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

. (page 53 of 140)
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 53 of 140)
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in order to protect existing loans. But short-term financing is expensive and re-
strictive as well as temporary ; and it is hardly the basis for establishing a sound
financial structure in an expanding market.

California Computer Products successfully redirected its memory systems efforts
away from the end-user market to the original equipment market and has become
the principal supplier of disk drives to Univac, Burroughs and a number of mini-
computer manufacturers. The success of this program should allow CalComp to
return to very profitable operating levels for the year ended June 30, 1974. But the
company has still been imsuccessful in its attempts to raise permanent capital at
reasonable prices ; and it is burdened by a heavy debt load and bank lines that are
currently costing in excess of 16% annually in interest charges and compensating
balances.

Without the ability to raise capital, the outlook for end-user independent periph-
eral equipment manufacturers was bleak through 1972 and 1973. Then, in Septem-
ber, 1973, the antitrust suit filed by Telex against IBM was decided in favor of



" IBM's price atljustments durins the period had no visible effect on the price schedules
of IBM's computer systems competitors.

40-927—75 36



5390

Telex. A number of the business practices adopted by IBM to contain the penetra-
tion of the IBM peripheral subsystems market were found to be in violation of
Section 2 of the Sherman Act. Telex was awarded $259.5 million in an amended
decision ; and some injunctive relief was granted to promote future competition
in the industry. The decision also found Telex guilty of misappropriating IBM
trade secrets. The Telex vs. IBM ease is now before the U.S. Court of Appeals for
the Tenth Circuit.

Judge Christensen's decision in Telex vs. 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, ^^hile providing a mean-
ingful damage award. Yet, following a very brief period of investment interest
immediately 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 : the Telex
decision could be overturned or it could be in the federal courts for another five
years ; the peripheral manufacturers had fallen too far behind in product de-
velopment to benefit materially ; there is too much risk in the industry because
of IBM's ability to control prices and the pace of technology. All the reservations
were valid, especially when combined with the most important consideration :
"Where are the peripheral subsystems 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 suc-
cess of plug-compatible peripheral manufacturers was significant. For the first
time, IBM computer users enjoyed a choice of equipment vendors for peripherals
to be used with their systems and were able to realize meaningful reductions in
total data processing expenses and improved systems performance by acquiring
independent equipment. And, technological progress was accelerated by IBM's
attempts to match — and surpass — superior competitive equipment, which provided
additional benefit to the computer user. IB]\I's systems competition also benefitted
from the availability of superior products from independent sources, which al-
lowed them to concentrate their limited resources on central processing unit and
software development.

The future contribution of a healthy computer peripheral equipment industry
could have been even more dramatic. The ability to enter the industry with a
single product line raised the possibility of expanding that line to include addi-
tional peripheral products — and. eventually, a central processing unit and a total
general purpose computer system. But that potential will never l)e realized, be-
cause the capital necessary is simply not available today even if a company
demonstrates that it has a superior product, capable management and current
profitability.

The emei'gence of the independent peripheral equipment manufacturers as an
important force in the industry and their current capital problems is a case
history of the critical role that financing plays in the structure of the general
puii30se computer industry. The product and marketing strategy adopted by
independents to penetrate the general purpose market avoided the IBM compati-
bility problem and reduced the capital requirements considerably by focusing
on a single component of a total computer system. Nevertheless, because of
IBM's Tuiusual competitive reactions, sufficient capital can no longer be raised to
establish strong and viable competitors over the long run.

At a recent management seminar, Mr. Edward Orenstein, President of Data
100 Corporation, a peripheral subsystem manufacti^rer that participates in a
fsubmarket that has not warrented direct IBM action, was asked the question
"Could you please summarize what you consider to be your competitive advan-
tages?"

Mr. Orenstein's answer was, and I quote "Our biggest single competitive ad-
vantage is a financial one. We are primarily in the leasing business. If a poten-
tial competitor, which has started out manufacturing on an OEM basis, then
goes into the leasing business, he must be ready to take a two-or-three-year set-
back in profitability. That's usuallv lethal. Companies usually can't survive
that."

Clearly, he was referring to Data lOO's advant^nge over any competitor in the
early stages of entry into the remote batch terminal market when he referred
to Data lOO's biggest single competitive advantage as a financial one. Data 100
has approximately 10% of the remote batch terminal market, a number of other
comi)etitors share 10 to 15% and IBM has the remaining 75 to 80%. If Data lOO's



5391

principal advantage over new competitors is a financial one, what is IBM's big-
gest single competitive advantage over Data 100? IBM had total revenues of
$11.0 billion in 1973. Data 100 had hotal revenues of $42.1 million in 1973. IBM's
cash flow (net income plus depreciation) was $3.3 billion in 1973, while Data
lOO's cash flow in 1973 was $8.0 million.

SOME CONCLUSIONS AND BECOMMENDATIONS

Raising capital is a problem for almost all U. S. industry today. Only the
strongest companies financially have ready access to new capital because of the
chaotic state of capital markets ha general and specifically because of financial
institutions' highly selective investment policies.

The deterioration of capital markets over the last few years has further con-
tributed to the problems that this subcommittee is addressing, since it tends to
promote even higher industrial concentration. And, difficult capital markets
will remain a fact of life in the industrial world for many years to come
because of the third world economic revolution, high consumption levels and the
large projected demand for new industrial capacity to meet the future require-
ments of our society.

Broad capital market considerations have certainly contributed to the in-
ability of IBM's competitors to raise capital. But unlike most U.S. industry, new
capital is not only important to the general purpose computer industry, it is the
most important consideration and very effective barrier to entry into the
industry.

The history of the general purpose computer systems manufacturers indicates
the extent to which the capital barrier and the "systems lock" have worked
to minimize competition in the industry. Even the "surviving" systems com-
panies as a group look weak from a financial point of view, relative to IBM.
Comparing IBM's financial strength to the other systems companies' ability to
internally generate and to externally raise capital indicates that the industry
could — and perhaps will — become even more highly concentrated in the future.

The rise and fall of the independent computer peripheral subsystems manu-
facturers as meaningful competitors in the end-user general purpose market
further dramatizes the effectiveness of the capital barrier. Competing with IBM
on a peripheral subsystems level avoided the compatibility problem and reduced
the capital commitment necessary to enter the market. Nevertheless, IBM's
ability to focus on peripheral subsystems companies by highly selective price cuts
has effectively eliminated them as meaningful competitors, because they can no
longer raise the capital necessary to compete.

The capital barrier to entry combined with IBM's practice of marketing a total
bundled computer system family gives IBM a high degree of control over the
general purpose computer market, if not absolute control. The ability of IBM
to shift profitability from peripheral subsystems to central processing units and
back again, depending upon the competitive realities of the market at that time,
makes it almost impossible to compete on any level but on a total systems level —
where the capital barrier has proven to l)e almost prohibitive. Profitability can
also be shifted among the various peripheral subsystems, between the central
processing unit and the operating system and from one end of the conjputer
systems family to another, if effective competition enters the market in any
of those areas. IBM has the added advantage over potential competitors of con-
trolling interface standards and new media standards in the industry ; of being
able to deny field service support ; of controlling the development of the operat-
ing system ; and of possessing the only truly accurate data in the industry about
market size and product profitabilit.v.

IBM's ability to orchestrate relative profitability and its many other advan-
tages over competition would not be so important if the industry giant did not
fully utilize all of those facilities in its competitive battle with the plug-
compatible peripheral subsystems manufacturers. Profitability was shifted (from
peripheral subsystems to the central processing units following the introdiiction
of FTP and from add-on memory to the central processing units with the intro-
duction of the System 370/158-168) ; interface information remains a closel.v
guarded secret at IBM : media staiulnrds are changed, but the new "de facto"
standard is not immediately released to the industry (the new disk pack for
the AVinchester disk subsystem) : field service support is occasionally denied to
IBM svstems with non-IP.:\I equipment attached (as in the case of Advanced
Memory Systems' add-on memory) : changes in IBM's operating system have
severely disrupted a competitor's business (Sanders Associates' terminal busi-



5392

ness) ; and the lack of accurate industry data has hampered competition (in the
late 1960s disk pack manufacturers were increasing production based on esti-
mates of the pack market that IBM knew to be about twice the size of the actual
market).

The effect of IBM's competitive response to the initial success of subsystems
manufacturers has been to warn Wall Street that competition on any level
except on a total integrated systems level has no chance of success. And. the
warning was not a subtle hint. Major financial institutions have .suffered — or
stand to suffer — large financial losses because of the experience, including Bank
of America (becau.se of its heavy commitment to Memorex), Continental Illinois
National Bank (Telex's lead bank), and Metropolitan Life Insurance Company
(because of its equity investment in Telex).

In the context of the disappointing performance of IBM's general purpose
systems competitors and the harsh lesson of the peripheral subsystems manufac-
turers, it is not sui-prising that the flow of new capital into the computer industry
has all but stopped. My contracts with major financial institutions today indicate
that they have no interest in investing in any peripheral subsystems manufac-
turers that are competing with IBM in the end-user market ; and that they have
very limited interest in investing in companies that are competing with IBM on
a general purpose systems level. — Since capital is so critical to success in the
industry, that can only mean that competition in the industry will decline even
further in the future.

Should the computer industry be restructured? The answer to that question
seems simple to this writer. A competitive computer industry is vital to our
national defense and to our continued economic and technological development.
And today, the industry is not only highly concentrated, but the present structure
of the industry suggests that there will be even less competition in the future.

IBM would have us believe that there is no general purpose computer systems
market — that there is only a total data processing market and that IBM's share
is relatively small. IBM's definition of the market is similar to suggesting that
there is no domestic automobile market — that there is only a transportation
market and that trains, buses, planes, taxicabs and roller skates should all Ite
included in the market.

IBM's broad definition of the data proces.sing market is similar to my trans-
portation industry analogy but even that comparison does not fully describe the
nature of the industry. Data processing is much more basic and, because it is .so
basic, control of the largest market within the broadly-defined data processing
industry (the general purpose computer systems market) also grants effective
control over technology in many areas that are critical to the future of this
country.

But, isn't technological progress best served by having one giant company
controlling new product development, especially ,]\-hen that company spends in
excess of $700 million annually for research and development? Unfortunately,
the present structure of the computer industry retards technological progress.
IBM's marketing strategy is to introduce new products when competitive pressure
within the industry demands advanced products. In the absence of competition,
the rental-base nature of the industi-y makes it more attractive for IBM to keep
installed products out in the field for as long as economically possible. Conse-
quently, IBM seldom takes the lead in new technological developments in the
industry, except where there is no existing base of product.

Even today, the investment community is reluctant to finance any new tech-
nological ventures into the general purpose systems market, because it is well
aware of the fact that IBM stands ready with its large technological reserve
to match any new developments ; and it probably has a product ready to go
if a new, innovative company begins to achieve some measure of success. What
will happen when IBM's technological reserve is broadened into even more
basic re.search areas?

Although the answer to the question of whether the industry should be re-
structured seems simple, the question of how the industry should be restruc-
tured is extremely complex, in part because it has been structured to resemble
a monolithic industry. My remarks have focused primarily on the rental-base
nature of the computer market and on IBM's equipment financing bu.siness,
because they are key elements in IBM's dominance of the general purpose com-
puter market ; and they must be addressed in any restructuring i)lan. Any
future restructuring of the industry also should recognize that IBM's data proc-
essing operations are actually the sum of a number of businesses, including



5393

tlie development, production and marketing of central processing uuit.s, operating
systems, applications programs and numerous peripheral subsystems such as
tape drives, disk drives, printers, communications controllers and terminals ;
and that It is also in the business of providing a number of services such as
field maintenance, education and systems engineering, as well as lease financing.
Any one of those businesses could potentially be established as separate and
independent competitive entities, significantly increasing overall competition
within the industry.

AFTERXOOX SESSIOX

Senator Hart. Tho committee will be in order.

Our next witness is the vice president and associate director of re-
search of Shareholders Management Co., Mrs. Marilyn Walter-
Carlson.

We welcome you.

STATEMENT OF MARILYN WALTER-CARLSON, VICE PRESIDENT
AND ASSOCIATE DIRECTOR, RESEARCH SHAREHOLDERS MAN-
AGEMENT CO., LOS ANGELES, CALIF.

INIrs. Walter-Carlsox. Senator Hart, I appreciate the opportunity
to be here today.

I liave been a security analyst for 18 years, beginning my career
as a research assistant in 1956. My initial assignment was coverage
of the emerging high technology industry, which primarily consisted,
at that time, of IBM, General Electric, Westinghouse, and the large
aerospace companies.

Ancillary hig'h technology companies emerged, exploded, and ex-
pired during that period which produced today's major semiconductor
companies such as Texas Instruments, Motorola, and Fairchild Cam-
era and Instrimient.

Ten years later, in 1966, I was asked to follow the emergence, ex-
plosion, and subsequent expiration of the computer leasing and soft-
ware companies and the peripheral equipment companies.

I was involved in research and corporate finance work in the high
technology area at W. E. Hutton & Co. from 1966 to 197i2, and nego-
tiated a sizable merger which was consummated in 1969 involving $200
million in consolidated sales.

For the past 2 years, I have been witli an investment advisory firm
with over $1 billion in assets under management, including six mutual
funds, small individual accounts, and pension fund accounts.

I am vice president and associate director of research and have re-
sponsibility for tlie analysis of companies operating within the entire
high technolog}' area, including computers, peripheral equipment, soft-
ware service companies, semiconductors, electronic instruments, and
consumer electronic products.

Because of the information flow from Wall Street and other sources
on the major companies we do not personally call on those com])anies,
but direct our efforts to following the small companies which do not
receive attention from Wall Street.

In spite of this policy I found that I was not getting objective in-
formation from Wall Street during the IBM-Telex trial last year and
devoted 100 percent of my time to the reading and analysis of many
of the documents which became part of the public record as a result
of that trial.



5394

My conclusion led me to recommend the sale of our IBM holdings
approximately 1 year ago — August 1973 — at a price of about $315 per
share. That reconunendation was followed and our accounts now have
a very small amount of IBM.

Perhaps the most illustrative example of the lack of easil)^ available
data to security analysts and manufacturers in the computer industry
is a comparison of the annual reports to stockliolders of IBM and
General ^lotors, which was selected simply because it is the largest
industrial company in the United States.

The IBM report begins with the traditional letter to shai'eholders,
which is 314 columns long and which contains only four paragraphs of
operating statistics, or at most, 10 sentences of text, less than i sentence
per billion dollars of sales.

That is folloT>-ed by a financial review which is less than two columns
in length. It is basically a terse document designed to conform to the
minimum standards for reporting required by the Securities and Ex-
change Commission and the accounting profession.

It is not in any way helpful in analyzing what occurred in the com-
puter industry during the j^ear.

In summary, IBM, the computer industry leader, provides no in-
dustry data either to its shareholders or to investment analysts in its
annual report.

In order to illustrate that an industry leader can divulge substantial
information I reviewed General Motors latest annual report. The letter
to shareholders is two pages long. The body of the report entitled "The
Year In Review" provides a wealth of information in approximately
nine pages of text plus another nine pages of illustrations.

Excerpts include :

Of all new cars sold in the United States during 1973, including imports, 45
percent were GM products. Electromotive division sales included 40 high-speed,
3,000-horsepovver passenger locomotives, et cetera.

Compare these facts with the most definitive statement in the IBINI
letter to shareholders, to wit :

Accompanying a record rate of worldwide installations in the final quarter of
1973, outright purchases of data processing equipment were also at an all-time
high for any quarter and were higher for the full year 1973 than for 1972.

The end of the GM annual report provides a 20-year history of oper-
ations and includes a 10-year history of the number of cars, trucks, and
coaches manufactured in the United States by brand name, and the
number of cars manufactured outside the United States by country.

None of this information is available from IBIM.

The other computer companies all make an effort to inform their
shareholders as to the performance of the several aspects of their
business.

NCR has made a successful effort to provide information and has
used a question-and-answer format in place of the traditional letter to
shareholders.

The questions represent those most frequently asked of management,
and the answers are their usual response. The 10-years of operations
present detailed information enabling analysts to immediately com-
pute significant financial ratios.

Burroughs' annual report describes each product group's experience
in the previous year in some detail. In the case of Control Data the



539^5

annual report is concise and does not give as miicli information as
analysts would like to have, but it does divulge sales performance by
group in tlie letter to shareholders.

However, Control Data follows the practice of mailing the complete
10-K report to security analysts as soon as it is available.

Sperry Rand's annual report is also complete and includes a table
on revenue and income for its four major product groups for the past 5
years. The 10-year summary is so inclusive that it should probably be
adopted by the SEC as mandatory for all companies in all industries.

Honeywell has not made analysis easy in the past, but the 1973 an-
nual report does provide significant information on tlie revenue stream
derived from Honeywell Information Systems and the amount of sales
and earnings coming from its other businesses.

Wliat is lacking in the IBM report ? The company could employ some
simple visual aids such as bar charts or graphs to present data for at
least a 5-year period.

Rental and service income and sales should be reported separately ;
and sales should be broken out between EDP sales and other sales.

The company should provide information as to the breakdown of
the ^•arious classes of machines shipped and the sales-lease ratio within
those classes.

Somewhei'e in the report management should at the verj' least com-
ment on the operations of its various divisions. In many ways, the IBM
annual report is actually misleading.

For instance, the average shareholder probably looks at the 10-year
record and sees a constant uptrend in sales and earnings. If IBj\I re-
ported the derivation of those sales, the shareholder would see that
EDP sales are rising much more rapidly than rental and service
income.

If IBM reported domestic and foreign revenues and earnings sepa-
rately, the shareholders would see that overseas growth has far out-
paced domestic growth.

Other industries have substantial statistical data which is reported
on a weekly and monthly basis by product. The steel industry reports
production figures on a weekly basis; the auto industry reports new
car production and sales every 10 days; the consumer electronics in-
dustry — radio and television — reports factory production, factory
sales, and dealer sales on a monthly basis.

And the home appliance industry reports factory sales monthly.

A trained security analyst uses this data, along with other informa-
tion, in making investment decisions. Manufacturers use this data to
help plan production schedules which in turn provide a key to the
proper level of purchasing activity which in turn should reduce the
cost of carrying inventories.

There is no such data available on the computer industry with the



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 53 of 140)