Building A Better Skunk Works

In a bold effort to nurture new businesses, IBM is putting its best and brightest in charge of its risky startups.

Rod Adkins couldn't understand why his career was taking such a sudden and devastating blow. Up until then, he was the epitome of a hotshot executive at IBM. In a culture where your status is determined largely by how many people you have working under you and how much revenue they produce, Adkins was a star. He ran the Unix computing division, a vital, thriving business with 35,000 employees and $4 billion in sales. And then, one day five years ago, the brass summarily stripped him of all that status and power. They reassigned him to a business that didn't produce any revenue. It didn't even really exist yet. Even its name -- "pervasive computing" -- seemed suspiciously abstract and weird. And now he had no one reporting to him. It looked as though this might be the company's way of letting a senior executive know that he was no longer wanted there.

"Geez," Adkins said. "What do I tell my mom?"

"He thought he was fired," recalls J. Bruce Harreld, IBM's senior vice president for strategy, who was one of the higher-ups behind Adkins's new assignment. IBM's then president, Samuel J. Palmisano, had to talk to Adkins personally and reassure him of his importance to the company. If anything, Adkins had actually been promoted, but that was hard to grasp because the new culture that Palmisano and Harreld were trying to instill was such a shocking departure from the company's long-entrenched ways. Five years ago, IBM was just beginning a radical shift in its attitude toward creating and nurturing new businesses. It used to be that IBM, like many large companies, came up with lots of promising ideas but had a hard time commercializing them. One of the many reasons was that its most talented and experienced executives, such as Adkins, took care of the big old established businesses that accounted for today's sales and profits, not the risky new efforts that represented the company's growth and future.

What Palmisano wanted Adkins to do was actually a lot harder than running a multibillion-dollar operation. It was creating one totally from scratch. And that's what Adkins quickly accomplished. Three years later, in 2003, his new venture, which applies wireless technology to extend computing beyond the home and office to such places as the car (with voice-command navigation systems), had already revved up to annual sales of $2.4 billion.

Adkins was a guinea pig for developing what IBM calls "emerging-business opportunities," or EBOs. The mission is to find areas that are entirely new to IBM and can grow into profitable billion-dollar-plus businesses in five to seven years. So far the program has been an extraordinary success. It's a lesson in something that's often a challenge for big organizations. "Breakthrough innovation has been very difficult for large, established companies," says Gina O'Connor, an associate professor at Rensselaer Polytechnic Institute and coauthor of Radical Innovation: How Mature Companies Can Outsmart Upstarts. "Projects get shut down before they come to fruition because senior management loses patience and they don't have appropriate metrics."

Harreld, who runs the program, promised the board that EBOs alone would produce two percentage points of growth for IBM. Given Big Blue's awesome size, that ain't hay: It means about $2 billion of new revenue every year. The actual results have wildly surpassed all expectations. Since the program's inception in 2000, IBM has launched 25 EBOs. Three failed and were closed down, but the remaining 22 now produce annual revenue of $15 billion, a figure that's growing at more than 40% a year.

But the impact reaches further than today's results. These internal startups are beginning to influence IBM's culture. "Through EBOs, IBM has become more of a learning organization," says Caroline Kovac, who built a new $1 billion, 1,000-employee business in computing for "life sciences" clients, such as pharmaceutical and biotech companies. "We've become more willing to experiment, more willing to accept failure, learn from it, and move on. It's more a part of our culture and our official processes. Now being an EBO leader is a really desirable job at IBM." Harreld says he doesn't even have to recruit EBO leaders anymore: "Today I have my peers coming to me and offering to run these."

The program began in September 1999, when Lou Gerstner Jr., who was then IBM's chairman and CEO, was working at home on a Sunday. Reading a monthly report, Gerstner found a line, buried deep, saying that pressures in the current quarter had forced a business unit to cut costs by discontinuing its efforts in a promising new area. Gerstner, a temperamental type, was incensed. How often did this happen?

As the head of strategy, Harreld looked into the issue and "found a similar pattern across the board," he says, which he documented with 22 case studies. IBM had plenty of new ideas -- its famous research labs won thousands of patents a year -- but it had a remarkably hard time turning those ideas into businesses. The company had produced many crucial inventions, such as the relational database and the router, then watched while others, such as Oracle and Cisco, built huge companies around them.

What were the root causes? Harreld asked. In a classic defensive posture, IBM rewarded short-term results and served current markets, and was constitutionally reluctant to devote management attention, resources, time, or talent to rolling the dice. "Everything was based on the current period, not on the future," says David C. Dobson, an IBM strategic planner who's currently Harreld's deputy. Neither Gerstner nor Harreld spent much time on new businesses, and they didn't tap their "A-team" of executives to run them. "We were relegating this to the most inexperienced people," Harreld says. "We were not putting the best and brightest talent on this." They realized they had to risk taking people like Adkins off the mainstay businesses and putting them on projects that didn't fit neatly into any specific existing divisions but looked like potential billion-dollar opportunities.

Intriguingly, the best new ideas for emerging businesses came mostly from talking to customers, or outsiders such as venture capitalists, rather than IBM's own researchers, who focused on advanced technologies that couldn't pay off in a five- to seven-year horizon. "I'm not interested in new technologies," Harreld says. "I'm interested in building businesses. Often I find the ideas coming out of research are really good technical ideas, but they need lots of work to make into a business."

After Harreld considers hundreds of suggestions, picks an idea, and selects the EBO's leader, that executive goes off, sometimes with no more than one colleague, to start the business. Harreld meets one-on-one with the leader for three or four hours a month. And that's usually when the cultural hiccups begin. At first, the process is confusing and difficult for the transplanted executive, who's still stuck in the mind-set of running an established division. "It takes me and them four months at least to stop the crap," Harreld explains. "In an established business it's all about keeping things under control. These guys are so buttoned up. You bring them into a new business area, and it's almost hilarious." When Adkins embarked on his new venture, Harreld re-calls, he showed up at his first few monthly meetings insisting that there were no problems. "Rod came from a culture where the senior managers feel they're expected to know all the answers to all the questions and deal with the issues themselves," explains Gary Cohen, who helped Harreld run the EBO program from its inception until last year. "You understand a mature business because it has a level of predictability. But with an EBO, there's a lot you don't know, and you have to discover, learn, and adjust."

The second big cultural bump usually comes when EBO leaders try to empire-build, Harreld says. "Everyone tries to staff up because in a company like this, how do you measure stature? One, revenues. Two, people. Having run and built businesses, I've learned the hard way that you shouldn't staff up before you have clarity."

So EBO leaders begin working alone, or maybe with a single colleague, as Kovac did with the Life Sciences initiative. Harreld gives them a little money, and they try to tap IBM's collective expertise. "We wanted to be Tom Sawyer getting the rest of the company to paint our fence," Kovac says.

IBM's EBO leaders start out by proving the concept behind the venture through small pilots. They try to "go deep" with market experiments involving just a few prominent customers. "Whether it adds up to $1 million or $50 million may not be a good measure," says Cohen. "But it will tell you a lot about whether customers and clients think what you're doing is valuable." If these small pilots meet specific milestones for success, only then does IBM make the decision to pour resources into the project.

Kovac's experience running Life Sciences is a good example of how an EBO actually gets off the ground. Life sciences was an untapped area for IBM's sales force. Granted, for years it had been calling on the big pharmaceutical companies, but only to sell computer hardware and software for back-office functions, such as payroll and accounting, not for the core work of pioneering scientific research. But now that computing power is opening up extraordinary new opportunities -- the Human Genome Project, for example -- IBM saw the chance to sell info-tech tools for cutting-edge scientists. Big Blue also needed to reach out to the numerous small and medium-sized biotechs. In the past, these smaller firms would have been targeted (if at all) by the same sales force that called on small and midsized businesses such as supermarkets. The salespeople would have no specific knowledge of the needs of medical researchers. But Kovac understood that realm. Her own academic background was in chemistry (she held a postdoctoral fellowship at the University of California at Berkeley before joining IBM Research).

Starting out in 2000, "we were probably a little late to the party around high- performance computing in life sciences," Kovac recalls, "so we needed some significant wins." IBM wasn't really active in early genomic projects, but it seized the chance to use its database software for newer and even bigger studies of proteins. From there, Kovac helped recruit "marquee engagements" with Johns Hopkins University and the National Institutes of Health. By 2003, the EBO was a $1 billion a year business, with half its revenues coming from small and medium-sized companies that IBM had never talked to before. Kovac was rewarded when IBM folded all its other health-care clients into her division, giving her a $4.8 billion-a-year fiefdom.

Now Kovac is also leading a new EBO focused on a more specific concept that IBM calls "info-based medicine." The idea is to compile and tap huge databases and apply computational power to produce better and more-personalized therapies for patients. One of the pilot users is the famed Mayo Clinic, which has put the medical records of its 4.4 million patients into an IBM database that can be accessed by any of its 2,400 physicians. They use it to run queries about cases similar to ones they're dealing with at present. In theory, that perspective should help doctors tailor treatment to the current patient while minimizing harmful side effects. This year, the business will produce hundreds of millions of dollars in revenue, and before long it will probably break out into the multibillion-dollar range.

Kovac says that the ideal EBOs are businesses where the "tipping points" are two to three years away, so now is the crucial time to prove the concept, forge the key relationships in the marketplace, and position yourself as a leader before the boom.

The EBO program was launched by Gerstner and accelerated by his successor as CEO, Palmisano. The point man all along has been Harreld, who continues to meet monthly with each EBO leader. Often the pow-wows are held in the conference room adjoining Harreld's private office across the hall from Palmisano's. On a side table there are two large glass jars -- one labeled valium (which actually contains pretzels) and the other novocaine (which is full of jelly beans). The jars are a holdover from the tense meetings at IBM in the 1990s, when Gerstner was jettisoning businesses in his successful turnaround effort. The table also displays talking figurines of the comedians Abbott and Costello, which reenact part of the duo's famous "Who's on First?" routine, yet another one of Harreld's tools to goad people to sort through the issues.

Gerstner himself recruited Harreld to IBM in 1995, and in many ways their backgrounds are similar. Both were management consultants who became executives in big food companies -- Gerstner at McKinsey & Co. and later Nabisco, Harreld at the Boston Consulting Group and then Kraft. After a stint as chief information officer there, Harreld taught business courses at Harvard and Northwestern before Gerstner called him and said, "You have to come back to the real world."

Now, looking for emerging business opportunities, Harreld spends a lot of his time talking with Silicon Valley venture capitalists such as John Doerr and Vinod Khosla at Kleiner, Perkins, Caufield & Byers, and he keeps a staff in northern California as a listening post. He says that venture capitalists don't need IBM's money -- they already have billions waiting to invest -- but both parties want to understand each other's interests. "We look at venture capital for 'headlights' about what's going on," he says.

"You want to celebrate failure because you learn something. You need some level of security to say, 'I screwed it up,' and be comfortable that you won't be fired."

Harreld's record with EBOs at IBM is remarkable. His hits include IBM's $2 billion Linux business, which charges for consulting about the free software; a digital media EBO, which helps companies manage video, audio, and images, has grown into a $1.7 billion business in just three years. Some of his most recent efforts are focused around geographic areas -- he has targeted China, India, and Brazil with EBOs. The three markets combined represent an estimated $60 billion opportunity for info-tech providers. He's also looking at Russia and Eastern Europe.

But not every one of Harreld's EBO initiatives has succeeded. A couple of doomed EBOs tried to capitalize on the Internet boom just before it busted in 2001. There was, for example, the "network processor," a chip IBM planned to sell to networking hardware companies like Cisco. Problem was, there were few such companies left (other than Cisco) after the crash. When a pilot doesn't work, Harreld quickly kills the EBO and finds another important position at IBM for the erstwhile leader who took the risk: "You want to celebrate failure because you learn something. It's harder to do that early in your career. You need some level of security to say, 'I screwed it up,' and be comfortable that you're not going to get fired," he says.

Palmisano's vision is for the spirit of EBOs to spread throughout IBM, and that's what motivates the people who've been involved early on in the program. "Doing something like this within a large company such as IBM is not like being an entrepreneur, but it is entrepreneurial compared to the rest of the environment," says Kovac. "I felt if we could do this right, it would change the ability of this company to move from ideas to markets. Our journey isn't over, but it truly is a profound change."

Alan Deutschman is a Fast Company senior writer based in San Francisco.

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