Big Changes in the Mill : From a New CEO to a New Home, Digital Is Busy Remaking Itself

Mark Fredrickson, a public relations manager at Digital Equipment Corp., believed that he knew a plausible rumor from a silly one.

So when whispering began earlier this year about a plan to abandon the historic red-brick mill--Digital’s birthplace, headquarters and spiritual home--Fredrickson told colleagues that it wasn’t true. The company’s problems were severe, sure, and the new man in charge was committed to change, but moving out of the mill, well, that was unthinkable.

The unthinkable has happened. Digital is abandoning the mill, ostensibly to save money. Yet it is also a perfect symbol of Chief Executive Robert Palmer’s determination to bury the corporate culture and business strategies of Ken Olsen, who founded Digital and built it into the world’s second-largest computer company before his abrupt departure last year.

Palmer, in fact, is giving something of a tutorial in how to bring radical change to a big, ossified East Coast computer company--a lesson that will not be lost on IBM’s new chief executive, Louis V. Gerstner Jr.

Palmer has reorganized Digital from top to bottom, slashed costs and jobs and recruited a new management team from outside. Even the color of the logo has been changed.

Already, a torrent of red ink that reached $3 million a day last year has been reduced to a trickle, and Digital shares are up to about $45 from a low of $30 (compared to a high in 1987 of $199.50).

With a new-product lineup centered around the super-fast Alpha chip--the brains of a high-powered new personal computer unveiled Tuesday--and a clear plan for regaining ground in all its main businesses, Digital seems poised for a comeback.

But is it too late? Digital is playing catch-up in all its core businesses, against competitors both numerous and battle-hardened. And there is also the risk that radical change will destroy what made the company great: excellence in engineering.

“Palmer is great, a very smart guy, and broadly speaking (the strategy) makes sense,” says consultant Charles Ferguson, co-author of a new book on competition in the computer industry. “But it’s a very nasty world out there.”

In hindsight, it is easy to see how Digital backed itself into such a tough spot. The company revolutionized computing in the 1960s and 1970s with the minicomputer--machines much smaller and cheaper than the mainframes of the day. But in the 1980s, Digital fell victim of its own devices, failing to see that cheap little personal computers would do to minis what minis did to mainframes.

Digital also failed to understand that PCs would help push the whole computing world toward standardized machines that could easily be connected with one another. Under Olsen, a strong-willed engineer, Digital remained religiously committed to its own proprietary hardware and software.

The popular VAX minicomputers and their accompanying software--as well as the service and accessories that went with them--were huge money makers. But suddenly, a couple of years ago, business began to dry up. Olsen recognized the problems but did not take the drastic steps needed to solve them and resigned last summer under pressure from his hand-picked board.

Enter Bob Palmer, 52, the slick-dressing, straight-talking opposite of the rumpled, enigmatic Olsen. Something of a surprise choice to run the company--he had been head of Digital’s modest computer chip operations after making his name as founder of a chip company called Mostek--Palmer relished the challenge of radical change.

He is not shy about cutting jobs: Employment is down to 98,000 from a peak of 137,000, and more layoffs--probably about 10,000--are yet to come. Moving out of the mill will save more than $10 million a year. And for the first time, Digital will cut spending on product development and engineering--by a whopping 19%.

“We had to rationalize our spending, have less redundancy in hardware and software design,” Palmer says, referring to Olsen’s philosophy of funding competing development projects and then seeing which one turned out best.

“We’ve been characterized as quite indecisive, with multiple strategies but a lack of clarity in terms of who’s accountable for what,” he adds. That began changing in December, when Palmer split the company into nine business units, five devoted to specific customer groups and four devoted to particular products and services.

To head the new units, Palmer recruited a string of well-regarded outsiders. Enrico Pesatori, who had been president of Zenith Data Systems, is running the new personal computer unit. Paul Kozlowski, founder of Contel Cellular, heads the division responsible for selling to communications and entertainment companies. John Klein, a respected IBM veteran, is in charge of marketing to consumer-goods companies.

The idea is that the customer groups will be more closely tuned to the needs of particular markets--oil companies, say, or telephone firms--than the geographical sales organizations they replaced. They will work with central engineering to come up with the best product, but will also be free to go to outside vendors for pieces of the total solution.

Meanwhile, some of the product groups--notably the PC business--will be highly independent and will not have to pay for central engineering and other overhead functions. Pesatori says the structure will enable Digital to compete with anyone.

“In the PC business you have to play by the PC rules,” he says. Successful PC firms such as Dell, he adds, generally spend only 2% to 3% of revenue on R&D; and have profit margins in the 3% to 5% range--both far below the norm for traditional computer companies such as Digital.

“We’re starting from scratch and building an organization in line with those numbers,” he says.

While Pesatori’s initial focus is on the commodity PC business, what could ultimately give Digital a competitive advantage in desktop computers--and elsewhere--is the Alpha chip technology.

On Tuesday, Digital unveiled the first of its Alpha PCs, which will use Microsoft’s new Windows NT software system. Though much faster than traditional PCs using Intel microprocessors, the Alpha machines are also far more expensive--prices start at $6,795--and will likely appeal only to sophisticated business customers for some time.

Digital envisions Alpha chips at the heart of everything from mainstream PCs to the huge computers that will store video images for new interactive TV services. Big Alpha machines will gradually replace the huge installed base of VAXes (still the core of Digital’s business), while small ones will move onto office desktops, providing many times more power than the standard PCs of today.

Some workstations and minicomputers using Alpha have already been introduced.

Based on RISC computing technology, which allows computers to process information much faster than conventional technologies, Alpha is widely regarded as one of the best new computer designs in the world. Yet it came to the market late--Olsen was a tardy convert to the benefits of RISC--and Digital must duke it out with competing designs from Intel, Sun Microsystems, Hewlett-Packard, Silicon Graphics and an Apple/IBM/Motorola consortium.

All the competitors are trying to persuade other computer vendors and software developers to adopt their RISC chips, which are now being used only in expensive desktop workstations but will gradually find their way into PCs. Digital is behind, especially in promoting systems that use the Unix software standard rather then proprietary designs.

Digital’s best hope may be with Microsoft’s Windows NT, yet NT will also run on Intel chips and Silicon Graphics chips, and maybe others as well. So the question is, will anyone need Digital?

“There is a war for control of the next set of business systems architectures,” says Ferguson, adding that it is far from likely that Digital will win.

Digital Rising Again?

After piling up profit in the 1980s, Digital Equipment Corp. was blindsided by changes in the industry and plunged into the red. Now, under a new CEO, the the company may be on its way back.

Tuesday close: $44.63, down $1.38 Source: Company reports, Bloomberg Business News