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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Mr. Xash. Having brought the latter points up, my next question is,
to what extent, if at all, was the French decision made because of a
concern over IB^I's share of the computer market ?

Mr. XicoLAiDis. Speaking about having a degree of control over this
industry, the big share of IBM was a key factor; because, at that
time — I think, I'm not sure of the figure — it was between 70 and 80
percent of the market. So, of course, the dominant position of IB]M in
France was a focal point of studies about the problem of control.

]\Ir. Nash. You have mentioned three factors so far. Are there any
other factors that went into the decision to implement "plan calcul"
that you can recall ?

Mr. NicoLAiDis. I think that it is very difficult to enumerate the
specific factors because I think it was much more a matter of currents
of ideas. That came in 1966 — and I have mentioned the specific rea-
sons. iDut I think it is more general.

Mr. Xasii. Some U.S. computer manufacturers have indicated that
"plan calcul" involves the French Government subsidizing CII. Would
3^ou l^e able to give us an indication of the extent of the subsidy ?

]Mr. NicoLAiDis. Yes, I can give you the budget of the Delegation a
rinformatique because all the money is going through the Delegation.
The budget of the Delegation a ITnformatique for 1974 is $62 million,
of which $18 million are for computers and systems, generally ; $9 mil-
lion for electronic components, peripherals, terminals ; and $5 million
for software and education in the computer iield. Another sum of
money, about $12 million, is under discussion with CII for the charges
related to the Unidata group — some transformations needed to make
the CII line compatible with the standards established with its partners
within the Unidata group — but this is not decided at this time.

[For further explanation of the above subject see exhibit 2 at the
end of Mr. Nicolaidis' oral testimony.]

Mr. Xash. To what extent do you believe the French Government
has a degree of control over multinational computer firms operating in
France ?

]Mr. XicoLAmis. No control at all. No real control at all because
IB^I-France, for example, is legally a French firm; but, in fact, IBM-
France doesn't exist by itself because it needs the other IBM plants in
Europe to build a computer. In France the main job of IBM-France
is to build the electronic components for other plants of IB]M.

Mr. Nash. I understand that a large number of U.S. minicomputer
companies of late have successfully penetrated the French comj)uter
market. Is this also a concern to the French Government?

Mr. Nicolaidis. Not at the present time. They are doing very well,
but it is not a matter of control. The market involved is not as big as
for IBM. Until now the French Government has always allowed the
U.S. minimakers to put a subsidiary or plants in France.

Mr. Nash. When you say it's not a matter of control you mean a
single company controlling a large share or a combination of com-
panies controlling ?

, Mr. Nicolaidis. No, I think it is more a problem of one company.
Mr. Nash. Thank you, Mr. Chairman. I have no further questions.
Senator Hart. Mr. Chumbris ?



5355

Mr. Chumbris. I have no further questions other than the point I
raised, Mr. Chairman. Thank you, again, for coming and giving us
this information.

Senator Hart. Thank you very much. I'm sorry that we had to
bring you back. This does conchide our hearings today. We resume in
this room, not at 10 o'clock as indicated on the earlier announcement,
but at 9 :30 in the morning. Tomorrow, in addition to those listed, we
will have testimony from the president of Sanders Associates.

[Whereupon, at 2:35 p.m., the subcommittee adjourned, to be re-
convened on Thursday, July 25, 1974, at 9 :30 a.m., in room 2228, Dirk-
sen Senate Office Building.]

[The following was received for the record.]

MATERIAL RELATING TO THE TESTIMONY OF
ALAIN NICOLAIDIS

Exhibit 1. — Subsequent Letter From Alain Nicolaidis re French Government
Subsidies to the Com,puter Industry

Ambassade De France Axjx Etats-Unis,

Washington, B.C., July 25, 197^.
Mr. Bernard Nash,

Asf<isfant Counsel, Subcommittee on Anti-Trust and Monopoly,
U.S. Senate, Washington, B.C.

Dear Bernie : First, I would like to add, for the record of the computer hear-
ings, some precisions to my answer yesterday to your question about subsidies
from my Government to the French Computer Industry.

I thiiik the word "subsidy" is, in the mind of many Americans, just an aid
without couni-erpart like the subsidies our governments both give to the farmers,
for example, 1 want to .say that the "subsidies" we spoke about, in the case of the
computer industry are, in fact, R&D contracts : the Delegation a I'Informatique"
gives to CII, for example, such or such amount of money to develop a model of
computer, or an operating system, or a peripheral. It is really a contract between
the French Government and CII which is similar to the many contracts the
Federal Government makes with many computer firms in this country (whose
amount was 300 million dollars in 1965, as Mr. Christopher Layton said
yesterday ) .

As an example, AMPEX — a firm I visited some months ago — received in 1973
2 million dollars from the Department of Defense for the development of a mass
memory, known as the TERABIT memory, which is not a specific device and
which will be marketed as any other product of this firm.

Secondly, I would want you to add to the record of my testimony a statement
(enclosed) about the so-called nationalistic policy in the procurement of com-
puters for the French Government. I think it is vei-y important because many
people in this country think CII has a monopoly in the government market.
Very truly yours,

Alain Nicolaidis, Scientific Attache.

Enclosure.

I have often heard it is said that the French Government has a very nation-
alistic policy in the procurement of computers for its Departments and Agencies.

Let me make two remarks :

(1) Before being there I was head of a computer center in a French agency,
the "Direction des Constructions Navales" which is a government-owned indus-
trial organization of about 25,000 employees in charge of designing, building
and repairing all the ships of the French Navy.

We had a lot of computers in our eight shipyards and, as a head of the central
computer center I had some responsibility in discussing the choices we made in
the procurement of computers. I had to explain why we needed a new computer,
why we made such and such a choice, how we made the technical evaluation and
so on before a special commission which exists in each Ministry. <,-ne of the
members of that commission is a representative of the Delegation a I'Infor-
matique. But I can say that we proposed for our needs, on the basis of cost-
effectiveness, one computer from CII and four computers from SIEMENS



5356

which at that time was just a foreign supplier as any other because UNIDATA
did not yet exist. I experienced no opposition from the representative of the
Delegation : Oil had lost on a competitive hasis and the Delegation wants only
to be sure that CII has a fair possibility of competing. In other cases, CII wins
because I must say that they have very good computers in some specific ranges
and their performance in other countries is a proof of that (CII exports about
20% of its production).

Of course if Oil is just fairly competitive, it has the preference of the French
Government, but in this case only.

lOn the other hand, do you really think any foreign manufacturer has a fair
chance to compete in a bid for the Federal Government?

(2) The structure of installed base in the French Government shows that the

share of U.S. manufacturers is still enormous :

Percent

CII 22

U.S. manufacturers 74

of which IBM 41

Honeywell 16

CDC 7

If we look at the shipments to the French Government for 1973, we can see
that there is diminution of revenues, compared to 1972, for the U.S. manufac-
turers, but not enormous :

Percent

IBM —1

Honeywell ~4

CDC -1

On the other hand, in the nationalized sector ( Soci^te Nationale des Chemins
de Fer, Electricity de France, Renault, Etc. . . .) also controlled by the French
Government, IBM has lost 1% of its share (56% to 55%) but Honeywell gained
2% (7% to 9% ) between 1972 and 1973.

This explains that the "Delegation a 1 ' Informatique" has no real power (and
no intention) to oblige the French Agencies and Departments to buy only French
computers.

It is true that the D§lagation wants to improve the share of CII but it does not
want to give CII a protected market because it thinks it is most useful for Oil to
have to compete on a cost-eftectiveness basis.



THE INDUSTRIAL REORGANIZATION ACT (S. 1167)
(The Computer Industry)



THURSDAY, JULY 25, 1974

U.S. Senate,
Subcommittee on Antitrust and Monopoly

OF the Committee on the Judiciary,

Washington.) D.C.
The subcommittee met at 9 :30 a.m. in room 2228. Dirksen Senate
Office Building, the Honorable Philip A. Hart (Chairman of the sub-
committee) presidino;.
Present : Senator Hart.

Staff present : Howard E. O'Leary, Jr., chief counsel ; Bernard Nash,
assistant counsel; Patricia Bario, editorial director; Janice Williams,
chief clerk; Peter N. Chumbris, minority chief counsel; Charles E.,
Kern, II, minority counsel; and Michael Granfield, minority
economist.

Senator Hart. The committee will be in order.

This morning: our first witness will be ]Mr. Eugene K. Collins, direc-
tor of research for the Wall Street firm of Evans & Co.

STATEMENT OP EUGENE K. COLLINS, DIRECTOR OF RESEARCH,
EVANS & CO., NEW YORK, N.Y.

Mr. Collins. Senator, I appreciate the opportunity to appear be-
fore the subcommittee.

My name is Eugene K. Collins. I am director of research and a
security analyst specializing in the computer industry at Evans & Co.

My undergraduate work was done in electrical engineering and
economics, and I studied investments and finance at New York Uni-
versity, Graduate School of Business.

I have been a security analyst at New York Stock Exchange firms
since 1965, initially following high technology cornpanies generally,
and aerospace and office equipment companies specificallv.

Since 1968 my analytical work has been almost exclusively in the
computer industry, except for a brief period during 1971-72.

]\Iy analytical work in the computer industry has focused pri-
marily on IB^M and on young companies in the industry that might
be able to successfully penetrate the industry.

My interest in young companies in the industiy and in IBM are
closely related disciplines since IBM is the computer industry and
the business practices of IBM largely determine the economic
structure of the industry.

I regular!}^ advise companies in the industry on the subject of
future financing plans and I successfully raised initial capital for
a company in the industry.

( 5357 )

40-927 — 75 34



5358

In 1968, I was instrumental in first introducing periplieral sub-
systems manufacturers to Wall Street and to financial institutions
as potentially attractive investments in the industry ; and have closely
followed the rise and fall of those companies as meaningful competi-
tors in the industry.

I am generally regarded as Wall Street's resident expert on com-
puter peripheral equipment manufacturers.

In my current capacity as a security analyst at Evans & Co., I
act as a consultant to banks, insurance companies, and mutual funds
on the subject of investing in the computer industry ; and I publish
extensively on the industry and on individual companies in the in-
dustry.

Maiiy of my remarks today will reflect impressions that I have
received through almost daily contact with major financial institutions
over a period of 6 years.

The computer industry is the fastest growing major industry in
this country and in the world. The industry has already contributed
to vast social, economic, and political change in its brief 20-year
history; and the next 20 years promise to be even more dynamic
because of quantum leaps in semiconductor technology, the increased
sophistication of the computer user, and the marriage of computer
and communications' technologies.

Yet, there are very few companies in the computer industry that
receive serious investment consideration today. The answer to the
apparent paradox of a growing and dynamic technology-based in-
dustry and the highly selective nature of current investment interest
can be found in the structure of the computer industry.

There are two major barriers to entry into the general purpose com-
puter industry: the "systems lock" and the highly capital intensive
nature of the industry.

Together they form an absolute barrier to entry that would allow
IBM to control virtually 100 percent of the general purpose computer
market, in my opinion, if IBIM did not operate under self-imposed
constraints that limit its market share to 60 to 70 percent.

Basic to establishing and maintaining the two principal barriers to
entry is IBM's policy "of marketing a total bundled system on a short-
term, risk lease basis.

Testimony before this subcommittee has extensively addressed the
esoteric subject of the system lock and IBM's related marketing sup-
port activities.

Tlie perspective I hope to bring to these hearings is the unique
importance of the financing question of the structure of the computer
industry; and some insight into how the highly capital intensive
nature of the industry is created and maintained to provide an effective
barrier to entry.

Although the ability to raise capital is an important consideration
in determining real and potential future competition in any indus-
try, it is a uniquely important factor in the general purpose computer
industry.

Its unusual importance to the computer industry relates to IBM's
practice of marketing a total bundled computer system on a rental
basis.

In my prepared statement is an example that shows the first year
of operation of two identical companies, with one shipping on an out-



5359

right sale basis and the other shipping on a rental basis, or lease basis.

The manufacturing company that is forced to ship its product
entirely on a rental basis records a first year operating loss of $36.9
million on shipments of $100 million, in contrast to a profit of $20
million for the typical manufacturing company.

If no new product were shipped on a rental basis in the second year
and expenses were reduced accordingly, revenues of $25 million would
be recorded for the rental-based manufacturer and a profit would be
realized.

But, that would be a company in liquidation. If, on the other hand,
the management of the company addressing a rental market was at-
tempting to build a viable company over the long term, shipments
could not be reduced to zero in the second year but would, in fact,
have to be increased on a year-to-year basis.

Increased shipments on a rental basis, in turn, result in an even
larger reported loss in the second year and increasing losses for
some time.

Eventually, the losses peak and begin to decline gradually until,
finally, a break-evon level is reached.

The problem from a financing point of view is enormous. An in-
vestor is being asked to commit capital to a business that may not show
a profit for perhaps as long as 10 years; and will only show a profit
at that time if management does not make any important mistakes
along the way ; if the economy does not slump into a recession at the
wrong time ; if the dominent company in the industry does not become
sufficiently concerned to focus its competitive strengths on the new
company; and if capital can be raised along the way to keep the
company alive.

The capital that must be raised is also equity and equity-related
risk capital since straight debt will not be made available to a com-
pany realizing a negative cash flow and operating at a loss.

Consequently, most of the companies that have attempted to enter
the general purpose computer market have been involved in other
businesses that could support some of the initial capital demands,
such as General Electric, Philco, Bendix, NCR, Burroughs, Sperry
Rand, RCA, and Honeywell.

This history of the general purpose computer industry clearly
establishes that reaching the critical mass level necessary for successful
entry takes a long, long time and huge amomits of capital.

In September 1971, RCA announced that it was withdrawing from
the general purpose computer field, and the company took a pretax
loss that year of $490 million as a result of its venture into computers.

RCA had already committed capital well in excess of the final write-
off of $490 million ;'and estimated at the time that it would have to com-
mit an additional $500 million to establish RCA as a viable company
in the computer industry.

General Electric's experience was similar; and in 1970 GE sold its
computer systems operations to Honeywell.

Even among IBM's systems competitors that have survived, it is
unclear to what extent they have successfully entered the general pur-
pose computer systems market.

The data in the table in my prepared statement raises questions
about the staying power of some of the remaining companies in the
industry. Burroughs is the only companv that realized profit margins
in 1973 that were in excess of the average of all major U.S. corpora-



5360

tions last year, altlioiigli Univac was just slightly below the average ;
and all of IBM's competitors realized a lower return on stockholders^
equity in 1973 than the average of all major U.S. companies last year.

The relative difference in profitability within the computer industry
is even more significant than the comparisons indicate, since IBM's
accounting for profits is in general more conservative than com-
petition.

Also, total corporation data masks the low level of profitability of
computer systems operations in many cases.

Since capital is a major barrier to entry into the computer industry,
the ability to internally generate cash to meet future capital require-
ments is an im]:)ortant measure of the ability of any company to com-
pete effectively in the future.

IBM's cash flow in 1973 at $3.3 billion seems overpowering relative to-
its nearest competitor, Honeywell, Inc., with cash flow in 1973 of only
$367 million.

Further, IBISI held cash and equivalents at yearend 1973 of $3.3
billion, excluding $1:96 million in securities held for repayment of long-
term debt.

In contrast, a number of IBM's general purpose systems competitors
are burdened by relativel}^ high debt levels.

The ability of IBM's competitors to raise outside capital is equally
uninspiring for many of the reasons that have already been mentioned.

Also, excluding Burroughs, price-earnings ratios are relatively low;
and again, excluding Burroughs, the ratio of co'mmon stock price to
book value indicates that any new common stock offerings could dilute
current stockholders' equity at a number of companies in the industry.

The future availability of external financing to computer systems
manufacturers must also be viewed in the context of the history of the
industry.

Through the decade of the 1960's, the mystique of the computer and
the hypnotic influence of possibly approaching IBM's profitability
attracted considerable external capital into the industry.

The myth that many companies would be able to achieve rapid
growth and high profitability in the computer systems market has been
shattered by the reality of the economics of the industry.

All of the previous financial considerations indicate that the indus-
try could, and perhaps will, become even more highly concentrated
than it is today if capital remains a major barrier to entry.

The history of independent peripheral equipment manufacturers*
attempt to penetrate the general purpose market further illustrates
the extent to which capital acts as an effective barrier to entry into
the industry and the dynamics of the interaction.

In the late 1960's, independent manufacturers began to address the
end-user market directly, with particular emphasis on the IBM rental
base of peripherals attached to the IBM System 360 family.

The development of the end-user market for peripherals was the
result of a number of factors : The potential market was large, particu-
larly among IBM systems users; the economies of scale of product
development and manufacturing were not significant barriers to entry :
teclmological progress in peripherals had been slow, perhaps because
IBM never had to compete on a peripheral subsystems level ; profit
margins were excellent : and peripherals were an increasing portion of
the dollar value of a total computer system.



5361

One of the major barriers to entry into tlie general purpose computer
market, software compatibility with IBM, was avoided by making
the independent peripherals fully compatible with IBM software and
s^'stems.

And the other major barrier to entrj', capital, was reduced signifi-
cantly, in part by investment enthusiasm for young technology com-
panies in the late 19G0's, but more importantly by the fact that an inde-
pendent peripheral equipment manufacturer could address one mar-
ket — for example, the digital tape drive market — and was not forced
to develop an entire computer systems family.

By 1970, the success of Telex and the availability of initial capital
had attracted a number of independent competitors into the industry.

During 1970, shipments of independent peripheral subsystems manu-
facturers increased sharply. Plug compatible manufacturers were
achieving what IBM's systems competition had failed to do : They
were providing some real competition.

Then, after careful study, IBM began to react; or overreact, de-
pending upon one's perspective.

Despite the sharp financial setback of the peripheral subsystems
manufacturers as the result of IB]M"s actions, some companies, through
superior product lines, strong management, or simply luck, were not
forced to drastically cut back product development and end-user mar-
keting programs, and were continuing to enjoy strong customer re-
sponse for their products.

But there was one missing ingredient: Xew capital was no longer
availal^le. IBM's actions served notice to Wall Street that competi-
tion on a peripheral subsystem level had little chance for success, and
"Wall Street listened.

IB]M*s promise of doom had the effect of a self-fulfilling prophecy.

Without the ability to raise capital, the outlook for end-user inde-
pendent peripheral equipm.ent manufacturers was bleak through 1972
and 1973. Then, in September 1973, the antitrust suit filed by Telex
against IBM was decided in favor of Telex.

A number of the business practices adopted by IBM to contain the
penetration of the TRM peripheral subsystems market were found to
he in violation of section 2 of the Sherman Act.

Judo-e Christensen's decision in Telex v. IBM seemed to represent
a new lease on life for the independent peripheral subsystems
manufacturers.

The decision recognized peripheral subsystems as individual and
distinct submarkets, and it recognized IBM's monopoly power in those
submarkets, while providing a meaningful damage award.

Yet, following a very brief period of investment interest imme-
diately after the surprise decision, Wall Street again turned a cold
shoulder toward peripheral manufacturers.

The stated reasons for the lack of investment interest were mixed.
And all of the reservations were valid, especially when combined with
the most important consideration: Where are the peripheral sub-
systems manufacturers going to get the capital necessary to regain their
previous position in the industry ?

The immediate impact on the general purpose computer end-user of
the initial success of plug-compatible peripheral manufacturers was
sicniificant.



5362

For the first time. IBM computer users enjoyed a choice of eqnip-
ment vendors for peripherals to be used with tlieir systems and were
able to realize meaningful reductions in total data processing expenses
and improved systems performance by acquiiing independent
equipment.

And technological progress was accelerated by IBlSl's attempts to
match and surpass superior competitive equipment, which provided
additional benefit to the computer user.

IBM's systems competitors also benefited from the availability of
superior products from independent sources which allowed them to
concentrate their limited resources on central processing unit and soft-



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 48 of 140)