This is paying off. According to Sanford Bernstein, a research firm, IBM has already increased profit margins from its services business, thanks to the cost reductions it has made in India.
Yet these are early days in the evolution of the Indian outsourcing industry. IBM will probably have to cope with two other new trends. The first is the decline in "mega deals", outsourcing contracts that are worth more than $1 billion over several years. These were common in the first wave of outsourcing a few years ago, but many are now due for renewal. Some companies are said to feel they ceded too much control to the outsourcing firms last time and now plan to manage the work more carefully, not least by parcelling business out to several firms. Contracts that would have gone to IBM alone may now be shared by IBM and, say, Infosys.
Nobody is really sure how significant this shift will be. After a slow year for mega deals, IBM signed three in the final quarter of last year — with the German army, Vodafone and the state of Indiana. But the consensus in the industry is that deals will be split, which is bad for IBM and good for its rivals.
The second big change is that Indian firms are rapidly moving upmarket. IBM's great strength is in offering total outsourcing. This includes everything from simple call centres to remote infrastructure management (over 40,000 servers outside India are managed from IBM's Bangalore operations) to "business transformation", in which IBM re-engineers and manages a company's entire operation, including its staff. The company has made much of one such deal, to run the back end of Bharti AirTel, India's leading mobile phone firm, whose boss spoke at IBM's investors' day.
But the Indian firms are rapidly acquiring the skills and connections they need to compete for these deals. Infosys now has a consulting operation. Its smoothly effective boss, Nandan Nilekani, spends time building the sort of friendships with other chief executives that IBM bosses have had for decades and regard as crucial in winning contracts.
IBM and the other multinationals are becoming increasingly nervous about the fifth-biggest Indian outsourcer, HCL Technologies. It is leaving the world's 200 biggest firms to the likes of IBM, and instead going after the next 800, which HCL's boss, Vineet Nayar, says tend to feel a bit neglected by the big traditional outsourcers. Largely unnoticed, HCL has won several contracts worth $300m-700m for infrastructure management and business transformation. In a recent deal with Cisco, HCL will take on risk from the American hardware company, using a contract that forsakes a fixed fee in favour of sharing revenue. According to IDC, a technology-research firm, HCL "may very well be one of the contenders to lead the IT services world of the very near future". As the Indian tigers improve, the pressure on IBM to innovate is bound to grow. That may get harder, which is why there is speculation that it will buy one of those Indian tigers. So far, adding jobs in India has not meant shedding many jobs in costlier places, such as America. And innovating may be harder when the corporate headquarters is in cosy New York rather than in the heat of the action in India. IBM's chief procurement officer may be in China, but no one who reports directly to Mr Palmisano is based outside America. Yet.
Play It Again, Sam
Hoping to get IBM's share price up, Mr Palmisano has promised double-digit growth in earnings per share over the long term. That is a tall order, and feasible thanks only to IBM's progress in other businesses, which has partly offset the difficulties in services. Huge savings have come as the company has broken down the barriers between its various operations. It has bought vast quantities of its own shares. It has continued to sell low-margin commodity businesses, such as hardware. In these businesses, IBM does not feel threatened by the rise of domestic competitors in countries such as China. On the contrary, it was delighted to sell one of them to Lenovo, which bought IBM's personal computer business in 2005.
But the future gains from selling low-margin hardware businesses may be limited. That puts a greater burden on IBM's high-margin software business. In the past four years it has spent about $16 billion on over 50 acquisitions, mostly small software firms that have thrived after having been stitched into the company. It has done this so well that (the growth story in services having become a little hollow) IBM is now claiming to be the next great software company. In 2006 software accounted for 20% of its revenue and for 40% of profits, up from 35% two years earlier. Much of the growth is in "middleware", software that helps all a firm's different software to run together.
But the strategy on which IBM is pinning its hopes is more complex than just software or services. The company is betting that it can produce synergies from the three business lines — hardware, services, software — in which, unlike any of its competitors, IBM is a global leader. That means prising the firm's employees out of their traditional product-driven business "silos" and getting them to work together. This strategy is articulated in the IBM way, ie, using plenty of jargon: "service oriented architecture", "solutions" and so on. Rather than simply push products at customers, the new approach means sorting out customers' difficulties using whatever mix of services, software and hardware leads to the best outcome.
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