Will the IBM Brand Guarantee Lenovo Success in PC Markets?

Acquisition of Big Blue's personal computer division by Chinese company causes quite a stir

15 December 2004--In 1994, Michael Pecht, an expert on the Chinese electronics industry at the University of Maryland in College Park, visited a factory owned by the Chinese technology company Lenovo Group Ltd., then known as Legend, near the humid, southern city of Shenzhen. Inside the plant, which was surrounded by farmland, Pecht saw a lean, efficient production line churning out personal computers. All the equipment, from places like Japan and Europe, was new. A half-dozen employees could be hired for the price of one laborer in the United States. "They were starting from a clean slate," says Pecht, an IEEE fellow.

Little did Pecht--or the rest of the world--know that Lenovo, 10 years later, would be in a position to buy out the PC division of IBM Corp. If the combined businesses produce as they did in 2003, they will sell 11.9 million PC units, generating approximately US $12 billion annual revenues--making Lenovo the third-largest PC business in the world, behind Dell Computer Corp., Round Rock, Texas, and Hewlett-Packard Co., Palo Alto, Calif.

The $1.75 billion deal between Lenovo and IBM, which was announced on 7 December with much fanfare, represents one of the largest acquisitions a Chinese company has ever made overseas. The addition of IBM's PC division will give Lenovo 8 or 9 percent of the world PC market, plus permission to use the IBM brand name on its products for five years. Lenovo also gets use of IBM's management and customer service teams.

IBM, for its part, gets 18.9 percent equity in Lenovo and a position that will allow it to move higher up the value chain to concentrate on selling more lucrative servers and services in the booming China market. Provision of information technology services now accounts for by far the biggest share of IBM's business and brings in more than $40 billion in revenue annually.

The Lenovo-IBM deal has been greeted with some fear in the United States by those worrying about a possible Mandarin takeover, much as people were spooked by Japanese acquisitions in 1989--remember the sale of New York City's Rockefeller Center? While the deal should not be seen as "a symbol of China taking over the world, it does represent the global ambitions of Chinese companies," says Ted Dean, managing director in Japan of the Beijing technology consulting group BDA China Ltd.

How is it that Lenovo, a name that is little recognized in the United States, has been able to burst on the international scene so suddenly? The answer in a nutshell is that the company has steadily been building up its brand in China over the past two decades, and at the same time nurturing relations with big players outside of China. Comments by Lenovo chairman Liu Chuanzhi point to the company's original mission. "Since the beginning, our unwavering goal has been to create a truly international enterprise," said Liu on the day the deal was announced.

Lenovo was established in 1984 under its original name Legend by 11 academics in a bungalow on the campus of the Chinese Academy of Sciences, China's premier scientific institution in the capital of Beijing. With initial capital of $24 000, the company first began as a distributor of non-Chinese computers and printers. By 1990, it had figured out how to do the job of producing computers itself, and rolled out 2000 machines in its first manufacturing year, thus introducing the concept of the homemade PC to China.

While other homegrown brands appeared as Lenovo expanded, it became the top PC seller in China in 1997, and has continued to hold about a quarter of the Chinese market ever since. "It is the big success story in China," says BDA China's Dean--a success that can be attributed in part to the nature of PC manufacturing. PCs being "a less R and D-intensive product" compared to many other high-tech items, Lenovo's managers "were able to focus on marketing and distribution, which they did very well."

At the same time, in contrast to some other Chinese companies with global ambitions, Lenovo was scrupulous about respecting intellectual property held by companies outside China and about properly licensing IP for its own use. According to Pecht, it consistently formed partnerships or joint ventures with multinationals, including Intel for the manufacture of microprocessors, HP for the design and production of computers and printers, Toshiba for the manufacture of notebook computers, and--not least--IBM for providing system integration services.

All the PCs in Lenovo's current line, which typically retail for between $700 and $950, run on a Chinese-language version of Microsoft XP and have a desktop look that closely resembles Dell's; most also have Intel's Centrino chip set.

Even so, Lenovo's latest move--its expansion into the international marketplace--has not been greeted with universal enthusiasm by industry analysts. Lenovo's position in the domestic PC market has slipped some in recent years, and a vaunted diversification strategy failed. Accordingly, the deal with IBM--despite its foundation in long-standing business relations--looked to some like a product of desperation.

The question is whether this deal will give Lenovo enough clout to recover lost ground and go up against the likes of Dell, which has PCs for the East Asian market manufactured in China and reportedly has lower costs than Lenovo's.

Since the IBM takeover deal was announced, CLSA Asia-Pacific Markets, a provider of brokerage and investment services based in Beijing, has advised its customers to dump shares of Lenovo. The PC division of IBM "was losing money last year and is only marginally profitable now," says Frank Shi, a technology analyst for CLSA Asia-Pacific. In addition, Shi says that operating efficiencies will be difficult to achieve without pay cuts or downsizing. Meanwhile, cultural clashes in the workplace--Chinese and U.S. executives have markedly different management styles--are inevitable.

Some Chinese agree with this assessment. Fan Jianping, the deputy director of the Institute of Computing Technology at the Chinese Academy of Social Sciences in Beijing, says that the deal seems to be "a waste of time and energy" on Lenovo's part. "Many of Lenovo's employees don't even know how to speak English. How are they going to manage the company? Will [Lenovo] be able to absorb this new culture?" Fan asks, adding that the deal took him and many of his academic colleagues by surprise.

Not everyone is so glum. What Lenovo critically gains from the deal, says Pecht, is "a brand name outside of China." Even within China, Pecht believes that consumers, particularly young urbanites, tend to buy brand names, which will work in Lenovo's favor.

Since Pecht first visited Lenovo's manufacturing plant 10 years ago, he has returned twice to Guandong province and has seen the company "expand like crazy." Today, off one newly built highway exit, the Lenovo Science and Technology Park sits like a new town, with buildings that look like hotels with five-floor atriums, he says. Farmland has been turned into sculpted parks and ponds. In short order, a provincial reseller has been turned into a global technology player.

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