LA CONCEPCION COLLEGE

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Capital Budgeting
(Digital Equipment
Corporation)

Angelique B. Abog
BSAT 4A
Ms. Ma. Melissa U. Bulic, CPA
Company Background

Digital Equipment Corporation (DEC), American manufacturer that created a new

line of low-cost computers, known as minicomputers, especially for use in
laboratories and research institutions. Founded in 1957, the company employed
more than 120,000 people worldwide at its peak in 1990 and earned more than
$14 billion in revenue. It was bought by Compaq Computer Corporation in 1998.

Digital was founded by Kenneth Olsen and Harlan Anderson, electronics engineers at the
Massachusetts Institute of Technology (MIT), with the idea of building a family of high-
performance, low-cost computers that could receive and analyze data from a wide array
of scientific instruments. The influential business magazine Fortune had published an
article showing that few companies were making any profit selling computers, and so
Olsen’s first business plan referred to building electronic “modules” in order to appeal to
his nontechnical investors. Digital’s first computer, the Programmed Data Processor, or
PDP-1, was sold in November 1960. Eventually 50 PDP-1s would be sold, nearly half to
International Telephone and Telegraph for message switching systems.

Based on technology developed at MIT for the Whirlwind Project (1944) and Project
Lincoln (mid-1950s), the PDP-1 had one of the most advanced memory systems of its
time and brought many innovations to the commercial marketplace. For example, the
PDP-1 incorporated the transistor-driven core memory design of the TX model
computers built by Olsen during Project Lincoln, and the machine improved upon the
Whirlwind computer’s timesharing capability—i.e., the ability to be used by more than
one person at a time. This capability made the PDP the first machine employed for
multiuser computer games when MIT students created SpaceWar! in the early 1960s.

The PDP line of computers sustained Digital’s growth for nearly 20 years. The PDP-8 was
the first minicomputer to achieve significant market success. (See the photograph.)
When it shipped in 1965, it offered the first viable alternative to mainframe computers—
the powerful, but expensive, machines built by companies such as the International
Business Machines Corporation (IBM) and the Sperry Rand Corporation (makers of the
UNIVAC computer). The entire PDP line had advanced features that appealed to a variety
of technical markets. For example, the PDP-11, introduced in 1970, was the first
computer to ship with a separate data communications path, called the UNIBUS, that did
not require using the resources of the central processing unit to move data inside the
system. Moreover, Digital competed on price with other minicomputer competitors
(such as the Hewlett-Packard Company) by reducing its manufacturing costs through
various innovative programs, including building assembly plants in inner cities where it
hired and trained only local residents. In 1971 Digital set up its European manufacturing
operation in Ireland—a move that paid off in 1973 when Ireland was admitted into the
European Common Market, helping the company quickly to seize a sizable market share
in Europe.
Between 1960 and 1970, Digital grew from a local computer company with 117
employees and $1.3 million in revenue into a global company with 5,800 workers
generating $135 million in sales. By the mid-1970s, however, the company’s leadership in
the minicomputer market was being challenged by IBM and other companies. In 1978
Digital introduced the VAX (Virtual Address eXtension) computer, arguably the most
successful minicomputer in history. The VAX line of systems ranged from low-cost
desktop workstations to high-end computers that challenged IBM’s most powerful
mainframes. Its operating system, known as VMS (Virtual Memory System), became
popular among software developers, giving VAX users a large selection of software
applications. In the early 1980s, Digital also helped to develop a version of the UNIX
operating system to run on the VAX, in part to appeal to university departments where
UNIX was popular but also to compete against Sun Microsystems, Inc., Silicon Graphics,
Inc., and other computer vendors who sold systems using UNIX. By 1990 VAX sales had
propelled Digital into the number-two computer sales position (behind IBM).

However, Digital’s success throughout the 1980s did not continue in the next decade. Hit
hard by the 1991–92 general economic recession in the United States, Digital lost market
share to Hewlett-Packard and Sun, companies whose adoption of the nonproprietary
UNIX operating system made far more software applications available than Digital’s
proprietary VMS. The company did not make a profit at all between 1990 and 1995. In
response, the board of directors removed Olsen as top executive, replacing him with
Robert Palmer, an executive at Digital since 1985. In 1995 Palmer succeeded Olsen as
chairman of Digital.

Meanwhile, the company continued to introduce a variety of new products. Its Alpha
microprocessor was possibly the fastest chip in the world when it began shipping in
1994; its search engine for the World Wide Web, Alta Vista, became one of the most
frequently visited Internet sites; and the company’s services division was one of the most
respected and profitable in the industry. Despite these advantages, Digital’s efforts to
counter competitive pressures in its main business of minicomputers and workstations
were insufficient. Likewise, its personal computer business failed; beginning in the early
1980s with its Rainbow PC, Digital never succeeded in earning money in this fastest-
growing segment of the computer market. By 1997 it became a target for acquisition,
and in 1998 it was purchased by Compaq in a cash and stock transaction totaling $9.6
billion. By that time Digital had 53,500 employees, less than half of its 1990 peak.

What happened to Digital Equipment Corporation?

Digital Equipment Corporation was perhaps the second most important computer company in
history, behind IBM. Its minicomputers challenged IBM, and, indeed, Unix first ran on a DEC
PDP-7. DEC’s Alpha CPU was one of the few chips to make Intel nervous for its x86 line. It
created the first really good Internet search engine. In a just and perfect world, DEC would still
be dominating. Instead, it faded away in the 1990s. What happened to Digital Equipment
Corporation, or DEC?

DEC in summary

Digital Equipment Corporation is a legendary company. It spend 25 years in the Fortune 500,
peaking at number 27 in 1990 and 1993. Its peak revenue was $14.6 billion in 1996, but from
1991 to 1996 it lost money every year but one. In 1996, its peak revenue year, it lost $112
million. By 1998, DEC was #116 on the Fortune 500 list.

DEC made PCs, minicomputers, Unix servers, workstations, CPUs, networking chips, and the first
great Internet search engine.

Compaq bought DEC in 1998 for $9.6 billion, a significant discount from its profits of that year.
DEC had a lot of technology that Compaq didn’t really want, but Compaq bought it for the
services business. Compaq saw services as the key to driving its future growth.

Compaq didn’t want the minicomputer business, or the Unix business, or the Altavista search
engine, and it certainly didn’t want the chipmaking business. An upstart from 1982 picking apart
its business, keeping what it wanted and selling off the rest like a corporate raider was a sad,
inglorious end to a once-proud company.

Why?

In 1988, DEC was on top of the world. It was the second largest company in the industry, an
investor darling, and everything looked great from the outside. But the company already had
problems.

DEC’s biggest problem was responding too late to the rest of the industry. The original IBM PC
was no threat to the DEC VAX, but 1986’s Compaq Deskpro 386 was. DEC also ceded too much
of the workstation market to companies like Sun Microsystems.

DEC’s response

DEC’s competition came in fits and starts. DEC started a RISC project called PRISM in 1985 to
replace the VAX architecture. It cancelled the project in 1988, and its lead developer, Dave
Cutler, and much of the PRISM team went to Microsoft, where they built Windows NT. Soon
after, DEC started work on the Alpha CPU. Windows NT ended up running on the Alpha, but DEC
could have had control of it, rather than sharing it with Microsoft. In the meantime, DEC built a
MIPS-based workstation that became popular. DEC didn’t transition that market smoothly to
Alpha, effectively killing a successful product.
DEC mishandled Alpha too. Apple was interested in using the chip in what became the Power
Macintosh line, but DEC never really took the offer seriously, creating a missed opportunity.
Commodore wanted to put the Alpha in its ill-fated Amiga too. DEC was slow to line up second
sources, and couldn’t produce chips as quickly or inexpensively as Intel. DEC had a successful
chip business, between its Strong ARM CPU, Alpha CPU, and its Tulip network chip, which for a
time was the best network chip for Linux machines. The Tulip was one of the first, if not the first,
good quality inexpensive Ethernet chip and it ended up on mass-market cards from companies
like D-Link, Linksys and Netgear.

DEC’s chip business would have been more successful if DEC could have simply produced more
chips.

The downsizing

Then DEC started downsizing in 1990. Over the course of six years, it cut its staff in half, at a cost
of $4.8 billion. The loss of skilled workers cut its production capacity and cut the company’s
reputation for stability.

DEC pushed out Ken Olsen, its controversial CEO, in 1992. Olsen didn’t get along with his board
of directors and the board of directors didn’t understand the company business.

The Internet

Google’s Larry Page and Sergey Brin pitched their Pagerank system that became Google to DEC
in 1997.

Nothing shows Digital Equipment Corporation’s vision like the Internet. It opened the first
commercial homepage on the Internet in October 1993. DEC wasn’t the first large business on
the Internet. It was the first business, period. Not only that, DEC was on the Internet long before
the Web. DEC accidentally invented spam way back in 1978 with a mass-mailed announcement
of its then-new System 20.

Altavista was the first commercially successful search engine, and Larry Page and Sergey Brin
approached DEC in 1997 with their Pagerank system before founding Google. Page and Brin
would have preferred to join Altavista.

DEC also invented the firewall. Computer security is a big business of course. DEC could have
been in that booming field from the beginning.

Finally, there’s printing. DEC’s printing business was never as big as that of HP or Lexmark, but it
was profitable. Whether DEC stayed in that business or sold it, printing was another missed
opportunity for Digital.
Misconceptions about DEC

Many analysts say DEC was too slow to get into PCs. This is a bit of a misconception. DEC was
right there in 1982 with its innovative Rainbow, which could do triple duty as a VT terminal, a
CP/M machine, and an MS-DOS machine. Its problem was that it wasn’t completely IBM
compatible. But DEC wasn’t the only one to make that mistake.

What happened to Digital Equipment Corporation

It’s popular to say that DEC relied too long on clunky terminals connecting to minicomputers
running VMS and Unix. But that’s an oversimplification.

In 1989, DEC introduced a line of Intel-based PCs within its DECstation line and DEC got more
and more aggressive with Intel-based PCs as the 1990s came on. Analysts frequently accuse DEC
of positioning proprietary machines against PCs, but that was only part of its strategy. IBM
didn’t compete against itself enough and maybe DEC competed against itself too much, but lack
of a PC strategy wasn’t enough to sink the company. If DEC were around today, it’s entirely
possible it wouldn’t be in the PC business anymore anyway due to the slim margins.

It’s also popular to criticize Digital’s reliance on VMS and Unix. It is to get DEC VMS and Digital
Unix out of environments. One can’t, even though 99% of the company wants it gone. Compaq
didn’t want them after it bought DEC, and HP didn’t want them either after it bought Compaq,
but both companies found them profitable. Had DEC, who did want them, continued, those
businesses would have flourished in their niche. VMS would be even harder to get rid of if the
company selling it actively marketed it and supported the two products’ cult following.

Ken Olsen: Punching bag

Ken Olsen never said there was no market for home computers. He meant there was no market
for evil computers.

DEC’s cofounder and second CEO, Ken Olsen, is frequently misquoted as saying there was no
market for home computers. That misquote, from 1977, is always taken out of context. Olsen’s
overall message when he addressed MIT in 1977 was that the computer as people knew it at the
time wasn’t welcome in homes. He was right. Nobody wanted HAL from 2001: A Space Odyssey
in their home. In the early 1980s, children’s books about computers had to answer the question
of why so many adults were afraid of computers.

Ken Olsen’s overall message in 1977 was that the industry had work to do. And even as the
home computer craze of the early 1980s rushed in, that work wasn’t done yet.
The biggest problem with Ken Olsen was his loss of his mentor, Georges Doriot, in 1987.
Without Doriot to advise him, Olsen couldn’t manage his relationship with his board of
directors. And when the board of directors forced Olsen into retirement, they replaced him with
Robert Palmer. Ken Olsen may have been the wrong person to turn DEC around in 1992. Robert
Palmer, as it turned out, wasn’t the right person either.

It’s important to remember DEC wasn’t the only company in trouble in 1992. Wang Laboratories
went bankrupt that year. IBM replaced its CEO in 1993 with Lou Gerstner. Even companies who
didn’t replace their CEOs in 1992 like Compaq and Apple downsized significantly that year.
Robert Palmer had six years to turn the company around and didn’t succeed.

What might have been with DEC

It’s not hard to imagine an alternative universe where the Alpha ended up powering the Mac
and Amiga. Whether an Alpha-powered Amiga would have been successful is another argument,
but we know an Alpha-powered Mac would have been commercially successful. DEC didn’t
know how to sell Alpha chips, but Apple would have known.

Meanwhile, Altavista could have easily become Google. That’s potentially bigger than all the rest
of this combined.

And besides all of that, DEC had a successful and profitable services business, its own line of PCs,
its minicomputer and Unix businesses, and should have had a booming Internet security
business.

If DEC had realized what it had, it would have a good problem today: Being too dominant and
having antitrust concerns. If DEC had restructured with better focus sometime in the early
1990s, it would have made fewer mistakes and at least preserved more of its shareholder value.
A DEC with missteps likely still would have been involved in some mergers in the 1990s and
2000s. But it could have been a buyer instead of a seller.

IBM’s example

IBM had to engineer a turnaround in the early 1990s, restructuring some businesses and
ultimately leaving some businesses, such as PCs. There’s every reason to think DEC could have
done the same thing. DEC wasn’t as big as IBM. But DEC had potential IBM didn’t.

IBM is no longer the company it was in 1998 when DEC sold out. Today in 2017, IBM is #32 on
the Fortune 500 list. It was #6 in 1998 and it’s been sliding for two decades, but it’s still around.
IBM no longer competes in Intel-based PCs and servers, the market DEC was criticized for being
too little, too late in. Today, IBM survives on services, hosting, minicomputers, Unix servers, and
mainframes. DEC had successful competing offerings in all those spots except mainframes and
hosting. The hosting business didn’t really exist in the 1990s.

So the IBM example provides something of a worst-case scenario for DEC if it had survived: a
mini IBM. Had DEC found success in one thing IBM couldn’t replicate, it could have been IBM’s
equal. If not, it might have turned into HP. HP today isn’t too different of a company than DEC
would have been, and it’s #61 on the 2017 Fortune 500 list.

Conclusions and Suggestions

1. The DEC should focus more on what they have than what they do not have.
Although they have the technologies that would one day become like Apple, they
still look for more opportunities that is way out of their line. There is one time
that they went to food industry selling donuts.

2. At the time of downsizing, DEC should weigh which is more important and it
should be employees over products. Some of their products are truly not
profitable. Their employees have the potential in making new technologies. The
massive lay-off only cause them a major loss.
3. DEC lacks marketing. If there should be a good portion of their capital for
marketing expenses, they will thrive and more people will be engaged to their
products. There is a simple problem of economic allocation going on inside the
company.

4. Based on the revenue 14.6 billion dollars in 1996 but lost an amount of 112
million in dollars. Everyone in the company should have known that it is a big
problem considering a large sum of revenue is lost. There is a problem with the
capital budgeting decisions.