Down Time: At Digital Equipment, Slowdown Reflects Industry's Big Changes

Belt-Tightening and the Use Of Outside Technology Strain Corporate Culture

Is New Mainframe a Cure-All?

By John R. Wilke
The Wall Street Journal

September 15, 1989

MAYNARD, Mass. -- Two years ago, Digital Equipment Corp. greeted its 30th birthday in grand style. The fast-growing computer maker staged a marketing extravaganza on Boston's waterfront, a nine-day, $26 million fete that drew 55,000 people and turned the majestic Queen Elizabeth 2 and the cruise ship Oceanic into floating hotels.

Digital could afford to celebrate. It had become the world's second-largest computer maker, a feat accomplished largely at the expense of International Business Machines Corp. Its stock was soaring toward a record. The ocean liners towering above the crowded piers said it all: Digital's ship had come in.

Today, Digital is nearly dead in the water. Domestic sales have stalled, and some analysts predict that, for the three months ending Sept. 30, Digital will report its weakest quarter in four years. Under fierce competitive pressure, the company is moving thousands of employees from assembly lines and corporate offices into the sales force. It has slashed costs, frozen pay and stopped hiring. This week, Digital offered a voluntary severance package to 700 manufacturing employees.

Digital isn't the only computer company that is hurting, by any means. But its slowdown reflects the wrenching changes that have swept the business -- and shows how fast fortunes can shift in the industry's swift-moving currents. As computers become more of a commodity, prices and profit margins are being squeezed. And as companies turn to software and new chip designs for a competitive edge, fewer workers are needed to solder circuit boards. Even strong companies are being forced to slim down.

"The whole world changed," says Jay P. Stevens, a computer-industry analyst at Dean Witter Reynolds Inc. "Digital was slow to see it coming. Now, they're accepting the world as it really is."

The unaccustomed belt-tightening and growing use of technology acquired from outsiders have strained Digital's proud engineering culture and its long tradition of avoiding layoffs. "This once was a place where working dawn to dark was rewarded. But the big raises are gone, and benefits aren't what they used to be," one manager complains. Workers in manufacturing and other shrinking areas say they expect to be forced out if they don't accept retraining or relocation to other parts of the company -- usually into sales.

The relentless pace of technology has forced Digital and other major computer makers into a delicate balancing act: They must keep their existing customers happy while developing the next generation of computers that they will need to stay competitive. That has proved awkward for Digital. For a decade, its marketing message was built around the flagship VAX computer design, which played the same software all across the company's product line. It was a potent weapon against IBM, with its welter of incompatible designs. The sales slogan "Digital has it now" was long used to devastating effect.

But a new computer design scrambled that strategy, and Digital has fumbled for months in trying to project a coherent new theme, even as it brought out a blizzard of new products. In just a year, the company rebuilt its entire VAX minicomputer line. At the same time, it adopted a powerful new computer-chip design that runs on industry-standard operating software -- marking a fundamental departure from the single-design VAX strategy. The nonVAX design, licensed from outsiders, no less, might once have amounted to corporate heresy.

It was too much, too fast. "We confused our customers, and it hurt us," Kenneth H. Olsen, Digital's president, says.

In another heresy, Mr. Olsen now says Digital should pay a dividend. That overturns a longstanding strategy of hoarding cash to finance fast growth -- a stance more suited to a hot start-up company than the mature giant Digital has become. "We believe in dividends," he says. "We'll be looking at it again soon. We haven't decided when." He calls last year's $1 billion stock buy-back an "alternative" to a dividend. Analysts say a dividend would make the shares more attractive to institutional holders and perhaps shore up the price, which has languished around $100 a share, half its pre-crash peak of $199.50.

Though painful, the sweeping changes should make the company more competitive in the long run, customers and analysts say. And for all its worries, Digital remains strongly profitable. In the fiscal year ended July 1, the company earned $1.07 billion -- though that was down from $1.3 billion a year earlier. Sales grew 11%, to $12.74 billion. In addition, Digital has "a phenomenal balance sheet, one of the best in American business," says Barry F. Bosak, a Smith Barney analyst.

Analysts applaud Digital's cost cutting. It has backed out of leases, consolidated facilities and recently canceled plans for a $100 million technical center in Britain. Capital spending, which doubled in fiscal 1988 to $1.52 billion, fell to $1.22 billion in 1989. There won't be any lavish harborside bashes this year. "They've slammed on the brakes," Mr. Bosak says.

Digital's aggressive efforts to broaden its product line should also pay off. Across the computer industry, popular software standards such as DOS and Unix are migrating from desktop PCs and work stations into the market for larger business computers. This shift -- plus a wave of powerful new chip designs based on RISC, or reduced instruction-set computing -- has irrevocably altered the industry. It has hurt the high-cost minicomputer makers that don't have a large-enough base of customers to support proprietary-design processors: Prime Computer Inc., Data General Corp. and Wang Laboratories Inc. each sustained steep losses and were forced into layoffs and new strategies.

But Digital's strategy is steering it away from the traditional minicomputer. Its sales of work stations -- powerful desktop computers -- totaled $1.1 billion last year, and it is closing in on first-place Sun Microsystems Inc. in that fast-growing market, says International Data Corp., a market-research firm. Digital has developed new technology that welcomes other computers into VAX networks. And, with a powerful new processor due out next month, it is poised to assault the mainframe market long dominated by IBM. Analysts say the new line is critically important to Digital, and they predict that it could boost sales by $1 billion next year.

That mainframes are a mature market showing single-digit annual growth doesn't faze Mr. Olsen -- it's still a $40 billion business. "The market is so big we don't really care whether it grows or not," he says. He adds that Digital's sales approach will differ from traditional mainframe marketing, focusing instead on emerging, faster-growing commercial and technical markets.

Customers haven't been the only ones confused by the dizzying pace of change at Digital. Its sales force has trouble keeping up, too. "Our people cringe when they see a Digital salesman coming," says Jay Delhom, a purchase planner for New Orleans-based Entergy Corp., one of the nation's largest electric utilities. "Some don't know their own products. They promise the moon and don't deliver."

That hasn't kept Mr. Delhom's company from buying Digital systems to run its nuclear-power plants. "Digital's hardware sells itself, which is a good thing because no one else seems to be," he adds.

Digital knows it has a problem. It is shaking up the management of the sales unit and sent the entire U.S. sales force of 6,300 to a company-run summer school at Brown University. The shakeup has reverberated through the senior ranks -- and has reshuffled the race to succeed Mr. Olsen, who founded the company 32 years ago.

But the mess in sales isn't the only problem that slowed revenue growth into single digits in the latest quarter. In a costly gamble, Digital decided last year to cancel a major computer design, leaving big customers without a replacement at the high end of its line. The cancellation -- in effect, skipping a generation of computers -- allowed Digital to concentrate on the VAX 9000 mainframe-sized model due out this fall. Though the move depressed short-run results, analysts see it bolstering Digital's long-term product position.

The new computer is the most powerful processor Digital has built. Indeed, "it will be one of the fastest mainframes on the market," Mr. Olsen promises. Analysts predict that Digital will price the new line at less than half the cost of comparable IBM mainframes.

The stakes are enormous. "The VAX 9000 series is the key to a turnaround at Digital," says Dean Witter's Mr. Stevens. He calls it the centerpiece of the strongest stable of Digital products since 1985 and says the company is poised for a powerful comeback, beginning next year.

Also important to Digital will be its increasingly urgent effort to trim its swollen payroll. Growth in the work force exploded in 1988 and then slowed in 1989; the total now stands at about 125,800. Analysts say Digital plans to keep the head count essentially flat for three years and let attrition take its toll. As in 1985, it is retraining thousands of manufacturing and administrative workers for direct-sales jobs. Digital's approach recalls IBM's 1987 efforts to cut overhead costs and bolster sales, but Digital moved far more quickly.

James Osterhoff, the vice president for finance, says Digital hasn't any plans for layoffs this fiscal year. But he says Digital's no-layoff history "is a tradition, not a policy." He is concerned about overhead in Europe, where sales are still strong, and is looking for ways to slow spending on the weak U.S. market. "The question is, are we doing enough, and are we doing it fast enough?" he says.

Digital is still investing heavily in research -- it spent $1.53 billion in the year ended July 1 -- and software now commands a growing share of that investment. A crucial effort has been to embrace evolving software standards and make them work in Digital networks.

Like many competitors, Digital was caught off guard by the clamor for standard software. Although its VAX line has been enormously popular, fueling Digital's explosive growth since 1985, more and more customers don't want to get hooked on computers based on proprietary software. "In the VAX prison, the food's great, but you're still locked in," says George Colony, a consultant at Forrester Research Inc. Moreover, PCs linked into networks are often far less costly than minicomputers and use off-the-shelf software.

But PCs can't offer the power, sophistication and security that many large customers need. And most standard software isn't yet suited for hard-core commercial computing, such as on-line transaction processing. Typical transaction-processing tasks, in which hundreds of terminals interact with a database, include airline reservations, on-line retail-sales tracking and bank teller networks, and such operations are a prime target for the VAX line, especially the 9000. Transaction processing "will be the savior of the VAX," which will probably last well into the 1990s, says Terry Shannon of International Data.

Meanwhile, Digital also is pushing ahead with new computer designs. Its new line, priced substantially below the VAX, runs on Unix operating software with chips from MIPS Computer Systems Inc.

At first, Digital couldn't come up with a clear marketing theme for the two lines. But now it has, analysts say. "More than any computer maker, Digital has positioned itself as the company that can tie together computers running different operating systems and different software on the same network at the same time," says Marc G. Schulman, an analyst at UBS Securities Inc. Digital has developed software that weaves disparate systems into a single network, he adds.

That approach enables customers to buy Digital's proprietary VAX without fearing that their investment will become obsolete if they get Unix-based computers later, says Barry F. Willman of Sanford C. Bernstein & Co. "No one else is doing what Digital has done," he says. IBM's Systems Applications Architecture is a similar concept, he notes, except that it focuses on integrating only IBM operating systems. Mr. Schulman calls Digital's capability in this regard "one of Digital's strongest assets," but he complains that the company "has done a poor job, up to now, communicating this strategy to the world."

As it changes its image, Digital is also changing the way it is run. Through the summer, executives forged a new management structure, dismantled marketing and product-strategy councils and rebuilt the sales operation. Digital was broken into a portfolio of business segments, and a new operating committee has been formed, effectively tightening Mr. Olsen's control.

Insiders say Mr. Olsen manages the company like the engineer that he is, taking apart things that don't work and tinkering with them until they do. "He tore apart the sales operation, and he didn't like what he saw," a senior manager says. In the aftermath, John J. Shields, a dynamic senior vice president who just a year ago was seen as Mr. Olsen's heir apparent, appears out of favor. And Charles E. Shue, who had been vice president of U.S. sales, quietly resigned last month.

With the contest to succeed Mr. Olsen clouded and the man himself in no hurry to go, speculation now centers on a new generation of managers. "Replacing the founder can be the hardest transition a company can make," says John F. Smith, a senior vice president and himself a candidate. "It's not like passing the baton from a fourth CEO to the fifth."

If Mr. Olsen has someone in mind, he isn't saying. "It's wide open," he insists. Though he used to say he would name a successor at age 65, he is 63 now and has no plans to retire. "I've changed my mind," he says. "They may have to kick me out."

Copyright (c) 1989, Dow Jones & Co., Inc.