United States. Congress. Senate. Committee on the.

The Industrial reorganization act. Hearings, Ninety-third Congress, first session [-Ninety-fourth Congress, first session], on S. 1167 (Volume pt. 7) online

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the IBM tab monopoly and to a limited extent at its rapidly growing
EDP monopoly.

In retrospect, it is clear the Department of Justice failed to realize
that IBM's monopoly of the tab market had already served its pur-
pose. It provided them with a massive customer base which could
be converted over to computers and in turn, allow them to escape from
the more onorous provisions of the consent decree.

IBM'S monopoly control was not shaken. During the period 1955
through 1967, IBM's share of the general purpose data processing
market fluctuated between 65 and 78 percent.

During this period, it should also be noted that some very able
and well-financed companies took an active interest in the computer
industry.

]My first assignment when I joined the professional staff of Booz,
Allen &. Hamilton in 1957 as a consultant was to examine the com-
puter market for the Bendix Corp.

At that time the EDP market a]:»peared to be highly competitive
and a number of companies were seeking to establish themselves.



40-927 O - pt. 7



5070

The United States v. IBM consent decree had been signed and her-
alded as a significant step toward establishing competition in the
computer marketplace.

Meaningful competition, however, did not develop. No competitor,
other than Sperry Rand, attained more than a 5-percent share of the
installed computer base through the year 1967.

In late 1960, I was again asked to examine the computer market
for Bendix.

They had been a competitor for some 4 years and achieved annual
sales of over $10 million. They had a good computer already in the
marketplace and several others in development.

Yet when all of the facts were in we were forced to conclude that
they had no alternative but to withdraw from the computer industry.

Our reasoning in 1960 remains valid today. First, IBM and its near-
est competitor can be expected to continue to hold more than 70 per-
cent of the market.

Next, IBM has established a pattern of rental that requires the
infusion of massive amounts of capital and substantial losses before
break-even.

Three, IBM sets de facto standards for the industry, unilaterally
and secretly.

Four, participation in the computer market requires major expen-
ditures for hardware and software development in the creation of a
large nationwide sales and service organization, even before you begin.

In our report to the Bendix board we concluded :

* * * in addition to IBM, in light of their control of 70 percent of the market,
there is room in the computer industry for only two or three other companies
on a profitable basis.

Currently there are at least 16 companies [I960], almost all of which are
knowledgeable, well-financed firms with an avowed purpose of making a perma-
nent place in the computer business. In our opinion, all but three or four will
fail to do so.

It is not easy to advise a client to withdraw from a market and forego
what later might prove to be a substantial profit opportunity.

Our conclusion as to IBM's monopoly ]:)ower was questioned by
many. An editorial carried in one of our industry's foremost trade
publications said that free enterprise was alive and well and innovation
and superior price and product performance would tell.

Of the author's nine examples, six have been forced to withdraw
from the market. Perhaps, of more importance, of the 16 companies
that we had identified as serious entrants into the computer market in
the late 1950's, 10 have since failed or withdrawn from the market, and
of those remaining none has achieved more than a 10-percent share
of the market.

Judge Sherman A. Christensen, in rendering his decision m the
Telex V. IBM case— 72-C-18, U.S. District Court for the Northern
District of Oklahoma, September 17, 1973— said :

The strength of competitors is relevant to an assessment of market power * * *
Difficulty in entering, weakness of competing companies, and dependence of
competitors upon dominant forces in the market are among the indicia of market
control on the part of an alleged monopolist.

Judge Christensen went on to say :

Claimed necessity of responding to competitive influences beyond the control
of the alleged monopolist may be only its excuse for anticompetitive conduct for
the purpose of maintaining or extending monopoly power or to surmount threat-



5071

ened competition * * * monopoly is possible in a young, dynamic and complex
industry, as well as in an old or static one and may be even more feasible, in
special cases, through the masking of selective market strategies in the overall
technological developments.

Many companies have sought to carve out a profitable niche in the
general purpose computer system's market. Few have succeeded.

How is this possible in our system ? It is ahnost inconceivable that
the vast majority of these companies were poorly managed, under-
financed, or incapable of satisfying some valid customer need.

Those who have sought to penetrate the market have lost, in total,
literally billions of dollars of their shareholder's money, yet their cor-
porate power and ability ranks them among America's most successful
corporations — Ford, RCA, Litton, General Electric, Bendix, Philco,
North American Aviation, and Xerox — yet none has been able to reach
break-even in the computer business.

One can only conclude that a formidable giant must indeed guard
the gate to the computer marketplace and to the land of profits.

Fortunately, the attempts of these other companies to enter the com-
puter market did not represent a complete loss. The industry in our
Nation benefited greatly from their transitory participation.

In their efforts to penetrate the market they became the principal
sources of innovation during the 1950-70 time frame.

IB]M has lagged behind rather than led the technology in the mar-
ketplace. An indication of their failure to innovate is vividly shown in
attachments 5 and 6 to our testimony.

Attachment 5 is the minutes of the management committee of the
IBM Corp. on October 29, 1970.

The management committee is the second highest management group
within the IBM organization. As you might note, in paragraph 3 of
those minutes, it says :

We are very strong in the marketplace and we are continuing to use old
technologies.

We believe that the control unit for the printer will pose technical problems
for competition but they feel that plug to plug printers should arrive in the
marketplace shortly.

These — IBM — printers, however, are predicated on older technology.

The only printer that they had at the time involving advanced tech-
nology, "has less than a 10-percent chance of being available within
a 5-year period."

The next attachment, 5B, the minutes of June 14, 1958, observe,
"That we were 2 or 3 years behind competition in the field effect tran-
sistor area." They indicate also some other efforts not to introduce
new products that did not fit their marketing strategy.

Perhaps in the technology area, though, the most significant one is
attachment 6, which is a quarterly product line assessment where
IBM's management team evaluates the competitive effectiveness of
their products against those in the marketplace.

They evaluate them as either being deficient relative to competition,
equal, or superior. In their opinion, as of August 12, 1971, out of 67
IB]M products evaluated they considered 36 to be deficient, 22 equal
to competition, and only 9 superior. These documents were entered
into evidence in the Telex v. IBM case.

IBM has seldom brought the fruits of their labors in the R. & D.
area to the marketplace until forced to do so by competitive pressures.



5072

IBM points to the continuing improvement in the price-performance
ratio of computers as an indicia of the competitiveness of the computer
market.

The facts, however, show that cost and prices have largely been
lowered by conversion from vacuum tubes to solid state devices such
as this committee saw yesterday.

The latter were based on research by Bell Laboratories. Similar
situations may be noted in the use and application of virtual memory,
time sharing, remote terminals, and most other important advances
in the state of the art.

The reason IBM invents but doesn't innovate is obvious. If you rent
your product, and recover your investment in x months, the bulk of
the revenues derived beyond this point are pure profit.

The longer the product can be kept in place the more profitable it
becomes. Under these circumstances the motivation is to maintain the
status quo as long as possible, bringing a new product to market only
when competitive pressures make it mandatory.

If innovation has not been the source of IBM's dominance of the
computer industry, Avhat has? Judge Christensen answered this ques-
tion in part when he said in his conclusions :

The court concludes that maintenance of IBM's monopoly power in the relevant
market for plug compatible peripheral products was not the result of IBM's
superior skill, foresight, or industry, and was not the result of superior products,
business acumen, or historic accident.

... It was its failure, as IBM itself recognized, to develop new technology and
superior performing products as rapidly and effectively as it had hoped, and the
capability of plug-compatible manufacturers to keep abreast of, and in limited
instances surpass, some of the technological developments . . . that motivated
it — IBM— to undertake predatory pricing and long-term leasing to stem the
growth of its plug-compatible competitors.

Judge Christensen also noted.

. . . The court infers and concludes that IBM had and exercised monopoly power.
... Its own strategy, investigations, and planning, were premised to an im-
portant degree upon the assumption that it had such power.

The very predatory intent with Avhich ... its strategies were planned, as well
as the nature and direction of its competitive responses, strongly suggest a con-
sciousness of market power and a determination to utilize it. . . .

This is not to say that there was any ruthless or nakedly aggressive programs
contemplated or carried out ; anything that was done by way of strategy was
sophisticated, refined, highly organized, and methodically processed and consid-
ered. But in this day and age such conduct is hardly less acceptable than the
naked aggressions of yesterday's industrial powers if unlawfully directed against
competition.

The organized, selected, subtle, and sophisticated approach, indeed, may pose
more danger under modern conditions than instantly more obvious strategy.

Senator, those are Judge Christensen's words, not mine.

If I might for a moment, though, turn to plaintiff's exhibit 67, "task
force to review OEH PC file suppliers" we see some insight as to Judge
Christensen's comment about carefully refined strategies.

This document, from the Telex vs. IBM case, was taken from IBM's
file aiul sets forth the project for a task force to review its plug-com-
patible competitors.

You will note listed supjiliers to be examined in detail were Memo-
rex, Telex. Centurv, Control Data Coi-p. and Potter.

You will note fui-ther down, paragra])!! 1 in the analysis, they ask
their field force to report fullv on all competitive installations.



5073

With a maintenance force that covers every IBM installation in the
United States it is very simple to issue an order to go out and count
competitive products.

The second page of that exhibit, numbered page 4, as entered in the
court, you will notice in paragraph 5 they want an indepth financial
analysis of these competitors — what is their cash flow ?

And, in fact, it came out in testimony that they built a very sophis-
ticated computerized model using all the latest techniques that ex-
amined the number of secretaries that the company might have, what
their cost of goods would be, and were able, then, in turn, to look at or
create hypothetical income statements and balance sheets.

They inquired into the finance company arrangements of these plug-
compatible competitors. And then the question is raised under point B,
what would be the effect of IBM 2314 price changes on the PCM
competitore?"

And then down below they really get to the heart of it. How long
can our competitors go on 2314 prices ?

We go to the next page, a memorandum to a senior financial officer
of IBM discussing the fixed temi plan indicates that some charts were
attached dealing with the presentation to the management review
committee, the highest level group in IBM.

You will note on the next page, part of the flip-charts, their con-
clusion was that if IBM lowered their prices, their competitors would
have to respond.

In doing so they would have no funds for manufacturing or en-
gineering, and, to use IBM's terms, would become dying companies.

Although sequestered in the Telex vs. IBM case, a document was
entered into the public record in the United States v. IBM case that
bears upon IBM's use of a combination of sophisticated and subtle
techniques in its programs to maintain absolute market control.

This memo, written by IB]\rs director of business practices, and
discovered in the files of IB^NI's director of marketing, is shown as an
attachment and a facsimile is reproduced.

Incidentally, Senator Hart, this is one of the 1,200 documents in-
volved in the Judge Edelstein's contempt of court citation against
IBM and his leveling of a $150,000 a day fine.

He was recently upheld by the Supreme Court, and these contested
documents have now been turned over to the Department of Justice.

You will note that !Mr. Faw says :

The liability of IBM's risk lease is dependent on price leadership and price
control.

By price leadership, IBM has established the value of data processing.

IBM then maintains or controls that value by various means : timing of new
technology insertion ; functional pricing ; coordinated management of delivery ;
support services and inventory : refusal to market surplus used equipment ; re-
fusal to discount for age or for quantity ; strategic location of function in boxes ;
solution selling rather than hardware selling; and refusal to support subsequent
use hardware, et cetera.

At the bottom of the page you Avill note that he observed that "Legal
problems are emerging as a result of certain practices which are key
underpinnings to our price control."

He goes on to say :

The key underijinnings to our control of price are interrelated and interde-
pendent. One cannot be changed without impacting others.



5074

These interrelationships are not well or widely understood by IBM manage-
ment. Our price control has been sufficiently absolute to render unnecessary direct
management involvement in the means.

The Department of Justice complaint specifically covers varying profit mar-
gins and an intensive investigation of this issue would reveal the extent of our
price control and its supix»rting practices.

Such a revelation would not be helpful to our monopoly defense.

He suggests that if IBM's price control is seriously threatened it
is necessary that IBM management fully understand how to respond.

His recommendation, which is consistent with what we have seen
in some of the other exhibits, was to assemble a small, knowledgeable,
secure group to think through these issues, particularly in their inter-
relationships, to define the emerging environment, and, in effect, de-
velop the strategies so at the end of the United States v. IBM case
all will continue to be well.

The effectiveness of these and other market control techniques has
been obvious to those of us who have worked in the computer industry.

After more than two decades, IBM still holds almost 65 percent of
the worldwide installed base of general purpose EDP systems.

Domestically, IBM's nearest competitor has a 9.4-percent share of
the market and even this was achieved in part by acquiring GE's in-
stalled base.

The third ranking competitor, TJnivac, with an 8-percent share, ac-
quired RCA's installed base when they closed the doors on their com-
puter operation.

Senator, if IBM's control of this important industry is to be reduced
it is necessary to understand how it was obtained in the first place and
how it is perpetuated today.

IBM's policies and pricing in the area of computer systems is con-
sistent with a long corporate history of exploitation of customers and
the exclusion of competitors.

In the 1920's the firm dominated the market for office tabulating
equipment to much the same extent it now reigns over the computer
industry.

As IBM emerged as the dominant supplier of computer equipment,
it again devised ingenious methods for profiting from and holding onto
its monopoly.

Though the technique of tying computing supplies to computer
equipment was foreclosed by IBM's earlier confrontation with the
Justice Department, the same ends were accomplished through slightly
different means.

The approach taken by management in the 1950's and 1960's was to
refuse to sell either computer main frames or peripheral equipment
outright; instead offering only month-to-month leases.

Maintenance had to be purchased from IBM.

In two ways this lease-only, required-maintenance marketing struc-
ture enabled IBM to effectively charge higher prices for computing
services to high-demand customers.

First, customers with a greater need for computers would tend to
want more peripheral equipment and, with a monopoly of both rnain
frames and peripherals, IBM could — and did — charge inflated periph-
eral prices.

The second method of discriminating in price between customers
lay in terms of the maintenance contract. More intensive users had to



5075

pay ''extra shift differentials'" on the pretext that extra use resulted
in added wear and tear.

In 1956 when the Department of Justice signed a consent decree
with IBM, supposedly curbing IBM's abuse of its market power, the
lease-only element of hs marketing policies was eliminated; however,
maintenance continued to be tied.

As in 1932, Sherman-Clayton had served to pry loose 1 of the 10
fingers closed around the customer's throat. Somehow the free enter-
prise system was supposed to loosen the others.

Once again the tenacity and creativity of IBM's management pre-
vailed. Additional strategies were developed and implemented in order
to freeze out potential competition.

The most significant anticompetitive policies through the 1960's
were the maintenance lock and software bundling, the provision of
operating and applications software at no extra charge to the lessees.

Both practices tended to erect insurmountable barriers to new
company entry.

Until the late 1960's IBM's competitive stance was basically pas-
sive; the barriers to entry erected by long term strategies had been
successful in protecting its monopoly, and the firm was rarely required
to take visible offensive action against competitors.

But after the introduction of IBM's System/360, things changed.

Yesterday, as Mr. Katzenbach said, "In a competitive market if
the dominant company charges excessive prices, competitors will move
in and serve the market's needs."

IB]\I was netting 35 percent on many peripheral products. A user
with an IBM, CPU was locked in because of the conversion problems.

The only peripherals it could use were IBM's. In 1967 the Telex
Corp. and other small electronics manufacturers began producing
equipmxent designed to replace IBM tape drives, disk drives, and
printers.

Their products simply plugged into the IBM main frame, and were
transparent to the system and to the user, hence the term "plug-com-
patible manufacturers."

These products, as Judge Christensen observed, in many instances
were technologically superior, yet less expensive than the IBM equip-
ment they replaced.

By 1970 business for plug-compatible manufacturers was booming.
They had captured, roughly, 10 percent of the plug-compatible market ;
leaving, of course, the remaining 90 percent to IBM.

The IBM response was quick. A series of price cuts Avas initiated
in 1970, which, according to internal IBM documents subpenaed by
Telex in its successful antitrust suit, were calculated to kill off the
plue-compatible competition.

These were followed in 1971 and 1972 with long-term leasing plans
which had been prohibited for 10 years by the 1956 consent decree —
but that expired in 1966 — designed to further erode the viability of
plug-compatible competitors.

Plaintift''s exhibit 323, dealt with the "dving company" prediction.
To offset planned revenue decreases in the peripherals area, IBM
raised main frame prices to maintain IBM's average profit at 32
percent.



5076

Judge Christensen, in his September 1973 decision characterized
IBM tactics as "* * * unlawful predatory conduct * * * intended
to * * * maintain its monopoly position."

The effect of IBM's moves on the plug-compatible competitors was
devastating. Telex, for example, lost over half its sales from 1971 to
1972, and has yet to operate profitably since the IBM attacks. The
same can also be said of Memorex.

The long IBM history of employing marketing strategies which
exclude competitors with a view toward maintaining its monopoly
power and profits is a textbook case of the abuses the authors of the
antitrust statutes intended to prevent.

When unchecked IBM complacently reaped the fruits of monopoly ;
when callenged it responded Avith vigor to bring competitors, no mat-
ter how small, to financial ruin.

Traditional antitrust enforcement, as was noted yesterday, has fo-
cused largely on eliminating blatantly illegal practices such as collu-
sion in restraint of trade, reciprocity, below cost selling, price fixing,
and other such obviously unethical practices.

Perhaps it has been the failure to understand that the modern day
monopolist employs a variety of far more subtle techniques to main-
tain his monopoly power that has caused the Department of Justice to
miss the target on two prior occasions.

Some of the more subtle techniques, as Mr. Faw has so helpfully
pointed out in his " 'Thoughts for Consideration,' * * * solution sell-
ing rather than hardware selling * * *" is a key underpinning of
IBM's monopoly power.

At the very beginning of the design cycle the architecture of an
IBM system, including the interconnection and interactions between
each of its separate functional parts, is structured to achieve efficient
data processing and to lock the customer into IBM products and
services.

This technique is employed in the design of the logical, mechanical,
and electrical interfaces between the central drives, memories, and
printers.

It is also used in the design of the software that operates the system.

Several examples serve to illustrate the interaction between archi-
tecture and monopoly power with the introduction of the IBM 370
family of computers, IBM standardized — internally — in the interfaces
between its central processing units and its peripheral devices. This
move briefly increased the computer's flexibility by allowing him to
replace various devices as his needs changed.

In 1969, however, IBM realized that many customers were inter-
connecting peripheral devices produced by other suppliers — devices
that were superior in performance and lower in price than the IBM
equipment — and they took steps to remedy the situation.

As one of several strategies aimed at stemming the competitive tide.
IBM moved the electronic controller out of the peripheral device and
into the computer main frame.

This forced competition to redesign its products, but furthermore,
resti-icted their opportunities to innovate in the electromechanical
design area.

Because IBM hardware interfaces are kept secret until first product
shipment, a user or a competitor Avishing to interconnect must obtain



5077

the new product, reverse engineer the interface, and then design their
device so that it works properly with the host IBM computer, obvi-
ously losing valuable time.

It is this that IBM's marketing force uses to sign up customers on
1- or 2-year contracts. n i ^^ i. ■*- •

When the competitor finally gets to the market he finds that it is

foreclosed. , . ^ ^ ^

The recent Bell d- Howell vs. Kodak case hinged on Eastman^s use
of the camera-film interface to obsolete competitive products and bring
new systems into the market while foreclosing competitive response.

In this instance, in order to settle a private antitrust suit, Kodak
agreed to disclose. 18 months before the first shipment, the specifica-
tions of any new film product, a market in which Kodak is alleged



Online LibraryUnited States. Congress. Senate. Committee on theThe Industrial reorganization act. Hearings, Ninety-third Congress, first session [-Ninety-fourth Congress, first session], on S. 1167 (Volume pt. 7) → online text (page 22 of 140)