IBM's Strategy
The company has divested low growth commoditizing product lines and acquired higher value opportunities to leverage IBM's infrastructure.
In IBM's view, the future of business is being shaped by the forces of global integration and innovation. They are foundational and intimately related to one another. A globally integrated enterprise is a new institutional form that shapes its strategy, management and operations globally, based on economics, expertise and open business environments. It is optimized for innovation in a worldwide economy and society that are increasingly integrated and specialized. IBM's strategic moves over the past several years—from divestitures and acquisitions, to areas of focus for innovation, to the transformation of its core lines of business—have been shaped by this vision.
IBM's strategic priorities to pursue this vision include:
-
• Offering
enterprises in the global economy innovative, high-value solutions based on IBM's ability to integrate technology and business model innovation to deliver
measurable results for IBM and its clients;
• Leading in the delivery of business value by providing business and information technology consulting and implementation services; building, running and maintaining cross-industry and industry-specific business process services; leveraging leadership technology and engineering services; and accelerating increased business value through Service Oriented Architectures (SOA) and Information on Demand;
• Leading in the delivery of advanced infrastructure through enterprise SOA and infrastructure software and services; increased share leadership in servers; driving to leadership in storage; and leading the transition to standardized services offerings; and
• Making IBM the premier Globally Integrated Enterprise — lowering costs and increasing effectiveness by integrating the company's decision-making at the point of client contact ("lowering IBM's center of gravity"); moving work to where it can best be performed; focusing IBM's resources to create the greatest value; and excelling in business collaboration.
IBM's Capabilities
To execute its strategy, IBM's business comprises three principal business segments:
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• Systems
and Financing
• Software
• Services
SYSTEMS AND FINANCING
Systems
Servers. IBM systems using IBM operating systems (System z and System i), as well as AIX, the IBM UNIX operating system (System p and BladeCenter) and the Microsoft Windows operating system (System x and BladeCenter). All servers can also run Linux, a key open source operating system.
Storage. Data storage products, including disk, tape, optical and storage area networks (SAN).
Microelectronics. Semiconductor design and manufacturing of customized products including microprocessors, application specific integrated circuits and standard products for IBM systems and external clients.
Engineering and Technology Services (E&TS). System and component design services, strategic outsourcing of clients' design teams, and technology and manufacturing consulting services.
Printing Systems. Production print solutions, on demand print related solutions, enterprise workgroup print technologies, print management software, services and maintenance.
Retail Store Solutions. Point-of-sale retail systems, software and solutions.
Financing
Commercial Financing. Short-term inventory and accounts receivable financing to dealers and remarketers of IT products.
Client Financing. Lease and loan financing to external and internal clients for terms generally between two and seven years.
Remarketing. The sale and lease of used equipment (primarily sourced from the conclusion of lease transactions) to new or existing clients.
SOFTWARE
Information Management Software. Advanced database, content management and information integration software that helps companies integrate, manage and gain value from their business information.
Lotus Software. Collaboration, messaging and social networking software that enables businesses to communicate, collaborate and increase productivity.
Rational Software. Software and process automation tools that help clients manage the business process of software and systems delivery.
Tivoli Software. Software for infrastructure management, including security and storage management that will help organizations better manage their IT infrastructure to more effectively deliver IT services.
WebSphere Software. Provides the foundation for web-enabled applications and is a key product set in deploying a Service Oriented Architecture. Management of a wide variety of business processes using open standards to interconnect applications, data and operating systems.
Product Lifecycle Management (PLM). Software that enables clients to improve their product development processes and their ability to use product-related information across their businesses.
Operating Systems. Software engines that manage the fundamental processes that make computers run.
SERVICES
Business Process Services (BPS) . A range of offerings from standardized processing platforms and Business Process Outsourcing (BPO) through Business Transformation Outsourcing (BTO) that delivers improved business results to clients through the strategic change and/or operation of the client's business processes, applications and infrastructure.
Consulting and Systems Integration (C&SI). Delivery of value to clients through consulting services for client relationship management, financial management, human capital, business strategy and change and supply chain management.
Strategic Outsourcing Services (SO). Comprehensive IT services integrated with business insight working with clients to reduce costs and improve productivity through the outsourcing of processes and operations.
Integrated Technology Services (ITS). Services offerings that help clients access, manage and support their technology infrastructures, through a combination of skilled resources, software and IBM's knowledge of business processes.
Maintenance. A number of support services from product maintenance through solution support to maintain and improve the availability of clients' IT infrastructure.
Application Management Services (AMS). Application development, management, maintenance and support services for packaged software, as well as custom and legacy applications.
Applications on Demand (AoD). Solutions for the management of clients' Web-based infrastructure and business applications, as well as a growing portfolio of industry-specific independent software vendor (ISV) solutions that are delivered as a service.
Business Segments
Organizationally, the company's major operations comprise a Global Technology Services segment; a Global Business Services segment; a Systems and Technology Group segment; a Software segment; and a Global Financing segment.
GLOBAL SERVICES is a critical component of the company's strategy of providing insight and solutions to clients. While solutions often include industry-leading IBM software and hardware, other suppliers' products are also used if a client solution requires it. Contracts for IBM services—commonly referred to as "signings"—can range from less than one year to over ten years. Within Global Services there are two reportable segments: Global Technology Services and Global Business Services.
Global Technology Services (GTS) segment primarily reflects infrastructure services, delivering value through the company's global scale, standardization and automation. It includes outsourcing services, Integrated Technology Services and Maintenance.
Global Business Services (GBS) segment primarily reflects professional services, delivering business value and innovation to clients through solutions which leverage industry and business process expertise. It includes consulting, systems integration and Application Management Services.
SYSTEMS AND TECHNOLOGY GROUP provides IBM's clients with business solutions requiring advanced computing power and storage capabilities. Approximately 55 percent of the Systems and Technology Group's server and storage sales transactions are through business partners; approximately 45 percent are direct to end-user clients, more than half of which are through the Web at ibm.com. In addition, the group provides leading semiconductor technology and products, packaging solutions and engineering technology services to clients and for IBM's own advanced technology needs. While not reported as external revenue, hardware is also deployed to support services solutions.
SOFTWARE consists primarily of middleware and operating systems software. Middleware software enables clients to integrate systems, processes and applications across a standard software platform. IBM Middleware is designed to open standards which allows the efficient integration of disparate client applications that may have been built internally, or provided by package software vendors or system integrators. Operating systems are the software engines that run computers. In addition, Software includes Product Lifecycle Management software which primarily serves the Industrial sector. Approximately 25 percent of software transactions are sold through business partners. Also, 50 percent of external Software revenue relates to one-time charge (OTC) arrangements, whereby the client pays one up-front payment for a perpetual license. The remaining annuity-based revenue consists of both maintenance revenue sold with OTC arrangements, as well as revenue from software sold on a recurring license charge arrangement. Typically, arrangements for the sale of OTC software include one year of maintenance. The client can also purchase ongoing maintenance after the first year, which includes product upgrades and technical support. While not reported as external revenue, software is also deployed to support services solutions.
GLOBAL FINANCING is described on pages 49 through 53 in IBM's 2006 Annual Report to Stockholders.
IBM Worldwide Organizations
The following three company-wide organizations play key roles in IBM's delivery of value to its clients:
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• Sales &
Distribution Organization and related sales channels
• Research, Development and Intellectual Property
• Integrated Supply Chain
SALES & DISTRIBUTION ORGANIZATION
With a comprehensive knowledge of IBM's business and infrastructure solutions, as well as the products, technologies and services IBM and its business partners offer, the company's global client teams gain a deep understanding of each client's organizational, infrastructure and industry-specific needs to determine the best approach for addressing their critical business and IT challenges. These professionals work in integrated teams with IBM consultants and technology representatives, combining their deep skills and expertise to deliver high-value solutions that address clients' pain points and innovational aspirations.
To facilitate its access to clients and local markets and to improve productivity, the Sales and Distribution organization utilizes geographic organizations in the Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific geographies. This structure enables resources and decision making to be closer to the clients.
The majority of IBM's revenue, excluding the company's original equipment manufacturer (OEM) technology business, occurs in industries that are broadly grouped into six sectors:
-
• Financial
Services: Banking, Financial Markets, Insurance
• Public: Education, Government, Healthcare, Life Sciences
• Industrial: Aerospace and Defense, Automotive, Chemical and Petroleum, Electronics
• Distribution: Consumer Products, Retail, Travel and Transportation
• Communications: Telecommunications, Media and Entertainment, Energy and Utilities
• Small and Medium Business: Mainly companies with less than 1,000 employees
Internal Routes-to-Market
Services consultants focused on selling end-to-end solutions for large, complex business challenges.
Hardware and software brand specialists selling IBM products as parts of discrete technology decisions and as part of broader client solutions.
ibm.com provides fast, easy access to IBM's product and business expertise via the Web and telephone. In addition, ibm.com identifies business opportunities for all of IBM's routes to market and provides online and telephone sales of standard hardware, software, services and financing for all size companies.
Business Partners Routes-to-Market
Global/major independent software vendors (ISVs). ISVs deliver business process or industry-specific applications and, in doing so, often influence the sale of IBM hardware, middleware and services.
Global/major systems integrators (SIs). SIs identify business problems and design solutions when IBM Global Services is not the preferred systems integrator; they also sell computing infrastructures from IBM and its competitors.
Regional ISVs and SIs. SIs identify the business problems, and ISVs deliver business process or industry-specific applications to medium-sized and large businesses requiring IBM computing infrastructure offerings.
Solutions providers, resellers and distributors. Resellers sell IBM platforms and value-added services as part of a discrete technology platform decision to clients wanting third-party assistance.
RESEARCH, DEVELOPMENT AND INTELLECTUAL PROPERTY
IBM's research and development (R&D) operations differentiate IBM from its competitors. IBM annually spends approximately $6 billion for R&D, focusing its investments in high-growth, high-value opportunities. In 2006, the company's investment in R&D was approximately 15 percent of its combined hardware and software revenue. As a result of innovations in these and other areas, IBM was once again awarded more U.S. patents in 2006 than any other company. This marks the 14th year in a row that IBM achieved this distinction.
In addition to producing world-class hardware and software products, IBM innovations are a major differentiator in providing solutions for the company's clients through its growing services activities. The company's investments in R&D also result in intellectual property (IP) income of approximately $1 billion annually. Some of IBM's technological breakthroughs are used exclusively in IBM products, while others are licensed and may be used in either/both IBM products and/or the products of the licensee.
In addition to these IP income sources, the company also generates value from its patent portfolio through cross-licensing arrangements and IP licensed in divestiture transactions. The value of these transactions is not readily apparent in the Consolidated Statement of Earnings, because income on cross-licensing arrangements is recorded only to the extent that cash is received. The value received for IP involving the sale of a business is included in the overall gain or loss from the divestiture, not in the separately presented IP income amounts on the Consolidated Statement of Earnings.
INTEGRATED SUPPLY CHAIN
Just as IBM works to transform its clients' supply chains for greater efficiency and responsiveness to global market conditions, the company continues to derive business value from its own globally integrated supply chain, reinvented as a strategic advantage for the company to create value for clients and shareholders. IBM leverages its supply chain expertise for clients through its supply-chain business
transformation outsourcing service to optimize and help run clients' end-to-end supply chain processes, from procurement to logistics.
IBM spends approximately $36 billion annually through its supply chain, procuring materials and services around the world. The company's supply, manufacturing and logistics and customer fulfillment operations are integrated in one operating unit that has reduced inventories, improved response to marketplace opportunities and external risks and converted fixed to variable costs. Simplifying and streamlining internal processes has improved operations and sales force productivity and processes and these actions have improved client satisfaction when working with the company. Since some of the cost savings this unit generates are passed along to clients, they will not always result in a visible gross margin improvement in the company's Consolidated Statement of Earnings. IBM is continuing to apply the supply-chain principles of product manufacturing and delivery to service delivery across its solutions and services lines of business.
In addition to its own manufacturing operations, the company uses a number of contract manufacturing (CM) companies around the world to manufacture IBM-designed products. The use of CM companies is intended to generate cost efficiencies and reduce time-to-market for certain IBM products.
Key Business Drivers
The following are some of the key drivers of the company's business.
ECONOMIC ENVIRONMENT AND CORPORATE SPENDING BUDGETS
If overall demand for systems, software and services changes, whether due to general economic conditions or a shift in corporate buying patterns, sales performance could be impacted. IBM's diverse set of products and offerings is designed to provide more consistent results in both strong and weak economic environments. The company accomplishes this by not only having a mix of offerings with long-term cash and income streams, as well as cyclical transaction-based sales, but also by continually developing competitive products and solutions and effectively managing a skilled resource base. IBM continues to transform itself to take advantage of shifting demand trends, focusing on client- or industry-specific solutions, business performance and open standards.
INTERNAL BUSINESS TRANSFORMATION AND GLOBAL INTEGRATION INITIATIVES
IBM continues to drive greater productivity, flexibility and cost savings by transforming and globally integrating its own business processes and functions. In 2006, the company continued the global integration of its internal support functions—such as Legal, Finance, Human Resources, Information Technology and Real Estate Site Operations—which had been previously replicated for many of the individual countries where IBM operates. In addition to eliminating redundancies and overhead structures to drive productivity, this integration has improved IBM's capacity to innovate by providing greater clarity of key priorities around shared goals and objectives and led to a sharper focus for the company on learning, development and knowledge sharing. The company will continue to focus on global integration initiatives to improve productivity in its integrated supply chain, service delivery and internal support functions.
INNOVATION INITIATIVES
IBM invests to improve its ability to help its clients innovate. Investment may occur in the research and development of new products and services, as well as in the establishment of new collaborative and co-creation relationships with developers, other companies and other institutions. Examples include IBM's leadership position in the design and fabrication of game processors; the design of smaller, faster and energy-efficient semiconductor devices; and the design of "grid" computing networks that allow computers to share processing power.
Through the Global Innovation Outlook (GIO), IBM has opened up its technical and business forecasting processes to include external leaders from business, academia, the public sector, nongovernmental organizations and other influential constituents of the world community. The GIO takes a deep look at some of the most pressing issues facing the world and works toward providing solutions to those needs. In 2006, IBM also announced that it will invest $100 million over the next two years to pursue ten new businesses generated by InnovationJam, an on-line brainstorming session which brought together more than 150,000 people from 104 countries, including IBM employees, family members, universities, business partners and clients from 67 companies. Over two 72-hour sessions, participants posted more than 46,000 ideas as they explored IBM's most advanced research technologies and considered their application to real-world problems and emerging business opportunities.
OPEN STANDARDS
The broad adoption of open standards is essential to the computing model for an on demand business and is a significant driver of collaborative innovation across all industries. Without interoperability among all manner of computing platforms, the integration of any client's internal systems, applications and processes remains a monumental and expensive task. The broad-based acceptance of open standards—rather than closed, proprietary architectures—also allows the computing infrastructure to more easily absorb (and thus benefit from) new technical innovations. IBM's support of open standards is evidenced by the enabling of its products to support open standards such as Linux, and the development of Rational software development tools, which can be used to develop and upgrade other companies' software products.
INVESTING IN GROWTH OPPORTUNITIES
The company is continuing to refocus its business on the higher value segments of enterprise computing—providing technology and transformation services to clients' businesses. Consistent with that focus, the company continues to significantly invest in growth opportunities as a way to drive revenue growth and market share gains. Areas of investment include strategic acquisitions, primarily in software and services, focused client- and industry-specific solutions, maintaining technology leadership and emerging growth countries such as China, Russia, India and Brazil.
Forward-looking and Cautionary Statements
Certain statements contained in this Form 10-K may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 ("Reform Act"). The company may also make forward-looking statements in other reports filed with the Securities and Exchange Commission, in materials delivered to stockholders and in press releases. In addition, the company's representatives may from time to time make oral forward-looking statements. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as "anticipates," "believes," "expects," "estimates," "intends," "plans," "projects," and similar expressions, may identify such forward-looking statements. The company assumes no obligation to update or revise any forward-looking statements. In accordance with the Reform Act, set forth under Item 1A. "Risk Factors" on pages 10 to 14 are cautionary statements that accompany those forward-looking statements. Readers should carefully review such cautionary statements as they identify certain important factors that could cause actual results to differ materially from those in the forward-looking statements and from historical trends. Those cautionary statements are not exclusive and are in addition to other factors discussed elsewhere in this Form 10-K, in the company's filings with the Securities and Exchange Commission or in materials incorporated therein by reference.
The following information is included in IBM's 2006 Annual Report to Stockholders and is incorporated herein by reference:
Segment information and revenue by classes of similar products or services—pages 111 to 115.
Financial information by geographic areas—page 115.
Amount spent during each of the last three years on R&D activities—page 93.
Financial information regarding environmental activities—page 87.
The number of persons employed by the registrant—pages 48 and 49.
The management discussion overview—pages 14 and 15.
Available information—page 121.
Also refer to Item 1A. entitled "Risk Factors" in Part I of this Form.
Executive Officers of the Registrant (at February 27, 2007):
| |
Age |
Officer since |
||
|---|---|---|---|---|
| Chairman of the Board, President and Chief Executive Officer: | ||||
| Samuel J. Palmisano(1) | 55 | 1997 | ||
| Executive Vice President: | ||||
| Nicholas M. Donofrio, Innovation and Techology | 61 | 1995 | ||
| Senior Vice Presidents: | ||||
| Michael E. Daniels, Global Technology Services | 52 | 2005 | ||
| Douglas T. Elix, Group Executive, Sales & Distribution | 58 | 1999 | ||
| J. Bruce Harreld, Marketing and Strategy | 56 | 1995 | ||
| Paul M. Horn, Research | 60 | 1996 | ||
| Jon C. Iwata, Communications | 44 | 2002 | ||
| John E. Kelly, III, Technology and Intellectual Property | 53 | 2000 | ||
| Mark Loughridge, Chief Financial Officer | 53 | 1998 | ||
| J. Randall MacDonald, Human Resources | 58 | 2000 | ||
| Steven A. Mills, Group Executive, Software Group | 55 | 2000 | ||
| Robert W. Moffat, Jr., Integrated Operations | 50 | 2002 | ||
| Virginia M. Rometty, Global Business Services | 49 | 2005 | ||
| Linda S. Sanford, Enterprise On Demand Transformation | 54 | 2000 | ||
| Robert C. Weber, Legal and Regulatory Affairs, and General Counsel | 56 | 2006 | ||
| William M. Zeitler, Group Executive, Systems and Technology Group | 59 | 2000 | ||
Vice Presidents: |
||||
| Jesse J. Greene, Jr., Treasurer | 61 | 2002 | ||
| Daniel E. O'Donnell, Secretary | 59 | 1998 | ||
| Timothy S. Shaughnessy, Controller | 49 | 2004 |
All executive officers are elected by the Board of Directors and serve until the next election of officers in conjunction with the annual meeting of the stockholders as provided in the By-laws. Each executive officer named above, with the exception of Robert C. Weber, has been an executive of IBM or its subsidiaries during the past five years.
Mr. Weber was a partner at Jones Day, an international law firm, until joining IBM in 2006. He was with Jones Day for almost 30 years, and his career included counseling corporations, individuals and boards of directors, as well as extensive experience in corporate derivative litigation, federal and state enforcement actions and commercial litigation.
Item 1A. Risk Factors:
Economic Environment and Corporate IT Spending Budgets: If overall demand for systems, software and services changes, whether due to general economic conditions or a shift in corporate buying patterns, sales performance could be impacted. IBM's diverse set of products and offerings is designed to provide more consistent results in both strong and weak economic environments. The company accomplishes this by not only having a mix of offerings with long-term cash and income streams, as well as cyclical transaction-based sales, but also by continually developing competitive products and solutions and effectively managing a skilled resource base. IBM continues to transform itself to take advantage of shifting demand trends, focusing on client or industry-specific solutions, business performance and open standards.
Internal Business Transformation and Global Integration Initiatives: IBM continues to drive greater productivity, flexibility and cost savings by transforming and globally integrating its own business processes and functions. In addition to eliminating redundancies and overhead structures to drive productivity, this integration has improved IBM's capacity to innovate by providing greater clarity of key priorities around shared goals and objectives and leads to a sharper focus for the company on learning, development and knowledge sharing. As IBM continues to drive higher levels of automation and integration into its business, IBM's dependency on internal IT systems also increases.
Innovation Initiatives: IBM invests to improve its ability to help its clients innovate. Investment may occur in the research and development of new products and services, as well as in the establishment of new collaborative and co-creation relationships with developers, other companies and other institutions. To deliver value that helps clients differentiate themselves for competitive advantage, IBM has been moving away from commoditized categories of the IT industry and into areas in which it can differentiate itself through innovation and by leveraging its investments in R&D. In the highly competitive IT industry, with large diversified competitors as well as smaller and nimble single technology competitors, IBM's ability to continue its cutting-edge innovation is critical to maintaining and increasing market share. IBM is managing this risk by more closely linking its R&D organization to industry-specific and client-specific needs.
Open Standards: The broad adoption of open standards is essential to the computing model for on demand business and is a significant driver of collaborative innovation across all industries. Without interoperability among all manner of computing platforms, the integration of any client's internal systems, applications and processes remains a monumental and expensive task. The broad-based acceptance of open standards—rather than closed, proprietary architectures—also allows the computing infrastructure to more easily absorb (and thus benefit from) new technical innovations. IBM is committed to fostering open standards because they are vital to the On Demand Operating Environment, and because their acceptance will expand growth opportunities across the entire business services and IT industry. There are a number of competitors in the IT industry with significant resources and investments who are committed to closed and proprietary platforms as a way to lock customers into a particular architecture. This competition will result in increased pricing pressure and/or IP claims and proceedings.
Investing in Growth Opportunities: The company is continuing to refocus its business on the higher value segments of enterprise computing—providing technology and transformation services to clients' businesses. Consistent with that focus, the company continues to significantly invest in growth opportunities, as a way to drive revenue growth and market share gains. IBM continues to invest in emerging growth countries such as China, Russia, India and Brazil. The developing nature of these countries presents political, social and economic risks to IBM's business, including the potential for inadequate infrastructure and labor disruptions.
Protection of Intellectual Property: While the company's various proprietary intellectual property rights are important to its success, IBM believes its business as a whole is not materially dependent on
any particular patent or license, or any particular group of patents or licenses. IBM owns or is licensed under a number of patents, which vary in duration, relating to its products. Licenses under patents owned by IBM have been and are being granted to others under reasonable terms and conditions. These protections may not prevent competitors from independently developing products and services similar to or duplicative to the company's nor can there be any assurance that these protections will adequately deter misappropriation or improper use of the company's technology. Also, there can be no assurances that IBM will be able to obtain from third parties the licenses it needs in the future.
Seasonality of Revenues and Purchases: IBM's revenues are affected by such factors as the introduction of new products and services, the length of the sales cycles and the seasonality of technology purchases. As a result, the company's results are difficult to predict. These factors historically have resulted in lower revenue in the first quarter than in the immediately preceding fourth quarter. In addition, the high volume of products ordered at the end of each quarter, especially at the end of the fourth quarter, may affect IBM's ability to successfully ship all orders before the end of the quarter.
Local Legal, Economic and Health Conditions: The company operates in more than 160 countries worldwide and derived more than half of its revenues from sales outside the United States. Changes in the laws or policies of the countries in which the company operates could affect the company's business in that country and the company's results of operations. The company's results of operations also could be affected by economic and political changes in those countries and by macroeconomic changes, including recessions and inflation. In addition, any widespread outbreak of an illness or other health issue, such as severe acute respiratory syndrome (SARS), avian influenza (bird flu) or any other pandemic, or local or global health issues, could adversely affect the company's operations, its ability to source and deliver products and services to its customers and customer demand.
Insurance: The company maintains third party insurance coverage against various liability risks and risks of property loss. While we believe these arrangements are an effective way to insure against liability and property damage risks, the potential liabilities associated with those risks or other events could exceed the coverage provided by such arrangements.
Environmental Matters: The company is subject to various federal, state, local and foreign laws and regulations concerning the discharge of materials into the environment or otherwise related to environmental protection, including the U.S. Superfund law. The company could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, as well as third-party claims for property damage or personal injury, if it were to violate or become liable under environmental laws and regulations. Compliance with environmental laws and regulations is not expected to have a material adverse effect on the company's capital expenditures, results of operations and competitive position.
Tax Matters: The company is subject to income taxes in both the United States and numerous foreign jurisdictions. IBM's provision for income taxes and cash tax liability in the future could be adversely affected by numerous factors including, but not limited to, income before taxes being lower than anticipated in countries with lower statutory tax rates and higher than anticipated in countries with higher statutory tax rates, changes in the valuation of deferred tax assets and liabilities, and changes in tax laws, regulations, accounting principles or interpretations thereof, which could adversely impact the company's results of operations and financial condition in future periods. In addition, IBM is subject to the continuous examination of its income tax returns by the Internal Revenue Service and other tax authorities. The company regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of its provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on the company's provision for income taxes and cash tax liability.
Internal Controls: Effective internal controls are necessary for the company to provide reasonable assurance with respect to its financial reports and to effectively prevent fraud. If the company cannot provide reasonable assurance with respect to its financial reports and effectively prevent fraud, the company's operating results could be affected. Pursuant to the Sarbanes-Oxley Act of 2002, the company is required to furnish a report by management on internal control over financial reporting, including management's assessment of the effectiveness of such control. Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. In addition, projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that the control may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If the company fails to maintain the adequacy of its internal controls, including any failure to implement required new or improved controls, or if the company experiences difficulties in their implementation, the company's business and operating results could be harmed, the company could fail to meet its financial reporting obligations, and there could be a material adverse effect on the company's stock price.
Use of Estimates: In connection with the application of GAAP and the preparation of the Consolidated Financial Statements, the company uses certain estimates and assumptions, which are based on historical experience and management's knowledge of current events and actions that the company may undertake in the future. The company's most critical accounting estimates are described in the Management Discussion on pages 45 to 47 of IBM's 2006 Annual Report to Stockholders. In addition, as discussed in note O, "Contingencies and Commitments" on pages 89 to 92 of IBM's 2006 Annual Report to Stockholders, the company makes certain estimates under the provisions of SFAS No. 5 "Accounting for Contingencies", including decisions related to legal proceedings and reserves. While management believes that these estimates and assumptions are reasonable under the circumstances, by definition they involve the use of judgment and the exercise of discretion, and therefore, actual results may differ.
Competitive Conditions: The company operates in businesses that are subject to intense competitive pressures. The company's businesses face a significant number of competitors, ranging from Fortune 50 companies to an increasing number of relatively small, rapidly growing and highly specialized organizations. The company believes that its combination of technology, performance, quality, reliability, price and the breadth of products and service offerings are important competitive factors. Intense competitive pressures could affect prices or demand for the company's products and services, resulting in reduced profit margins and/or loss of market opportunity. Unlike many of its competitors, the company has a broad set of capabilities and businesses and must allocate resources across these businesses while competing with companies that specialize in one or more of these product lines. As a result, the company may not fund or invest in certain of its businesses to the same degree that its competitors do, and these competitors may have greater financial, technical and marketing resources available to them than the businesses against which they compete.
Volatility of Stock Price: The company's stock price is affected by a number of factors, including quarterly variations in financial results, the competitive landscape, general economic and market conditions and estimates and projections by the investment community. As a result, like other technology companies, the company's stock price is subject to significant volatility.
Dependence on and Compensation of Key Personnel: Much of the future success of the company depends on the continued service, availability and integrity of skilled personnel, including technical, marketing and staff resources. Experienced personnel in the information technology industry are in high demand and competition for their talents is intense. There can be no assurance that IBM will be
able to successfully retain and attract the key personnel it needs. In addition, companies in the information technology and services industry whose employees accept positions with IBM may claim that IBM has interfered with noncompete obligations of their former employees, engaged in unfair hiring practices or that the employment of these persons by IBM would involve the disclosure or use of trade secrets. Any such claims could limit or prevent IBM from hiring employees or cause it to incur liability for damages or substantial costs in defending the company or its employees against these claims, whether or not they have merit. Further, many of IBM's key personnel receive a total compensation package that includes equity awards. New regulations, volatility in the stock market and other factors could diminish the company's use, and the value, of the company's equity awards, putting the company at a competitive disadvantage or forcing the company to use more cash compensation.
Relationships with Critical Suppliers: IBM's business employs a wide variety of components, supplies, services and raw materials from a substantial number of suppliers around the world. Certain of the company's businesses rely on single or a limited number of suppliers, although the company makes every effort to assure that alternative sources are available if the need arises. The failure
