Kyndryl CEO Martin Schroeter: ‘AI Sits At The Heart Of How We Run Our Own Business’

‘AI is something that’s going to make [customers’] whole IT estate more complicated again. And where we do our best work is in super complex IT estates where customers need help managing across disparate architectures. So there is a role for us to play with Microsoft in our joint customers in order to try things and then to run them over the long term,’ says Kyndryl Chairman and CEO Martin Schroeter.

No Looking Back: Kyndryl Touts Success, New Relationships Out Of IBM’s Shadow

Global IT infrastructure services provider Kyndryl managed to pull off its first adjusted pre-tax profit in its first fiscal quarter 2024, showing the New York-based solution provider is on a path toward profitable growth less than two years since it was spun out from IBM’s global infrastructure business.

It has been a long journey for the company, which at the time it became an independent entity was saddled with IBM’s legacy systems and business processes as well as legacy contracts, many of which were not profitable, according to Chairman and CEO Martin Schroeter.

However, Schroeter told CRN in an exclusive meeting that the company has steadily moved away from its legacy operations to take advantage of its own skills to build an operation aimed at creating a profitable and growing business.

“We’ll make money not only this year, but we’ll make money on an operating basis from here on out. … This is a great quarter, a great start. And our strategy not only is working, but it’s clear it can work to turn around this company and get to a stable revenue growth and a much more solid competitive level of profitability.”

A big part of that march toward sustained profitability will come as Kyndryl moves away from its legacy IBM processes and especially the unprofitable accounts that came with the IBM spin-out, Schroeter said.

“We’ve made a lot of progress in the quarter to restructure the contracts to keep and continue to do the work that our customers love where we provide high-value services while addressing elements from the IBM spin-out that put us in a highly negative spot,” he said. “There are instances, for example, where we get $100 of revenue for a customer, and it costs us $150 in software and hardware costs from IBM.”

Growth will also come from a focus on developing new ways to win customer business, Schroeter said. For instance, Kyndryl this week signed a strategic agreement with Microsoft under which it will bring that company’s AI technologies to its customers, the majority of whom have Microsoft as a big part of their IT infrastructure, he said.

“While every customer is thinking about how to use AI, we can help in the initial phase with data architecture, security, resiliency, etc.,” he said. “[And] there’s also a place for us to help them run all of that because it’s likely that it will be on somebody else’s infrastructure. AI is something that’s going to make their whole IT estate more complicated again. And where we do our best work is in super complex IT estates where customers need help managing across disparate architectures.”

There is a lot going on at Kyndryl. Here is what Schroeter had to say about how the company plans to steer itself toward sustainable and profitable growth.

How do you define Kyndryl?

Kyndryl is the people and the [intellectual property] that run the world’s mission-critical systems that we all rely on every day. We design, build, manage and run those systems in a way that allows our customer base to trust us with mission-critical and to meet their business goals to grow to delight their customers. So we are mission-critical, we are people, and we are IP.

Kyndryl Monday reported a good fiscal first quarter 2024. What happened?

We upped our profit guidance for the year. Basically we’ll make money not only this year, but we’ll make money on an operating basis from here on out. We feel very good about our progress on each of the elements that leads us to that high-single-digit profit margin that we’ve been talking to the world about over the medium term. And I think this is a great quarter, a great start. And our strategy not only is working, but it’s clear it can work to turn around this company and get to a stable revenue growth and a much more solid competitive level of profitability. But I feel really good about where we are.

What are those ‘elements’ you mentioned?

Our strategy is what we call the ‘Three A’s’ and ‘Plus Plus.’ So the Three A’s are our alliance activity, our advanced delivery work, and our focused accounts. And Plus Plus is building our advisory and consulting business called Kyndryl Consult, and prudently managing what it costs us to run the place. And each of those elements contributed to the great start.

The largest contributor for us both in the quarter and what will be over the medium term is our work on addressing the focus accounts, the accounts that we inherited [from IBM]. Those accounts are essentially break-even, and many of them even worse. We’ve made a lot of progress in the quarter to restructure the contracts to keep and continue to do the work that our customers love where we provide high-value services while addressing elements from the IBM spin-out that put us in a highly negative spot. There are instances, for example, where we get $100 of revenue for a customer, and it costs us $150 in software and hardware costs from IBM. We’ve made a lot of progress on those focus accounts.

The second biggest contributor to us is our advanced delivery work, which is using the IP and the data that we have to deliver better levels of service. We’re reducing our customers’ operational risk by using our data and our AI to automate and to deliver services that allow us to free up our labor, which is a big part of our costs, in order to move them into other revenue-producing activities. So between the contribution from advanced delivery, which is ahead of track for the year, and the contribution from addressing these focus accounts, we got off to a great start. Kyndryl Consult, which is part of our Plus Plus, and our alliances activity, one of the Three A’s, has also gone very well, but within the quarter they’re not as big a contributor as advanced delivery and focus accounts.

Is Kyndryl is actively getting out of contracts that are no longer profitable going forward?

The overwhelming majority of our customer base will still be our customers even when we make it through the focused accounts. It’s not that the contracts or the customers are going away. It really is that the elements of some of these contracts have to be restructured, and quite often we will encourage our customers to go directly to the owner of the IP. For us, IBM is a big deal. We’re a big user of their software. We will encourage our customers to go directly to IBM to get the software licenses they need, and we’ll obviously continue to manage their infrastructure. But we’re getting out of the challenging economics that IBM created for us in the spin. So almost every customer will stay. But there are elements of these that we have to address, which basically brought us an entire portfolio of $8 billion revenue when we started at essentially zero gross profit.

What is your IBM relationship now? How is that changed in the last year or so?

The ownership piece is already gone. The TSAs that allowed us to run on IBM’s systems is nearly gone. That’ll end in another three months.

The [final] piece is the commercial relationship that IBM created. When they spun us out, they determined what we pay them for hardware and software, how we buy, and how we get discounts using the IBM Cloud, etc. But it’s [changing]. We’ve already renegotiated, for instance, the maintenance component of that agreement. That gives us a little bit of savings. It gives them a little bit of a commitment from us to use them for maintenance. But each of those elements of the commercial relationship will continue to evolve. Over time, the two biggest pieces are obviously hardware and software, but it also extends into cloud discounts, security services, reseller agreements, etc. That is all evolving into what I expect will be a different kind of win-win relationship. But we’re IBM’s biggest customer, and when the customer and IBM and Kyndryl are all aligned with what’s the right way to go, it works just fine.

You said that Kyndryl is IBM’s biggest customer?

I would think so. With the way they structured the spin-out agreement, I think we pay them a bit over $4 billion a year. And I don’t think any other single customer pays $4 billion a year.

You said ‘customer’ in this case. Do you mean biggest channel partner?

No, I mean, customer. If we run a mainframe for a customer, we need the whole software stack that goes with it. We’re contracted directly with IBM to buy and own the mainframe, and to buy and own the software licenses. We re-contract with the customer, and that’s how it gets consumed. So we’re IBM’s customer. I wouldn’t say we’re partners. I’d say we’re their customer.

But you partner with IBM for hardware, software and cloud in other areas?

When it’s the right fit. In many instances, our customers retain architectural control and so more often than not, they’re making the IBM decision if they have for some reason a strong preference for the IBM cloud or IBM storage or Power servers. Customers have architectural control and dictate what they want us to work on and where we interact with them. When they ask for our opinion, we’ll bring in whatever is the most suitable for their requirements. For instance, on cloud, the biggest market share in our customer base is Microsoft. And so that’s the discussion we have more often than not with our customers. AWS is a very close second in terms of cloud choices in our customer base. So it all depends on what customers want.

Kyndryl this week signed an agreement with Microsoft on AI collaboration. What’s happening there?

We’re working with Microsoft to help our customers get ready to dip their toe, whatever metaphor you want to use, into the world of AI. There are a lot of science experiments going on right now. Customers want to understand, ‘How do I how do I use it? How do I think about it?’ But that has to be preceded with work around data architecture, security, and resiliency in order to advance some of these ideas. Microsoft is the biggest platform in our customer base. While every customer is thinking about how to use AI, we can help in the initial phase with data architecture, security, resiliency, etc. [And] there’s also a place for us to help them run all of that because it’s likely that it will be on somebody else’s infrastructure. AI is something that’s going to make their whole IT estate more complicated again. And where we do our best work is in super complex IT estates where customers need help managing across disparate architectures. So there is a role for us to play with Microsoft in our joint customers in order to try things and then to run them over the long term.

For the new Microsoft AI collaboration, does Kyndryl need to hire more engineers and AI experts to advance the initiative?

We have the hiring sign out across our advisory and consulting business because it’s growing so fast. We need to keep finding more and more people who can help fulfill the demand we have. And some of that would fall directly in AI, although not uniquely. We have a lot of demand for security, for resiliency, for data, etc. So we absolutely have the hiring sign hung up on advisory consultants. And at the same time, we’ve invested quite heavily in the skills that we had. And our advanced delivery approaches allow us to free up some of the most talented technical skills you’ve ever seen. And we can retrain, reskill and move those people as well into some of those roles. So for us it’s a mix. There is hiring, but at that same time we supplement that with the deep technical skills we have and make them relevant in the spaces where we see the demand.

Do you have a similar AI relationship with Google or AWS as well?

We will.

Any idea when?

Not yet. We’ll see how they evolve, We have to figure out what the customer demand is for that. But we’ll get more done with AWS and Google. And there’ll be other AI players with whom we’re working as well because AI for us is not just helping our customers. It’s also how we run. What sits at the heart of Kyndryl Bridge [open integration platform] is our AI and our data. And that’s what’s driving insights for our customers. That’s what’s driving our ability to automate, the way we do our work. So you’ll see partnerships from us not only from the other hyperscalers, but also on how we run ourselves, how we run our delivery, because it’s what our customers are counting on from us in order to help them run both more efficiently. …

AI sits at the heart of how we run our own business, how we run our own delivery. So the Microsoft deal is great for customers, but AI is a much, much bigger play for us internally as well.

You mentioned Kyndryl Consult. What is that?

When IBM owned Kyndryl, they focused on landing massive deals, billion-dollar deals. So there were a lot of people within this business—IT architects, data architects, security specialists—all of whom would land in one of these deal teams to help build out the architecture of the future. When we were spun out of IBM, one way to think about that was that it was free consulting. And ‘free’ is not part of our business model. So we’re recognizing all the great value that we’ve been bringing to our customers. We’re basically turning that into an advisory and a consulting business so that we get paid for the value we create along the way as we get ready to engage in the run transaction. … Our advisory consulting business is growing 20-plus percent a quarter because now we’re getting paid for the work we’re doing.