United States. Congress. Senate. Committee on the.

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

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the plug-compatible industry which had grown up in the interim, as is evidenced
by the material made public in the Telex vs. IB^M case. And perhaps most diflScult
of all. IBM, having announced in 1964 a compatilde set of .systems which had
common interfaces to peripheral units, has gradually been altering that customer
oriented policy in order to pi-event or make more difficult the interconnection of
non-IBM peripherals to IB:\I central processing units.



5467

One can go on : changing specifications for media, stopping support of previously
supported software wlieu a certain class of terminal becomes a problem ; elimi-
nating software interfaces in new software releases where competing software
is competitive ; however, it seems to me that this point is proven by the follow-
ing incident. The Computer Industry Association identified a potential problem
in the future of data security. It is clear that in the future it will be necessary
and important to provide means for users to prevent unauthorized accessed to
their data files in order to provide data privacy and confidentiality. The CIA
has suggested that one dangerous possibility in that regard is the creation by
IBM of a hardware/software privacy lock which prevents other manufacturers
from providing access to or compatibility with IBM systems. We have announced
this fear in many forums, including National Bureau of Standards seminars,
National Computer Conference panels, etc. Although there may be argnment
with our fear and concept, there has been no comment ever made that IBM eoiild
not or n-oHld not embark on such a strategy to change the environment and pre-
vent or reduce competition. In other words, industry leaders are so used to the
dominance of IBM in creating and changing the environment in which they
operate that they don't question that continued factor.

Can Our Current Laics Solve the ProUem?

I would like now to turn to the question of whether or not our current laws
and legal processes can solve the problem of IBM's monopoly power and domi-
nance as outlined both in my paper and other evidence presented to your Sub-
committee. A look at the history and status of the Government's antitrust action
against IBM might be instructive in that regard.

A brief examination makes it clear that speed in such a solution is unlikely.
The Justice Department has sued IBM for Sherman II violations in 1932. 1952.
and 1969. The latest effort, five and one-half years old, is due to go to trial in
four months, although many observers believe that that schedule will not be
met. Even if it were to be met and IBM be held in violation of the Sherman
Act, it would be many years — up to 15 — before the solution which the Justice
Department would like to impose has been developed, screened, analyzed,
adjudicated, negotiated and implemented. At the very best, this means that a
solution is created which solves a problem identified 10 to 20 years previously. In
a high-technology, rapidly changing industry, this is obviously unacceptable.
Justice delayed is .iustice denied, and justice delayed is, in this particular case,
to i>e applied to a situation from ancient history. Given the legal resources of a
large monopoly, the necessity to operate within our current laws, and with the
safeguards of our current legal system, it appears that reasonable speed in the
solution of a monopoly problem is not possible today.

The problem of a timely solution can be divided into two parts. The first of
those is, "Is it possible within our current laws to establish a violation of the
Sherman and/or Clayton Act on the part of a dominant company in a resonable
period of time?" It is clear that one purpf)se of S-1167 is to solve that problem
by estalilishing criteria more easily proven : I commend the concept, if not the
specifics of that bill. The second problem is. "Given the finding of monopolization,
is it possible within our current structure to establish and carry out a relief
plan that will solve the in-oblem?" From past history, one has to assume that
the courts, upon prosecution by either the Federal Trade Commission or the
•Justice Department, have an automatic bias toward regulation. It seems quite
straightforward and easy for a court to lay down a series of injunctions, either
by court order or through a consent decree, which regulate specific i)ractices or
business conduct. From thf few instances in which a solution has been found
through restructuring or divestiture, we must assume that our current system
is much less able to deal with any solution other than regulation.

Criteria for a Solution

In the particular case of the computer industry, what criteria must a solution
meet? Rather than generalize. I will attempt to list specific criteria which must
be satisfied for the problem of monopoly in this industry to he solved.

1. The first and most important criteria is that the solution should break the
market power of the dominant company or control it in such a way that it is
deleterious neither to computer users nor other competitors attempting to supply
alternate products. This includes insurance that IBM or its remaining entities*
do not have the ability to create and change the environment in which competi-
tion takes place in the computer market place. To accomplish this, it would
undoubtedly be necessary to eliminate or sterilize the four billion dollars in



5468

cash assets tliat stand behiud IBM's enormous financial power and market control.
At the same time, the large accumulation of software cannot be permitted to
continue IBM's lock on the market place.

2. Any solution would have to lead towards an interchangeability of competing
systems. This implies a rigorous industry effort on standards and interchangea-
bility in both software and hardware. Only if such compatibility were established
would it be possible for competing entities to offer comparable products and
services to all computer users.

3. Assuming that a solution did not create a large number of competing entities
in place of IBM, it would be necessary that no company could dominate the
injection of technology by surprise announcements of new interfaces between
various pieces of hardware and between hardware and software. An analogy
here could be made to the recent agreement between Bell & Howell Co. and
Eastman Kodak on disclosure of related technological developments in the
film industry in order for camera makers to be able to respond.

4. Next, any solution would have to encourage relatively easy entry for new
firms into the market place. If we define a competitor as a firm that is one per
cent of the size of IBM, there have been no new competitors in the computer
industry for at least ten years.

5. The computer industry today contributes a significant dollar amount to
our balance of trade. A solution must not change, and in fact should be designed
to improve, the positive balance of trade created by the computer industry.

6. Perhaps most importantly, any solution should take advantage of the forces
of free enterprise and managerial entrepreneurship which are available to this
economy.

7. Lastly, a solution should be implemented this century if not this decade.

Dimensions of Possible Solutions

The boundaries within which a solution will be found are : a restructuring of
IBM into several competitive entities, as requested by the Justice Department ;
regulation of IBM's business and business practices in a foi-m comparable to the
Consent Decree of 1956; and a whittling of IBM's market share through a com-
bination of regulation and divestiture, looking forward to a time when more com-
petitive conditions would exist in the industry, at which point the regulation
could be removed. Numerous proposals have been made, in this forum and others,
which fall within these boundaries. It is worth considering each of the three
modes of extremity as a framework for evaluating proposals.

Regulation through court order, whether arrived at by a judgment or a consent
deci-ee, would lay down a set of rules under which IBM would have to conduct its
business in the future. The rules devised would be intended to guide and control
IBM's market practices and policies for the benefit of users, and to permit a
viable competitive industry to develop and prosper. The rules would undoubtedly
include some restraint on the permitted contractual forms for IBM to do busi-
ness, perhaps, for example, prohibiting leases of a greater duration than one year.
It would also include rules under which pricing could be set, and technological
changes introduced. The regulation of such things as the transportation industry,
the communications industry and public utilities would be a model for the type of
regulatory activity which would result from this mode.

There is ample precedent for this kind of action in the United States economy.
Where problems of natural monopoly, or unlimited economies of scale have arisen
in the past, this solution has been used many times. It is certainly in keeping
with the economic school represented by Professor Galbraith. On the other hand,
most of the current trends within both the Executive and Legislative branches
of the U.S. Government are directed away from such regulation ; in fact, there
are numerous efforts afoot today to de-regulate some of the regulated industries.
In addition, most economic schools of thought, either liberal or conservative, tend
to feel that the advantages of the American free-enterprise system are reduced
insofar as such Government regulation is undertaken.

Certainly the current philosophy within the Antitrust Division of the Depart-
ment of .Tustice is away from additional regulation of American industry. Despite
industry's general interest in promoting competition and the lack of Government
interference, most industries which have once embraced regiilation by the Federal
Government find tlie protective aspects attractive, partly because, as demon-
strated in the Penn-Central fiasco, such regulation normally precludes bankrupcty.

The second node of possible solutions, here called whittling, is a combination
of temporary regulatory provisions, combined with strictures requiring a reduc-
tion in market share to some predetermined level (such as 30% of all applicable



5469

luiirkets) or divorcement from activities such as terminals or software vs'hicli
may represent the largest future growth areas iu the industry. The combination
of these two look toward the time when the market-share goals have been reached
and the regulations are then automatically removed.

Since this solution has the expectation of removing all regulations, either after
a given period of time when the effects are expected to have been achieved, or
when a specific event occurs, they are, to conventional economists, a more attrac-
tive than indetinite regulation. In addition, since it ensures an expanding market
share for competing companies, this plan has considerable attractiveness to those
companies currently attempting to capture an increased market share through
the working of the free enterprise system.

On the other hand, the consent decrees won by the United States against IBM
in 1U3G and 1956 were of such a kind. Since they have been largely ineffective
iu achieving their objectives, there are many within the industry and within
the Government who are not sanguine concerning the likely results of such
a whittling action. In an industry as dynamic as data processing, it would
require an inordinate degree of foresight to be confident that the expected
results could be achieved.

This solution is clearly the most penalizing one to the corporate entity of
IBM. If it is successful in achieving its objectives, the plan undeniably rewards
success by ensuring that growth will be zero or negative in the future.

The restructuring solution currently advocated by the United States is in-
tended to go to the heart of the market power of IBM, splitting it ino a number
of competing entities. Since none of these entities would have the image, installed
base, resources or monopoly position of IBM, the assumption is that they would
vigorously compete with each other as well as with other firms in the industry,
and thereby restore open competition without regulation.

This restructuring would make the objectionable market practices less likely,
since their effectiveness depends upon the total market power of IBM. Without
such power, the encouragement of renting, lack of information on interfaces,
tie selling, refusal to deal and unilateral establishment of standards would be
much more diflBcult, if not impossible, to carry oiit.

The Government expects that this solution will lower the cost of computing
through price competition among the new firms. It expects that by removing
the image and enormous lease base of IBM — that is, splitting it up into a num-
ber of pieces — the price differential between IBM products and those of other
manufacturers would be substantially reduced. Any other structural factors
which would tend to give the newly created companies a competitive advan-
tage — like access to IBM's component division on an exclusive basis — would also
be removed.

The disadvantage of this solution is that the increased competitive atmo.s-
phere within the market place, and the probable lowered cost to the user could
put the survival and viability of other mainframe firms in serious question.
By leaving the installed user base intact, even though split among several firms,
and dedicated to what is now IBM equipmnet, additional market share for
CDC, NCR, Honeywell, Univac and Burroughs would be almost as difficult to
achieve as it is today. Other factors in the industry would, of course, have addi-
tional potential OEM opportunities and OEM competition from the new entities.

Tlie intention of the Government proposal would be that the sum of the bal-
ance of payment positions for the new companies would be exactly identical
to that of IBM currently, with the hope that increased competitive factors
between these companies could increase the U.S. share of foreign markets.

Most traditional economists, whether liberal or conservative, would tend to
support the Government's solution as the one most likely to bring the advantages
of the free enterprise system to the computer market. A combination of en-
lightened self-interest and doubts concerning some of the projected results of
such a restructuring causes many industry executives to prefer either of the
other two nodes of the solution matrix to the restructuring one.

Some Suggestions

On the more general topic of your legislation, I would like to advance a few
modest proposals which might be worth considering as commendable additions
to Bill S-1167 or reworked into a new piece of legislation. My comments are
focused towards attempting to have a solution to the concentration problem
assisted rather than opposed by the considerable entrepreneurial resources avail-
able in our free-enterprise economy.
40-927—75 41



5470

In the first place, any statute on the subject should establish very clear
criteria of concentration and/or monopolization. Today it is almost impossible
to get a clear statement of what constitutes a violation of Section II of the Sher-
man Act. Such a criteria could easily be based on market share. Without a
market share of approximately 30%, held for a reasonable period of time in a
relevant market place, there cannot be market power. At the same time, a market
could have a "four-firm concentration ratio" of 100% with no firm having as
much as 30% market share, which would indicate that the criteria is not overly
restrictive. Thirty per cent, therefore, seems like a minimum number, although
it could be increased to a somewhat larger share. And clearly, if it can be demon-
strably proven that over 30% of a market is required to achieve economies of
scale, than it could be permitted, assuming that there were firm provisions that
protected the consumer in such an unusual case. The point is that the danger of
monopoly is the holding of market power rather than something vague like
"attempt to monopolize".

But would not such a stricture create a strong disincentive to management?
Why strive and compete if there is a mandated ceiling beyond which an enteriJnse
cannot grow in the market place? This is a serious and real pr()l)lem. Monopoly
or a significant power over the market place is the goal of all managers of free
enterprises. However, when such a goal is achieved, at least partially, the
entrepreneurial energy is diverted to maintaining and extending the monopoly
and avoiding prosecution by the authorities rather than creating ways of increas-
ing service to customers. As a consequence, an alternate course must be devised
which permits the entrepreneur to continue to compete, and creates greater rather
than less competition.

I would like to make an additional proposal in this regard, which should be
analyzed and investigated as one possible solution to this problem. The concept
is that a "restructuring tax credit" comparable to the investment tax credit
be established. A publicly held company which divests of a suI)Sidiary com-
pletely—setting up an independent company, transferring appropriate assets to
that company, establishing an independent board of directors and distributing
the shares to its stockholders — would be permitted to take a credit against
income tax for the following ten years. The credit would be a percentage of tlie
assets transferred to the new independent company. In other words, a successful
entrepreneur who reached the ceiling of his allowable market shares could spin
off a competitive entit.v and achieve not only new ownership in a new enterprise
for his stockholders, but in addition receive credit in his future income taxes for
the economically sound act which such divestiture would represent.

Obviously, economic studies have to be made of the cost of such a proposal,
as well as the proper level of tax credit — 2%, 5%, 7%, 10% or 50%. I would
suggest that the cost of such a program could be covered by a graduated income
tax for corporations which increased to something like 65% for all annual taxable
income over $100 million. Obviously the exact percentages in dollar amounts for
these proposals will need to be closely scrutinized, but the concept of taxing
to a higher degree those large agglomerations of power about which social policy
is properly concerned would pay for the deconcentration instituted as an entre-
preneurial venture by business managers. There is an almost unlimited store
of creative enterprise available within our economy. Let us structure an environ-
ment which harnesses that energy to achieve deconcentration by incentives
rather than through the dead hand of regulation.

In summary, Gentlemen, we have a real problem in the computer industry.
Our current laws appear incapable of solving the problem in terms of either
defining it or creating a constructive solution. What we need is clearly a criteria
for a solution, and more creative ways in which such solutions can be structured.



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



FRIDAY, JULY 26, 1974

U.S. Senate,

SUBCOMMITI^EE OX ANTITRUST AND ]MONOPOLY

OF THE Committee on tjie Judictaky.

Washington, D.O.

The siibconiniittee met, at 10 :42 a.m. in room 2228, Dirksen Senate
Oftice Building. Hon. Philip A. Hart (Chairman of the subconunittee)
presiding.

Present : Senator Hart.

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

Senator Hart. The committee will be in order.

Our first witness today is j\Ir. Hugh P. Donaghue, assistant to the
chairman of the board. Control Data Corp.

I apologize for having been delayed at the office.

You are welcome and you may proceed.

STATEMENT OF HUGH P. DONAGHUE, ASSISTANT TO THE CHAIR-
MAN OF THE BOARD, CONTROL DATA CORP., WASHINGTON, D.C.

Mr. Donaghue. Thank you, sir.

I am pleased to have this opportunity to appear before the commit-
tee to revieAv for you the historical development of Control Data's
antitrust laAvsuit against the International Business Machines Corp.

But first, let me say a word about Control Data. Control Data Corp.
is a major manufacturer of computers and related computer periph-
eral equipment not only for our own systems needs, but we also man-
ufacture peripheral equipm(>nt for other computer manufacturers in
the United States and abroad.

In 1973, our computer operations jn-oduced revenues of $948 million.
Of this, $330 million was overseas business. We operate in 31 coun-
tries worldwide and employ nearly 35,000 people in our computer
business.

The corporation was founded in 1957 bv William C. Xorris, our
chairman o^f the board. The growth of Control Data since its forma-
tion in 1957 was the result of careful concentration in selected areas,
particularly in scientific computing, and the avoidance of general
competition with the very much larger companies in the industry;
as they existed in those days.

(5471)



5472

The technological excellence of Control Data's equipment, coupled
with a careful marketing effort, enabled the company to gain an
initial foothold in the industry.

Our first product, the model 1604 computer, was a great success and
IBM was startled to see us getting orders from the prestigious organi-
zations that were its first users.

The 1604 was announced in 1957 and it gained virtually immediate
acceptance. It offered more price/performance to tlie important scien-
tific segment of the market than any other large computer.

Because that type of customer relied mostly on his own software
it was necessary to offer only a minimum amount of software and
professional service support with the computer.

IBM's bundled pricing policy where hardware and software were
provided as a package, and which could be applied to all types of
users, made it possible for Control Data to set a lower price and yet
maintain a reasonable profit on the total 1604 system.

This was accomplished by including only a minimum of softAvare
and support since the scientific customer in those days didn't really
need or want the extra software and support.

The wide acceptance of the 1604 started Control Data on its way
to becoming a major computer company. It also started a chain of
events within IBM that took quite a different direction. IBM's reaction
at first appeared confused because there wasn't any legitimate way to
compete with the 1604 without a major change in IBM's pricing
policy.

But ultimately they reacted violently, principally by the announce-
ment of new computer models that were only slightly modified versions
of their existing model 7090 computer, and with prices well below
the 1604.

For almost a year after the announcement of the first modified ver-
sion of the 7090 in 1961, Control Data was unable to get an order.

Finally we succeeded in getting some more orders by lowering our
price and increasing the performance of the computer.

Also, we hastened to bring out a new computer, the model 3600. Fach
time that Control Data offered improved price /performance IBM
countered by the announcement of further reduction in prices of slight-
ly modified existing products or new paper machines.

In addition, buy-back arrangements, large educational discounts,
and/or excessive free analyst support Avas provided for those users
with less experienced staffs.

Our 3600 was followed by announcement of our 6600; and again
IBM countered in the same manner and the struggle was prolonged for
more than 10 years.

In my prepared statement I have detailed the various offerings that
Control Data made and the countermoves that IBjNI made.

I would recommend tliat the staff read those actual details.

Senator Hart. The statement will be printed in the record.

[JNIr. Donaghue's prepared statement appears as exhibit 1 at the end
of his oral testimony.]

Mr. DoNAGiiuE. Fine.

Late in 1964, because of IBlM's actions, Control Data found itself in
extremely serious circumstances.



5473

It had not fullv rccoxered from the devastating- blow to our 1604.
Also, other machines, tlie IGOIA and the 3600 never gained very profit-
able positions because of IBlNI's continuing announcements.

Control Data had been making a number of proposals to the Bettis
and KAPL Laboratories of the AEC for our 6600 computers.



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 64 of 140)