The Perils Of Success

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In 1984 IBM had the greatest after-tax profit of any company in the history of the world: $6.58 billion. Eight years later it had the greatest corporate loss in history up to that time: $5 billion.

How could so profound a reversal of fortune happen to so powerful a company in so short a time? Simple. In those eight years the computer world changed and IBM didn’t.

IBM’s greatness lay in mainframes, the powerful computers that are now indispensable to every big business and government agency. With the introduction of the revolutionary Series 360 system in the mid-1960s, IBM came to dominate the mainframe business worldwide. And once IBM mainframes were installed, companies were very reluctant to change to another brand, because the risk of a system crash and the consequent loss of data in the changeover was too high. IBM had a monopoly.

And like all monopolies, IBM became fat, dumb, happy, and almost incredibly bureaucratic. One executive vicepresident, for instance, although among the top fifty people at IBM, still had no fewer than seven layers of management between him and the chairman. In many billion-dollar companies there aren’t seven layers of management between the janitors and the chairman.

This, of course, stifled innovation. Although IBM had been trying to develop a personal computer for years, it was only when the chairman cut through the bureaucracy and established a separate task force reporting directly to him that the IBM-PC came into being in 1981. It was one of the great commercial success stories of all time, and IBM quickly grabbed 80 percent of the exploding PC market.

But the PC, combined with the onrushing increase in the power of the microprocessors that are the heart of the beast, changed everything about the computer market. Only IBM didn’t realize it. A mainframe company to the core, IBM thought PCs could be sold in the same way. The two markets are utterly different, but IBM simply could not change its ways to deal with the new reality until disaster forced it to begin the process last year.

A reluctance to change a winning formula that no longer applies has cost many a company dearly. Henry Ford’s insistence that the Model T’s 1908 technology was just what the people needed and wanted in the mid-1920s is perhaps the most famous example. But Sewell Avery and Montgomery Ward is also a cautionary tale worth the telling.

Born in 1874, Sewell Avery had ideas about how a company, or for that matter a society, should be run that were a bit old-fashioned even in the late nineteenth century. For most of his career these ideas stood him in good stead as a chief executive. Then the New Deal and World War II changed everything about the U.S. economy except Sewell Avery.

Avery’s family had become prosperous in the Michigan lumber trade and had investments in two gypsum companies. (Gypsum is the raw material from which olaster and later wallboard are made.) Young Avery, fresh out of law school, went to work for one of these companies in 1894. In 1901 it merged with many other similar concerns to form the United States Gypsum Company, known as the gypsum trust or, inevitably, Big Gyp.

The new trust, as many trusts did, took a long while to settle down internally, and in 1905 there was an explosion in company politics. Avery became president, explaining, “I came down last, and, lighting on top, I stuck.” He proved to be exactly the right man for the job, running a very tight ship and turning the operation from a regional to a dominant national building materials company. When the 1920s came along, the company was ready to take advantage of the decade’s building boom.

In 1926 U.S.G.’s earnings peaked at more than $10 million. But while Avery took advantage of the good times in the 1920s, he never fell for the idea that they would roll on forever. He had come of age in the depressed 1890s, and that fact, combined with a natural tendency to always see the glass as half-empty, led him to be very wary of the future. He soon was known throughout the American business world as “Gloomy Sewell.”

In 1929 Avery’s predilection to expect the worst made him appear positively clairvoyant. In September of that year, the very month when, years later, economists would say the Great Depression began, Avery laid off two thousand employees, almost half the firm’s payroll. Further, he had squirreled away fully $35 million in retained earnings and had almost no long-term debt. As a result, U.S. Gypsum not only was able to survive the Great Depression, but flourished.

Montgomery Ward’s story was the exact opposite. It had been perennially overootimistic and had taken a bath in the short, sharp depression of 1920–21. In the prosperous days of the mid-twenties it began to transform itself from being simply a catalogue company into being a major retail company as well. It had 10 stores in 1926, 248 two years later, and 554 in 1930. Even in that year of gathering depression it opened 49 more stores. But it was no longer making a profit. In 1931 it lost $9 million, and its stock, which had peaked at 156 7/8 in 1929, could be bought for 6 5/8.

One of Montgomery Ward’s principal stockholders at this time was J. P. Morgan and Company, and Morgan persuaded Avery to take over and be a new broom. Avery was certainly that. He wrote off unprofitable lines, closed stores, tightened central control, brought in new certified public accountants and told them to be ruthless, hired experienced store managers, and fired the catalogue merchants who had been mismanaging the retail outlets.