An Ecological Theory of the Creation of the Computer Industry

That was a mighty long recess!! Over 35 years ago, many of you were captive in my sales training classes about financing computers. Some others of you were captive in my classes on Finance for Non-financial People.

You can relax. There will be no term paper required or any quizzes - and only one question.

Charles Flint, of General Motor’s fame and the very wealthy George Fairchild formed the company by combining three previously existing companies with a total capitalization of $6.5 Million – a whole lot of money in 1911. This was some years before Tom Watson, at age, 40, was hired for an obscure marketing position where he remained for ten years before becoming President.

The National Cash Register Corp. (NCR) was founded by John Patterson, who owned the patents on the cash register. One of his better salesmen was young Tom Watson who, working out of Rochester, New York would load five cash registers on the back of his horse drawn wagon and not come home until they were all sold.

Patterson believed that 100% of the cash register market was his by divine right and he took umbrage with anyone who dared to try to compete with him. If someone had the audacity to try to compete for the cash register business, he would make a “Chinese copy” of the competing machine and sell it below cost. Selling these machines, which were called “knock out” machines, readily assured him of his desired market positioning!

Tom Watson was one of the best salesmen of “knock out” machines and he had a rapid rise up through the ranks of NCR – assisted by marrying Patterson’s daughter.

Ultimately, a more devilish competitor, in the form of people selling used NCR cash registers arose. Patterson was livid at the thought of someone making money off of “his” machines and searched for means to quash them. The plan that he adopted was to put $3 million into a “sub-rosa” corporation, with Tom Watson as President, which would open a store across from the offending store and sell new cash registers below cost. This certainly had the desired effect of discouraging such resellers and the rise of a secondary market.

To John Patterson’s and Tom Watson’s surprise, the US Justice Department took a dim view of these proceedings and indicted this pair of outstanding citizens and charged them with a nefarious crime. Not only were they indicted, they were tried. Not only were they tried, they were convicted. Not only were they convicted, they were sentenced and they, who were used to a standard of living that many of us would envy, were being offered somewhat less lavish, albeit free, accommodations in one of the facilities of the Federal Government.

They were out on bail, during an appeal and while the government was trying to decide where to house them, when the great flood of 1912, triggered by a tornado, hit Dayton. The campus-like NCR plant was the only high ground in Dayton and the populace of Dayton was moved into the NCR plant.

Tom Watson and his wife and her sister were in New York where they had gone shopping for clothes – obviously for the women as Tom was about to be provided with free clothing. This was fortunate as he, in New York, and Patterson, in Dayton, were able to organize a relief train which was the last one to get through the flood. THEY SAVED THE POPULACE OF DAYTON.

After the above incident, no Ohio judge was going to enforce their jail sentences and Paterson and Watson were pardoned. However, soon thereafter, Patterson fired his son-in-law for not being the “fall guy” during their recent misadventure and providing his father-in-law with what, in current parlance, we call “believable deniability”.

Tom then found his way to the Card-Tabulating-Recording Company (C-T-R), the company that I mentioned earlier, which had been founded by Flint and Fairchild. Flint wanted to hire him as VP of Marketing but Fairchild, who was the Chairman of the Board, was opposed to hiring a character with such a nefarious background. They reached a compromise – Tom could be hired, but only for an obscure position with little authority.

This obscure assignment, which lasted until Fairchild died ten years later, provided Tom with ample time to contemplate his past sins and to develop a scheme to prevent the future from repeating the past.

If no one could acquire ownership of IBM equipment, he would never have to face a secondary market.

He devised what he called a “Machine Service Agreement” which provided service on a listed number of machines which machines were included in the agreement. This agreement bundled the maintenance and hardware into one monthly equipment service –not equipment rental – charge, and without an option to purchase. He wanted to avoid any possible implication that the customer was acquiring the equipment or accumulating any interest therein. He also provided the personnel to operate the equipment (for after all he owned it and reserved the right to determine who could operate it) – who were put on the customer’s payroll – but beholden to IBM for their future careers.

(His worst fears were later realized when “purchase options”, mandated by the Justice Department, were exercised by “third parties” to acquire ownership of IBM equipment and an extremely active secondary market emerged.)

When, after 10 years he became President of C-T-R, he changed the name of the company to the International Business Machine Corporation (IBM).

It is my thesis that it was this Machine Service Agreement which created the data processing industry. I maintain that the customers (for other than engineering or scientific applications) would never have been able to justify the “purchase” of these very expensive machines and that the “computer data processing” industry would not have developed! Witness the relatively small process computer industry, which being “one of a kind” systems could not be rented: - few of them were sold even though their benefits were much more easily quantified. Gerald Philippi in the late 1950’s, when he was GE’s Comptroller, advised GE’s Managers of Finance to place computers on order – then after cleaning up their procedures to get ready to install them – cancel the order as they would have achieved 90% of the contemplated savings and the computer acquisition would no longer be justifiable!

Amazingly, very few people ever saw this Machine Service Agreement. Wherever possible, IBM negotiated a “master” agreement at the highest level of management in their customer. GE had over 100 different locations using IBM equipment and the DP managers merely executed “schedules” to add equipment to this Master Machine Service Agreement. When we were writing the “terms and conditions” to our “Use Agreement”, I received contradictory information from Sales and Marketing concerning IBM’s terms and conditions. When I went looking for a copy of an IBM agreement all I found were these schedules. I finally tracked down GE’s “Master Machine Service Agreement” somewhere (I no longer recall where) at 570 Lexington Avenue and only managed to get a copy after demonstrating a “need to know”.

Not only was IBM in the enviable position of providing equipment to “their” DP Managers under this Machine Service Agreement, by merely adding schedules, they did some other things that made it possible for these DP managers, who were beholden to IBM for their training and professional progress, to add lots and lots of peripherals and upgrades to these systems which, if purchased, could not have been justified in the first place:

· The “Master” Machine Service Agreements made it easy for them to acquire the equipment within their expense budgets by merely adding a schedule – avoiding those nasty Appropriation Requests which would have required extensive justification and been reviewed by all levels of management up to and including the Board of Directors.

· IBM convinced corporate managements that their Purchasing Agents were not capable of evaluating the acquisition of data processing equipment and had them give the DP Managers purchasing authority. This bypassed the purchasing agents with their annoying and time-honored practice of requiring three competitive quotes and negotiating for better prices and terms.

· IBM convinced many of the corporate 500 to pass board resolutions prohibiting the “purchase” of computers[1] – again negating the need for Appropriation Requests, and greatly increasing the cost of entry for potential competitors who would need to compete with the Machine Service Agreement by also providing equipment on a monthly rental basis.

· There was a conspiracy of silence where the “IBM beholden” DP managers did not readily acquaint their management with problems with IBM equipment and/or software. This gave IBM a huge number of “beta sites” to test and improve their offerings.

It’s remarkable that competition was ever able to make any inroads into this tightly controlled market.

When Dr. Gale “Buck” Cleven finally broke IBM’s power in the Hughes Aircraft Company, he returned over 30% of the IBM equipment to IBM as being excess.

In conclusion, like the butterfly in the rain forest that effects the ecological balance of the world, THE COMPUTER INDUSTRY IS A RESULT OF a small Ohio tornado that caused a flood!

[1] The Ford Motor Company, in the mid 1960’s, acquired a GE process control computer that was built into a carburetor test stand with a planned life of ten years. It made no financial sense for Ford to acquire this computer, which would have three shifts of usage, on a short-term rental basis – with overtime charges. In order to get around Ford’s board resolution prohibiting the purchase of computers, the author wrote a 30-page addendum to Ford’s standard computer monthly rental agreement to morph it into a seven-year net-net finance lease.