| hi,
this was widely circulated, it seems related and good article to
pause and read on, so i post it here.
/nasser
Subj: I:"Deconstructing the Computer Industry"-Business Week Article /bg
Deconstructing The Computer Industry
------------------------------------
Special Report - Business Week: Nov. 23, 1992
As the monolithic mainframe gives way, the industry breaks
into leaner, faster, smaller parts.
It sure looks like an industry on the skids. The signs are
everywhere and grow more painful every day: World-wide leader
IBM Corp. is shedding 40,000 workers this year, for a total of
100,000 since 1985. No. 2 Digital Equipment Corp. ousts its
founder, after taking $3.1 billion in charges over two years
to cut 18,000 jobs and vacate 165 facilities. Wang
Laboratories Inc. files for Chapter 11 protection. France's
Groupe Bull lays off 18,000 workers and closes 8 of 13
factories; Italy's Olivetti downsizes by 20%; Siemans Nixdorf
plans to lose 6,000 workers. And the list goes on.
"Think," an industry byword in IBM's heyday, is giving way to
"Shrink." It's not just computers that are getting smaller,
it's most of the companies that make them, too. They're
deconstructing - shutting factories, farming out work, and
slashing managements.
Doldrums
--------
Even the younger generation is feeling the pinch. Relative
kids such as Apple, Sun Microsystems, and Compaq are attacking
costs, too. Apple Computer Inc. and Compaq Computer Corp. have
laid off thousands to cut overhead and stay a step ahead of
the hundreds of wannabes nipping at their market shares. Only
in Japan, it seems, have companies avoided downsizing. But
they may be next. Sales are slowing and Fujitsu Ltd. reported
a $160 million loss for the first half of fiscal 1992.
What's going on? Like all manufacturers, computer makers are
under pressure to slash costs. But they also face a unique
challenge. In their business, every 18 months, advances in
microprocessor technology double the amount of computing
power a dollar will buy. These powerful chips and standardized
software have already turned PCs into a low-margin commodity,
and PCs have become the industy's biggest part. (chart shows
world-wide sales of PCs passing sales of other computer
hardware in 1991) Now that computer makers are building
large-scale systems - including machines that will surpass
IBM's biggest mainframes - from the same cheap chips, the
harsh economics of the PC are sweeping computerdom. "The
computer systems business is rapidly evolving to become
similar in structure to the PC business," says John Levinson,
computer analyst at Goldman, Sachs & Co.
Already, the industy's net income has plunged from 6.5% of
revenues in 1986 to -0.12% last year, excluding special
charges, according to Standard & Poor's Compustat Services,
Inc. That's billions in earnings up in smoke - a figure
reflected in the dismal performance of computer stocks.
(chart shows S&P 500 index growing from 100 to 170 from 1987
to 1992 while computer industry stocks drop from 100 to 55 for
same period) And the forecast is for more of the same, as
powerful microcomputers gobble up more of the market. "We
never plan to see margins come up again," says Peter Bonfield,
chairman of Britain's ICL PLC.
Niche-Picking
-------------
So the business is a disaster, right? Not at all. Although
falling prices have slowed revenue growth, from nearly 20%
annually five years ago to the low single digits, demand for
computer gear remains strong. Lower prices are inviting more
customers. And there's plenty of new technology on the drawing
boards - pen-based PCs, handheld "digital assistants," and
massively parallel supercomputers - to create demand well into
the next century.
But before then, the old industry has to deconstruct. With
gross margins of 40% and falling, the vertically integrated
that thrived on margins as high as 70% must do some painful
soul-searching. They now have to choose at which points along
the "value chain" they can most profitably apply their skills
and resources. They may write software, build parts, or make
complete systems. They may sell computers built by others.
They may team up with partners. Or they may just help
customers choose and install computers to solve specific
problems. But even the mighiest, it seems, can no longer do it
all.
The pattern for the industry's future structure has already
been set - again, by the microprocessor revolution. In the
past decade, the industry has splintered into an array of
specialty companies. Each focuses on a different part of the
value chain: chips, disks, distribution, data-base software,
customer service, and so on. And, as a whole, they are proving
more efficient than old-line, integrated makers. Again,
there's an analogy to what's happening in hardware itself:
Computing power has fragmented, breaking out of the monolithic
mainframe and spreading to flexible networks of powerful,
desktop machines.
Big Blue and other giants grew up as vertically integrated
organizations, a la General Motors, because that's how
companies worked then - and because there was little choice.
They had to build their own chips, circuit boards, disk
drives, terminals, printers, tape drives, and even the boxes
the stuff went into. They wrote software, too, and fielded
teams of salespeople, consultants, and technicians. Tens of
thousands of employees, dozens of plants, and huge investments
in research and development were involved.
But the PC changed all that. In 1981, when IBM chose an Intel
Corp. microchip and Microsoft Corp. software for the IBM PC,
it inadvertently sowed the seeds of its own deconstruction.
Because anybody could buy the same parts, everybody got into
the business. From Taipei to Tampa, from Delhi to Dublin,
anfrastructure of suppliers sprang up to feed the right bits
and pieces to thousands of assemblers.
With the PC market saturated with players, gross margins
hurtled below 30%. As long as the big companies had a healthy
business in "big iron" - minis and mainframes - this didn't
hurt bottom lines much. But those core businesses have slowed.
And now, sooner than DEC or IBM expected, big machines are
threatened with extinction by low-cost, micro-based
alternatives. "It has unfolded beyond our wildest
imagination," says Gilbert P. Williamson, president of NCR
Corp., acquired by Americon Telephone & Telegraph Co. in 1991.
NCR's big thrust these days is building machines using
multiple microchips that can do transaction-processing work
for a retailer - but for a fraction of what it would cost with
a mainframe.
Free Market
-----------
So the falling tide is lowering all boats. McKinsey estimates
the companies that in 1986 built and sold finished computer
systems were capturing about 80% of the total profits being
generated by computer sales. The reason: Older, high-margin
systems from the big computer makers still dominated. These
computers all had proprietary software that kept the customers
locked in - and paying high prices.
By 1991, however, systems makers were getting just 20%. Why?
Because the PC had cut out the fat - and not just by lowering
costs. The PC and other "open" systems such as minis and
workstations using Unix software made it possible for
customers to choose from a wide range of machines that all ran
the same programs. They turned the industry into a free
market. And the market soon reallocated profits. The biggest
chunk, 49%, simply stayed in the pockets of customers in the
form of lower prices - an economic surplus that "customers are
unlikely to give back," notes Michael Nevens, a McKinsey
principal.
That's not all. Computer makers also gave up profits to
suppliers of components, software, and services, whose share
of the pie rose from 20% in 1986 to 31% in 1991, according to
McKinsey. In effect, the market said that chipmakers and
software writers added more value than the folks cobbling
those parts into systems and should be rewarded accordingly.
That why, as computer makers scramble, companies such as Intel
and Microsoft, suppliers of the main chips and software,
respectively, for the IBM PC market, are lapping up the gravy.
This explains the frenzy of deconstruction within the old
verticle empires. Without fat profit margins on complete
systems to mask inefficiencies, big companies can no longer
afford in-house divisions - unless they're really competitive.
And in many cases, the best way to improve performance of a
division or factory - indeed, just to measure it - is to
expose it more fully to market forces.
Clearly, that's the motive behind IBM Chairman John F. Akers'
massive deconstruction project announced last December. He
broke the spawling company into 13 semiautonomous units. This
past September, he created yet another, just for making and
selling PCs. Each of these units is likely to subdivide until
there's "a whole host of little companies under the IBM
umbrella," says President Jack D. Kuehler. The free-standing
units will keep their own books, and before long, it will be
apparent where IBM can be truly competitive - and where it
might cut its losses. "There will be some fallout and
dislocations," says Kuehler. "Some won't make it." But if all
there Baby Blues are operating at peak performance, the sum of
the parts will be greater than today's whole - to shareholders
and customers.
"You're the Best."
------------------
The risk, of course, is that computer makers whose divisions
can't cut it will quickly hollow out, shutting more plants and
laying off more workers. That could boost short-term profits.
But they would soon lose manufacturing and design knowhow,
making them less able to bring innovations to market. And that
would be the beginning of the end for a computer maker. "You
have to have something where you're the best," says Charles E.
Exley Jr., retired chairman and CEO of NCR.
The companies that dig out "best of breed" capabilities in
their organizations and free them to compete can hope to
rebuild profits. Of course, most of the industry's best gigs
are already taken: Even if you're great at operating software,
Microsoft has that about sewn up. Ditto Intel in
microprocessors; Conner, Quantum, and Seagate in disk drives;
Anderson Consulting and Electronic Data Systems in systems
integration; and so on.
The deconstructionist can take heart, though, from some
examples of surprising innovation by their compatriots.
Consider Hewlett-Packard Co.'s printer division, in Boise,
Idaho: A decade ago, the minicomputer maker saw a chance to
carve out a new niche in laser printers. It freed the division
to pursue the new market - regardless of whether the printers
would help sales of other HP machines. And now, HP has 43% of
the $5.4 billion U.S. market.
Get a Focus
-----------
There are already some promising possibilities among IBM's
deconstructed units. Adstar, which used to design disk and
tape drives primarily for use in IBM computers, is now
mounting a massive effort to sell it drives on the open
market, even for use in computers that will compete with
IBM's. Another unit is beginning to sell memory chips and
other components outside, so Big Blue will have a chance to
prove what it has frequently asserted - that it has
world-class capabilities in chipmaking. In fact, IBM may come
to resemble its Japanese rivals. Those electronics giants have
always built components for the open market as well as for
internal use.
Success in chips and other components may be essential if big
players want to avoid even more downsizing - to the hollow
extreme of deconstruction epitomized by Dell Computer Corp. As
Chairman Michael S. Dell acknowledges, his fast-growing
company's value added - it's "core compentency," as the
management gurus would have it - is not computer technology at
all, but distribution and marketing. Dell is set up to excel
in two areas: handling orders and queries from 30,000
customers a day and providing and endless supply of new models
and options. Dell does no real manufacturing - only final
assembly and testing. And in many cases, it doesn't even
design the machines it sells: Dell engineers, using input from
a vast customer base, create specifications for new computers
and hire subcontractors to build them.
The message is focus, as Sun Microsystems Inc.'s huge success
attests. The leader of the technologically demanding
workstation business builds no components itself; it relies on
outside subcontractors to build the guts of it systems. That
leaves it money to spend where it can really add value: the
Solaris operating software and Sparc, its microprocessor
design.
Of course, IBM and Digital can't just turn into Dell or Sun
overnight - nor should they. Despite the battering they have
sustained, the big players have enormous skill and unmatched
assets, not least their tight relations with blue-chip
customers and decades of experience creating comprehensive
information systems for specific industries.
Solving complex information-handling problems for corporations
is an obvious way of adding value - and replenishing profits -
for old-line makers. IBM, for instance, is pursuing a variety
of professional services, including writing custom software,
outsourcing, and most recently, management consulting.
Before they can reap profits in new businesses, however,
computer makers need to trim more costs in the old ones. That
would have been a lot easier if they had started sooner. But
in many cases, management assumed the slowdown in hardware
profits was caused by the recession, not by fundamental
changes in the industy. "A lot of people in our industry,
including myself early on, didn't see that clearly," says
James A. Unruh, CEO of Unisys Corp.
Finnish Line
------------
One company that caught on early was Britain's ICL. Having
survived a brush with extinction in 1981, ICL pared product
lines and limited it marketing to a few key types of
customers. More important, management punctured old
assumptions. For example, when it bought a Finnish PC maker,
Nokia Data Systems, instead of remaking the company in the ICL
image, Bonfield encouraged his managers to pick up some fresh
pointers from the younger organization. "If you've got the
same structure you've got now in two years," he says, "you'll
be out of business."
Digital Equipment, on the other hand, has only just grasped
the need for a massive overhaul. Under former CEO and founder
Kenneth H. Olsen, the company split into 150 business units -
none with bottom-line accountability. The new CEO, Robert B.
Palmer, has moved to consolidate those, to just 10 units, each
of which will have profit-and-loss responsibility. "Clearly,
we have some business units that can be more independent,"
Palmer says. One early candidate: the $775 millon disk-drive
business. But he has no plans to spin out subsidiaries as IBM
and some other big players have done, he says.
Once regarded as a basket case, Unisys now looks like a winner
in the deconstruction game. Pressed by the enormous debt that
former Chairman W. Michael Blumenthal took on in the 1986
merger of Sperry and Burroughs that created the company,
Unisys had to come to grips with reality early. Unruh says he
saw that "the economic model had changed and the cost
structures of the past were obsolete."
The resulting makeover has put Unisys well ahead of IBM and
others in many respects. Unisys began selling computers that
were designed and produced by other companies. It has pared
its work force by 54% since 1986, in part through
divestitures. It stopped making some PCs, began phasing out
two entire lines of mainframes, shut several factories, and
narrowed it marketing to focus almost entirely to four
industries: government, financial services,
telecommunications, and airlines. The idea, says Unruh, is to
understand those industries extremely well and help customers
there install complex information systems, which may not be
100% Unisys-built.
No Sacred Cows
--------------
Unruh has had the company back in the black for four quarters,
after three years of losses, and has pared debt to a more
manageable 59% of capital - down from 65.7% at the peak. But
it took measures that were painful in human terms. And, Unruh
says, there can be no end to honing operations. "Our phrase is
'a little restructuring every day.'"
Every day and every way. As deconstruction ramps up at IBM,
it's clear there can be no artificial boundaries - no sacred
cows. That means the mainframe division no longer can squelch
projects just because they might compete with its machines.
Indeed, with the future of traditional mainframe technology
dimming, IBM has several projects under way to create
chip-based alternatives. Adstar, for instance, is teaming up
with a small Silicon Vally company to produce a "file server"
that could replace a mainframe as the hub in data networks.
"We want to jump in and use the new technologies," says
Kuehler. "I'm not trying to protect our old ways."
One new way IBM is catching on it partnering. A major fact of
life in the deconstructed computer industry is that more
products are a ambigous parentage - a blend of hardware and
software from many sources. Indeed, even as it fragments, the
industry is developing a thick web of strategic alliances,
joint ventures, technology-licensing deals, and consortiums
aimed at divvying up development costs, getting products to
market quicker, and pooling technologies and skills. So IBM is
working with Apple and Motorola Co. on a new generation of
chips and software. Meanwhile, Apple works with Japan's Sharp
Electronics Corp. on handheld computers, and IBM teams up with
Toshiba Corp. on screens and memory.
Faster, Faster
--------------
Such globe-spanning alliances may be the only way for some
computer makers to stay in the game. Take Groupe Bull. It sell
NEC Corp. mainframes, IBM workstations, and personal computers
from Zenith Data Systems, which it acquired in 1990. Bull has
sold 4.7% of its equity to NEC and 5.7% to IBM and is
developing new computers that IBM will sell, too. Also, it has
joined Olivetti and Siemans Nixdorf in Trans European
Information Systems, a venture that is bidding on pan-European
projects.
"Do I worry about being hollowed out?" ask Michel Bloch,
president of Bull Systems Products, the company's main
product-development group. "Yes, it's a permanent concern. But
everything in life is a trade-off. We had to think in terms of
cost and time to market."
Indeed, next to cost, the biggest motivation for
deconstruction is speed. The vertically integrated companies
often have trouble keeping up with the product cycles being
set by tightly focused component makers. In PCs, product
cycles have telescoped from two or three years in the late
1980s to as little as six months now. Miss a beat - as Compaq
did in 1990 when other PC makers used Intel's i486 first - and
profits vanish.
Draconian
---------
Compaq rebounded this year by slashing prices and overhead,
which has put its stock back on Wall Street's buy lists - for
the moment. But the outlook for computer stocks remains
murky. Some analysts say it's no longer possible to forecast
the long-term profitability of computer companies. Over the
past several years, investors have been trampled after rosy
turnaround plans failed, to be followed by more draconian
cuts. Who's to say that more unpleasant surprises aren't in
store? "I don't detect any management team that has a real
good plan that is several years forward-looking," says Barry
Bosak of Smith Barney, Harris Upham & Co.
Steven M. Milunovich, computer analyst at Morgan Stanley &
Co., says he has begun looking at companies altogethers
differently: Forget technology and focus on marketing clout.
He likes Sun, because its identity as workstation leader is
planted so firmly in the minds of computer buyers that it
doesn't matter if Sun's technology isn't always ahead. Still,
Milunovich warns, "nothing's safe as a predictor for the long
term. You constantly have to, more than in other industries,
reassess the situation. The pieces are constantly moving."
And what does the industy's fragmentation mean for overall
U.S. competitiveness in computers? Judging from the PC
industry, the U.S. can field a lineup of aggressive specialty
firms that is unmatched anywhere. Unlocking the resources that
have been hidden inside the verically integrated monoliths can
only make those companies better at what they do. Competition
will goad them to innovate at a ferocious pace. New products
may surface that might not have in earlier times.
That's the gleam of a bright future that computer makers can
focus on. But in the here-and-now, there is still a painful
transformation to struggle through. A massive industy in the
midst of deconstructing itself is not pretty sight.
(written by John W. Verity, with bureau reports)
[this article also had 'box-articles' about Sun, ICL and
Unisys - reprints are available by calling Business Week
Reprints at 609-426-5494]
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