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 63 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 63 of 140)
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poration out of its component production facilities ?

It gets to keep the production of the CPU and the systems soft-
ware. It has to announce a standard interface when it changes or re-
writes the systems software — say 18 months or whatever period is
reasonable — in advance.

It has to spin off its manufacturing facility for peripheral equip-
ment, and its maintenance organization, and its application of soft-
ware. It makes separate entities out of those different functions.

Mr. McGuEK. And its money ?

Mr. O'Leary. What's your reaction ? Is that feasible ?

Mr. McGuRK. Well, first let me say, Mr. O'Leary, that Avhen one
looks at the problems of the industry today and describes a solution
like that, I believe that for the good of the computer user it's better
than what we have today.

The trouble I have with that, personally, is that you would re-
quire continued intervention in the business world by enforcing regu-
lations about standards by saying no, you can't diversify and have
peripherals. You have kind of permanent strictures of these entities
that you've created or if you don't have permanent strictures on them,
I think the person that gets the cash and the systems design will,
in a few years, create his own peripheral equipment and we'll be right
back Avhere we were. So I have problems with that because on the one
hand you say that I'm going to have to keep my finger on this and
these pieces for a long, long, time to come, or if I don't I'm not sure you
solve the problem.

Mr. O'Leary. With respect to your tax credit — and it is an idea
which obviously has a certain amount of appeal — I have two questions.

What is to prevent a firm from spinning off that which subtracts at
least from its market power; and with respect to a firm like IBM,
doesn't that generate more in the way of financial power?

In other words, the tradeoff being you have given tliem tax relief
or money in order to spin off some assets. Doesn't that add to their
power ?

Mr. McGuRK. Let me first say, Mr. OT^eary, I'm not an economist
or a lawyer and I'm delving into industrial organization which is a
common meeting ground of those two professions, though I'm over
my iiead.

I tlirow this out as a suggestion which, I think, should be studied.
Let me just say that to start with.

But my view of tlie ansAvcr to your question is that I make the
assumption that the entity that is spun off must be a vial)le entity or
the stockholders will be u]:)set that they were given a worthless piece
of paper which includes sufficient assets, including cash, for it to be
operating.

So that, for example, in the case of IB]M, som.e of that $4 billion
ATOuld be moved over into a new entity and although it would, in the
lono- run, bring some additional earnings to that firm, it would mean



5461

presumably that it would be getting increased competition from its-
entity and therefore it would be forced to give better service and lower
prices and serve the consumer better.

Now, I might say that I'm not sure that this solution would be a
good one in the computer industry because it implies that IBM could
divide up into three pieces, one of which could be office products, and
would still maintain its market share between those two. That would be
quite difficult. It might work and it might not.

Mr. O'Leaky. Thank you. I have no further questions.

Senator Hart. Mr. Granheld ?

Mr. Granfield. Again, I will try to be brief, Mr. Chairman. In your
prepared statement, and it's certainly not critical to your statement
and your suggestions, you say "liberals and conservatives would tend
to support their Government's wish and is the one most likely to bring
the advantage of a free enterprise system in the computer market."

Do you have any evidence for that statement ?

Mr. McGuRK. No.

Mr. Granfield. Why did you make it ?

Mr. McGuRK. Because I talked to a number of economists, botli-
liberal and conservative, and they seem to tend to be agreed on that.
I take it you don't.

JNIr. Granfield. Personally, I don't know what a liberal or a con-
servative economist is, either good or bad. It's like good or bad sci-
entists. I don't know a good liberal physicist or a conservative physicist.
You're either good or you're l)ad. Either your suggestions make sense
and will promote consumer welfare or they won't.

I was just curious because, to my knowledge, I have read nothing
in the literature which has given an indication, certainly of an em-
pirical nature, that the Government's solution is the proper one in
terms of proving the competitiveness of the computer market.

It may deal with another subject along that line. You have indi-
cated tliat perhaps vou will support the way the Government seeks to
restructure the IBM Corp. and you communicate there might be some
ad vanta.n"e to that. «

Would you say they should prevent any computer company from
l)oing a total systems company? At least you might imply that the
allpired market power of IBM is where it originates ?

]Mr. McGuKK. The Government solution that I'm talking about is
the one that was entered in the court as their relief plan, which de-
scribes the establishment of a munber — the number was vague —
of integrated systems companies that did the full range of systems.
So am I afraid that seven companies with 10 percent and five more
with 30 percent are going to dominate the market in some way? I
don't understand how it would. Is that what you're asking?

Mr. Granfield. Maybe I don't understand. Is your solution
different than the Government's ?

Mr. IMcGuRK. I think it's probably the best solution.

Mr. Granfield. And your caveat to that would be if any of these
would grow in size tliey should be curtailed ?

Mr. McGuRK. I hope that they will. If any of them gets to the
point where IBM is now they should be curtailed ; yes.

If any of them gets so dominant that they can control the mar-
ketplace, yes ; they should be curtailed. In probably the same way.



5462

Mr. Granfield. Well, as you may or ma}' not know, it's my under-
standing that the strnctural approach implicit in S. 1167 says that even
if we have four or five firms in the market, some are able to tacitly
delude and act as if they're monopolists. Do you have any concern
along those lines that you may replace one kind of monopoly with
another, if indeed this could be interpreted as monopoly behavior?

Mr. McGuRK. First, the solution the Government advances would
leave at least 8 and probably more like 12 integrated systems com-
l)anies, and I don't think anybocl}' claims that there's like collusion
with those numbers.

I'm not, frankly, as concerned with oligopoh' collusion by silent
agreements as some other people might be. I am mainly concerned with
dominant market power, which I think is dangerous.

Collusion, if it becomes evident, can be handled by our current
laws fairly well. People do go to jail.

]\rr. Graxfield. So you're more concerned with the section 2 vio-
lations as o])posed to section 1 ?

iNIr. ]McGuRK. Yes. I'm most concerned with the computer indus-
try where it's clearly a section 2.

Mr. Graxfield. Clearl}' a section 2? I thought that had to be
litigated.

Mr. McGuRK. That's why ifs litigation. It's very clear to me that
it's fact.

]SIr. Graxfield. Wliat do you mean by market power; dominant
market power?

Mr. McGuRK. Well, I really can't add too much to the other testi-
mony that's been given here in the last couple of days that describes it.
I described it or tried to describe it, at least from the viewpoint of
a small competitor, in my paper. It means the ability to structure the
environment in your way, and change that environment as you see
fit ; and I think you have heard testimonj^ that describes how that lias
and can be done.

Mr. Graxfield. Wouldn't any technology leader in industry or low-
cost producer have th^ ability to change the environment?

]\Ir. iSIcGuRK. In this industry that certainly has not taken place.
That is to say that there has been a number of low-cost producers, those
who have sold below the market price established by others.

In fact, I think it's the case that IBM is normally, if not always, the
highest price in any particular area, so that most other people are sell-
ing at a lower cost.

There are some technological innovations that have been described
that have heen introduced and they have not changed the dominance of
IBM nor the market environment.

Mr. Grax'field. Would you say that the automobile industry has
recently been changed ?

Mr. AfcGonv. I'm certainly not an expert on the automobile indus-
try. Yes; the environment has changed in terms of the buying public's
attitude. That's an important part of the environment and that cer-
tainly is the case ; yes.

Mr. Graxfield. So we can't have change in the environment without
having dominant market power ?

Mr. McGuRK. By environment I'm really looking at the kind of rules
of the game. There are, in any business, some random factors that one



5463

Itas to consider Avliicli includes the marketplace, the stock market in its
lip and going down, and whether we go to war or not the availability
•of money, whether or ]iot your research team will hit on it or miss it.

Those' are some random problems that you have. But those are com-
mon to all business. All business has the problem of operating in that
ikind of changing environment.

The diiference is that in the computer industry there's a rather spe-
■cial set of rules that one has to understand and live by; and that isn't
bad enough, but then they get changed, and not by the common factors.

You have those, too. but by factors that tend to be, if you're \evy
«riccessf ul, you'll get whomped in some way or other.

Mr. Gkaxfield. Well. IB^S didn't come'to this market, or did they —
this kind of market dominant power? It's my understanding Sperry
Rand was, at least for a while, the leading firm.

Mr. ]McGuRK. I'm sorry you weren't here, ]Mr. Granfield, when I Gov-
't} red that subject. That was never the case.

Mr. Graxfield. I was liere for your whole testimony.

Mr. McGuRK. I don't know when Sperry Eand was ever the domi-
nant power except Avlicn they built the first computer. They bought a
small company that had built a computer, was designing a computer,
so in that sense, they had the first computer.

MIT had one before that, but by the time there was any significant
tictivit}'. IBM, as Avas described earlier, linked it to their monopoly and
punched cards, which they had, and which gave them the strength and
anuscle, market power, sales presence, image, and so forth, to just con-
tin ue it right on.

Mr. Gr-vxfield. Just one last question.

Mr. McGuRK. Let me just add that I think Sperry Rand miglit have
had the opportunit}-, but the oft-c[uoted statement that there's only
room for 50 of these machines in the world was, I think, made by the
niiirket research department of Sperry Rand.

Mr. Granfield. The way it could be proposed to restructure this
industry, the feeling is apparently there's not that many internal
economies of scale — at least they would be outweighed by the proposed
restructuring. Do you know any evidence that would support that
•contention?

Mr. McGuRK. Xo: nor any in the other direction. Data is very dif-
ficult to come by. I do believe that there's one area where there is real
■economy of scale- — and that's a problem I frankly don't have a solu-
tion to — and that is in the development cost.

That is where there is obviously an economy of scale, particularly
in software, because almost the entire cost of software is in its
dcvelo}nnent.

The reproductio7i cost is almost negligible. It's equal to the postage
■cost, if you like, the sliipping cost, and that definitely is a problem.
There is considerable technical evidence to indicate that the amount
find complexity of the systems software, which is the biggest part of
that, is in the case of IBM software, larger than necessary, largely to
make sure that the machines operate efficiently, as Mr. Sanders was
sayi?^:g.

I don't know whether that's the case or not. A lot of technical people
believe that to be true. That's the only place where I feel that there is
iin economy of scale ; and I don't know what that scale is.



5464

I mean, in one sense it's infinite because the reproduction cost is
zero.

Mr. Granfield. But you would agree it's very difficult in terms of
whetlier this restructuring will be to lower prices for computer uses.
No one knows.

Mr. McGuRK. Well, obviously no one knows the future. I think we
can analyze the situation, and I think there have been some studies
made that would tend to indicate that the cost of computing could
come down significantly under greater competitive pressures.

Mr. Granfield. What bothers me, Mr. McGurk, is that I often hear
this argument, certainly implicit in the Industrial Eeorganization Act,
that more firms mean more competition, yet I know there is no evidence
to demonstrate that.

I know that there's a competitive model and you get the competitive
results. I know when there is a monopoly model, one firm in the indus-
try. But there's a large area in between, all the way from two firms to
several hundred firms.

I know of no evidence that tells me you're better off with three firms
rather than having 10 firms versus three firms.

I don't deny that it's possible. I just don't know of any evidence. In
restructuring IBM this way that's the road we are pursuing along, but
I don't know any evidence that tells me that's a proper road to pursue.
It seems to me it's fraught with tremendous risk.

i\Ir. McGuRK. I submit that permitting IBM to continue their dom-
inance of this very important industry, and possibly extend it in the
wav tliat ^Ir. Sanders lias described, is much more dangerous.

Mr. Granfield. I can understand why you feel that way. I'm just
saying that to me the other path is fraught with even greater risk.
Thank you very much.

Thank you, Mr. Chairman.

Senator Hart. Thank you very much, Mr. McGurk. We are sorry
we held you so long.

Mr. McGtjrk. Thank you, sir.

Senator Hart. We have concluded the testimony scheduled to be
received today. We will adjourn, to resume tomorrow morning at 10 :30
a.m., in this room.

[Whereupon, at 5 :10 p.m., the subcommittee adjourned, to recon-
vene at 10 :30 a.m., Friday, July 26, 1974 in room 2228, Dirksen Senate
Office Building.]

[The following was received for the record :]

MATERIAL RELATING TO THE TESTIMONY OF DAN L. McGURK
Exhibit 1. — Prepared Statement of Mr. McGurk

Statement of the Computer Industry Association, as Submitted by Dan L.

McGuRK, President

HART subcommittee TESTIMONY

Gentlemen, I appreciate the opportunity to again appear before your Sub-
committee, having previously testified in the opening hearings which you held
on the Senate Bill S-1167 in May, 1973.

You have already heard testimony in this set of hearings that described the
structure of the market place, and some of the problems for users and competitors
alilie that are created by the dominance of one firm in this important industry.
I would like today to indicate from a more practical and parochial viewpoint



5465

what the results of such market dominance are to a competitor in the industry.
Tliat is what are the practical effects of tlie market power of the dominant hrm.
In addYtion I would like to point out some of the problems inherent in our cur-
rent legal system, indicate criteria necessary to solve this problem and make
modest contribution to the task of devising more appropriate legislation.

There are two important constraints on the way in which a smaller competitor
must operate in the data processing industry today. In the first place, he must
adjust his total business strategy to take account of the fact that he must com-
pete in an environment which has been structured by the dominance of IBM.
This entails his acceptance of a set of conditions which he must operate if he is to
have a successful business ; in addition to that, however, a small competitor finds
it necessary to make relatively rapid and sometimes major changes m his busi-
ness strategy when IBM decides that the environment is due for a change. In
other words', not only is the competitive environment a difficult one, but that
■environment is subject to "change without notice" when IBM's corporate objec-
tives are not being met within that environment. This makes the business stra-
tegy of a smaller competitor extremely difficult.

The structure of the environment

As I am sure you have become aware during the course of these hearings, the
computer industry is an extremely complex and diverse one. It has witliin it many
small specialized submarkets as well as a very large total market place. The
large market place is characterized by a very definite customer demand for
rental rather than purchase of this important capital equipment. Although there
are specialized market places where purchase is the more likely means of equip-
ment acquisition — such as some research laboratories and specialized applica-
tions — the vast bulk of users are accustomed, by a long period of IBM market
control, to leasing their equipment on a month-to-month basis. What this means
for a small company attempting to gi'ow is that it must defer profits into the far
• distant future and, perhaps more importantly. ))e able to acquire the relatively
large financial resources necessary to design, develop, program, produce, market
and deliver the product without any financial return until a significant period
of time has passed. Since such a large store of capital is extremely difficult for
. a smaller company to acquire, considerable efforts have to be focused on identifi-
cation of customers who are interested in purchasing rather than renting, and
marketing effort must be devoted to demonstrating not only that the equipment
and services are superior to alternate offerings, but that the form of acquisition
should be either long-term leasing or purchase. That is to say, the sales job is
a lot simpler if a supplier does not need to worry about whether the customer
■desires to rent on a short-term basis, contract for a longer term lease, or buy
equipment outright. Thus a smaller competitor, without the large financial re-
. sources of IBM, must sell more than the superiority of his own equipment and
services ; he must also convince the customer to make a purchase commitment
to which he is not accustomed. In addition, the top management of a small com-
pany must be spending a considerable proportion of its energies on solving the
prolilem of raising capital rather than on just improving the operation of the
business.

A second major environmental constraint to a small competitor in this indus-
try has to do with the enormous "weight of software" which overhangs the
market place. By avoiding significant software standardization. IBM makes sure
that its enormous resources devoted to creating new software make it impossible
for any competitor to compare with it in the amount of software availal>le to
customers. I remember particularly a point in time at Scientific Data Systems —
a small general-purpose computer manufacturer — when we had been success-
fully in business for about five years, with annual revenues between J?r)0 and
$100 million. We were very proud of having accumulated about .$.30 million worth
of software which we had written over the course of the company's history. It
was then that we discovered that IB]M liad invested, in its 360 operating system
alone, over one billion dollars worth of effort. Even assuming that we were twice
as efficient in software creation (which we thought we were), that is an extremely
high barrier to cross when convincing a customer that your offering is a viable
alternative.

New firms in many industries are able to compete because of significant tech-
nological innovation, whicli creates a market for a newly designed jirodnct.
Because of IBM's enormous market power, in the computer industry sucli inno-
vation must be limited to doing just what IBM does in some better or new way.



5466

A ne^A• "widget" to improve the data processing function cannot Iiave a broad
market acceptance until IBM legitimizes it by coming out with a comparable
widget itself. Until that happens, any inventor of such a new \Aidget has to have
his marketing force spend most of its time explaining why the widget is good,
why IBM doesn't have it, and whether or not it will make a system encomixissing-^
the widget non-compatible with "the standard of the industry." that is, IBM.
This necessity to match IBM on a functional basis is one reason that there has-
developed an industry of "plug comi>atible" peripheral devices and, recently, even,
central processing units as well as software and recording media.

Another fact of life for a smaller competitor is that IBM. by its size, has the
ability to, and in fact does, completely blanket the worldwide computer market
place with its sales force. Not only does this mean that more opportunities
are available to IBM, but it also means that many corporations \A'ith large ofliccs-
or plants in smaller towns have a strong predisposition to go to IBM to make
sure that if they adopt one manufacturer throughout their company they can be
assured of sales and service at all their locations. In order to combat this prob-
lem, marketing strategies of small competitoi s must devise a way to focus their
efforts by geographical area or industry application in order to be able to offer
anything approaching such total coverage. This is another imi>edinient that
makes the business strategy of a smaller company extremely difficult.

The net result of the structure of the environment described here is that a
small competitor has to locate either a market where IBM has not focused any
attention (normally because it is too small to be of great interest) or to live
within the environment structured by the dominant company. Most firms at-
tempting to grow in the computer industry have started out with the first
strategy, and then in order to expand their market have been forced to live with
the difficult environment created for the computer industry by IBM.

Changing the Environment

Having developed a business strategy which permits existing and growing in
the above-described environment, a smaller competitor has to accept the fact
that the environment can be changed by the whim of IB;\I. It matters very little
if that whim comes about L>ecause a company or some group of companies have
become successful, and therefore deliberate action is taken to limit their growth,
or whether some other cause creates a corporate need for IBM to change its
practices in the market place. In either case, disaster can result ; if a mouse has
learned to live in a stall with an elephant, whether the elephant steps on the
mouse intentionally or not, he can still be wiped out.

One of the solutions to the leasing problem devised in the late 1960's came
about through the creation of a number of independent leasing companies that
bought equipment from IB^I or its competitors and released it^ to customers.
Based on the historical relationships between IBM sales prices and rental prices,
this appeared to be a relatively viable business. On the introduction of new
machines, however, and after the leasing companies had Itegun to impact IBM's
bu.siness plans, IBM drastically changed the relationship between purchase
prices and rental prices, thus making the lea.sing industry relatively uneconomic:
Shortly thereafter. IB;m also introduced long-term leasing plans, which had
previously been offered l)y their competitors. IBM was constrained by the Con-
sent Decree of 1056 from offering such plans until 1966, and it was not until 196!)
that such an offering was made. This had the result of creating a new oppor-
tunity for the leasing companies (since they could more easily compete with
this form of contract while at the same time destroying a small competitive ad-
vantage which their hardware competitors had been able to create, given the pre-
vious environment.

In fact, IBM liong retained a price umbrella for all of their competitors, carry-
ing out a policy of never reducing the prices of curi-ently available products. Al-
though this policy still appears to hold in theory, starting in 1969 and 1970. IBM
introduced new products with new product numbers that turned out to be tech-
nically indistinguishable from older products except for the changed model num-
ber designation and a sharply lower price. This created considerable havoc in



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 63 of 140)