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 72 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 72 of 140)
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But such shifts are relatively easy. IBM now spends about $400 million annually
on plant and equipment and such a flow of investment funds would be divided
among the successor companies for new investment. The high rate of growth of
computer sales — over the ten years from 1959 to 1969 the market growth aver-
aged over twenty percent annually- — further enhances the opportunity of the new
companies to alter their product lines. In addition, existing computer manu-
facturing plants are relatively adaptable to different kinds of manufacture. The
major capital items in computer manufacture (except for components) are floor
space and easily movable test and assembly equipment. Plants can be readily
adapted to different products.

Although the new companies initially will have a limited computer line,
the fact that they would be compatible would be an initial benefit to the U.S.
national defense posture in that compatible computers would be available from
multiple sources. In addition, over time, the siiccessor companies could diversify
into wider product lines if they so choose and, in so doing, have the financial
advantages and manufacturing flexibility described above for vertical integra-
tion. In sum, the .successor companies should not only be financially viable
but economic successes. Each starts with an established prodvict, proven in
the market place and with facilities for its manufacture. Each will have
access to IBM's present peripherals and components, together with the oppor-
tunity to buy such items on the outside market. Each will have the financial
security from a big lease base. Each will have a development group and the
financial resources to extend its product line horizontally and vertically. Each
will have a substantial fraction of IBM's extensive marketing and maintenance
force.

3. The divestiture plan represents a siffnificant step foricard in achieving
effective competition
The plan would still leave IBM products as virtually dominant in separate
computer sub-markets. Tliis the successor computing company would have
initially the same market share as IBM in a particular product line submarket.
While high market share in a particular product is a significant source of
IBM's market power, IBM's dominance is intensified by the compounding of
market power through its position in all the various submarkets and combin-
ing such positions with (1) massive financial resources from a huge lease-base;
(2) a marketing force that blankets the data processing field; (3) a complete
product line so that customers with changing data needs will continue to be
linked to IBM; and (4) a commanding position across product lines as well as
with peripherals so that IBM can largely dictate the nature of technological
change to its own advantage.

The divestiture plan strikes at these four sources of market power, even though
it fails initially to modify the fifth — large share in a specific submarket. Fi-
nancial power will be reduced because the successor computer companies will
no longer be able to concentrate the massive flow of funds from the lease base
on the development and marketing of certain product lines. The marketing
force will no longer be ten-to-fifteen-fold the size of competitors and blanket
every potential customer. And this marketing force will no longer be able to
direct each customer, as his data processing needs expand, from one IBM
product to another. Rather, in such situations the customer will evaluate on
their merits the products of new independent IBM successor companies rela-
tive to those of competitors.

Tlie adverse impact of IBM's monopoly power upon technological change and
innovation will be dis.sipated. With several successor companies, it will be no
longer possible for a single firm to paralyze the pace of change in the computer
industry by announcements of proposed sweeping product changes or impose
its standards on the entire computer manufacturing and user community. Al-
ternative pos.sibilities for procurement will serve both the immediate and long
term national interest. To be sure, compatibility is important but aksent IBM's



4D-927 O - pt. 7-44



5518

massive size, one would expect the initiative for change would be more widely
distributed — both among successor companies and other computer manufac-
turers. Various companies would announce changes and those that met the
market test as substantial progress and were followed by competitors and
widely accepted by users would become the industry norm. Such a freeing up
of technological change would yield a more desirable rate of technological change
simply because it would be market tested, rather than the fiat of one organi-
zation.

Finally, the divestiture plan does offer the possibility for correction of
the dominance by successor companies in particular submarkets. As indicated
earlier, it is likely that successor companies will broaden their product lines
and so compete with one another. The availability of former IBM peripherals
and components to newcomers and other computer manufacturers on equal
terms with IBM successors will encourage the rise of additional competition.
The removal of the advantages of IBM's massive overall size and extensive
product line will enable the present competitors of IBM to compete more effec-
tively in each submarket, resulting in an increased market position of com-
petitors.

4. The divestiture plan does not entail significant long-run losses in eco-
nomic efficiency

In evaluating the divestiture plan, it is important to distinguish between
"social" and "private" losses resulting from the removal of IBM's massive
scale. Social economies of scale are true gains for the economy as a whole ;
private economies of scale are those accruing to the benefit of a single firm
and not to the economy. Public policy is concerned only with social economies.
And the divestiture plan involves relatively little loss in social economies.

As indicated above, the divestiture plan does not divide either individual
plants or products. Hence the only conceivable source of the loss of economies
of scale are those operations that encompass several products and plans ; namely,
financing, the use of common products such as peripherals and components,
marketing, providing associated customer services, and development of new
products.

The massing of financial power is one example of a private economy of scale.
It is an advantage to IBM because it permits them to concentrate development
expenditures on certain products and gain a competitive edge. It is not an ad-
vantage to the economy because the competitive edge for one company does not
necessarily speed up technological progress for the economy. Rather there is
considerable evidence suggesting that IBM, while massive in its resources, has
not been the technological leader in computer development. IBM competitors,
with a lower level of spending, have made many important contributions to the
industry's progress.

IBM's vertical integration into peripherals and components again appears
to be primarily a private economy of scale. IBM has a private advantage in that
its extensive line of peripherals are unavailable to other computer manufacturers,
except at the retail price. Yet since these terms restrict sharply the use of IBM
peripherals by other computer manufacturers. IBM's private gain is a social
loss. Since any true scale economies operable with re.spect to a particular
peripheral product would remain intact, the future availability of each such
product to all computer companies could thus well convert IBM's private econ-
omy to a social economy. Moreover, given the size and growth of the present
computer market, there is evidence to suggest that any true scale economies
are maximized at levels far below IBM's current production. The same situa-
tion is applicable with respect to components.

An extensive marketing service is again a private economy of scale for IBM.
giving them a competitive edge. Whether or not one massive marketing service
for a complete computer line takes less real resources in terms of manpower than
several separate sales forces for the successor companies, and so becomes a social
economy, is uncertain. The difference, however, cannot be very great, since
the computer is not a repeat item sold in considerable volume but instead, each
procurement must be individually tailored and marketed. Moreover, such man-
power economies as may exist with respect to "repeat" customers, due to cus-
tomer loyalty or the exploitation of other competitive advantages resulting from
having a machine "on the inside", would — to the extent worthy of considera-
tion — be preserved and reflected in favor of any previously "successful" vendor
regardless of its size.



5519

Maintenance and basic associated software are perhaps even less clear a case
of minimal economies of scale. These services are now oragnized by IBM in
teams specializing in various computers and so the economies of size are limited
to such relatively minor items as common oflSce space. INIuch applications soft-
ware can be used by several computers but this work is now carried on by in-
dependent software companies and the plan leaves IBM's existing application
software in the residual marketing company. Also much of the application soft-
ware is now available as a separate product as the result of the "unbundling" of
computer pricing.

Development is similarly unlikely to reflect significant social economies of
scale. As indicated above, IBM's development groups for specific computers
and for components are geographically separated and function in large part as
separate teams. Moreover, the fact that other computer manufacturers with less
extensive development groups have been able to keep pace and sometimes lead
IBM's technological progress proves feasibility and suggests that the efliciency
difference between very large scale and more modest scale development efforts
is not a decisive one for the rate of technical progress. Finally, due in part to
its large lease base, IBM has tended to defer announcement of new products
until forced to do so by competition or to maintain a "desired" growth rate,
thereby denying to seciety such benefits as could even theoretically derive from
massive development efforts.

5. The plan is equitable to IB^rn stockholders, executives and emplioyees

Although the Supreme Court has recognized the minimal consideration to be
given "private interests" in framing effective remedies to redress antitrust
violations, TJ.S. v. duPont, 368 U.S. 316, the instant divestiture alternative is
fair to the interests of such parties. The IBM stockholders will receive stock
in all the successor companies in exchange for their present IBM holdings. In
aggregate, the same financial and physical assets will be represented by the new
stock. Stock in IBM, as oi^posed to that in successor companies, does provide
the financial security of diver.'-ification by reflecting wide product line and a
wide range of "data processing" activities. Yet stockholders that continue to
want such diversification can leave their holdings distributed among successor
companies. Those that wish to concentrate on particular activities can re-
arrange their portfolio to do so. IBM stockholders can thus select varying mixes
of activities if they so wish and, in addition, will be able to select as well as
invest in different managements of the various successor companies.

Agiinst this gain must be set a loss in the portion of the value of IBM stock
representing monopoly profits. This is an inevitable cost of a public policy
directed at eliminating monopolization. Yet in the high growth computer in-
dustry such losses should be modest and transitional. While it is obviously fool-
hardy to predict the course of post-divestiture stock values, the risks seem less
than in other major divestitures

As for IBM executives, divestiture will convert many IBM divisional execu-
tives now serving as second or third level management into top management
since there will be eight top management groups rather than one. The executive
losers from divestiture will be confined primarily to the small group of top
executives who will forfeit the power and prerogatives of administering one of
the world's largest private enterprises.

The successor companies would assume all the obligations of the pension plans
and benefits of the executives and employees in facilities they are assigned. The
special leasing company described above will assume a corresponding obligation
for branch and central ofl3ce employees who are not hired by the successor com-
puter or components companies. This company will have both the extensive office
buildings owned by IBM throughout the country and the leases on older com-
puters as assets with which to meet obligations to these employees.

To sum up, the divestiture should preserve much of the significant equities of
IBM stockholders, executives and employees.

B. Divestitures in related markets

The preceding measures are directed at the general purpose computer market.
There remain other components of IB:\I that should also be divested to IBM
stockholders on the grounds that: (1) They can be economically viable compa-
nies in their own right; (2) assigning any one to a particular successor com-
puter company would make successor companies unequal in size; and (3) the
particular operations are so large in their resi)ective markets and so closely



5520

related to the marketing of computers that ownership by such a computer com-
pany jeopardizes competition in the computer market.

Four IBM operations particularly fit these conditions : The Service Bureau
Corporation (SBC), the OflBce Product Division, Science Research Associates,
and the World Trade Corporation.

1. The divestiture of SBC

Under the 1956 Consent Decree, SBC is supposed to be operated as an arms-
length corporation. Yet there is considerable evidence that its computing serv-
ices promote IBM's computer business through "customer captivity" as well as
through offering IBM opportunities to institute price discrimination through
the free usage of computer time, free manpower or software support, and buy-
backs of computer time. Furthermore, it provides a sheltered market for IBM
equipment. As a result, SBC is another source of IBM market power in the
computer business.

The divestiture of SBC, through a stock distribution, would prevent this source
of market power in the computer market from being utilized by any successor
computer company.

2. The divestiture of the Office Product Division

IBM's OflSce Products operations are organized as a separate division, with its
own plants, development group, and executive organization and with revenues
in the hundreds of millions of dollars. The principal product of this division is
office typewriters in which IBM has a substantial market share. In addition, IBM
recently announced entry into the office copier market. This division should have
no difficulty operating as a separate company. While at present the interrelation-
ships between office products and computers are not extensive, the coupling of
magnetic tape to typewriters and copiers could give a computer manufacturer
with a large share of outstanding office typewriters and an entry in the copier
market a powerful position in the computer market. Accordingly it is proposed
that the Office Product Division be divested into one, or perhaps two, separate
companies.

3. The divestiture of Science Research Associates {SRA)

SRA is a recent IBM acquisititon which develops and markets computer ap-
plications in the educational area. It is an asset in the marketing of computers
which should not be assigned to any one particular successor company. Since
SRA has previously been successful as a separate company it can be easily re-
established in this status.

4. The Divestiture of the World Trade Corp.

IBM has concentrated its foreign operations in a single subsidiary — IBM World
Trade Corporation. This subsidiary can be a separate company for it already has
its own overseas marketing force, extensive manufacturing and development ac-
tivities, and a distinct set of executives. As a separate company, it would have
over a billion dollars in annual revenues.

As a separate company, however, at least initially World Trade would have
to buy the many products it does not manufacture from successor companies in
order to offer a complete data processing line. And it is likely to need to license
technological know-how from successor companies to stay abreast of changing
technology. But these relationships would have a somewhat lesser impact on do-
mestic competition than the existing ones.

The impact of a dominant position in many markets abroad would be diffused
among several successor computing companies. At the same time, the impact on
American trade from divestiture would be minimal since AVorld Trade in effect
now buys from IBM's domestic operations. Over the longer run. World Trade
could buy from other American computer manufacturers if their products proved
superior. Thus World Trade's commanding position in various foreign markets
might become 'available to other American computer manufacturers.

C. Anti-competitive practices

Since the divestiture recommendations are fairly comprehensive, the scope of
injunctive relief can be limited to a few key items. Nonetheless, since the IBM
successors will have, at least initially, very substantial market shares in par-
ticular computer submarkets. four major provisions are required: limitations
on price discrimination, limitations against paper machines and the like; re-
quirements on product disclosure, and provision for royalty-free licensing.



5521

1. Pricing

Price discrimination is a traditional tactic of a dominant firm to gain and to
maintain market power — cutting prices for a group of customers or with respect
to products where competition is vigorous while maintaining high prices else-
where. IBM has made extensive use of price discrimination. Given IBM's record,
the importance of price discrimination as a source of market power, and high
market shares in many computer lines even after divestiture, injunctive provi-
sions are recpiired to eliminate price discrimination.

Price discrimination can be eliminated by requii-ing IBM to institute "auto
sticker pricing". Such pricing would have the following features :

(o) Each successor company and WTC would be required to publish a sepa-
rate list price, together with terms of sale such as credit, trade-in allowances, etc.,
for (i) each unit of the computer, (ii) software (.such as each compiler, a.ssem-
bler, application, and special user program), (iii) maintenance services, (iv)
programming services, (v) customer training, (vi) other products or services
related to the sale and support of computers. This would make mandatory the
present practice of "unbundled" prices.

(&) All sales (except competitive bids to a government agency) must be at
the list or "sticker" price and at published terms except as justified to meet com-
petition. Each product or service priced seperately must be available for purchase
separately and profit margins on different products or services must be reasonably
similar. Such provisions would restrain price discrimination directly by requiring
uniform prices to different buyers, prevent any single item from being tied to
another (often hiding price discrimination), and prevent any item from being
offered at a low profit margin. It would eliminate the educational discount.

(c) All .sales offers, bids and proposals would be made in writing containing
the above prices, delivery date, and other terms and conditions, and the customer
would be allowed 30 days to accept or reject the proposal or any part of it. Orders
would be filled in the order of their receipt. This would prevent hidden price dis-
crimination via oral agreements, prevent the practice of stampeding a customer
into accepting an order, as well as prevent discrimination between customers via
delivery dates.

{(I) To prevent subtle forms of price discrimination, grants to a customer or
participation in joint ventures or projects to induce a purchase of a computer or
related service would also be prohibited.

2. Paper machines, programs and the like

This practice can be reached by a provision prohibiting successor computer com-
panies and "WTC from offering, advertising or otherwise disclosing to the trade
any computers, programs, or related equipment prior to an operational demon-
stration of such item. These demonstrations are to be open to competitors and the
public and the operational characteristics demonstrated must conform to the
advertised specifications, which specifications must themselves contain sufficient
detail as to be meaningful. Such demonstration shall not be held prior to the
time the products or services are ready for manufacture and distribution in pro-
duction quantities, thus insuring quotation of realistic delivery schedules.

3. Product standards and compatibility

One advantage of IBM's vast market share is that by its dominance it creates
certain standards on a de facto basis to which its competitors must conform, thus
raising difficulties for other manufacturers in making their equipment compati-
ble with that of IBM. While dividing IBM's product line among several com-
panies reduces the .scope of the problem, the dominance of successor companies in
particular markets still leaves a potential threat to competition from sharp
changes in product standards by the firm with the dominant market share.
Without prior notice, competitors would be placed at a sub.stantial disadvantage.
Accordingly, with respect to all new or proposed products or software which have
characteristics which will affect information interchange or interface between a
successor company's or WTC's systems and competitive systems, such companies
and WTC should be required to disclose confidentially to every U.S. computer
manufacturer complete functional specifications of all such new products and
software and of each major change in existing products and software 24 months
prior to their first delivery. The particular standards which require disclosure re-
late to devices utilized for information interchange in general and particularly
those that involve interchangeable media. Some mechanism would have to be
devised to prevent the abuse of this requirement by disclosing new standards
which subsequently are not actively marketed.



5522

Jf. Royalty-free patents

IBM and WTC now have thousands of U.S. and foreign patents and patent
rights, relating to computers which consitute one source of its marliet power.
To give the portfolio to any one successor manufacturer would give that com-
pany a major edge over others and provide the basis for new positions of mar-
ket power. To divide the portfolio would necessarily require extensive patent
cross licensing between competing companies. The simplest solution would be
to establish royalty-free licensing of all IBM's present patents.

Such royalty-free licensing should be extended to all domestic computer
manufacturers so that this limitation on the growth of competitors would be
eliminated. New discoveries of suecesor companies would, of course, be patent-
able so that there would be no lack of incentive for research and development.

II. MARKET SHARE LIMITATION

An alternative to horizontal divestiture is the gradual reduction of IBM's
substantial market share — the source of its market power. The reduction in
market share is achieved largely through proscription of certain practices that
now maintain IBM's market share. Described below is an illustration of this ap-
proach in the general digital computer market. The accompanying prohibitions
on anti-competitive behavior as well as divestiture of certain activities out-
side the computer manufacturing market are integral parts of this proposal.

A. The general purpose digital computer market

1. The general concept

If IBM would grow at a slower rate than the market (though faster than most
large corporations) then its market share could fall substantially and existing
competitors could grow relative to IBM. As a result the market share disparity
between IBM and its competitors would substantially narrow. The anti-compe-
titive character of the computer market is this size disparity rather than too
few competitors.

The effects of such market share limitations can be illustrated by one feasible
set of assumptions as follows :



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 72 of 140)