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 57 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 57 of 140)
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Data on revenues, incomes, research and development expenditures, net com-
puter rental base, number of employees, and selected balance sheet items are
summarized in Table I at the end of tliis statement. These simple statistics are
presented merely to emphasize the great disparity in the sizes of the six primary
companies in the computer industry.

Of primary interest in Table I are the revenues generated by each firm's com-
puter business, labeled "EDP Revenue Only." and the installed computer rental
base net of accumulated depreciation, labeled "Net Computer Rental Base." In
1973 IBM generated computer-related revenue of .$8.7 billion, or 64.7 percent of
the total computer-related revenue for all six companies of $13.4 billion. Four
of the other five companies generated computer-related revenues of around $1.0
billion in 1973. while National Cash Register generated about $.550 million. The
disparity in net computer rental ba.se among the companies is even wider, although
IBM maintained approximately the i^ame ratio, or 6-").l percent of the total of
$5.S billion of installed computers. IBM's net computer rental base at the end
of 1973 was $3.7 billion, compared with .$816 million for Honeywell, and $^69
million for Burroughs. However, the.se figures are not really indicative of the
number of machines installed, nor of thhe installed base, which is estimated at
about $30 billion. Since depreciation pra^-'tices vary for each company, IBM's
net rental base is understate<l because of its extremely conservative accounting
relative to Burroughs with its more liberal accounting. In any ca.se. l»oth IBM's
EDP revenue and net computer rental base in 1973 were almost double that of



5417

the other five computer companies combined. These comparisons are shown
graphically in Figure I at the end of thi", statement.

Pretax income from all operations including non-computer related activities
totaled $3.7 billion for all six companies (see Figure 2). Of this amount, IBM
reported $2.9 l)illion, or just under four times the combined pretax income of
the other five companies. Even more striking is the fact that IBM's pretax income
was almost 14 times tliat of the .second largest company, Sperry Rand, while its
total revenue was only 4 times as large. Obviously, IBM is the most profitable in
the industry, and this is evidenced by the fact that while its total revenues,
including EDP, were about 55 percent of the combined companies, its pretax
income was proportionately much higher — 79 percent of the total. Similar com-
parisons could be drawn for net income also, as shown in Table I.

Figure 3 iwrtrays research and development expenditures for each of the six
mainframe companies, and again the disparity in size is most apparent. In 1973,
IBM's research and development expenditures of $730 million was nearly equiv-
alent to the combined pretax income of the other five companies combined, which
totaled $794 million. IBM's $730 million expenditure for research and develop-
ment represented one and a half time the total amount spent by the other five
companies, and was 61 percent of the total spent by all six companies. However,
if we compute the percentage of pretax income each company allocates to its
new product development programs, an entirely different picture emerges. In
1973, IBM's $730 million R. & D. expense represented 25 percent of pretax income
and about 8.5 percent of EDP revenues. Honeywell's R. & D. expense of $160 mil-
lion was 85 percent of pretax income and 13.5 percent of sales. Similarly, Sperry
Rand spent $l-!6 million on R. & I)., or 69 percent of pretax income, and 13
percent of EDP sales. Clearly, IBM's huge R. & D. expenditures come not as a
result of spending a proportionately higher percentage of income or sales on
R. & D., but because its massive profit base permits it to do so.

IBM's relative size is further underscored by reference to its net worth, or
shareholders equity, which was $8.8 billion at the end of 1973. This amount is
about 66 percent of the total net worth of all six companies, and nine times that
of each of the next two largest firms, Sperry Rand and Burroughs. Furthermore,
IBM's cash and equivalent of $3.8 billion (including about $500 million of securi-
ties "held for repayment of long tenu debt") is only 20 percent less than the
combined shareholders equity of the other five companies. A comparison for
IBM's cash and equivalent and those of the other companies is shown in Figure 4
at the end of this statement.

The foregoing statistics indicate that IBM is a self-perpetuating giant with
a formidable financial lead over its competitors, and it is this .strength in sheer
dollars which is the crux of the competitive problem in the industry. Because
IBM has been spending so heavily on research and development based on its
financial ability to do so, the company in the very recent past has gained a tech-
nological lead over its competitors. However, this technology has not immediately
benefitted the user by reducing his computer costs, nor has it been available to
the competition at the same time at which IBM had the technology in-house.
IBM has withheld that beneficial technology from the marketplace to protect its
rental ba.se until a competitor, whether it be the peripheral equipment companies
with a speetlier product, a mainframe company with virtual memory, or a semi-
conductor company with MOS memory, forced IBM to move forward. This prac-
tice has impeded technological progress because none of IBM's competitors can
afford to risk the viability of their company on an unproven technique. It is only
when IBM bestows its official blessing via the introductor route that competition
returns to the marketplace.

If IBM continues to restrain competition by withholding technological ad-
vances for its own financial benefit, it is possible that the technology which exists
in our other mainframe computer companies, which is well advanced from that
of foreign competitors, will be exported through foreign investment in those
firms. This has already occurred in a roundabout manner with the acquisition
of Bull by GE and then the sub.sequent merger of GE and Honeywell and the
intensive amounts of investment in Honeywell-Bull by its U.S. parent. Another
example of the export of U.S. technology was the inability of Amdahl to raise
sufficient capital domestically to bring its new computer to market and the
subsequent majority po.sition gained by Fujitsu and Xixdorf through their
infusions of cash.

IBM's research and development activities, while privately financed, have
become a national asset. Although the company's scientists present many papers



5418

before various professional society meetings, the competitors in the industry do
not have the financial wherewithal to pursue a large number of state of the art
research activities. Any restructuring of IBM should therefore direct itself to
giving the scientific community an opportunity to have at least limited access to
this vast pool of knowledge. This would actually be a conservation of assets.
since those with limited resources would not continue to seek a nonexistent light
at the end of the tunnel. A good example of this is a small company called
Energy Conversion Devices which had worked with amorphous devices for more
than five years and was never able to produce them in quantity. About two years
ago, their research finally arrived at a point which began to show some promise
and IBM requested, and was granted, a license. IBM began essentially where
ECD's research ended, and within 18 months had sufficiently changed the process-
ing techniques and other variable so that it was obtaining product. ECD had
committed about $25 million of public stockholders' money to this development,
all of which was lost to those shareholders. IBM may have committed as much,
although that is doubtful, but it was barely noticeable.

PART III. — THE INSTITUTIONAL INVESTOR'S DILEMMA — INABILITY TO
INVEST IN SMALL COMPANIES

The institutional investor has come under attack recently for creating the so-
called "two-tier" market, meaning the acquisition of stocks of those companies
which have unblemished earnings records. These stocks are also referred to as
"one decision" stocks, meaning that a portfolio manager buys them, puts them
'tway, and adds to them in market downturns, but never sells them. One of the
reasons for this philosophy is that these companies typically have very large
capitalizations and can be purchased in size or in large blocks. Theoretically,
they can also be sold in size, but this isn't necessarily so.

Why the commitment to large capitalization stocks? A portfolio manager gen-
erally is responsible for a sizeable pool of money — at least $100 million at an
institution of any size — which he will invest in 20-30 stocks. His minimum posi-
tion would therefore be $3-$5 million, and since it is considered unwise to own a
sizeable percentage of the market value of a given stock, the portfolio manager
typically will look only at stocks with total market value in excess of $100
million. Small pools of capital will invest in lower market capitalizations, perhaps
down to the $50 million area, but anything below that is generally considered
quite risky. Some of the biggest institutions have aggressive pools of money which
invest only in very high risk securities in the hopes of owning an emerging IBM
or Xerox in its earliest stages. The University of Rochester has done this very
successfully in the past, but because of the lack of venture capital available today,
there aren't many startups in the high technology area.

As an illustration. Table II shows the market capitalizations of a random
sample of both large and small companies in the overall high technology area.
Prices for the calculations are as of July 10, 1974, and the earnings per share are
for 1973 or the latest twelve months if the company is on a fiscal year. There are
20 companies in the sample, the six mainframe computer companies, seven semi-
conductor companies, and seven peripheral equipment companies. The mainframe
companies all have market values well in excess of the $100 million criteria and,
in fact, all except Control Data have market capitalizations in excess of $1 bil-
lion. Again, IBM is the standout with a market value in excess of $29 billion. The
semiconductor companies show up fairly well with two of them, Texas Instru-
ments and Motorola, having market values in excels of $1 billion, while three
more are in excess of $100 million. Of the two remaining companies. Mostek is
close to $50 million, but Advanced Micro Devices is under .$20 million. The periph-
eral equipment companies, however, regardless of earnings, all have market
capitalizations well below the $50 million minimum, and only Telex and California
Computer are above $20 million.

Obviously, one of the best measures of the value of an investment is the price
one pays today for future earnings. While it is true that the stock market is de-
pressed and thus there are many outstanding values in every industry, the tech-
nology companies are selling at multiples which signify maturity rather than con-
tinued growth. Prevailing multiples for the mainframe companies, including
IBM, and the semiconductor companies are at least 10 points below previous bear
market lows, but the peripheral equipment companies are selling at multiples
which would tend to indicate their imminent demise. The two companies in the
industry with the best records, CalComp and Storage Technology, are selling at
5 and 7 times earnings, resi)ectively, based on last year's earnings. In both cases,



5419

earnings are expected to increase this year, so the multiple on future earnings
is even lower. Both companies are in need of longer term financing to replace their
costly short term bank debt, but are unable to go to the equity market because of
the low relative prices of their common stocks. Their debt to equity ratios are
nlready top heavy so that the debt route is closed to them also. The third avenue
of cash inflow is also unavailable and this is private placement of some combina-
tion of securities with an institutional investor.

The offering statement for a private placement generally contains more informa-
tion about future product plans and strategies than the prospectus covering a
public offering. In many cases a five year plan is included estimating contribution
to sales and earnings' of both existing and planned products. The peripheral
equipment companies are unable to present such a long range plan very con-
vincingly because of IBM's past practices of introducing phantom machines and/
or price' reductions in the form of long term leases. Furthermore, the peripheral
companies have diflSculty in establishing the size of their market because of the
lack of information on computer shipments per se. The iii-stitutional investor has
a strong fiduciary resp<msibility because he is investing funds for others. He must
operate under the Prudent Man theory for he is legally liable for the loss of tho.se
funds. Based on past experience, prudence dictates that it is unwise to invest in a
company which exists only so long as it does not encroach upoii IBM's market
share. This is especially true with regard to restricted securities, which are not
freely tradeable.

The institutional investor is unable to invest in the publicly owned common
stocks of the peripheral equipment companies because their market values are
far too low. Storage Technology has a market capitalization of less than $30
millitm and CalComp's market value is just over $21 million. This compares with
$29 billion f(n- IBM, $3.4 billion for Burroughs and almost $2.0 billion for Texas
Instruments. The dilemma which we face is that on a multiple basis. CalComp at
5 times and Storage Technology at 7 times, are more attractive than either IBM
at 18 times and Burroughs at 29 times earnings. CalComp and Storage Tech-
nology are also growing faster than IBM or Burroughs, so if the computer market
was truly competitive, these two stocks would be selling at a premium. However,
investors assume that the computer market is not competitive, and thus the
future of CalComp and Storage Technology is uncertain. If the competitive
question is not resolved quickly, the viability of these companies is not assured
because of their inability to finance internally generated long term growth.

It is to management's credit that these companies have i>erfornied so well in the
face of unfair and uncommon competition. As an institutional investor. I would
like to own CalComp and Storage Technology because I have been given every
reason to have faith in management. Fiduciary responsil>ility and prudence pre-
vent me from doing so because the risks from outside, uncontrolled forces are
too great. My universe of acceptable investments has thus been curtailed : con-
versely, the risk of foreign investment in these companies, and consequent export
of their technology, has increased markedly. The management instinct is to
survive, and if the only avenue for survival is control from outside the United
States, then that is the avenue which will ultimately be followed. We cannot
permit that to happen and there is not a great deal of time left to prevent it.
The other traditional avenues of finance must be reopened domestically and the
doors to foreign investment in our technology companies must be closed. That
is the only way in which we will maintain the technological lead w'hich we now"
have and which is an important aspect in a favorable balance of trade.

PART IV. THE HEART OF IBM COMPONENTS

In 1912, in a small house in Palo Alto, California, Lee de Forest and his
associates started the electronic revolution by perfecting the vacuum tube as a
sound amplifier and generator of electromagnetic waves. That led to the inven-
tion of the loudspeaker in 1913 and the beginnings of what is now the ^lagnavox
Company. Vacuum tube companies proliferated, and one of them evolved into
Litton Industries. In 1927 two milestones were achieved, the first successful all-
electronic transmission of televi.sed pictures and advanced shortwave radio tran.s-
mitters. In the late thirties, the Varian brothers were unable to find financing for
their as yet unperfeeted klystron tube, a variant of the original vacuum tube,
and went to work at Sperry Gyroscope. The klystron tube became the heart of
I'.S. antiaircraft and antisubmarine radar during World War II. In another devel-
opment at Sperry, the computer was invented which was to have a limited market



5420

of perhaps five machines. Its heart was the vacuum tube which was developed
more tlian thirty years earlier. Ten years later, or forty years after its invention,
IBM used vacuum tubes to build its first computer, the 701 ; it was introduced
in 1953 and all the vacuum tubes were purchased by IBM from outside suppliers.
Thus, the original electronics technology, invented in 1912, was widely used for
at least half a century, and is still used for some applications.

The next major technological event occurred on December 23, 1947 at Bell
Telephone Laboratories. The three distinguished scientists who later won the
Nobel Prize for their invention demonstrated the first successful transistor. It
was made of germanium and was a point-contact device which looked something
like a crystal detector with cat's whiskers. The inventors were Dr. John Bardeen,
Dr. Walter Brattain and Dr. William Shockley, and it is the latter who is the
father of the commercial semiconductor industry. Dr. Shockley was determined
to capitalize on his invention and went to Raytheon in Boston in 1954 as a con-
sultant to establish the first semiconductor company under its auspices. His
asking price was $1 million over a three year period, not an unrealistic figure
when one considers that today a semiconductor startup costs on the order of $5
million. Raytheon was appalled at that figure and Dr. Shockley followed the
advice of Horatio Alger and went West, thereby creating the series of events
which established Santa Clara County in California as the semiconductor center
of the world. The original Shockley Transistor Corporation, backed by Beckman
Instruments in 1955, is the direct antecedent of nearly 25 companies in the San
Francisco Bay Area. But Dr. Shockley decided to concentrate on Shockley diodes,
a four-layer device, rather than transistors, and eight of his young scientists
found a willing backer in Fairchild Camera and Instrument Corporation of
Syosset, New York. Shockley Transistor never became the successful commercial
venture which its founder envisioned and was sold by Beckman to Clevite, who
sold it to IT&T, who was unable to sell it and finally shut it down in 1968.

The eight young scientists who left Shockley were Dr. Robert Noyce, Dr. Gordon
Moore, Dr. Jean Hoerni, Dr. Jay Last, Dr. Victor Grinich, Dr. Sheldon Roberts,
Julius Blank, and Eugene Kleiner. However, none of these men had any man-
agerial experience, so Fairchild recruited Dr. Ewart M. Baldwin from Hughes to
run the new company and gave him a founder's share. About a year and a half
later. Dr. Baldwin gained backing from Rheem Manufacturing and started Rheem
Semiconductor, which was subsequently sued by Fairchild for theft of trade
secrets. Although the suit was settled out of court for an estimated ?70,000,
Rheem agreed not to use one of Fairchild's proprietary process steps, and after
only two and a half years in business, Rheem sold out to Raytheon. So it came
about that in 1961 Raytheon acquired the first Fairchild spinout, which was the
first Shockley spinout which Raytheon had been offered seven years earlier.

Meanwhile, at Fairchild Dr. Noyce had been asked to become temporary gen-
eral manager of the semiconductor operation when Dr. Baldwin left to form
Rheem. Dr. Noyce held the top position for nine years until he left Fairchild
to establish Intel in 1968. As far back as 1961 all was not well at Fairchild
Semiconductor, as the Western money-maker continued to provide the financing
for its Eastern parent's acquisition program and the founders' stock did not
refiect their spectacular performance. Half the founding group, Dr.Hoerni, Dr.
Last, Dr. Roberts, and Mr. Kleiner, left in 1961 to form Amelco Semiconductor,
which was to be the forerunner of Teledyue Semiconductor. Dr. Hoerni left
Amelco in 1964, before its acquisition by Teledyne, to establish a semiconductor
department with Union Carbide Electronics. Three years later, in 1967. Dr. Hoerni
left UCE to found Intersil, and the co-founder of UCE moved the division south to
San Diego where it was said to Solitron Devices in 1969. Also in 1961, another
group left Fairchild to form Signetics and they were later joined by P Joseph
A"an Foppelen, Jr. from Motorola. Signetics' original backing was from Lehman
Bros., the New York banking house, but losses during the startup period were
extra heavy because the industry was going thi'ough its first shake-out and
Lehman sold control to Corning Glass The shake-out was occasioned by the
switch over from germanium transistors to silicon transistors, and the entire
industry was forced to write down huge amounts of inventories as prices
declined.

Corning Glass sent in James F. Riley to head Signetics, which caused the
departure of Mr. Van Poppelen who went to Fairchild from which Signetics had
spun out. In 1969, two of the original founders of Signetics, which was then
controlled by Corning Glass, wanted a company of their own which they no
longer had. and started Signetic Memory Systems as a subsidiary of Signetics. A
third founder backed out at the last minute. Zeev Drori. and found backing from



5421

an MOS memory house, Electronic Arrays, to form a bipolar house, Monolithic
Memories.

The transistor was still the dominant device type being built in the early
60's, although technologj- was progressing to the point where processes for other
types of semiconductors were nearly perfected. This is the primary reason for
tile number of spinoffs which occurred during this period. TJie biggest loser
ever to spin out from Fairchild in 1961 was General Micro-Electronics, which
was formed to exploit the new MOS (metal-oxide-silicon) technology. Its co-
founders included Howard Bobb and a retired Marine colonel named Arthur
Lowell, who was rather a promoter and who coined the acronym, GM-E, which
created the impression that the new company was backed by (Jeneral Motors.
Fairchild sued GM-E and that suit was settled out of court but little GM-E
was forced to find another sponsor. About a year earlier, Dr. William Hugle
and his wife, Dr. Florence Hugle, went to Baldwin Piano in Cincinnati where
they established a semiconductor division. They then migrated to California
where they set up a consulting finn which evolved into Siliconix. Policy dif-
ferences ensued, and so it was that in 1963 both the Hugles and Col. Lowell were
in Chicago looking for backing for new firms. Hugle was talking to Plye-National
and Lowell was zeroing in on .Stewart- Warner to back GM-E. Both men were
insisting that the new companies be established in California to take advantage
of the skilletl labor force but both companies were insisting that the new ven-
tures be located in Chicago, the home of the potential parents. Thus negotiations
were temporarilv suspended, and when they were reopened, there had been a
complete change of partners. Therefore, Pyle-National wound up backing Col.
Lowell in GM-E and Stewart-Warner set up Stewart- Warner Micro-Circuits
under the two Drs. Hugle.

Pyle-National was nearly bankrupted by the losses of GM-E because MOS
technology was in its earliest stages, and the process refused to be stabilized.
Philco-Ford came to the rescue in 1966 and acquired GM-E, so that it had a
major auto company as a backer after all. but even Philco-Ford couldn't tolerate
losses estimated at over $1.0 million per month with no revenue. Philco was
already in the semiconductor business but in 1968 it shut GM-E down and gave
up on MOS technology forever. [Meanwhile, the original founder of GM-E,
Howard Bobb, left Philco in 1966 shortly after it took over GM-E from Pyle-
National and founded American Micro-Systems, which was to be the first success-
ful MOS company. However, it took until 1968, seven years after GM-E was
founded, to produce the new type circuits and to turn a profit. Electronic Ar-
rays was formed in 1967 to produce MOS circuits with substantial backing from
Phillips, the Dutch company, but profits remained elusive and even in 1973



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 57 of 140)