The Empire Strikes Back In 1986
Digital Equipment Was Taking On IBM And Winning
Now, Big Blue Has Turned The Tables
Lawrence Edelman
The Boston Globe
December 2, 1990
In October 1986, Fortune magazine profiled Kenneth H. Olsen, founder of Digital Equipment Corp., and proclaimed him "America's Most Successful Entrepreneur."
The story pegged Digital as the hottest computer company around. And rightfully so. Defying an industrywide slump, its earnings would nearly double that year to $1.1 billion. Armed with its VAX computer line, Digital was taking on the world's biggest computer maker, International Business Machines Corp., and winning.
Fortune is said to be readying another big spread on Digital. But this time around the Maynard company is no longer steamrolling IBM. In fact, Big Blue, bolstered by new products and aggressive belt-tightening, seems to have regained the upper hand with customers and investors.
Consider: Thanks to its new best-selling minicomputer line, called the AS/400, IBM has stopped losing sales by the billions to Digital's VAX machines. The Armonk, N.Y.-based company remains the No. 1 vendor of personal computers and is gaining ground in engineering workstations, a Digital bastion. And having reduced its work force and slashed costs, IBM's profits are rising while Digital's sink under the weight of bloated expenses.
The depths of Digital's decline can be measured to a certain extent by its ailing stock price. Digital is foundering around $50 -- 25 percent below per-share value of its assets -- while IBM has hovered between $110 and $115. Compare that with the market's peak in 1987, when Digital shares commanded $199 and IBM's fetched $175.
"IBM has become a lot more aggressive," says Stephen Smith, an analyst with Paine Webber. "It seems to be paying off."
It's been an embarrassing reversal of fortune for Digital, one that has forced it to rethink key pieces of its strategy.
Gone is its total reliance on the VAX, which spans desktop computers to mainframes; Digital now sells minicomputers and workstations based on industry standard microprocessors and running Unix, a software operating system that Olsen had for years blasted as inferior to Digital's VMS system. Even its tradition of no layoffs will likely be broken as it struggles to become more competitive with lower-cost rivals like Houston-based Compaq Computer Corp.
Ironically, it could be said that Digital was hurt by too much of a good thing. While the rest of the industry was battered by the 1985-87 slump, VAX sales soared and Digital hired employees by the thousands. But when sales finally leveled off, it was left carrying more weight than it needed.
"We had a lot of momentum going for us," says Mark Steinkrauss, a Digital spokesman. "We didn't need to work as aggressively as IBM on costs."
That is something of an understatement. Since 1986, IBM's aggressive chairman and chief executive, John Akers, has cut Big Blue's worldwide work force by 8 percent, to 373,000, through attrition, asset sales, early retirement and other voluntary means. He has eliminated 60,000 "overhead" jobs in adminstration and support and retrained some 65,000 employees for positions in revenue-generating like sales, service and software. He has closed factories, consolidated operations and streamlined management.
By contrast, Digital's work force had grown to 124,000 at year ended last June, from 95,000 in 1986. Voluntary severance plans are expected to cut 9,000 jobs this year, but analysts say the company must cut deeper. IBM generates about $175,000 in sales per employee; the figure for Digital, even after the voluntary layoffs, will be about $106,000.
Yet IBM has done more than just scale back. Where Digital really hurt it was in the market for minicomputers used to automate small businesses and departments of larger ones. IBM had always been weak in this segment, with a variety of machines that could not talk to each other or with its PCs and mainframes.
Customers flocked to Digital because all VAXes run the same software and are easy to connect to each other and computers from other suppliers. Indeed, it was often easier to link various IBM machines through a VAX than via IBM connections.
In 1987, IBM fought back with the model 9370, the so-called VAX killer. But sales of the machine were hurt by a scarcity of software and poor links to IBM's existing minicomputers. The company tried again in 1989 with the AS/400, which was announced along with thousands of software packages. This time it hit the jackpot.
"It's not that the AS/400 has taken DEC accounts away," explains Merrill Lynch analyst George Elling. Instead, IBM has been able to hold onto customers who had previously defected to Digital.
Elsewhere, IBM's PS/2 personal computers, unveiled in 1987, have reversed the decline in its PC market share that came at the hands of Compaq Computer and other makers of IBM clones. Digital, meanwhile, has virtually no presence in PCs. IBM has even made inroads into the engineering workstation with its highly praised RS/ 6000 family.
"A lot of the holes in its product line have been plugged," says Elling.
Nevertheless, analysts say Digital's customers remain fiercely loyal. "American industry has adopted VAX like a pet dog," says Howard Anderson, president of the Yankee Group, a Boston-based consulting group.
But some cracks are appearing. Bedford-based Atex, for example, had long built its newspaper and magazine publishing systems around Digital hardware. But last June the company, a unit of Eastman Kodak Co., said future products will be designed for IBM desktop computers. Michael Akillian, an Atex spokesman, says the shift was made to accommodate customers who wanted IBM hardware so they could also run off-the-shelf business software like spreadsheets written for IBM.
But Atex's move also reflects the accelerating switch from minicomputer-based computing to a so-called "client/server" arrangement in which desktop machines, linked to network traffic cops called servers, replace centralized minicomputer systems.
Patricia Seybold, a Boston-based computer consultant, says a growing number of users want to avoid the heavy upfront investment required for VAX-based networks. Instead, they prefer to mix and match desktop computers and servers from a variety of vendors.
"It is not so much what IBM is doing right, but that the DEC approach is a bit off target," she contends.
While IBM has for the moment turned the tables on Digital, analysts say both companies face the same fundamental challenge: wean themselves from reliance on profitable proprietary systems while building competitive client/server product lines.
Despite his deep roots in the old minicomputer world, Olsen is poised to make this change, says George Colony, president of Forrester Research Inc., a Cambridge consulting firm. "I think Ken is going to pivot that company, overhaul it, reinvent it," says Colony, who in the past has been critical of Olsen.
The move to client/server will be more painful for IBM, Colony adds, since it is so heavily dependent on mainframes for its profits.
Yet IBM's ability to battle back in the past five years has convinced many investors the company will be the force to reckon with in the 1990s and beyond.
EDELMA;11/29 NKELLY;12/03,16:07 DEC02
Caption: PHOTO
1. Chairman John Akers has put Big Blue back on top. / AP PHOTO
2. 'I think Ken (Olsen, right) is going to pivot that company, overhaul it, reinvent it.' / GEORGE COLONY / Forrester Research
Copyright 1990