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The Computer Wars

Once Nintendo game machines become popular in the US and Japan, the company did everything possible to control the games that could be played on its machines. Many other companies designed video games, but unless Nintendo licensed them (and received a fee for each cartridge sold) they could not adapt the games for play on Nintendo machines. It was as if Matsushita supplied 90 percent of the VCRs in Japan and America—and only tapes licensed by Matsushita could be viewed. Nintendo maintained conditions of artificial shortages, licensing only a small number of new games per year, as a way of maintaining high prices (and license fees). It intimidated merchants in Japan and America who sold cartridges at a discount, cutting off their future supply. One dealer advertised cartridges at a few cents off the standard price. Nintendo quickly brought him back into line by suspending cartridge shipments.

Nintendo was terrified that a game-rental industry would evolve, comparable to today’s huge video-rental industry, and undercut sales. (The fear was that children would rent a game for a few days, for five dollars, and tire of it rather than buying it outright.) It told retailers that if they wanted to keep selling Nintendo cartridges, they could not sell more than one or two copies of a game to a customer. Bulk purchasers might be planning to set up rental outlets. Sheff describes Nintendo’s successful campaign to squash a challenge mounted by Masaya Nakamura, the most influential figure in the Japanese video-game industry, who was not part of Nintendo. Nakamura took the unusual step of filing an anti-monopoly suit in Japanese court, complaining about Nintendo’s practices. If anyone could challenge Nintendo, it was thought to be Nakamura. His company, Namco, had come up with the famous “Pac-Man” game. But Nintendo stonily refused to compromise, and rather than face the threat of losing his Nintendo license, Nakamura capitulated and accepted Nintendo’s terms.

Nintendo’s dominance, Sheff shows, is neither inevitable nor permanent. It was almost aborted before it started. In 1982, the American entertainment firm MCA Universal demanded that Nintendo turn over all revenues from what was at that point its only successful video game, “Donkey Kong.” MCA claimed that the game, in which janitors resembling the Mario Brothers rescue a woman from an ape; infringed the copyright to King Kong. (The odd name of this game, which was designed by Sigeru Miyamoto, resulted from Miyamoto’s search through an English dictionary. “Kong” implied ape; “donkey” was meant to suggest the stubborn wiliness of the beast.) For complicated reasons, MCA decided at the last moment not to sue, and Nintendo survived.

Now the company faces other threats. Starting in 1990, the Congress and federal regulatory agencies have scrutinized Nintendo for possible anti-trust violations. Nintendo responded by making it somewhat easier for other companies to produce games for its machines. The worldwide market for video games has stopped growing, at least temporarily, and Nintendo’s total sales fell by about 10 percent last year. Another Japanese game company, Sega, has been gaining market share against Nintendo with higher-priced but more sophisticated game machines. Sega’s games, moreover, tend to be more violent. Nintendo is holding on—last year, its pretax annual profit exceeded $1 billion—but the competition with Sega is bound to become more and more intense.

If Nintendo had been an American company, it could never have grown so large or rich. The reason does not involve differences in savings rate or work habits between the two countries. Rather, within the US legal structure the threat of anti-trust action would have hung over everything the company did. Indeed, the underlying fear of anti-trust enforcement, rather than an actual suit, is part of the background of the most famous single episode in the history of American personal computer industry.

4.

This moment occurred in 1980, when IBM was preparing for the launch of its first personal computer. At the time IBM enjoyed clear leadership in the world market for large computers, a position it had maintained since the dawn of the computer age after World War II. Its most important business decision during this period had been the introduction of its System 360 computer in 1964. The System 360, which had required enormous capital investment by IBM, offered much more computing power for the price than competing machines from companies like Burroughs and UNIVAC. “Instead of raising prices, in traditional monopolist style,” Charles Ferguson and Charles Morris wrote in their book Computer Wars:

IBM typically forced widespread price-cutting through the industry, always following up its initial offerings with a steady stream of new technology breakthroughs…. IBM’s leadership was based not on controlling a technology but on exploiting it better than anyone else.

By 1980, IBM decided it could no longer ignore the personal computer market whose potential Apple and other companies were beginning to demonstrate. IBM’s personal-systems division, based in Boca Raton, Florida, rushed to put together a system that could be based on existing components and technology, instead of requiring complete re-engineering as the mammoth System 360 had. Among the other components it wanted to acquire was an operating system for the new machine.

The most likely candidate to produce IBM’s operating system was a small company called Digital Research, whose operating system, “CP/M,” was the market leader for personal computers. But IBM could not come to an agreement with Gary Kildall, the engineer who was head of Digital. The usual explanation for this failure is that Kildall missed his golden opportunity by choosing that day to go flying in his private plane. But as Manes and Andrews point out in Gates, Kildall’s wife, Dorothy McEwen, normally handled business negotiations for Digital Research. She was there to meet with the IBM representatives—and to reject the terms they offered as being too one-sided in IBM’s favor. (Her main objection was to the “nondisclosure” agreement required by IBM, which would, as she saw it, have allowed IBM to hear all about Digital Research’s products and plans and then go out and duplicate them on its own.)

Microsoft saw more advantages to accepting IBM’s terms. Kildall’s company had only one main product, its operating system. According to Manes and Andrews, Digital Research feared that if it sold the rights to the program for the flat fee IBM was offering, it might end up with no future business base. Microsoft, by contrast, looked on the operating-system contract as a vehicle that would allow it to sell its real products—the programming languages. So late in 1980 IBM signed the agreement that would eventually help Gates and his partners Paul Allen and Steve Ballmer become billionaires.

Every history of either IBM or Microsoft describes the moment when IBM went looking for Kildall and ended up with Gates. Manes and Andrews describe IBM’s attitude toward Microsoft as an indication of how small a role the new personal-computer division seemed to play in IBM’s plans. IBM’s main goal was to get a machine on the market in a hurry. In order to do so, IBM decided to buy existing components from a number of outside suppliers, rather than go through the painstaking process of developing a new system in-house. This approach extended even to the operating system. IBM code writers could of course have turned it out, but going through their official channels might have taken several years. Gates’s Microsoft, however, could supply one almost immediately. (Microsoft, in turn, bought the rights to what was called the “Quick and Dirty Operating System” or QDOS, from the small firm Seattle Computer. Microsoft first paid $25,000 for non-exclusive rights—a sign, as Manes and Andrews stress, that Gates did not realize how valuable DOS would become—and then paid another $50,000 for exclusive rights. In 1986 Microsoft paid Seattle Computer nearly $1 million to settle a dispute over rights to DOS.)

After this start, Microsoft shrewdly eliminated rivals in the operating-system business, especially the later versions of Gary Kildall’s CP/M, and established DOS and Windows as near-requirements for PC-compatible computers. While Microsoft’s market control was solidifying, IBM’s was eroding—especially because it waited for years to challenge the “clone makers” who were trying to push it out of the personal-computer business. IBM could theoretically have discouraged the clone-makers through legal challenges, like those Apple used to keep companies from building imitation Apples. (Apple won a famous copyright-infringement case against Franklin Computer in 1983 that effectively ended the “Apple-compatible” industry.) IBM could presumably have won a price war against any smaller company, using the earnings from its big-computer divisions to subsidize cutrate PCs. It did neither until it was far too late to recover its past dominance of the industry.

Why was IBM so passive? Manes and Andrews emphasize the position of the personal-computer division within IBM as a whole. For years the company underestimated the potential of the PC business; moreover, it was afraid of making the small machines too powerful or effective, since they might then undercut its profitable large computer business. In their book Computer Wars, Charles Ferguson and Charles Morris say another factor made IBM hesitant to defend its interests in the PC business. This was the after-effect of a long anti-trust battle with the federal government.

In 1969, the US Justice Department launched a wide-ranging anti-trust action against the company, because of its dominance of the computer industry. Litigation dragged out through much of the following decade. (Ferguson and Morris say that IBM’s chief expert witness in the case, Professor Frank Fisher of MIT, named the yacht he bought with his fees The Section 3, after the relevant part of the anti-trust statute). “Many of IBM’s actions in the 1970s and 1980s, particularly its supine attitude toward small suppliers of PC components and software, can be explained as reflexes ingrained by a decade in the courtroom’s harsh glare,” Ferguson and Morris write in Computer Wars.

The suit may not have been the reason IBM went to Bill Gates for an operating system. (Manes and Andrews say there is no evidence that anti-trust fears had any effect whatsoever on this decision. The paramount reason, they say, was IBM’s knowledge that it could get an operating system sooner if it bought it from some other firm.) Nonetheless Ferguson and Morris argue, as do several other accounts of IBM, that the company’s decisions from the 1960s through the 1980s were colored by the fear of anti-trust. Ferguson and Morris say:

There is no exonerating IBM executives for their company’s sudden decline; but it is only fair to point out that for some thirty years IBM’s business was carried on in the face of official hostility on the part of the governments of almost all industrial countries, most particularly those of Japan and the United States itself.

IBM did indeed have another headache throughout the period of its dealings with Microsoft, which was the Japanese government’s determination to build a Japanese mainframe computer industry on a par with IBM’s. Marie Anchordoguy of the University of Washington, in her analysis of this project in Computers Inc., also emphasized the aftereffects of anti-trust.3 At just the moment when its Japanese competitors were becoming more collusive and concentrated, IBM was under legal pressure to allow all its competitors, foreign and domestic, more room.

The point of recalling these background factors is that they play a significant part in understanding Microsoft’s current mastery and IBM’s current predicament—and they are also virtually absent from Paul Carroll’s supposed history of the company’s troubles, Big Blues.

Carroll is a reporter for the Wall Street Journal, and his approach to the IBM story is similar to the approach his former Wall Street Journal colleague Bryan Burrough took to the RJR-Nabisco buyout in Barbarians at the Gate. Burrough and his co-author, John Helyar portrayed the excesses of the leveraged-buyout era by concentrating on Henry Kravis, Ross Johnson, and the handful of other financiers making the deals. In their case, the approach was wise, since the people they portrayed really made the crucial decisions. Carroll tries the same thing with backstage anecdotes about IBM’s executives. Nearly all of them he shows to be smug, timid, short-sighted, and out of their depth. The book presents a simple morality play, in which the out-of-touch old men of the East, at IBM’s headquarters in Armonk, get their comeuppance from younger, smarter, faster, funnier competitors in Seattle and the Silicon Valley.

Even if we accept the premise that every damaging anecdote Carroll has collected is true, they are not enough to explain what happened to IBM. Most other accounts emphasize a tangle of problems. These include bureaucratic stodginess, to be sure. But at least as important a factor was the long-term shift in technology that allowed small, cheap computers to perform tasks that mainframes used to do. The mainframe market, in which IBM was strongest, shrank most dramatically, while the small-computer market, in which IBM was still learning its way, boomed. IBM was also affected by foreign strategies aimed specifically at copying its technology, especially by Japan; and by the lasting effects of the anti-trust suit.

In Carroll’s version, these other factors don’t matter; bureaucratic stodginess is enough. The index to his book contains thirty separate entries under the heading, “IBM: bureaucratic failings of,” but not a single reference to “anti-trust problems of” or “Justice Department actions against.” (He makes passing reference to the suit in his text.) The book is riddled with embarrassing small errors that cumulatively undermine its authority.4

More than merely imprecise, the book is actively biased: nearly everything IBM does is stupid, nearly everything Microsoft does is cool. On the basis of this book it would be very hard to understand why IBM had ever succeeded at anything it had done, Carroll, to cite one of many examples, says that in 1990 Gates visited IBM’s headquarters in Armonk, and saw that on many secretaries’ desks were machines comparable to the original IBM PC XT, by then seven years old. Carroll quotes with obvious approval Gates’s contemptuous reaction: ” ‘Jesus,’ Gates said, “this tells me more about IBM than anything I’ve ever seen.’ ”

What this episode tells Gates, of course, is that IBM is hopelessly behind the times. Yet someone with a different axe to grind could use the same anecdote to make exactly the opposite point. For purely secretarial purposes the “antique” XTs would have been adequate if not sexy. They could run word-processing programs and send electronic mail. By holding onto them, a company might show its determination to spend money only where it mattered. There is a lot to be told about IBM, but not from the computers on these desks.

Bill Gates and Microsoft may soon have more sympathy for the legal and institutional pressures that weighed for so long on IBM. Two years ago, the Federal Trade Commission began investigating Microsoft for excessive market power. When that investigation concluded last year, with no finding against Microsoft, the anti-trust division of the Justice Department began an investigation of its own.

There are two main complaints about the way Microsoft uses its power. One is that its dominance of the market for operating systems gives it an unfair advantage in selling other products. For instance: WordPerfect, Lotus, and other companies sell word-processing programs that must be compatible with Microsoft’s operating system, DOS, and its popular “Windows” software. If other companies’ programs are not compatible with DOS or Windows, the programs won’t run at all on most computers, and if the programs don’t mesh well with the commands used by DOS and Windows, they will not run as fast as they could. In addition to producing operating systems, Microsoft also makes its own “application” programs—word processors, spreadsheets, and so on—that compete head to head against those from WordPerfect, Lotus, and other companies. The other companies allege that Microsoft enjoys an inherently unfair advantage, comparable to “insider trading,” since the experts who produce its “application” programs may have prior knowledge of changes in the operating systems. If that were true, Microsoft programs would always run better than programs any other company could write. (Microsoft initially maintained that it carefully separated its employees writing operating systems from those developing application programs. It no longer makes that claim; instead, it says that any contact between the groups has no significant competitive effect.)

The second main complaint involves Microsoft’s pricing policy. It gives discounts to computer makers if they pay for one copy of DOS for every computer they sell. Its operating-system rivals (mainly Novell) claim that this policy gives computer-makers no incentive even to consider alternatives to Microsoft products.

These days the computer press is full of the same sorts of grievances about Microsoft that IBM’s competitors lodged against Big Blue two decades ago: that it is arrogant and out of touch with its customers, that its leaders are becoming smug, that it rolls over its competitors with advertisements and PR.

Microsoft’s most vociferous defenders contend that the company has earned its position through technical excellence alone. Moreover, they argue that there are strong natural tendencies toward dominance, even quasi-monopoly, in high tech industries. According to this reasoning, some company, somewhere, is likely to become strong enough to set standards for the others and enjoy extra profits. Therefore it is better, from an American economic perspective, if such a company is based in Redmond or Armonk rather than in Kyoto or Tokyo. In Computer Wars Charles Ferguson and Charles Morris say the Justice Department’s scrutiny of Microsoft makes sense in theory. They add, clearly thinking of the IBM case:

On the basis of history, however, the Justice Department will harass Microsoft for the next decade without ever reaching a conclusion in the case, to the detriment of everyone except lawyers.

Ferguson and Morris suggest replacing court cases with faster, less legalistic remedies—for instance, arbitration panels with expert fact-finders. Another alternative is to relax anti-trust laws in general so that Microsoft rivals such as Lotus, Borland, WordPerfect, Novell, and even IBM can collaborate to compete with it. The Clinton administration, although dense with lawyers, is committed to “grow” the high-tech economy. It can help to do so with computers by keeping the lawyers away.

  1. 3

    Marie Anchordoguy, Computers, Inc.: Japan’s Challenge to IBM (Harvard Council on East Asian Affairs, 1989).

  2. 4

    To support this point in full would mean listing scores of errors and misemphases. Here are two from a single page, page 36: describing the computer scene in 1981, Carroll says, “it’s hard to remember back that far”—and proves his point in an unfortunate way. He says that most machines at the time “had screens that contained just a few lines.” With a few oddball exceptions, that was not true. Many computers at that time displayed twenty-four lines, just as DOS-based computers do today. Most displayed at least sixteen lines, which is not “just a few.” Carroll also says that when IBM was preparing its PC, “Even the better machines generally used tapes for data storage.” This would have been true in 1978 but was simply false by 1981, when floppy-disk drives were standard and the first hard-disk drives were coming onto the horizon for a few “better machines.” The three year difference is an eternity in the history of personal computers. Similarly, Carroll makes a crucial timing error in saying that Bill Gates had begun work on his Windows software in 1981, just as the first IBM PC was being released. In reality Windows began at least a year later, by which point the business and technical landscape had dramatically changed.

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