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How Digital Equipment ducks IBM shadow

Kenneth Olsen is well aware of what can happen when you go head to head with IBM. Thus far, he has managed to keep his company, Digital Equipment Corporation, from that fate. Take Apple Computer, which practically created the personal computer industry. When IBM brought out its own PC, the most profitable customers, the business community, jumped on the IBM bandwagon. IBM now has some 60 percent of the business market.

At the other end of the spectrum, IBM's shadow has stunted the growth of mainframe computermakers. IBM has a lock on some 70 percent of the mainframe business; Burroughs, Sperry, Honeywell, NCR, and Control Data have to fight over the rest.

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So how did Mr. Olsen steer his minicomputer firm past these bigger companies to take the No. 2 spot in the computer industry?

In part, he caught IBM asleep at the switch. By the time IBM seriously turned its attention to minicomputers (which range from $10,000 to about $450,000), Digital was entrenched. It had already developed a vast and loyal customer base; in fact, there are more Digital computers out there than IBMs, if you don't count personal computers.

Olsen no longer has the luxury of an indifferent IBM. Big Blue has taken aim at the $15 billion midsize market, and DEC (pronounced ``deck'') in particular. In 1984 IBM outsold DEC in minicomputers (in dollars, not units), according to the Gartner Group, a research firm.

Competition is also coming from smaller companies, like Data General, which sell faster, more-powerful machines for less money.

And, of course, the computer slump has taken its toll, though not as severely as for most of DEC's competitors. After a decade in which sales and profits grew tenfold, Digital's profits last quarter were half what they were in the same quarter last year. (They were down 11 percent, if a one-time tax benefit from last year is excluded.)

Why, then, does Marc Schulman at Salomon Brothers predict an earnings growth of 35 to 40 percent a year for the next three years? Or why does Daniel Chertoff at Sanford Bernstein Research call it ``an excellent company that's only getting stronger -- we're only beginning to see what it will do''?

Explains Mr. Chertoff, ``For DEC, the key to profitability is the product cycle, and they are at the beginning of a long and sustained product cycle.'' In the next few months, DEC is expected to unveil an IBM-compatible personal computer, a midrange VAX minicomputer, and a new engineering work station. In the last year, it has brought out its two most profitable machines ever -- the VAX 8600 and MicroVax II -- and they are hot. It also has high hopes for the new top-of-the-line 8650.

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But there are more fundamental reasons for optimism, says Mr. Schulman. ``The computer industry has played into DEC's hands,'' he says. ``For a good number of years, their major theme has been networking. They were way ahead of their time.''

``Networking'' allows different computers to share information or ``talk'' with each other. It's a concept that Digital has emphasized for 15 years, Olsen says, but only recently -- with the explosive growth of personal computers -- has it become a top priority.

``The personal computer almost by definition is for an individual,'' Olsen says. ``But a corporate entity means everybody working together. So tying a whole organization together is an obvious need. Suddenly people realized they had made these major investments and they did not have the usefulness they had hoped for.''

Indeed, the minicomputer market does seem to be veering in Digital's direction. Hardware is becoming a commodity item; it's the software that counts. Analysts estimate that for every $1 of computer hardware a customer buys, it will spend $3.50 on software and services over the life of the machine.

All of DEC's VAX computers can be upgraded or married to small computers without throwing out software. And since the VAX concept was introduced in the mid-'70s, practically every engineer and his brother has written programs for it. The system had more power for the dollar than IBM mainframes. So universities and small engineering companies at the cutting edge of computer technology worked on DEC computers.

Today, other companies are doing to Digital what it did to IBM: giving more power at a cheaper price. But Digital's dominance isn't immediately threatened, says Kenneth Flamm, a research associate at the Brookings Institution. ``Unless the hardware has to be dedicated to a specific function,'' he says, ``it makes sense to buy a computer that runs the broadest range of software.''

It won't all be smooth sailing for DEC. IBM is coming on strong: It has captured 22 percent of the computer-aided design and manufacturing (CAD/CAM) market, a traditional DEC stronghold, according to the Gartner Group. And though DEC's office automation system, All-in-1, has sold well, IBM still holds sway over departmental managers who order computers.

There is some controversy whether IBM is doing better at invading DEC's scientific and manufacturing turf than DEC is at getting into the office. Most believe DEC is gaining in the office and will continue to gain at IBM's expense. First, DEC's VAX series is better than IBM minicomputers like the System 36, they say. Also DEC -- which has always said that good machines sell themselves -- is starting to beat the bushes for customers.

``DEC is a much more laid-back company than IBM,'' says one customer who is looking to replace a Digital mainframe that is being phased out. This customer is trying to decide between an IBM and a Digital system.

``There's a loyalty'' toward Digital, the customer says, ``but IBM is always hustling, sales-wise. . . . I haven't seen people talking to Data General or Prime or Hewlett-Packard; they're going to IBM.''

One reason for DEC's ``laid back'' attitude is that its sales force is in on salary, not commission. A few weeks ago, however, it began a bonus program for high-performance salespeople, the first such incentive ever.

There have been other changes made of late that indicate DEC is not taking its position for granted.

DEC sat out the personal computer boom. When it did bring out a less expensive PC, the Rainbow, it was ``a turkey,'' one customer says. But next spring Digital will be bringing out an IBM-compatible PC. Analysts say the $5,000 to $7,000 machine could allow Digital to hold IBM at bay in the lower end of the market and could help Digital penetrate IBM's fiefdom in the office.

DEC's lackadaisical attitude about utilization of its assets (thus profitability) is changing, too. Last year Olsen recruited James Osterhoff, a former Ford executive, to head the finance department, and profit margins are already expanding, analysts say.

In a volatile industry, Digital's stability is a plus and a minus. One analyst says DEC doesn't want to be on the ``leading edge where the risk is high. They let the pioneers get the arrows in the back.''

In fact, he says, DEC's best strategy -- and biggest challenge -- may be to act a little less like IBM. CHART: Digital family grows rapidly Number of employees (thousands) A decade of accelerating sales and costs Millions of dollars

Revenues Costs and expenses 1975* $534 $459

'76 736 618

'77 1,059 881

'78 1,437 1,199

'79 1,804 1,521

'80 2,368 1,985

'81 3,198 2,662

'82 3,880 3,296

'83 4,272 3,909

'84 5,584 5,190

'85 6,686 5,691 *Fiscal year ends June 30 Source: Digital Equipment Corporation

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