avatar IBM World Trade Corporation Manufacturing


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    As we look at the world of business today— including our clients and their industries —we like what we see. Even better, we like what they see. We are certainly encouraged by IBM’s recent performance in a tough economy and by our future growth prospects. But what gives us even more hope for the future is the way companies, leaders and institutions of all kinds are coming to share in a highly promising consensus about the direction —and the very nature —of business. About the potential of technology for integration, not just automation. About the power of innovation that combines invention and insight. About the links among openness, standards and trust. Sometimes, consensus is driven by reaction and fear. But at other times, it’s fueled by hope. This is one of those times. Which is very good news, both for IBM and for a new era of global business growth. So, while it’s certainly nice to be a company that’s doing well… it’s even nicer to be doing so in such good company.

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    SAMUEL J. PALMISANO Chairman, President and Chief Executive Officer 2

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    Dear IBM Investor, Last year, I told you that we were repositioning IBM for leadership, in all the ways that a business can lead. I described how IBM defines leadership, along with our plans to achieve it. And I said that I believed the results of this repositioning would roll out in meaningful ways in the years and decades to come. twelve months later, it’s clear that the future we Our revenue from continuing operations, at envisioned is arriving, and more rapidly than we $89.1 billion (a company record), increased by expected. This is in part because of the hopeful signs 10 percent. Earnings from continuing operations were we’re seeing of economic recovery, with the promise $7.6 billion compared to $5.3 billion in 2002, which of renewed business investment in information tech- included $1.6 billion of after-tax charges for second nology. It’s partly because of the rapid adoption of our and fourth quarter 2002 actions. We continued to gain on demand strategy by clients, partners and the overall market share across all our core businesses. IBM today IT industry. But it’s also something more—something is the market leader in servers, middleware, business specific to this company and its people, and something transformation services and strategic outsourcing. longer lasting than a particular economic cycle. Highlights for the year included revenue growth IBM today is a very different enterprise than it in every server segment, a WebSphere middleware was just a few years ago. Our business model has been platform that grew 12 percent and gained market quietly but substantially reshaped to capitalize on the share, and 14 percent growth in strategic outsourcing. most promising growth and profit opportunities in Our success with clients was evident in faster-than- the market. Even more important for the long term, market growth for five of IBM’s six industry sectors. our operations and culture are being transformed as For example, in the public sector, which includes well. We are now focused with an intensity and unity our relationships with governments and health care I haven’t seen since the heyday of the mainframe. As a providers, we grew by 15 percent; in communications result, we are poised to take IBM to the next level, and by 8 percent; in industrial by 14 percent; and in to redraw and extend the boundaries of the IT industry. financial services by 13 percent. We again generated excellent cash flows. After A very good year, for a very different company investing $5.1 billion in R&D, we had $12.7 billion in IBM’s 2003 is the kind of year on which it’s gratifying to cash available for investment and distribution to look back—both for our overall achievements and for shareholders. We invested $3.9 billion of that in net the strong momentum with which we ended the year. capital expenditures and $1.8 billion in acquisitions to 3

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    CHAIRMAN’S LETTER strengthen our portfolio. And we were able to return clients or shareholders. In a word, we lost sight of $5.4 billion to investors—$4.3 billion through share IBM’s mission, of what had always set us apart. repurchase and $1.1 billion through dividends—ending Well, we’ve regained our focus now. IBM is an inno- the year in a strong cash position, with $7.6 billion, vator—in every dimension of that word. We know that including marketable securities. IBM and IBMers are at their best when they create Overall, despite facing serious challenges, the IBM value that our clients cannot get from anyone else. team executed with discipline. And indications for the That means we will provide leading-edge technology, year ahead are encouraging, including a strong demand services, expertise and intellectual capital, and will pipeline (enlarged by more than $17 billion of services integrate these capabilities for each client to provide signings in the fourth quarter) and a growing number them with competitive advantage. of alliances with business partners and software We commit to that. We commit to innovating to companies committed to leading with IBM’s open, deliver client success. And that is something for which standards-based platforms. clients are willing to pay a premium. All in all, a very good performance. But is it sustain- This may seem like a truism, but it actually commits able? Can we, in fact, improve upon it and keep grow- us to a very focused strategy, based on a choice between ing for the foreseeable future? I believe so, and let me the two primary sources of growth and profit in IT tell you why. today: the high-volume, undifferentiated product play; and the high-value, innovation and integration Recommitting to high value play, focused on the enterprise. It is this high-value For the past couple of decades, if you were to look at space we have chosen to lead. IBM’s performance in any given year or over several We believe this is the right choice for IBM and our years, what would you see? You’d see a very large global investors. By focusing on this space, we believe we can, company in which some businesses are growing rapidly, on a sustainable, long-term basis, generate superior some are flat and some are declining. Add it up, and it returns compared to the overall IT industry, command would average out to steady profitability—but perhaps leading share position in our selected businesses, out- uninspiring growth. For people with comparatively perform the average of the S&P 500 on return on short memories, this might be the only IBM they’d invested capital, and produce strong cash flows. ever known. And it would be legitimate to ask if the In recent years, we’ve taken many steps to seize this company is capable of more. position. Before I talk about those steps, I want to spend The answer is: We certainly are. In fact, over most a minute on what constitutes “high value” for clients of our nearly 100-year history, IBM was consistently today, and what will do so for the foreseeable future. It’s a company that outperformed others in our markets embodied in what we call the on demand enterprise. and generated superior returns. And that was because And that, in turn, is all about a new kind of integration. we were singularly focused on leading, and most often creating and defining, the high-value spaces The next wave of integration in our industry. After two decades of disaggregation, the IT industry Of course, with a company of IBM’s breadth and is re-integrating. This is being driven simultaneously global presence, there are always ups and downs that by a major shift in client demand, and a major shift result from economic cycles, product and technology in technology. transitions, and sometimes issues of execution. But Companies have come to realize that if they’re it’s also apparent that, somewhere along the line, we going to respond rapidly and effectively to today’s became more focused on defending our existing lead- volatile marketplace, they need to do more than ership position than on creating the next one. We Web-enable discrete systems, processes or business weren’t particularly bold or imaginative in getting into units. They need to pull together all of the systems new markets or developing new businesses, products they’ve already got and integrate them securely with and services, even when our strategic analyses indicat- their core business activities—horizontally, across ed that something new was coming. And, just as not just their whole company but their entire value important, we hesitated to reinvent or get out of busi- chain, from customers to suppliers. This is an nesses that no longer represented high value for either on demand enterprise. 4

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    Focus on High Value IBM Global Services generated In , IBM earned , U.S. IBM Global Financing pre-tax  billion in services signings patents, breaking the record income was . billion for , in , including seven con- for patents received in a single representing a  percent year- tracts over  billion and an year and eclipsing the nearest to-year increase. additional  contracts in excess company by more than , of  million each. patents. During the past eleven In , revenue from IBM years, the U.S. Patent Office has middleware increased  percent IBM Systems Group revenue issued IBM more than , to  billion, primarily driven by increased  percent to  billion patents—nearly triple the total continued strength in demand for in . It outpaced competitors of any U.S. IT competitor WebSphere ( percent growth), with double-digit growth in during this time. DB2 database ( percent growth) strategic UNIX, blade and and Tivoli ( percent growth) Intel-based servers, and storage middleware products. systems products. TOTAL REVENUE BY BUSINESS SEGMENT $ 89.1 $ 85.1 $ 83.3 $ 83.1 $ 81.2 15% 16% GLOBAL SERVICES 4% 32% 40% 3% HARDWARE 2% 1% SOFTWARE 39% 48% GLOBAL FINANCING 99 00 01 02 03 ENTERPRISE INVESTMENTS/OTHER REVENUE ($ IN BILLIONS) 1999 2003 INDUSTRY SECTOR GROWTH YEAR TO YEAR (2002-2003) $ 8.1 $ 12.7 $ 7.9 $ 12.0 $ 7.6 $ 7.4 $ 11.3 REVENUES IN ALL SIX OF IBM’S INDUSTRY SECTORS GREW FOR THE FULL YEAR, $ 10.7 $ 10.5 WITH THE FINANCIAL SERVICES SECTOR, INDUSTRIAL SECTOR AND PUBLIC SECTOR AMONG THE STRONGEST, AND WITH CONTINUED GOOD RESULTS IN THE $ 5.3 SMALL AND MEDIUM BUSINESS SECTOR. FINANCIAL SERVICES INDUSTRIAL COMMUNICATIONS 12.8 % 14.0 % 8.1 % 99 00 INCOME FROM 01 02 03 99 00 CASH AVAILABLE FOR 01 02 03 CONTINUING OPERATIONS INVESTMENT AND FOR DISTRIBUTION PUBLIC DISTRIBUTION SMALL & MEDIUM BUSINESS ($ IN BILLIONS) TO SHAREHOLDERS* ($ IN BILLIONS) 14.8 % 4.2 % 14.0 % * This represents management’s view of cash available for investment and for distribution to shareholders. See the company’s Management Discussion section on pages 64 and 65 for a reconciliation of these amounts to GAAP net cash from operating activities and basis for its presentation. incubated new businesses emerging growth areas • In its first year, IBM’s Engineering & • In just three years, Life Sciences has • In China, India, Russia and Brazil, IBM Technology Services business designed become a $1 billion business, more than generated revenue of $3 billion in 2003 and products for Medtronic, New York Stock doubling its revenue each year. It has saw double-digit growth. Exchange, Raytheon, Mayo Clinic and grown from two employees in 2001 to others, generating more than $160 million • IBM Business Consulting Services’ in revenue in 2003. more than 1,000 employees in 2003. Business Transformation Outsourcing • IBM’s Digital Media business grew 60 per- (BTO) unit generated fourth-quarter supply chain improvements cent to $1.7 billion in revenue in 2003. 2003 signings of nearly $3 billion. Major • By the end of 2003, the work of transforming • Application Management Services grew contracts are in place with clients including and integrating the supply chain resulted in 30 percent and contributed more than BP, Procter & Gamble, Sprint, Raytheon the lowest inventory levels for IBM in more $1 billion in new revenue since the line Aircraft, Dresdner Bank of Germany, and than 20 years. of business was created two years ago. United Technologies Corporation. • IBM’s supply chain transformation efforts • In 2003, Linux revenue grew over • With more than 2,000 clients, e-business have reduced the amount of time the sales 50 percent to more than $2 billion, as Hosting Services revenue increased by force spends on activities like checking on the rate of related software and services more than 20 percent each of the past order status, proposal generation and combined nearly doubled year to year. three years, topping $1 billion in revenue contracts by 20 percent. in 2003. • IBM’s Pervasive Computing business • By speeding inventory turns and improving generated more than $2.4 billion in revenue • IBM clients have more than $10 billion client collections and supplier payment in 2003, 36 percent growth mainly from in dormant computing capacity installed, terms, IBM’s supply chain efforts generated services and software installations. which can be turned on and paid for on more than $700 million in cash in 2003. demand. More than $500 million in capacity was turned on in 2003.

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    Financial Highlights INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES ($ in millions except per share amounts) FOR THE YEAR 2003 2002 Revenue $89,131 $81,186 Income from continuing operations 7,613 5,334 Loss from discontinued operations (30) (1,755)) Net income 7,583 3,579 Earnings/(loss) per share of common stock: Assuming dilution: Continuing operations 4.34 3.07 Discontinued operations (0.02) (1.01)) Total 4.32 2.06 Basic: Continuing operations 4.42 3.13 Discontinued operations (0.02) (1.03) Total 4.40 2.10 Net cash provided by operating activities from continuing operations 14,569 13,788 Investment in plant, rental machines and other property 4,393 4,753 Cash dividends paid on common stock 1,085 1,005 Per share of common stock 0.63 0.59 AT YEAR END Cash, cash equivalents and marketable securities 7,647 5,975 Total assets 104,457 96,484 Working capital 7,098 7,502* Total debt 23,632 26,017 Stockholders’ equity 27,864 22,782 Common shares outstanding (in millions) 1,695 1,722 Market capitalization 157,047 133,483 Stock price per common share 92.68 77.50 Number of employees in IBM / wholly owned subsidiaries 319,273 315,889 * Reclassified to conform with 2003 presentation. 6

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    CHAIRMAN’S LETTER Becoming one is dauntingly hard to pull off. It For our part, we’ve decided. The two parallel trajec- requires both the end-to-end integration of the tech- tories of integration—in client demand and in what the nology—which niche product vendors simply cannot technology requires—play directly to IBM’s historic do—and the integration of technology with business strengths. However, even with everything IBM brought processes. This in turn requires deep business knowl- to this table, we needed more. That’s why we’ve made edge and industry expertise that few traditional acquisitions such as PricewaterhouseCoopers technology companies have, and significant technical Consulting (PwCC), Rational software and 19 other knowledge and research strengths that few consulting companies in the past two years. And it’s why we reset firms possess. our priorities in R&D to develop more technologies Integration is also an emerging force in core tech- and services specifically for client needs in the nology and computing architectures. To cite one on demand era. example, advances in semiconductor devices have On demand integration is also why we’ve placed a been largely propelled by increasing the clock speed huge bet on standards, from the Internet protocols of the microprocessor chip; this is like revving up the and Linux to grid computing and Web services. RPM of a car engine. But while advances in raw speed Without open technical interfaces and agreed-upon are continuing apace, they are no longer enough to standards, even integration within a single enterprise increase chip and overall system performance. For one would remain a gargantuan task. And forget about thing, chips have become so densely packed with integration with the other companies, business transistors that they produce more heat than can be processes, applications, pervasive computing devices, cost-effectively dissipated. laws, regulations, customs and cultures that make up The solution is integration—putting multiple, often the ever-more-global marketplace of the 21st century. less-than-top-speed processors on the same chip, along An IT company’s position on open standards—not with additional functions like fast memory and high- just its rhetoric, but its actions—is a clear indicator performance input/output. This is the approach IBM of whether it faces forward or backward, is serving engineers have taken in developing our Blue Gene the needs of clients or protecting its market position. supercomputer. Integration of this sophistication is In addition to the opportunities I’ve described, our beyond the reach of most chip and systems companies. move into on demand has opened up some very large It requires expertise not just in semiconductors but businesses beyond the frontiers of the traditional IT in advanced systems architecture, custom logic industry—opportunities that remain out of reach for design, operating systems and software tools. This most of our competitors. is the kind of expertise that IBM has built up over One promising example is Business Transformation decades, and it is not easily replicated. And that’s Outsourcing (BTO), which was not even part of the why technology leaders like Sony, Cisco, Apple and industry lexicon 18 months ago. In BTO engagements, QUALCOMM have partnered with IBM for advanced IBM becomes responsible for transforming—and technology—and why last year Microsoft licensed actually providing—a client’s business process in IBM’s microprocessor technology for use in its areas such as human resources, procurement, customer next-generation Xbox game console. care, and finance and administration. Thanks to the acquisition of PwCC and the formation of IBM Bulking up in on demand Business Consulting Services, we generated nearly Many IT companies will struggle with this world that $3 billion in BTO signings during the fourth quarter of is dawning—with the need to choose between open 2003 alone. To give a rough idea of the potential here, and proprietary, between serving consumers and the current size of businesses’ outsourced spending on enterprises, between redistributing other people’s sales, marketing, logistics, finance, HR and all other intellectual capital and innovating. This is not about administrative processes is about $1 trillion a year. Of making pronouncements or promises. A company that, there is an opportunity in excess of $1oo billion cannot be all things to every client, every partner in the BTO areas we are pursuing. We are committed and every investor. to extend our leadership position in BTO in 2004. 7

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    CHAIRMAN’S LETTER Remaking IBM become a $1 billion-plus revenue stream. In the areas To some people, it may seem bold to have made all we’re targeting within life sciences and digital media these moves during the worst market ever seen in the alone, third-party analysts see more than $60 billion IT industry. But I don’t believe it was particularly of market opportunity by 2006. risky, because it was driven by client demand and the While we do all this, we’re continuing relentlessly realities of the technology. What’s really important to improve execution. By becoming an on demand for you to understand is that our commitment to lead- business ourselves, we’ve made big strides in product ership in the high-value spaces and in innovation isn’t cycle time, new product introduction, sales productivi- a mission statement. It’s a business model. And it ty and simplification of our processes. Our inventories commits us to continual reinvention of IBM itself. are at their lowest level in more than 20 years, and our Over the past several years, we’ve taken aggressive continuing progress in integrating our supply chain steps to remix our business so that we are positioned took $7 billion of cost out of the business in 2003, for long-term leadership and new opportunities in the surpassing what we achieved in 2002. high-value enterprise space, however that changes. We have, since 1997: Business value, and a company’s values As I mentioned last year, we’ve been spending a great • exited or reduced our presence in such areas as deal of time thinking, debating and determining the application software, hard-disk drives, networking fundamentals of this company. It has been important hardware, low-end printers and retail PCs—which we to do so. When IBMers have been crystal clear and estimate have declined from 31 percent to 25 percent united about our strategies and purpose, it’s amazing of IT industry revenue; what we’ve been able to create and accomplish. When • entered or increased our presence in distributed we’ve been uncertain, conflicted or hesitant, we’ve middleware, non-hardware maintenance services, squandered opportunities and even made blunders Intel-based servers and mobile PCs—which have that would have sunk smaller companies. grown from 40 percent of industry revenue to It may not surprise you, then, that last year we 46 percent, and are expected to continue outper- examined IBM’s core values for the first time since forming the overall IT market; the company’s founding. In this time of great change, • increased our revenue in business and technology we needed to affirm IBM’s reason for being, what sets consulting services, infrastructure services and the company apart and what should drive our actions infrastructure software—which generate superior as individual IBMers. long-term revenue growth, profit, cash and return Importantly, we needed to find a way to engage on invested capital—from 48 percent to 64 percent everyone in the company and get them to speak up on of our total, with expectations of increasing that these important issues. Given the realities of a smart, going forward; global, independent-minded, 21st-century workforce like ours, I don’t believe something as vital and personal • grown aggressively in emerging markets; in China, as values could be dictated from the top. India, Russia and Brazil we generated revenue of So, for 72 hours last summer, we invited all 319,000 $3 billion last year and saw double-digit growth; IBMers around the world to engage in an open • upped our rate of new account growth, giving us a “values jam” on our global intranet. IBMers by the total of 730,000 large, medium and small enterprise tens of thousands weighed in. They were thoughtful clients—with IBM’s small-and-medium business and passionate about the company they want to be a segment alone growing 14 percent to outperform the part of. They were also brutally honest. Some of what market in 2003, adding $2.4 billion in revenue; and they wrote was painful to read, because they pointed • incubated successful new high-growth businesses out all the bureaucratic and dysfunctional things that such as life sciences, digital media, application man- get in the way of serving clients, working as a team agement services, e-business hosting services, Linux or implementing new ideas. But we were resolute in and pervasive computing—each of which has already keeping the dialog free-flowing and candid. And I don’t 8

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    CHAIRMAN’S LETTER think what resulted—broad, enthusiastic, grass-roots To me, it’s also just common sense. In today’s world, consensus—could have been obtained in any other way. where everyone is so interconnected and interdepend- In the end, IBMers determined that our actions will ent, it is simply essential that we work for each other’s be driven by these values: success. If we’re going to solve the biggest, thorniest • Dedication to every client’s success and most widespread problems in business and society, • Innovation that matters, for our company and we have to innovate in ways that truly matter. And we for the world have to do all this by taking personal responsibility • Trust and personal responsibility in all relationships for all of our relationships—with clients, colleagues, partners, investors and the public at large. This is IBM’s I must tell you, this process has been very meaningful mission as an enterprise, and a goal toward which to me. We are getting back in touch with what IBM has we hope to work with many others, in our industry always been about—and always will be about—in and beyond. a very concrete way. And I feel that I’ve been handed something every CEO craves: a mandate, for exactly the Playing offense right kinds of transformation, from an entire workforce. Put it all together—a more focused business model, Where will this lead? It is a work in progress, and an industry shift that plays to our strengths, bets that many of the implications remain to be discovered. are paying off in the near term, and a workforce that What I can tell you is that we are rolling up our is united and impatient to become the great company sleeves to bring IBM’s values to life in our policies, we all aspire to be—and I feel good about IBM and procedures and daily operations. our prospects. I’ve already touched on a number of things relating Without the prod of fear or of a “burning platform,” to clients and innovation, but our values of trust and we’ve begun a substantial transformation of our personal responsibility are being managed just as seri- company. For the first time in a very long time— ously—from changes in how we measure and reward probably since my early days with IBM 30 years performance, to how we equip and support IBMers’ ago—I’m seeing a company ready to focus more on community volunteerism. opportunities than on threats, more intent on setting Our values underpin our relationships with investors, the agenda than on reacting to the moves of others. as well. In late February, the board of directors approved Our deep-seated optimism—a fundamental belief that sweeping changes in executive compensation. They IBMers have always possessed in progress, science include innovative programs that ensure investors first and the improvability of the human condition—is receive meaningful returns—a 10 percent increase in reasserting itself. IBMers are ready to reclaim a the stock price—before IBM’s top 300 executives can position of leadership—in our industry and in the realize a penny of profit from their stock option grants. larger world of business. Putting that into perspective, IBM’s market value Which is a very exciting place to be. For me would have to increase by $17 billion before executives and my colleagues, it’s just terrific to be part of an saw any benefit from this year’s option awards. In energized IBM company that is once again ready addition, these executives will be able to acquire mar- to play some offense. ket-priced stock options only if they first invest their own money in IBM stock. We believe these programs are unprecedented, certainly in our industry and perhaps in business. Clearly, leading by values is very different from some SAMUEL J. PALMISANO kinds of leadership demonstrated in the past by busi- Chairman, President and ness. It is empowering, and I think that’s much healthier. Chief Executive Officer Rather than burden our people with excessive controls, we are trusting them to make decisions and to act based on values—values they themselves shaped. 9

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    In the company of leaders if you want to understand the changes shaping global business in the  century, take a look into the corner office. We’re seeing the rise of a new generation of CEOs, who share a common point of view about how value is created today, how to exploit technology for tangible benefit, how to build different kinds of business relationships —and why those relationships, spanning all their company’s constituencies, are vital to its success. You’ll also, more and more, find a leader who is actively driving the integration of business and technology and changing the way the organization operates —becoming what we at IBM call an on demand business. For IBM, this shared point of view shapes everything we do — from our work with clients to the way we innovate. We have a new understanding of the potential for business in the world today. And we didn’t just think it up on our own. 10

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    “If you can’t differentiate yourself in this world, you get commoditized instantaneously. So we are constantly driving for more innovation, more differentiation and more technology. When I rally people inside GE, I say, ‘Growth is out there to be had, but it’s going to be uneven. Unless you are willing to make investments in the future, to take steps and stands, this is not a tide that’s going to raise every boat. There are going to be clear winners and losers.’” Jeffrey R. Immelt C H A I R M A N A N D C EO, G E Tracing its origin to Thomas Edison’s 1878 electric light company, GE has grown to become the world’s most valuable company, with a market capitalization of more than $132 billion and 315,000 employees. 11

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    Jorma Ollila C H A I R M A N A N D C EO, N O K I A “Nokia sees a future where the mobile phone industry can help companies mobilize their business processes, so they can be more competitive, innovative and flexible, and where users will enjoy the true benefits of enterprise mobility— connection to the people who matter, and to the data and processes that matter. Building this future requires strong industry cooperation and relies on an open business ecosystem to implement it successfully.” Nokia is the world leader in mobile communications, driving the growth and sustainability of the broader mobility industry. Nokia is dedicated to enhancing people’s lives and productivity by providing easy-to-use and secure products like mobile phones, and solutions for imaging, games, media, mobile network operators and businesses. 12

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    Meg Whitman P R ES I D E N T A N D C EO, E BAY “eBay is an on demand business. Our industry is incredibly dynamic, and we have to be the fastest moving, most flexible, most single-focused: a very simple company, actually. We have  million customers who expect us to be up  by , and their needs are constantly changing.” AT IBM’S BUSINESS LEADERSHIP FORUM, NOV. 12, 2003 With 971 million listings in 2003, representing $24 billion in gross merchandise sales, eBay defines the category of online marketplace. Along with nearly 95 million confirmed registered users, eBay hosts more than 150,000 stores online and provides services such as its payment solution, PayPal. 13

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    Michael L. Eskew C H A I R M A N A N D C EO, U PS “On demand and synchronized commerce are about treating every customer — and for us, every package— as if it were the only one we have. With  million packages a day going to and from  million customers, that’s a tall order. Bringing synchronized solutions to our customers will allow the small to act big, the big to act small, and everyone to act global.” Founded in 1907, UPS has grown into a $30 billion corporation, and is a leading global provider of specialized transportation and logistics services. UPS operates in more than 200 countries and territories worldwide. Its innovative digital content management solution has streamlined and automated its workflow and approval routing processes. 14

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    John Chambers P R ES I D E N T A N D C EO, C I S CO SYST E M S, I N C . “The corporations who win in the future will be those that thrive on change. Companies that build a culture of accepting change, that build a process implementation that allows for rapid change and standardization are uniquely positioned to take advantage of market transitions.” Cisco Systems, Inc., is the worldwide leader in networking for the Internet. The IBM and Cisco strategic alliance provides our clients with industry-leading, adaptive, integrated and secure network-enabled solutions to solve business problems, reduce complexity, and enhance business opportunities. 15

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    W. James McNerney, Jr. C H A I R M A N A N D C EO, 3 M CO M PA N Y “The best and most sustainable innovation occurs where creativity and customer needs intersect. Good ideas don’t just leap out of laboratories — they are called out by the clear voice of the customer and need to be reinforced with the right resources.” With operations in 60 countries and clients in more than 200, 3M is one of the United States’ largest global manufacturers and a diversified technology company that has become an icon of innovation. Its creativity spans many markets—from display and graphics to electronics and communications, health care, safety, security and protection services, transportation and beyond. 16

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    Sir John Bond H S BC G R O U P C H A I R M A N “HSBC has to be flexible to succeed. Companies today have to reinvent themselves constantly. You have to preserve the best of what’s gone before, jettison what’s no longer relevant and build the new. And you have to maintain your essential character while doing it.” HSBC is the world’s second largest banking and financial services organization. Its international network, linked by innovative advanced technology, includes more than 9,500 offices in 79 countries and territories in Europe, the Asia-Pacific region, the Americas, the Middle East and Africa—and serves more than 110 million customers. 17

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    In the company of innovators innovation is not just “invention.” It’s what results when technical invention meets business insight. And it crosses fields of study, as well as industries. What results? New business models. New ways to envision and build the physical environment. New ways of integrating knowledge and technology to enhance health and extend life. New ways to serve clients. New forms of creative expression. This is how IBM pursues innovation —and this is the kind of innovation we pursue — every day, in our clients’ workplaces, and in our own. Together, we apply intelligence, reason and science to make not just a product or a profit, but a difference. Because, while invention can be a solitary activity, innovation is always a collaboration. 18

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    ibm has been working with the airline industry since the 1960s. Today, 18 of the world’s top 20 airlines are ibm clients, including delta air lines, air canada, japan airlines and american airlines. what are an airline’s assets, and how do they gener- ate revenue? There are the fleet and routes, of course—but there is also a vast and continually growing store of data about travel and purchase histories. The problem is, this asset has been essentially Finnair unused. But what if that data could be analyzed and integrated with marketing programs and processes to predict buying patterns and h ig h e r m at h sales appeal? Customer relationship management would then become customer equity management. And that would be a whole new way to run an airline. That’s how Finnair’s long-term relationship with IBM took a new turn this past year, with the deployment of mathematical mod- eling and optimization algorithms designed by researchers from IBM’s Zurich Research Lab. Processing frequent-flier data has a potential impact of reducing marketing costs by 20 percent while improving marketing response rates by as much as 10 percent. And that means big money—in increased revenues and in savings. Still only a prototype, IBM’s Customer Equity Management solution already has an 80 percent accuracy rate for predicting the eventual value a customer represents. By forecasting a frequent flier’s future travel decisions, it’s also helped improve the airline’s customer satisfaction rate by 10 percent. And all from pulling numbers out of Finnair. “With the many ills the airline industry faces today, and in a highly logistical business, managing processes by applying technology more widely and more innovatively is a necessity.” E E R O A H O L A , S E N I O R V I C E P R ES I D E N T, CO R P O RAT E B U S I N ESS D EV E LO P M E N T A N D ST RAT EGY, F I N N A I R 01. 02. OTHER DESTINATIONS GETTING UPGRADED Finnair now uses IBM’s Customer Equity Finnair’s relationship with IBM began decades Management system to understand its best ago, in the mainframe era. Since 2002, IBM has customers much more deeply, and to tailor run the airline’s data center operations, as well. marketing programs to them—even aligning But with Customer Equity Management, IBM company strategy around their needs. And future and Finnair are taking a whole new trip together. applications could be broader still—helping make “They’ve gone from being a supplier to being our decisions about fleet deployment, the allocation data center to being a partner,” says Eero Ahola. of new routes, and contingency plans for some of “It’s a totally different relationship.” the most serious challenges facing airlines today. 19

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    Frank Gehry th i nk i ng outs i de t h e box “This technology provides a way for me to get closer to the craft. It felt like I’d been speaking a foreign language, and now, all of a sudden, the craftsman understands me. In this case, the computer is not dehumanizing; it’s an interpreter.” F RA N K G E H RY, A R C H I T ECT WA LT D I S N EY CO N C E RT H A L L , LOS A N G E L ES 20

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    replacing boxy buildings with bold, reflective, curvilinear designs takes courage and vision—especially when dealing with large-scale public works. Master architect Frank Gehry is so excited about the potential of software to free architects from the constraints of paper, pencil and two-dimensional design programs that he recently created 01. Gehry Technologies. This IBM-certified business partner sells the FIRST COMES CREATIVITY… concept and the software itself to other architects and designers to A crumpled napkin. The movement of water help them unleash their own creativity. around the bow of a boat. Who knows what will spark the creative mind? But the more unusual Gehry was inspired by his experience designing Los Angeles’ the design, the greater the risks. Can it be built? Walt Disney Concert Hall. Collaborative virtual product design What will it cost? Will it perform as intended? software originally developed by IBM and Dassault Systèmes for Innovators like Frank Gehry have embraced new the aerospace and automotive industries allowed craftspeople to tools to tame this uncertainty principle—and to let their creativity take flight. understand Gehry’s novel, three-dimensional designs precisely. With the technology, IBM Product Lifecycle Management Solutions, they knew how much material the design required and how the 02. complex components would come together. …FOLLOWED BY SAVINGS… That helped in both creative and pragmatic ways. Removing Complex, free-form surfaces excite designers uncertainties reduced costs as much as one-third, which proved and delight the eye. CATIA (computer-aided three- critical in overcoming a raft of obstacles—from an economic down- dimensional interactive application) software makes turn to a major earthquake—standing in the high-profile project’s way. even the most complex and unconventional designs The result: One of the most acoustically sophisticated concert readily understandable and gives craftspeople the tools they need to fabricate and assemble halls in the world, an instant global architectural landmark and components efficiently. the centerpiece of a $1.2 billion redevelopment project in L.A.’s downtown Bunker Hill district. 03. …AND THEN THE APPLAUSE The Los Angeles Philharmonic Orchestra per- formed the first concert in its new home on October 23, 2003. Music critics marveled at the concert hall’s acoustics. Architecture critics praised the “exquisite craftsmanship” of the “stunning organic sculpture.” One critic pronounced it a “rhapsody in steel.” Yet another was confident that, “over time, it will be to Los Angeles what the Eiffel Tower is to Paris.” in 2003, independent software vendors with whom ibm has a more than 90,000 business partners worldwide strategic alliance influenced more than $ 10 billion (consultants, integrators, software vendors, value-added of ibm services, hardware and software revenue, more than resellers and distributors) generated more than 1/3 of ibm ’ s double the amount influenced in 2001. revenue in 2003. 21

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    flip a switch, and thousands of people and buildings instantly appear. Flip it off, and they go away. On. Off. On. Off. Sounds like a cartoon, doesn’t it? For Threshold Digital Research Lab, a digital production company that’s really in the business of intellectual property man- agement, it is a cartoon… or a full-length film, a television show, or 01. THE VIRTUAL STUDIO a Web site. It’s whatever high-end graphic, animation and special effects power they need right at that moment. On. Off. Major film studios used to need up to 500 acres They have all the IT muscle they need to challenge far larger of sets, props, costumes and characters. Today, Threshold’s “virtual backlot” is making a feature competitors without breaking the bank, because this groundbreak- with more of all of these than the largest epics of ing studio pays only for the computing capacity as it’s needed—an the past—in a studio of less than 10,000 square especially attractive pricing model for an entertainment company, feet. And when filming “wraps,” Threshold doesn’t which faces surges in demand (“opening next week, everywhere”) have to destroy the sets and send its character actors packing. They remain intact and accessible and periods of lower-intensity use (“coming next fall to a theater for modification and future use by other near you”). Think of it as supercomputing on demand: IBM hosts Threshold artists. the computing in New York, and Threshold animators and artists in California apply their super-creative talents to make the most of it. Threshold’s upcoming full-length animated feature, Foodfight!, 02. will include 138 speaking characters, more than 6,000 “extras” ON TIME AND ON BUDGET and 174 sets with nearly 5,000 buildings—all digital, and all ready Even popular films often lose money simply for an early call at the flip of a switch, anytime they’re needed. So because they cost too much to make. Threshold’s on demand e-studio avoids the large permanent despite the complexity of the project, Threshold has been able to overhead some of its competitors must support. use IBM’s Deep Computing Capacity On Demand Center to And it uses human capital just as efficiently. shorten its production cycle to 18 months—less than a third of Threshold’s core group of animators can tap the time it takes to produce most animated films. the talents of remotely based colleagues using industry-standard IBM workstations. Chairman and CEO Larry Kasanoff believes his on demand business model can cut costs as much as 40 percent. some customers tap into ibm ’ s deep computing capacity on demand center, while others have capacity on demand sitting in their ibm machines, waiting to be turned on. in fact, more than $ 500 million of that capacity on demand was turned on in 2003, with another $ 10 billion still in the marketplace. 22

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    Threshold Digital Research Lab r e a dy f o r i t s c l o s e - u p L A R RY K ASA N O F F (A BOV E , FA R R I G H T ) M E E TS W I T H M E M B E R S O F T H E C R E AT I V E T E A M O F F O O D F I G H T ! (O P P OS I T E PAG E ) A S C E N E F R O M F O O D F I G H T ! “IBM on demand technology is allowing us to compete against people who may have more resources than we do, in the following very simple way: It allows us to make our entertainment better, faster and cheaper. The On Demand Center takes away the words, ‘I can’t,’ and makes you say, ‘Hey, I can do anything I can think up.’” L A R RY K ASA N O F F, C H A I R M A N A N D C EO, T H R ES H O L D E N T E RTA I N M E N T 23

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    GILFAM r e a l - t i m e r e a l e s t at e “We have to set a legal framework in order to provide a land register available to everybody, yet we have to satisfy specific conditions, such as insuring privacy and safeguarding against misuse.” J E A N - LU C VA L L E N S, J U D G E , P R ES I D E N T O F T H E P U B L I C G R O U P FO R T H E CO M P U T E R I ZAT I O N O F T H E L A N D R EG I ST E R O F A L SAC E A N D M OS E L L E (G I L FA M ) over the last five years, ibm ’ s business with governments in the united states, ibm hardware, software and services worldwide has more than doubled —growing at a rate can be found in more than 90 percent of federal agencies. in 2003 more than five times the industry average in europe, the middle east and africa combined, and more than seven times the industry average in the americas.

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    in the alsace and moselle jurisdictions of eastern France, what worked to ensure the rights of property owners has worked against the needs of modern business development. Local law in the region keeps things very local. Only original documents can be used for all land title transactions. 01. Also, the documents may not leave their regions. And their THE MORE THINGS NEED TO STAY THE SAME… authenticity has to be guaranteed—signed—by the local Land title archives for the three government jurisdic- judge. The rules are in some ways unique, due in part to the tions that make up GILFAM—Moselle and the Upper and Lower Rhine divisions of Alsace—go back 300 inheritance of regulations and customs from periods of years and have at different times been written in French and German sovereignty. French, German and Gothic German. An elementary The problem was, owners and mortgage bankers could but necessary step was turning all these deeds— barely conduct business away from the local courthouse. So 2.5 million sheets of paper in 40,000 registers held in 46 registry offices—into digital documents. GILFAM, the government bureau that oversees the comput- As a result of the system created by IBM, the erization of the land registry for this part of France, worked transfer of real estate titles will now combine the with IBM to create a novel system for on demand security and assurance of a secure system with robust user the authenticity of digitized titles and deeds. The result is authentication, to maintain the registry’s integrity, as required by law. Something a judge has (such as useful not just for land registries, but for many other regulatory a hardware token), plus something the judge knows agencies requiring official approvals and notarizations. (a personal password), and something the judge Using smartcards, biometric identification tools and “is” (a biometric pattern like a fingerprint) will time stamps, judges will be able to sign registry documents produce something everyone can use and trust. in digital fashion, making them available online for buyers, builders and lenders as well. The GILFAM registry and process 02. have thus been virtualized—one of the keys to making the …THE MORE THINGS NEED TO CHANGE business of government on demand. The project for a computerized land registry (livre foncier informatisé) is a good example of the integra- tion of technology and law in effective e-government. New processes and supporting technology were created by the IBM team to support the GILFAM mission, but new laws had to be passed by the French government to support the validity of digital signatures and the authenticity of an e-business registry office. This model can apply to governments everywhere as they transform themselves to become on demand. In the United States, for example, the Food and Drug Administration has issued regulations that permit the use of electronic records and digital signatures in place of paper and handwriting once the outlined requirements are met. The end result for these agencies is greater flexibility and efficiency, as well as easier access for citizens and corporations. 25

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    in academic circles, it’s widely known as the “traveling salesman problem”: Take a finite number of points and the cost of travel between each pair of them. Then find the most cost-effective way to visit all the points and return the traveling salesman to where he started. But for a leading limousine company serving thousands of traveling salespeople and other professionals 01. every day, it was a complex business problem, as well. NOW SERVING ATLANTA When BostonCoach initially asked IBM to install a global- Despite the name, BostonCoach has operations positioning system, so that its dispatchers could find optimal in nine major cities, with affiliates in more than 450 other cities globally and with as many as routes, it inspired us to see the fleet itself as an organic system. 1,000 to 1,400 rides per day in its largest markets. In the process, we rethought how a limo company (with thousands Normally, establishing service in a new city would of customers, rides and routes on any given day) could become an require BostonCoach to create a new dispatch on demand business, with continual response and analysis of data center operating 24 hours a day, 7 days a week, right at startup. With the efficiencies of the in the search for maximum efficiency. Fleet Optimization System, in 2003 the With the solution developed by IBM, the drivers’ assign- company entered an entirely new market—in ments are still made by fleet controllers—real people with years Atlanta—by relying completely on its existing of experience. But the system now uses an algorithm developed dispatch centers. by IBM researchers to solve the problem of scheduling. By consid- ering positioning data, business “rules” and even driver pay rates 02. and FAA schedules, the Fleet Optimization System maps the BETTER SERVICE WITH BETTER SCHEDULES location of drivers and customers and suggests to dispatchers the best matchups. BostonCoach leads in the van, limousine and sedan service industry for on-time pickup, but As a result, while other travel companies have experienced leadership used to come at a cost. Before the declines in revenue and customer loyalty, BostonCoach is on target system created by IBM’s On Demand Innovation to achieve a 20 percent increase in productivity and a 10 percent Services, dispatchers would often turn down increase in sales. last-minute reservations—or send two cars to meet a single customer—rather than risk brand- damaging disappointment. Now, fleet controllers can accept more business and use cars more efficiently, with a system that optimizes sched- ules for three different time scales: daily, every 15 minutes and even several times per minute. 26

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    on demand innovation services is IBM’s first formal client-focused arm within IBM Research. clients can access any of ibm ’ s 3,000 researchers worldwide who specialize in business transformation and technology consulting. BostonCoach yo u r r i d e i s h e r e “The real differentiation is in the quality of service that you deliver. More likely than not, technology initiatives will become a commodity down the road, so you really want to be first to market —to get in first and hook customers.” RU SS CO O K E , P R ES I D E N T, BOSTO N COAC H 27

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    Mayo Clinic r e f i n i n g t h e a rt o f h e a l i n g ( L E F T ) H U G H C . S M I T H , M . D. , V I C E P R ES I D E N T, A N D C H A I R, BOA R D O F G OV E R N O R S, M AYO C L I N I C I N R O C H EST E R, M I N N . ( R I G H T ) D E N I S A . CO RT ES E , M . D. , P R ES I D E N T A N D C EO, M AYO C L I N I C “Wouldn’t it be marvelous if I knew not just the exact location of the patient’s cancer but its gene characteristics, and the outcomes with the last  patients at Mayo with cancer in that identical location and with those identical genetic characteristics?” D R. H U G H S M I T H , M AYO C L I N I C PAT I E N T R ECO R D A R C H I V ES AT M AYO C L I N I C . ( N O PAT I E N T P R I VACY O R CO N F I D E N T I A L I T Y WAS CO M P R O M I S E D FO R T H ES E P H OTO G RA P H S. ) 28

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    in three years, Life Sciences has become a $1 billion business in the area of medical devices and diagnostics, more than for ibm, more than doubling revenue each year since its 60 leading analytical instrument and tools companies now base their formation in 2000. new clients include 25 of the top offerings on ibm technology, including ibm middleware, pharmaceutical and biotechnology companies. server platforms and services. 01. 2,400 HEADS ARE BETTER THAN ONE The new system will provide Mayo Clinic’s 2,400 physicians with differing levels of on demand access to medical data to support diagnoses and treatment decisions based on information collected from millions of informed, consenting patients. To ensure patient privacy and confiden- tiality are maintained, physicians conducting for a medical center, loss means something far more research will access only general information serious than it does for almost any other business. (“a 38-year-old female with a family history of heart disease”), while the treating doctor accesses And the prospect of loss becomes maddening if there’s any the records of her specific patient—no matter possibility information for treatment and cure might already where those records originated or physically reside. exist—but be hidden inside archived case files, or in trends across millions of records, requiring lengthy, expensive studies to uncover. If only doctors could tap data from consenting patients with 02. similar epidemiological or genetic makeup, much faster, more FROM MONTHS TO MINUTES effective, individualized therapy would be possible. The Mayo Clinic Life Sciences System can perform Now, with IBM’s help, the world-famous Mayo Clinic is complex, cross-patient correlations across patient increasing exponentially the ability to sift through their warehouse demographics, diagnostics and laboratory results— for all of the 4.4 million patient histories in their of patient data—and helping doctors make sense of it. As a result, vast data warehouse. Medical searches by symp- medicine can become less about the science of trial-and-error and tom, patient age, laboratory result, drugs pre- more about the art of healing. scribed and other factors—searches that once took It was Mayo Clinic that originally pioneered the idea of months—are completed in a matter of minutes, giving physician investigators the information collaborative medicine—the joint application of the greatest they need, where and how they need it, facilitating medical minds to treat an illness and cure a disease. And now they’ve discovery and patient care improvement. expanded that collaborative approach into the realm of patient histories. Through IBM’s on demand solution, trends and correla- tives become identifiable—speeding the course of discovery and 03. enhancing patient care. CHANGING HOW MEDICINE IS PRACTICED As the understanding of genetics increases, the system will aggregate patient genomic information, as well as proteomic data and research information, from a variety of sources. This will help quicken the pace of clinical research, identify likely participants in clinical trials, help researchers understand illness on a molecular level, and allow physicians to treat patients and practice preventive medicine based on an individual’s own physical makeup.

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    In the company of visionaries there is a growing —we think unstoppable — realization that neither technology nor business will for long be controlled by a small number of people or companies. Aside from the obvious economic advantages of an “open” approach, there is simply no other way to bring about the world we envision —the world we need. The implications are far-reaching and broadly empowering. Opening access to other people and their information creates relationships that didn’t exist before, which then become engines of creation themselves. Crossing barriers —between languages or even areas of expertise —opens up opportunities for the creation of new economic, business and societal value. Connections arise between people and ideas, technologies and processes —and what started as a commitment or passion just a few years ago may end up as the leading position. And once you’re there, it’s good to find out that you’re not alone. 30

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    + Martin Scorsese FILMMAKERJEHAIN, THE FILM FOUNDATION Film has undeniably changed the way people view themselves. The ability to see the world in motion, mechanically reproduced, % first in image and then married to sound, is a monumental development in human history. on Tes allowed us to see ourselves in ways “ we never would have previously imagined. Ofcourse, a change ofthis magnitude affects culture and societyin complex, dramatle ways, samehetter thanothers. Butultimately cinemaisaboutpeople—allcinema is about ‘whowe are esboumanbeing.Andfimhay allowedusaglimpse into othercultureslike no other medium. Jotheworking Americm neighborhoodwhere 1 grew up, cinemawas myintroductionto othercultures. ‘Through fm, l identifiedwiehpeoplewholockedandlived differentfromapselEThroughthis Klentifcation, superficial differences disappeared, endI sewmyselfandthepeople I newin these film. Intodayworld, t's importantwe recognizeonrIntende- pendency.we are not alone, and certainlynotisolated. “Technologiesas complexas the Intemet, andascomparatively simple ax motipictures, serve to unite theworldandto erase boundaries. Exposure to otherculsurea oalycariches cur cv. Film is apowerfultool fur knowledge and for understanding. {ui THEFAL FOUNDATION xD TE UCLA PILA AND TELEVISION ARCHIVE WILL PESSZEVE ano Aacurve mart en 27 MILLION evr or ECLARIT MSTRONONE NIES COLLECTION NEWANZEI YOOTADE DATING FRDAE 1913 10 THE 19604, WHICH HISTORLANE, NOOLANS AW THR GENMEAL PUBLIO cam acco vrm. IL ALLO AUTORS TED FILA FOUNDATION'S EDUCATIONAL INTIIATIVA, “PER ETUET OF MOTIRIPAN INTERACTIVE, INTERDISCIPLINANY CURMCULOM BNAZLING EDUCATORI TO tnech studenti arikelbiking ABOUT TRE RIFFORICAT. {AD COLPUMAL SIGNIFICARCE OF T1141.

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    DON’T THINK “COMPUTERS,” THINK COMPUTING INESTOR-BENERAL, DEPARTUENT 01 MINIATEY OF EDUCATION, PEOPI “The China Grid will provide a wide range of advantages over standard computer networks for ‘university students and researchers —andits uses will go far beyond the academic world. Tnnovetion u the spirit nd soulof ‘This implementation ofgrid computing Chinaseconomicdevelopasent.And ‘wilhelpbringdown costsand raise the delsalso keyw ourstudent’ expiration Barfor qualitycontrol Iwill transform forpersonaldevelopment und formaking teaching and education ingeneralby difference—fortheir country andfor Betterutiizing online information and by humancirfizarion. providing arobust environment forscien- China is one ofthe fitcounties to tific reseerch, Students andresearchers implement 6computingged ofthls scale. ‘willuse the ChinaGrid forimage pro- Tei acomputing netwark, mach more esting, blologicel information science, efficient thanenetworkofcomputers. ‘nydcodynamics, e-campus activities and ‘You simplycan’t compare traditional other computingintensive projects. ctustesing anddata storage capacitywith ‘Butgridcomputing is alo the future those ofagrid. For example, the China ceavironment forapplications ranging Gridwl aliutilize tbe information md ‘frome-business, telemedicine anda ‘computingresources ofour CERNET varietyofindustries toeven the home (ChinaBdocationand ResearchNetwork), ‘andentertainment markets. Wocking undwillenable resource sharing, chim! together, progressive policy and IT nate information islendsandprovide zn Infrastrocture canenableeconomics and effective endhigh-seandardplatform for markets to grosrepidlybatin an computingat ouriniveraitien. ordedyfushlon, [UPON COMYLITION, THE CHINA OCATION AND Run ORD WI. PO CAPA: 0 LIMEmere that 200,000 nudentıandfaultymembers CN MEABLE 100 UNTVRASTING ‘ACOTHE 7207121 RAPURIIC O) CRINATOAVIRTUAL SUPRACOMPUTIN— 24610 ont verwwan SuRVICRE TACHNULOGY zaWinssen capanız OF comnueramo 15 TRILLIONcarcurarions zen aroma.

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    Rn en, ee » Robert Grady, James W. B FEE VENTOR CAPITAL repusraydutingthebubblepechaps made ‘one mistalbe—investing onlyin cutting-edge technologiesbeingsald onlyto other, larger IT companies,When the bigap companies ‘caught a cold, the litle companissgotpneumanin,We believethat: the morepowerful mend is thedeployment oftechnologythroughout ‘the industrialeconomy—inautomotive mansfacturing,defense ‘and acroepece, healthcare,logistics, transportation, you name i. "Technologycontinuestopenetrate andofferproductivityimprave- ‘ments ineach ofthese scctors.'The recogineeringofbusinessesin America und around the world is far from complete, and its daily mannyisveryexriting toun—nonent snapr sour rome sarOVEN soquca softwarehas ermmmodilacd segments ofthe ITindustry, but Iwould argue that it re-energized technologies ‘that bad wragnared andlacked innovation forsemetime. Costomers havelong felt exploitodbythe proprietaryvendorswho bate their pricing onJockinand marie power, therthan innosatiem asvelus delivered.The open source movementis ax mmcha customerrebellion. ‘against that exploitationas i is a developer movement. Andit's nat alyabout cost. Onthe flipside,traditional softwarecompanieshad betterbepreparedto justifytheirvalue cantinnelly ortheynakfalling ‘preyto the next opensoureeproject.JANES DREYER "THE WILD BxUBREANGE surroundingtbe Internet resultedin aget ‘ich-quickeuphoriathat affictedentrepreneur,large corporations, venture capitalists andamall investors, Hugeamounts ofmoneywent into businessmodelstftneverreallymade sense.Vast rimswere spent on marketingand adrestinig topropelgrowehinaneffortto IPO the ‘companyas soonaspossible. Hopefully theVC industryleamedsome (goodlessona.Weare stillveryexcited abour the cuntiouingianows- ‘Hons thatwe sce inthe IT seetot But, wehave tobuildcampaniee the old-fashionedwap. withlotsofentrepreneurial hardworkandsweat equity, analler rounds offinancing, slowergrowehand self-financing revemve plans, andwithmoreresponsible involvement framventure capitalistein buildingthe businesses, —LiP-BU TAN gaia nastro 147 Venrrvan cArirasiaré ants POWREFUL FORCE: zor erovarzen. Wi achoely build relriombigo WITH THE VENTURE CAPITAL. COMMUNTIT 10 SHARE QUE VISIONI, FTEATSOTES, STANDARDS "AND AXCETTECTURZA, AND TO IDIATFIFY RUBICINO JUSINESS OPTONTOMITIRA. From bft vorigen OI GRADY IN MANAGING DIBECTOR UP TSE CARLYII OROUR, [AMES EREYER 15 MANAGING PAMTNUR OF ACCBY PARTIES, IXR-BO TAN 18 CIRATEMAN 0Y WALDAST INTIANANIONAL.,

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    » Sanjay K. Jha ans “it Wireless communications is one ofthe most exciting growth opportunities in technology. \ Andits greatest impact may not be in the new multimedia devices that support CD-quality audio, integrated cameras, high-quality graphics for gaming, and video for news and teleconferencing thatare generating most of the attention in theindustrialized countries, Perhaps less sppreciated, though more consequential, is the role the wireless Industry is playing in bringiug simple voice commmnication and Internet connectivity to newer, emerging markets, ruch as India, Southeast Asiz, Latin America, and ofcourse Ching, which nowhas mote wireless ‘users than users oftraditional lendlines. QUALCOMM develops the chipsets and integrated ‘applications to make wireless devices smaller, mare ‘versatile and less costly. To do that, we have to manage one Blobel supply chain and understand the needa and prefer- ences ofconsumers in cach regional marketplace, We also have to be acutely sensitive to governmental practices in each ofthe dozens ofcountries in which we do business, because the scarcity ofwireless spectrum Invites a high degree ofregulation. "With so mach to know and so little time to act on that knowledge, we knewweld have to stay extraordinarily focused ifwe were to succeed. From the beginning, we were convinced the most successful companies would be ‘those that concentrated on their core areas ofexpertise ‘while depending an the proficiencies oftheir partners, The transition from an Innovative idea to a commercially successful product requires an enormous amount of collbo- "nation among consumer electronics device mamufactarers, applications developers, wireless carriers, and partners Tike TAM, whose technology development expertise we rely am to deliver leading-edge semiconductor. WORKING TOGETEZE FOR mort thot royears, QUALCOMO AND TRUE {AVE MAMOFACTURED AND SEZPPED MORE TEAN 300 MILLION ces von rasız CaizULaR raonvare, [HKLEINNG QUALCOM TO BECOME THES WORLD"A LAnozer “panas” smacicONDUCTOM COMPANY.

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    In the company of IBMers A publicly held corporation is a legal entity, but it is also a set of relationships —between the company’s people and its shareholders, and among clients, suppliers, distributors, organizations and the communities where its people live and work. For , IBMers around the world, relationships are the context for our work, where collaboration fosters innovation and leads to client success. In July , tens of thousands of IBMers reexamined their relationship with this company and with each other in a -hour online discussion that took place via IBM’s global intranet. They discussed, debated and explored what it means to be an IBMer today and what needs to change to keep them motivated for tomorrow. In the end, they shaped and committed to three values that will guide everything we do. IBMers value: • Dedication to every client’s success • Innovation that matters —for our company and for the world • Trust and personal responsibility in all relationships 40

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    report of management _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 42 report of independent auditors _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 42 management discussion _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 43 43 ROAD MAP _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ MANAGEMENT DISCUSSION SNAPSHOT _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 44 DESCRIPTION OF BUSINESS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 45 YEAR IN REVIEW _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 51 PRIOR YEAR IN REVIEW _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 61 LOOKING FORWARD _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 63 EMPLOYEES AND RELATED WORKFORCE _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 69 GLOBAL FINANCING _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 69 consolidated financial statements EARNINGS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 74 FINANCIAL POSITION _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 75 STOCKHOLDERS’ EQUITY _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 76 CASH FLOWS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 79 notes to consolidated financial statements A SIGNIFICANT ACCOUNTING POLICIES _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 80 B ACCOUNTING CHANGES _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 86 C ACQUISITIONS/DIVESTITURES _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 89 D FINANCIAL INSTRUMENTS (EXCLUDING DERIVATIVES) _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 92 E INVENTORIES _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 93 report of F G FINANCING RECEIVABLES _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 93 PLANT, RENTAL MACHINES AND OTHER PROPERTY _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 93 financials H I INVESTMENTS AND SUNDRY ASSETS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 94 INTANGIBLE ASSETS INCLUDING GOODWILL _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 94 J SALE AND SECURITIZATION OF RECEIVABLES _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 95 K BORROWINGS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 95 L DERIVATIVES AND HEDGING TRANSACTIONS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 96 M OTHER LIABILITIES _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 99 N STOCKHOLDERS’ EQUITY ACTIVITY _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 100 O CONTINGENCIES AND COMMITMENTS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 101 P TAXES _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 103 Q ADVERTISING AND PROMOTIONAL EXPENSE _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 104 R RESEARCH, DEVELOPMENT AND ENGINEERING _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 104 S 2002 ACTIONS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 105 T EARNINGS PER SHARE OF COMMON STOCK _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 108 U RENTAL EXPENSE AND LEASE COMMITMENTS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 109 V STOCK-BASED COMPENSATION PLANS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 109 W RETIREMENT-RELATED BENEFITS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 110 X SEGMENT INFORMATION _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 117 five-year comparison of selected financial data _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 122 selected quarterly data _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 123 board of directors and senior executive officers _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 124 stockholder information _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Inside back cover 41

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    Report of Management INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES Responsibility for the integrity and objectivity of the financial guidelines, translated into numerous languages, are distributed information presented in this Annual Report rests with IBM to employees throughout the world, and reemphasized management. The accompanying financial statements through internal programs to assure that they are understood have been prepared in conformity with generally accepted and followed. accounting principles, applying certain estimates and judg- PricewaterhouseCoopers LLP, independent auditors, is ments as required. retained to examine IBM’s financial statements. Its accom- IBM maintains an effective internal control structure. It panying report is based on an examination conducted in consists, in part, of organizational arrangements with clearly accordance with generally accepted auditing standards, defined lines of responsibility and delegation of authority, including a review of the internal control structure and tests and comprehensive systems and control procedures. We of accounting procedures and records. believe this structure provides reasonable assurance that The Audit Committee of the Board of Directors is com- transactions are executed in accordance with management posed solely of independent, non-management directors, authorization, and that they are appropriately recorded in and is responsible for recommending to the Board the inde- order to permit preparation of financial statements in con- pendent auditing firm to be retained for the coming year, formity with generally accepted accounting principles and to subject to stockholder ratification. The Audit Committee adequately safeguard, verify and maintain accountability of meets periodically and privately with the independent audi- assets. An important element of the control environment is tors, with the company’s internal auditors, as well as with an ongoing internal audit program. IBM management, to review accounting, auditing, internal To assure the effective administration of internal controls, control structure and financial reporting matters. we carefully select and train our employees, develop and dis- seminate written policies and procedures, provide appropriate communication channels, and foster an environment con- ducive to the effective functioning of controls. We believe that it is essential for the company to conduct its business SA M U E L J. PA L M I SA N O J O H N R. J OYC E affairs in accordance with the highest ethical standards, as Chairman of the Board, Senior Vice President and set forth in the IBM Business Conduct Guidelines. These President and Chief Executive Officer Chief Financial Officer Report of Independent Auditors To the Stockholders and Board of Directors of Those statements were audited by other auditors whose International Business Machines Corporation: report thereon has been furnished to us, and our opinion In our opinion, based on our audits and the report of other expressed herein, insofar as it relates to the amounts included auditors, the accompanying consolidated financial state- for the company’s Business Consulting Services Reporting ments appearing on pages 74 through 121 present fairly, in all Unit, is based solely on the report of the other auditors. We material respects, the financial position of International conducted our audits of these statements in accordance with Business Machines Corporation and subsidiary companies at auditing standards generally accepted in the United States of December 31, 2003 and 2002, and the results of their opera- America, which require that we plan and perform the audit tions and their cash flows for each of the three years in the to obtain reasonable assurance about whether the financial period ended December 31, 2003, in conformity with statements are free of material misstatement. An audit includes accounting principles generally accepted in the United examining, on a test basis, evidence supporting the amounts States of America. These financial statements are the and disclosures in the financial statements, assessing the responsibility of the company’s management; our responsi- accounting principles used and significant estimates made by bility is to express an opinion on these financial statements management, and evaluating the overall financial statement based on our audits. We did not audit the financial state- presentation. We believe that our audits and the report of ments of the company’s Business Consulting Services other auditors provide a reasonable basis for our opinion. Reporting Unit (which includes the consulting practice acquired from us as discussed in note C) for the year ended December 31, 2003 and the three months ended December 31, 2002, which statements reflect total revenues of 14.5 per- P R I C EWAT E R H O U S ECO O P E R S L L P cent and 4.3 percent of the related consolidated totals in the New York, New York periods ended December 31, 2003 and 2002, respectively. January 15, 2004 42

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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES road map • The Management Discussion is designed to provide readers with a view of the company’s results and certain factors The financial section of the International Business that may affect future prospects from the perspective of Machines Corporation (IBM) 2003 Annual Report, consist- the company’s management. A new snapshot of the key ing of this Management Discussion, the Consolidated messages in the Management Discussion has been added Financial Statements that follow and the related notes on page 44 immediately following the Road Map. While thereto, comprises 81 pages of information. This Road Map the details of the Management Discussion remain, readers is designed to provide you with some perspective regarding will be able to assess quickly the most important and key the information contained in the financial section and a few drivers within this brief overview. helpful hints for reading these 81 pages. • The Management Discussion was redesigned to reflect I B M ’S B U S I N ESS M O D E L the company’s continued and improving strength in IBM’s business model is built to support two principal goals: providing broad client solutions, as opposed to a “piece helping clients become more efficient and competitive parts” conglomeration of many hardware, software and through the use of business insight and information tech- services businesses. The Description of Business begin- nology (IT) solutions; and providing long-term value to ning on page 45 (introduced in the 2002 Annual Report), shareholders. In support of these objectives, the business Results of Continuing Operations on page 51, Financial model has been developed over time through strategic Position on page 57, and Looking Forward on page 63 investments in services and technologies that have the best sections, all are now written from the perspective of the long-term growth and profitability prospects based on the consolidated entity. Detailed analysis for each of the com- value they deliver to clients. In addition, IBM is committed pany’s segments follows the consolidated perspective and to its employees and the communities in which it operates. appears on pages 55 t0 57. The model is designed to allow for flexibility and periodic • A separate Global Financing section beginning on page 69 rebalancing, as demonstrated with the 2002 acquisition of (introduced in the 2002 Annual Report) is retained and PricewaterhouseCoopers’ (PwC) consulting business (PwCC), not included in the consolidated perspective that is the acquisition of Rational Software Corp. (Rational) in referred to above. This section was separately retained 2003, and the 2002 divestiture of the company’s hard disk given its unique impact on the company’s financial condi- drive (HDD) business. tion and leverage. The company’s portfolio of capabilities ranges from serv- • The Liquidity and Capital Resources section beginning on ices that include business transformation consulting to soft- page 64 was expanded to provide greater insight on the ware, hardware, fundamental research, financing and the strength and factors affecting the company’s liquidity. component technologies used to build larger systems. These capabilities are combined to provide business insight and H E L P F U L H I N TS solutions in the enterprise computing space. Organization of Information In terms of financial performance, over the last two years, • This Management Discussion section provides the IBM increased its participation in the high-growth areas of reader of the financial statements with a narrative on the its industry, while at the same time maintaining a breadth of company’s financial results. It contains the results of capabilities that has allowed it to gain market share during operations for each segment of the business, followed by weak economic environments. In general, this strategy a description of the company’s financial position, as results in less volatile returns overall, because each individual well as certain employee data. It is useful to read the capability has unique financial attributes. Some involve con- Management Discussion in conjunction with note X, tractual long-term cash and income streams while others “Segment Information,” on pages 117 through 121. involve cyclical transaction-based sales. • Pages 74 through 79 include the Consolidated Financial In terms of marketplace performance—i.e., the ability to Statements. These statements provide an overview of the deliver client value—it is important to understand that the company’s income and cash flow performance and its fundamental strength of this business model is not found in financial position. the breadth of the portfolio alone, but in the way the com- pany creates business solutions from among its capabilities • The notes follow the Consolidated Financial Statements. and relationships. Among other things, the notes contain the company’s accounting policies (pages 80 to 86), detailed information T RA N S PA R E N CY on specific items within the financial statements, certain Transparency is a primary goal of successful financial reporting. contingencies and commitments (pages 101 to 103), and The following are additional improvements you will find in the results of each IBM segment (pages 117 to 121). this year’s Annual Report: 43

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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES • The selected reference to constant currency in the CO N T I N U I N G O P E RAT I O N S Management Discussion is made so that the financial The increase in IBM’s 2003 Income from continuing oper- results can be viewed without the impacts of changing for- ations and diluted earnings per share from continuing eign currency exchange rates and therefore facilitates a operations as compared to 2002 was due to: comparative view of business growth. • The results of the company’s productivity and efficiency initiatives, including the benefits from the 2002 Discontinued Operations Microelectronics and productivity actions On December 31, 2002, the company sold its HDD business to Hitachi, Ltd. (Hitachi). The HDD business was accounted • Stronger demand associated with the improving economy for as a discontinued operation under generally accepted (especially during the fourth quarter) and continued mar- accounting principles (GAAP). This means that 2002 and 2001 ket share gains income statement and cash flow information were reformatted • The charges recorded in 2002 for the 2002 actions to separate the divested business from the company’s con- • Favorable impact of currency translation, partly offset by tinuing operations. This presentation is required by GAAP related hedging activities and facilitates historical and future trend analysis of IBM’s continuing operations. On page 92, the company discusses The increase in revenue in 2003 as compared to 2002 was this transaction and the accounting for the divestiture. due to: • Stronger demand associated with the improving economy (especially during the fourth quarter) and continued market management discussion snapshot share gains (dollars and shares in millions except per share amounts) • The impact of the fourth quarter 2002 acquisition of YR. TO YR. PERCENT/ PwCC and the first quarter 2003 acquisition of Rational, MARGIN FOR THE YEAR ENDED DECEMBER 31: 2003 2002 CHANGE partially offset by decreases in revenue due to Technology Group divestitures Revenue $«««89,131 $«81,186 9.8% * Gross profit margin 37.0% 37.3% (0.3) pts. • The favorable impact from currency translation Total expense and With regard to the way that management reviews the busi- other income $«««22,144 $«22,760 (2.7) % ness, as-reported and constant currency revenue trends were Total expense and all positive for most of the company’s segments, geographies other income to revenue ratio 24.8% 28.0% (3.2) pts. and industry sectors. See page 51 for the summary trend rates Provision for on an as-reported and constant currency basis, as well as such income taxes $«««««3,261 $«««2,190 48.9% information for each segment on pages 55 to 57. Income from Gross profit margins remained relatively flat. Increases in continuing operations $«««««7,613 $«««5,334 42.7% Hardware and Software margins resulting from the ongoing Earnings per share benefits from the company’s integrated supply chain initiatives from continuing and favorable currency translation were offset by decreases operations: in Global Services margins driven primarily by investment Assuming dilution $«««««««4.34 $«««««3.07 41.4% costs on the early stages of a Strategic Outsourcing (SO) Basic $«««««««4.42 $«««««3.13 41.2% contract and the company’s changing mix of revenue toward Weighted-average Business Consulting Services (BCS). shares outstanding: As discussed above, there were several charges in 2002 Assuming dilution 1,756.1 1,730.9 1.5% that impacted the year-to-year expense comparison. These Basic 1,721.6 «1,703.2 1.1% items contributed 2.8 points of the improvement in the Total Assets ** $«104,457 $«96,484 8.3% expense and other income-to-revenue ratio. The remaining Liabilities ** $«««76,593 $«73,702 3.9% improvement was primarily due to the results of productivity Equity ** $«««27,864 $«22,782 22.3% and efficiency initiatives partially offset by an increase in * 2.8 percent at constant currency retirement-related plans cost. ** at December 31 44

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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES The company’s effective tax rate increased by almost 1 point In its relationships with its clients, IBM has found that a primarily due to a less favorable mix of geographic income majority of enterprises are concerned with four main issues: and the absence of the tax benefit associated with the • Demand for faster innovation Microelectronics actions taken in the second quarter of 2002. • Reducing expenses With regard to Total Assets, approximately $7 billion of the increase relates to the impact of currency translation. • Integration across the organization’s “value chain” (repre- The remaining increase primarily consists of an increase in senting every transaction or interaction within an enterprise, Goodwill associated with recent acquisitions and increased with other enterprises and with individuals) pension assets, as well as strong cash performance. The • Demand for predictable return on investment increase in cash during 2003 was due to the combination of By redesigning their business processes and organizational stronger operating results and lower pension funding in structure, supported by and enabled by new systems operat- 2003. The company reduced non-Global Financing debt in ing environments, these clients are seeking to become on 2003 as a result of strong 2003 cash flows from operations. demand businesses. Global Financing debt decreased, but the company’s Global IBM defines an on demand business as an enterprise Financing debt-to-equity ratio remained flat at 6.9 to 1 and whose business processes are: within the company’s target range. Looking forward, the company’s business model targets • Responsive to any client demand, market opportunity or revenue to grow in the mid to high single digits and earnings external threat; per share to grow at low double digits over the long term. • Integrated end-to-end across the company; and The company’s ability to meet these objectives depends on a • Integrated across industry value nets, interconnected chains number of factors, including those outlined on page 50 and of partners, suppliers and clients. on pages 101 and 102. Global Services signings were $55 billion in 2003 as com- An essential aspect of an on demand operating environment pared to $53 billion in 2002. The Global Services backlog is is that its infrastructure is based on industry-wide standards $120 billion at December 31, 2003. (commonly referred to as “open standards”). In IBM’s view, an investment in such an infrastructure provides the greatest returns rather than relying on proprietary control by a single description of business company or affiliation of companies. One positive devel- Please refer to IBM’s Annual Report on Form 10-K filed on or about opment in this regard is the emergence of “open source” March 8, 2004, with the Securities and Exchange Commission operating systems and programming languages that benefit ( SEC ) for a more detailed version of this Description of Business, from further development by the business and IT communi- especially the detailed “Significant Factors Affecting IBM’s ties, as in the case of the Linux operating system or the Java Business” section. programming language. IBM focuses on the intersection of business insight and However, to realize the full benefits of an on demand technological innovation for enterprise clients. environment, solutions with the highest returns also require Over the past decade, IBM has been a leader in the IT the transformation and integration of business processes market’s shift of focus from selling hardware, software and within and among institutions. services, to the creation of solutions to clients’ business IBM’s clients include many different kinds of enterprises, problems. During the early years of the Internet’s entry into from sole proprietorships to the world’s largest organizations, mainstream commerce, communications and business oper- governments and companies representing every major ations in the mid- to late- 1990s, value was created first industry and endeavor. Over the last decade, IBM has exited through providing widespread access and then through the or greatly de-emphasized its involvement in consumer markets integration of business processes, such as supply chain, and divested itself of other non-core businesses to concentrate client relationships and human resources. Today, IBM is once on the enterprise market. In IBM’s view, the enterprise market again leading the industry toward the more fundamental, represents approximately two-thirds of the IT industry’s industry-specific transformations of on demand business. revenue, as well as twice the growth and three times the 45

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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES profits compared to consumer areas of the industry. As a Business Value result, IBM has made acquisitions and invested in emerging overview business opportunities important to its enterprise clients. Services and software to improve business performance for Many of these investments have since grown to a point Enterprise Computing clients. IBM helps its Enterprise where their revenue and opportunity now can be considered Computing clients transform their business processes and part of IBM’s mainline businesses. The majority of the com- gain competitive advantage by applying its skills and experi- pany’s enterprise business, which excludes the company’s ence to processes specific to the client’s industry or to business original equipment manufacturer (OEM) technology busi- challenges across industries and processes. The company ness, occurs in industries that are broadly grouped into six enters into long-term relationships and creates solutions for sectors around which the company’s sales and distribution clients, on its own or in partnership with other companies, activities, as well as an increasing number of its services and drawing upon its broad product and service offerings, and products businesses are organized: relying on its BCS organization, the capabilities of IBM Research, its experience in chip design and application, and SECTOR INDUSTRIES the company’s own viewpoint of developing trends in business Financial Services Banking and technology. Financial Markets strategy Insurance Drive on demand business innovation. Public Education Government capabilities Health Care Business Consulting Services – Delivery of value to clients Life Sciences through consulting services for application innovation and systems integration, client relationship management, financial Industrial Aerospace management, human capital, business strategy and change, Automotive supply chain management and the transformation of business Defense processes and operations. (Global Services) Chemical and Petroleum Electronics Customer financing – Lease and loan financing to clients and internal clients for terms generally between two and five years. Distribution Consumer Products (Global Financing) Retail Travel Engineering & Technology Services (E&TS) – System and com- Transportation ponent design services, strategic outsourcing of clients’ design Communications Energy and Utilities teams, and technology and manufacturing consulting services. Media and Entertainment (Technology Group) Telecommunications On Demand Innovation Services (ODIS ) – IBM Research scien- Small & Medium Business The majority of businesses tists and experts work with BCS consultants to analyze in this sector have fewer clients’ business challenges and provide solutions that than 1,000 employees address these challenges. ODIS offers a number of cross- industry micropractices with deep expertise in business optimization, security, mobile enablement, information T H E I T I N D U ST RY A N D I B M ’S ST RAT EGY mining and more. (Global Services) IBM operates in both the business services and IT indus- tries, which comprise the following three categories: Software and services to meet industry-specific needs – Solutions and applications built on an on demand, standards-based • Business Value infrastructure to transform a process that is unique to • Infrastructure Value specific industries. (All IBM Groups) • Component Value The primary rationale for IBM’s investments in the Compo- Infrastructure Value nent Value category is to provide a competitive advantage in overview the Infrastructure Value category, which in turn is consid- Hardware, software and services integrated into a comput- ered a competitive advantage in the Business Value category. ing environment. Infrastructure Value concerns systems, IBM sees a shift in revenue and profit growth up from such as high-volume server computers; middleware software Component Value to Infrastructure Value and into the that can interconnect disparate operating systems and applica- Business Value category, where revenue and profit potential tions with data; storage networks; and devices. It also refers are thought to be greatest in the decade ahead. to such services as infrastructure management—whether on 46

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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES the client’s premises or managed remotely at IBM’s own Rational software – Integrated tools designed to improve an facilities —and consulting about how to improve and organization’s software development processes and capabili- strengthen the infrastructure and realize greater return on ties. (Software) investment in it. Central to IBM’s approach for building value Remarketing – The sale and lease of used equipment (primarily in the infrastructure category is its support of open standards sourced from the conclusion of lease transactions) to new or and its active promotion of Linux, the open source operating existing clients. (Global Financing) system, which helps IBM’s clients control costs and allows Retail Store Solutions – Point-of-sale retail checkout equip- them to benefit from the latest developments created by the ment, software and solutions. (Personal Systems Group) Linux development community around the world. To support Linux development and deployment, IBM has enabled its Servers – IBM eServer systems using IBM operating systems servers and storage products to operate with Linux, IBM’s (zSeries and iSeries), as well as AIX, the IBM UNIX operat- leading middleware products are designed to work in a Linux ing system (pSeries) and the Microsoft Windows operating environment, and Linux is a preferred choice for many of the system (xSeries). All servers can also run Linux, a key open- company’s services and consulting engagements. source operating system. (Systems Group and Software). Storage – Data storage products, including disk, tape and strategy storage area networks. IBM continues to be a leading vendor Deliver open and integrated offerings; expand partnerships; in storage services. (System Group) continue to exit select markets, such as application software. Strategic Outsourcing Services – Competitive cost advantages capabilities through the outsourcing of processes and operations. Application Management Services – Application development, (Global Services) management, maintenance and support services for pack- aged software, as well as custom and legacy applications. Tivoli software – Software for infrastructure management, (Global Services) including security, change, configuration, job scheduling, storage capability, performance and availability. (Software) Commercial financing – Short-term inventory and accounts receivable financing to dealers and remarketers of IT prod- WebSphere software – Management of a wide variety of business ucts. (Global Financing) processes using open standards to interconnect applications, data and operating systems. (Software) DB2 information management software – Advanced database and content management software solutions that enable Component Value clients to leverage information on demand. (Software) overview e-business Hosting Services – Solutions for the management of Component Value describes advanced semiconductor devel- clients’ Web-based infrastructure and business applications, opment and manufacturing for IBM’s server and storage as well as a growing portfolio of industry-specific independent offerings, and services, technology and licenses provided to software vendor (ISV) solutions that are delivered as a service. OEMs that create and market products requiring advanced (Global Services) chips and other core technology elements. Integrated Technology Services (ITS) – Design, implementation strategy and maintenance of clients’ technology infrastructures. Leverage components for Infrastructure Value; and continue (Global Services) to participate in select markets and to pursue outsourcing Lotus software – Collaboration and messaging software that for manufacturing of select products. allows a company’s employees, clients, vendors and partners capabilities to engage in real-time and asynchronous communication and Application Specific Integrated Circuit (ASICs)– Manufacturing knowledge management. (Software) of customized semiconductor products for clients. Personal computers – Desktop and notebook computers featur- (Technology Group) ing ThinkVantage technologies that provide enterprises and Advanced Foundry – Full suite of semiconductor manufactur- end users with increased productivity and cost-effectiveness. ing and integrated supply chain services using either a (Personal Systems Group) client’s or IBM’s design. (Technology Group) Printing Systems – Production print solutions, on demand Standard products and custom microprocessors – Semiconductors print-related solutions, enterprise workgroup print technolo- designed and manufactured primarily based upon IBM’s gies, and print management software and services. (Personal PowerPC architecture. (Technology Group) Systems Group) 47

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    Management Discussion INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES B U S I N ESS S EG M E N TS Personal Systems Group includes the company’s lines of personal Organizationally, the company’s major operations comprise a computers, printers and point-of-sale terminals. These Global Services segment; three hardware product segments— offerings are designed to assist clients to improve productivity Systems Group, Personal Systems Group and Technology and to reduce clients’ total cost of ownership. Group; a Software segment; and a Global Financing segment. Software consists primarily of middleware and operating See the IT Industry and IBM’s Strategy section on pages 46 systems software. Middleware software enables clients to and 47 for the specific capabilities relating to these busi- ness segments. integrate systems, processes and applications across the clients’ enterprises through the use of open standards. Global Services is an important part of the company’s strategy Middleware is designed to be the underlying support for of providing insight and solutions to clients. While solutions applications provided by ISVs who build industry- or often include industry-leading IBM software and hardware, process-specific applications according to open industry other suppliers’ products are also used if a specific client standards. Operating systems are the engines that run com- solution requires it. Global Services outsourcing contracts as puters. Approximately 70 percent of Software volumes are well as BCS contracts with the U.S. federal government and directly with the end-user clients and about 20 percent are its agencies are typically seven to ten years in duration. Other through Business Partners. While appropriately not reported contracts range in periods generally up to one year, including as external revenue, the remainder is deployed internally to consulting contracts and ITS. support Global Services solutions. The company’s new Business Transformation Outsourcing Approximately 40 percent of external Software revenue (BTO) capabilities combine the insight of BCS with the relates to one-time charge (OTC) arrangements whereby the company’s process outsourcing capabilities to assume responsi- client pays one up-front payment for a lifetime license. bility for the operations and management of a client’s business Typically, arrangements for the sale of OTC software include processes in areas including human resources, procurement, one year of maintenance. The client can also purchase ongo- customer relationship management, finance and administra- ing maintenance after the first year, which includes product tion, among others. The company will only enter into BTO upgrades and technical support. The remaining software is agreements with clients when it believes that IBM can lever- sold on a monthly license charge arrangement. age its business knowledge and technology to drive client productivity and cost improvements. These generally are Global Financing is described on pages 69 to 73. large-scale, multiyear contracts ranging up to ten years in Enterprise Investments develops and provides industry- length that include the operation, strategic change and specific IT solutions supporting the Hardware, Software and transformation of the client’s business processes. BTO Global Services segments of the company. Primary product engagements may include support and involvement of various business units that have capabilities such as BCS, lines include product life cycle management software and Application Management Services, e-business Hosting document processing technologies. Product life cycle man- Services, middleware and hardware. agement software primarily serves the Industrial sector and helps clients manage the development and manufacturing of Systems Group provides business solutions to clients. Approxi- their products. Document processor products service the mately half of the Systems Group’s sales transactions are Financial Services sector and include products that enable through business partners and approximately 46 percent are electronic banking. direct to clients, slightly more than half of which are through the Web at ibm.com. While appropriately not reported as I B M WO R L DW I D E O R GA N I ZAT I O N S external revenue, hardware is also deployed to support Global The following three company-wide organizations play key Services solutions. roles in IBM’s delivery of value to its clients: Technology Group provides leading semiconductor technology • Sales & Distribution Organization and related sales and products, packaging solutions and engineering technol- channels ogy services to OEM clients (approximately 78 percent) and, • Research, Development and Intellectual Property although appropriately not reported as external revenue, to • Supply Chain the Systems Group (approximately 21 percent). Using a “one-team” approach, Systems Group works Sales & Distribution Organization hand-in-hand with the Technology Group on product plan- IBM offers its products through its Global Sales & ning and strategy, given the high content level of Technology Distribution organizations. Consistent with IBM’s focus on Group components inside Systems Group products. In Business Value, the company’s global corps of account repre- recognition of the increasing degree of collaboration between sentatives combine a deep understanding of each client’s the two segments and as discussed on page 118, the company organizational and industry-specific needs with comprehen- combined the Systems Group and the Technology Group in sive knowledge of the products, technologies and services the first quarter of 2004. offered by IBM and its network of business partners. 48

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