisions into a single business unit. The Asia-Pacific headquarters moved from Singapore to Beijing. Chen Shaopeng, the senior vice president and president for Greater China, was picked to lead the new organization.

In February 2009, Lenovo announced the departure of CEO Amelio, with Yang Yuanqing taking over as CEO, and Liu Chuanzhi returning as chairman. The new management team was given the mandate to put the company back on track and make it profitable. Liu said, “So right now, we should emphasize China and emerging markets, and consumer customers.”

In March 2009, Yang created two business units, Mature Markets and Emerging Markets, and two product groups, Think and Idea. The Mature Markets unit included business in Western Europe, the United States, Canada, Japan, Australia, New Zealand, and Global Accounts, including large enterprises, SMEs, and relevant consumer products. The Emerging Markets unit, headed by Chen Shaopeng, was composed of business in China, the rest of Asia, the Middle East, and Africa, including large enterprises, SMEs, and relevant consumers. Lenovo’s Latin America group, including Mexico, was to report to Rory Read, the president and COO.

The Think Product Group, led by Frances K. O’Sullivan, took worldwide responsibility for all Think-branded desktops, notebooks, workstations, displays, peripherals, and software. The Think group focused on commercial customers, Lenovo’s relationship business model, and the premium end of the transactional small/medium business market. The Idea Product Group, led by Liu Jun, oversaw product development and portfolio management for the Idea product line. The group focused on consumer and commercial SME transactional business in emerging and mature markets and entry-level products.

More recently, Lenovo launched its own tablet computer, LePad, and shifted its focus toward the emerging markets, especially India. The emphasis shifted from the top of the line toward computers that were more affordable for the potentially huge market emerging in the developing world.

Lenovo had reorganized itself based on lessons learned in a few short years after biting off a dynamic portion of one of the world’s top multinationals. The gamble seemed to be paying off. In the third quarter of 2011, Lenovo shipped 12.5 million units, surpassing Dell to become the world’s second largest PC maker, surpassed only by Hewlett Packard, which briefly considered getting out of the PC business. Lenovo’s sales were up 14.5 percent over the previous quarter, while global computer sales increased only 5.5 percent during that period. The increase gave Lenovo a global 13.9 percent market share. Analysts attributed Lenovo’s increased sales to China’s booming PC market, while the economic slowdown in the West and the growing interest in smartphones and tablet computers had depressed PC sales from U.S. and European competitors.

NOTES

1. The IBM/Lenovo Deal: Victory for China? http://knowledge.wharton. upenn.edu/article.cfm?articleid=1106.

2. Steve Lohr, “I.B.M. Sought a China Partnership, Not Just a Sale,” New York Times, December 13, 2004.

3. Fortune, “The Man Who Bought IBM,” December 27, 2004, http://money.cnn.com/magazines/fortune/fortune_archive/2004/12/27/8 217968/index.htm.

4. New York Times, December 13, 2004.

5. New York Times, December 13, 2004.

6. “IBM Collaborates with China in Steps to Healthcare Reform,” May 1, 2009, www.healthcareitnews.com.

7. “Lenovo Reports Third Quarter FY 2005/06 Results,” January 26, 2006, www.lenovo.com.

8. “Lenovo Reports Fourth Quarter and Full Year 2005/06 Results,” May 25, 2006.

9. “Bill Amelio: The Boss Who’s Breaking Free of a Big Blue Shadow,” The Independent, April 1, 2007.