This Key IBM Business Is Being Boosted by AI

International Business Machines' (NYSE: IBM) largest segment is software, but the consulting business is a hidden gem that enables the company to build integrated solutions for its clients. Unfortunately, clients have been slow to commit to discretionary technology projects in an uncertain economic environment, creating a consulting headwind. While software revenue soared 9% in IBM's third quarter thanks to strong demand for hybrid cloud and automation, the consulting segment reported middling 2% growth.

Consulting growth looks likely to accelerate in the near future as IBM leans into artificial intelligence. While consulting revenue isn't as lucrative as software revenue, consulting contracts help drive incremental software and infrastructure sales, and can accelerate IBM's overall growth.

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Strong AI bookings in the consulting business

As of the end of the third quarter, IBM has booked $9.5 billion worth of generative AI business. Consulting accounts for a bit over 80% of that total. In the third quarter alone, IBM's consulting business booked $1.5 billion worth of new AI business.

Large enterprises looking to deploy AI workloads and agents need more than just software. AI implementation services are a critical component, and that's an area where IBM shines. Earlier this year, Gartner put IBM in the "emerging leaders" category for generative AI consulting and implementation services.

That $1.5 billion of new consulting business related to AI will take time to convert to revenue, but as that process unfolds, the headwinds facing the consulting business will start to be overcome by AI growth. "So as those consulting projects start to get executed and as that backlog builds up, certainly the contribution to consulting is going to be very real," said IBM CEO Arvind Krishna during the third-quarter earnings call. " ... it is overcoming the headwinds from staff augmentation projects going away and people getting rid of discretionary spending and consulting."

Already, AI is improving results in the consulting segment. IBM noted that all lines of business within its consulting segment returned to sequential growth in the third quarter, and that segment profit margin reached its highest level in three years. AI projects have the potential to be more lucrative than the types of projects that are fading away, which can help IBM's overall profit margin expand.

An improving story in the consulting business, plus a strong mainframe product cycle and strength in the software business, led IBM to raise its full-year outlook. The company now expects constant-currency revenue growth of more than 5% and free cash flow of around $14 billion. While an uncertain economy will continue to pressure aspects of the consulting business, AI-related projects are turning into quite a boon for this critical IBM segment.

Timothy Green has positions in International Business Machines. The Motley Fool has positions in and recommends International Business Machines. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.