Five years ago, Liu Chuanzhi sent shockwaves through the global business community when Lenovo, the computer manufacturer he founded and chaired, announced it would buy IBM’s legendary PC unit for $1.75 billion. The deal made Lenovo the third largest PC maker in the world, and marked the first time that a Chinese company had taken over an American one. After the acquisition, Liu gave up the chairmanship — but remained a director — to make way for the new Sino-American leadership team.

Merging the two companies proved difficult, however. As Lenovo’s consumer products failed to gain traction, an internal battle over the company’s combined managerial culture brewed. Its share price languished — going from $22.50 in October 2007 to $5.50 in December of the following year. When the financial crisis hit at the end of 2008, the company reported a loss of nearly $97 million for its fiscal third quarter.

Last year, the board took action. Yang Yuanqing, who had been at the helm before the IBM deal, was renamed chief executive officer after CEO William Amelio, an American, resigned; Liu resumed the chairmanship and the company also launched a new business strategy.

The changes appear to be working: Lenovo returned to profitability in the second half of 2009, and Businessweek named Liu one of “China’s Most Powerful People.” On November 11, Lenovo posted a 44% rise in profit in the fiscal second quarter, helped by orders from the U.S. and Europe, and increasing demand in emerging markets. Net income totaled $76.6 million in the quarter, compared with $53.1 million in the comparable quarter a year earlier.

Knowledge at Wharton recently met Liu at the World Entrepreneurship Forum in Lyon, France, to talk about the company’s history, what it was like to be the first Chinese CEO ever to take over a U.S. company, and how he and the new management team are rebuilding the Lenovo brand.

An edited version of that conversation follows.

Knowledge at Wharton: Tell me about the early days of Lenovo.

Liu: We started the company with 11 researchers in November of 1984 with RMB 200,000 in funding from the Computer Institute of the Chinese Academy of Sciences. At the time, that amount of money was equivalent to about $30,000. We began as a small start-up in a front gate reception room in Beijing.

Knowledge at Wharton: What were some of the obstacles you faced?

Liu: The company in its initial stage faced a lot of challenges. The first being that we were researchers: We knew nothing about how to run a business. Funding was an issue too — at that time a computer cost about $10,000, so we could only afford three computers. But the biggest challenge was the planned economy. We needed to import components, but the state wouldn’t cooperate so we had to buy from the black market. These difficulties and challenges are different from the ones faced by entrepreneurs today; the Chinese market economy has made things much, much better. But even despite these challenges, we became very successful: We competed against global brands, built confidence in Chinese companies and helped pave the way for our country to enter the World Trade Organization.

Knowledge at Wharton: You were the first-ever Chinese CEO to take over an American company. What was that like?

Liu: It was very shocking news at the time. People likened it to a snake swallowing an elephant. Most people were negative about it. They thought we were courageous, but they also thought we’d fail. I remember that after the acquisition I gave a speech at a Chinese business school for a group of Executive MBAs. I asked the audience how many people felt confident about the acquisition, and only two people raised their hands. I looked and saw that they both were Lenovo employees.

Knowledge at Wharton: What specific steps did you take to integrate IBM’s PC operations into Lenovo?

Liu: Prior to the integration we mapped out every possible risk, so when it came time to combine the two companies, it went pretty smoothly. The first thing we wanted to integrate into the company was the [laptop computer] brand ThinkPad. The second thing we wanted to absorb was the technology. The third thing we needed to integrate were the global resources: the sales channel, the distributions channel and the employees.

Knowledge at Wharton:Even though you had calculated the risks of the purchase, what were some of the biggest challenges you faced when you merged the two companies?

Liu: We had three serious risks. Number one: After the acquisition, would clients buy from the new owner? Number two: Would employees continue to work for the new owner? And number three: Would there be potential conflicts in management between the Chinese management and the Western management?

Knowledge at Wharton: Were there management conflicts? Was it hard to establish trust among people from very different cultures?

Liu: I have to say that it was difficult to some extent. Most of the problems lay in senior management.

Knowledge at Wharton: How so? Did it have to do with the way the power structure was aligned?

Liu: With the previous management, when it came time to make a major decision, the CEO at the time would discuss it with only the head of the function that the decision directly affected. The others on the management team were then asked to vote ‘yes’ at the end.

Knowledge at Wharton: When their ‘yes’ vote was a foregone conclusion?

Liu: Yes. They were left out of the discussions, so they had to agree.

Knowledge at Wharton: What was the corporate culture like then?

Liu: In its previous status — after the acquisition and right up to the crisis — the company didn’t care about the principle of delivering on your commitment. The top management had a budget year to year, but every quarter when they couldn’t deliver, they revised down their expectations. The board witnessed a lot of cases of the management failing to deliver. It was a similar situation with subordinates and managers. When it came to drafting targets, the subordinate would sometimes come up with targets that were too high, or too boastful. But the manager didn’t say anything for fear of alienating the employee. Or on the other hand, sometimes a manager would come up with unrealistic targets for the subordinate, but the subordinate wouldn’t speak up so as not to criticize his or her boss.

Knowledge at Wharton: What happened when the financial crisis hit?

Liu: When the financial downturn came in the fourth quarter of 2008, we had big losses. The last three months of that year — October, November and December — were very, very dark days. At that point, the board took decisive measures. The former chairman, Yang Yuangqing, became the CEO. And I became the chairman once again. The company realigned and reorganized.

Knowledge at Wharton: How is the new power structure of Lenovo aligned?

Liu: We now have built a top leadership team consisting of nine people — four Chinese and four Westerners, including three Americans, and one European. These nine people represent the whole spectrum of the company. It’s a blending of talents from East and West. The team knows each other very well, they all get along and they have a good rapport.

Knowledge at Wharton: And does this new management team use a more collective decision making process?

Liu: Each month they convene in one place to discuss various issues in the company. They are very thorough and each one has a say. When it comes to a major decision, they look at the macro environment and the details of the company — each one thinks about how this decision affects his function. Yes, decision making does take longer this way, but for critical issues, this kind of strategy is the best one. The ultimate decision they come to is the best one.

Knowledge at Wharton: Tell me about the corporate culture you’re trying to cultivate — what you call “the Lenovo way.”

Liu: We pay a lot of attention to corporate culture here. The culture refers to the core values; “the Lenovo way” means we do what we say, and we own what we do. The Lenovo way now is an alternative to the status of Lenovo right after the acquisition. The new culture — we do what we say — is not just a matter of attitude. When we propose a target, we think it through, and we have a clear idea of how we’ll execute to meet it.

Knowledge at Wharton: How does “the Lenovo way” translate into the way you treat employees?

Liu: The key or essential part of our core values is to put people first. We need to make sure our employees love this company. And when we are successful, we need to give back to our employees with incentives and rewards. We need to take care of our employees to make sure they have a good life.

Knowledge at Wharton: What about the company’s new strategy?

Liu: In the old status, the company focused on mature markets with little emphasis on emerging markets. But the new management is thinking differently, and we’re spending on emerging markets. In the past, the client base was commercial, with little in the consumer space. But today consumer growth of PCs outpaces commercial clients. The previous top leadership didn’t address that. They did not have the strategy to grow our PC business. Because of the correct strategy, our business has much more ballast.

Knowledge at Wharton: Give me some examples of how you’re focusing more on consumers.

Liu: Our company is rolling out a lot products focused on the consumer. This year we introduced ThinkPad Edge, a light, powerful notebook for the small-business market; we launched [the] Skylight smartbook, a combination mini-PC and smartphone, and we will also bring out the IdeaPad U1 hybrid, a notebook with a detachable screen. In addition, this year we launched LePhone, a 3G smartphone, in China, [which is] our answer to Apple’s iPhone, and we will roll out more products in the new area of mobile Internet. We’ve moved from a 7.6% market share just before the crisis to a 10.4% market share today. We are ranked number four in global market share in the PC business.

Knowledge at Wharton: Last month we learned that China has just developed the fastest supercomputer in the world. How big an edge does this give the Chinese? And do you think this latest news is emblematic of the state of American and Chinese technology?

Liu: I think for computers being used by people around the world, 70% to 80% are physically made in China. For some of the components, like storage and display, only 20%, or 30% or 40% are made in China. But for those software components like operating systems, the technology is not in the hands of the Chinese. I don’t have a comment about what China’s new supercomputer means on a symbolic level.

Knowledge at Wharton: As Chinese domestic consumption increases, do you think global tech companies will decide to set their development roadmaps to follow Chinese consumer tastes rather than American tastes?

Liu: The Chinese will certainly have more influence on the direction of IT companies. The total volume of cars and PCs are starting to match the U.S., and China has 800 million mobile phone users. The sheer size speaks for itself. We’ve already seen examples of Chinese influence on how certain technologies evolve and become popular. Ten years ago in Western countries, text messaging was not that popular. But in China, it was already taking off. In China, at the New Year or during the Spring Festival, it’s a customary tradition to send greetings to family and friends. Calling people takes a lot of time so when this technology became available many people chose to send texts. Texting became very popular in China, and in the West, too, eventually.

Knowledge at Wharton:What advice would you give a U.S. company interested in expanding into the Chinese market?

Liu: If I happen to acquire one, I will tell you.