Playing catch-up

Lenovo’s $1.25 billion purchase of IBM’s PC division pushed it up to third place in the world rankings of largest PC vendors. And the Chinese company may just have what it takes to close the gap on the top two still further

Set out in black and white in IBM’s SEC filings, the revenue decline in its Personal Computing Division (PCD) is stark: From $10.08 billion in 2001, total net revenue toppled to $9.24 billion in 2002, and to $5.22 billion in 2004. The division, say the filings, is a "lower margin business", associated with "management oversight" and "volatility", without which "IBM’s profit margin, both gross and net, will improve".

With such a history of struggle, speculation has understandably mounted over the ability of the division’s new owner, Lenovo, to turn it around. In a mature market that is based almost entirely on replacement, only a few big firms are able to stay in the PC race; those without an efficient cost structure in place will fall by the wayside fast.

China’s number one PC vendor may well boast 7.1 per cent of the global PC market (according to IDC) as a result of its purchase of IBM’s PCD, which saw its headquarters relocate from Beijing to Purchase, New York. But against Hewlett-Packard (HP)’s 15.4 per cent and Dell’s 18.9 per cent, there is a sizeable gap for Lenovo to close.


IBM has described Lenovo as "a business that is well-positioned to exploit the PC opportunity, because of its scale and operational efficiency, as well as exclusive focus on that segment." And Lenovo, too, seems outwardly confident that it can return the business to profit within one year through cost-cutting.

And looking to the long term, Lenovo plans to use its new PC market to jumpstart growth by expanding abroad, in the hope of doubling profit within three years. This strategy, it hopes, will bring it neck and neck with top PC vendor Dell by 2010.

In an interview with OPI, Yang Yuanqing, chairman of Lenovo Group, claimed: "The new Lenovo will enjoy the following benefits: global brand recognition; a top-ranking international management team; unique leading edge technology; a more diverse and competitive product portfolio; a more diverse customer base and global distribution network; and more efficient operational capabilities.

"All the above will help us win in competition," he added. "This acquisition will be a historic integration, which will have a profound impact on the global PC industry structure."

In recent weeks though, Lenovo has had it tough. Not only has it seen its share price – at the time of going to press – slump 15 per cent since the announcement of the takeover bid last December, it has also been knocked off its perch as leading PC vendor in Asia Pacific (excluding Japan) with a 10.9 per cent market share, by HP which, in Q1, gained an 11.7 per cent share, according to figures from IDC. And on 8 June, Lenovo reported a 12 per cent fall in its Q4 profit to HK$166 million (US$21 million), against analyst estimates of HK$194 million.

IDC analyst Roger Kay, however, says recent events offer few clues to the company’s future. "When a company announces a merger, it is normal for it to lose share – the same happened with HP when it announced its purchase of Compaq – partly because customers can be confused and can abandon the company. But after the deal closes, figures even out." Kay claims it is worrying for Lenovo to be pipped at the post by HP in its own part of the world, but in Q2 when IBM’s 6.1 per cent share will be added on, boosting Lenovo’s to 17 per cent, the Chinese giant will be way ahead of HP.

Furthermore, Lenovo has reported that the integration of the former IBM division into Lenovo International – which, like Lenovo China, is part of Lenovo Group – has gone smoothly so far. In addition, the 19,000-strong workforce that had moved over from IBM has remained stable and the company is planning no job cuts.


In fact, Kay claims that Lenovo will have other, wider opportunities than IBM to make profits on the PC division. This is for various reasons. First, and significantly, he says, Lenovo has different ways of accounting to IBM. IBM’s PCD only counted PC hardware, transferring any software revenue to its software division; Dell’s PC division, on the other hand, counts the hardware as well as the software that sells with it. Lenovo, he says, will likely use an accounting system more like that of Dell.

Second, adds Kay, the IBM umbrella spent a lot of money on corporate ad campaigns. "PCD had some $25 million tied in ads, but in general, PCs don’t get direct revenue from advertising campaigns." HP has, similarly, spent a lot of money on its F1 race car sponsorship, which will not result in direct revenue, he says. "You need ‘call to action ads’, such as ‘buy before Saturday’ deals, or ‘buy a PC and get a free printer’, which actually translate into sales. You need to streetfight. Lenovo has the chance to better target its advertising to generate specific results."

Finally, says Kay, the company will have a totally different dynamic. "The top management at Lenovo is Chinese, and having the Chinese owning and running the division is a very new thing; they are very different people, and are smart, patient and fantastic at long-term planning." As an example, he cites China’s strict one-child policy issue and its patient wait to regain control of Hong Kong from the British. "There is also a lot more continuity in the Lenovo/IBM deal than a lot of people think," he adds. "IBM already had a PC manufacturing joint venture with Chinese company Great Wall, which was bought out and handed to Lenovo in the deal."

Lenovo had plans to do business in the US for a long time, he continues. With an office in Freemarket, California, for a number of years, it mulled over a number of opportunities – either coming in to the market on its own or buying out smaller companies. It took the group a long time to finally settle on IBM’s PC division.

Lenovo will continue to use the IBM logo to market its products for the first five years, during which time it will also try to build up the Lenovo brand. And as time goes on, and the Chinese giant gradually creates a blended output of the separate product lines, it plans to not only conquer the US market, but also brand-new markets. "Through operational excellence, innovation and branding, we will grow Lenovo into a worldwide brand and start targeted investments in new products and markets," Yuanqing told OPI.


Since the deal’s closure, Lenovo has already announced plans to establish a new innovation centre in North Carolina that will enable customers, business partners, solution providers and independent software vendors to collaborate on new PC solutions.

It has also announced plans to enter India, one of the world’s fastest growing PC markets, where it expects a 17 per cent annual growth in demand. It plans to use its marketing and production facilities in China and other markets in order to expand the IBM range in the country at both the high-end and the low-end. And it has already started recruiting for a centre in Bangalore.

Yuanqing particularly singled out plans to expand IBM’s Think brand product offering, which Lenovo gained in the takeover. And in early June, Lenovo/IBM released one of its first products, the ThinkPad X41 tablet PC, marking its entry into the world of tablet computing, and leaving Dell out in the cold as the only Tier 1 level manufacturer not making a tablet PC.

On another positive note, recent analyst PC growth estimates have been more upbeat. In May, market researcher Gartner revised its earlier predictions, estimating PC shipments worldwide to exceed 202 million units in 2005, up 10.2 per cent from 2004 due to an expected spurt in laptop shipments that will offset weak desktop sales. This is good news for Lenovo. According to IDC, the purchase of IBM’s PCD will significantly strengthen its place in the fast-growing notebook PC marketplace.

Lenovo could well spend a period in the red before it becomes profitable. But if it ensures it has the right cost structures in place, IDC’s Kay believes its growth opportunities are solid. "There are no guarantees in this industry, but I believe Lenovo’s prospects are as good as HP’s. And when it comes to catching up with Dell by 2010," he adds, "who knows, but it can have a good shot at it."