Communications of the ACM

Viewpoints

Computing in the Depression Era

By Martin Campbell-Kelly
Communications of the ACM, October 2009, Vol. 52 No. 10, Pages 21-22
10.1145/1562764.1562775
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Since the beginning of the computer industry, it has been through several major recessions. The first big one was in 1969; there was a major shakeout in the mid-1980s; and most recently there was the dotcom bust in 2001. A common pattern observed in these downturns was that they occurred approximately five years after the establishment of a new computing paradigm—the launch of the IBM System/360 platform in 1964, the personal computer in the late 1970s, and the commercial Internet in 1995. These new computing modes created massive opportunities that the entrepreneurial economy rapidly supplied and then oversupplied. It then took only a small downturn in the wider economy to cause a major recession in the computing industry.

The current recession appears to be quite different when compared to these earlier downturns. Unlike in earlier recessions, computing is not a victim of its own excess, but is suffering from the general economic malaise. Computing is not much different than any other industry in the current recession—it has no unique immunity. However, it has no unique vulnerability either, which offers a small amount of comfort.

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Lessons from the Great Depression

To get some insight into what is happening today we have to look back to the Great Depression. Electronic computers did not exist at the time of the Wall Street crash of 1929, of course. But there was an office machine industry whose products—typewriters, adding machines, and accounting equipment—performed many of the tasks now done with computers. Indeed, the most successful of the early computer firms sprang from the office machine industry—IBM, NCR, Remington Rand (later Univac), and Burroughs among them.

During the depression years protectionism was seen as one of the policy options. Because this option still surfaces from time to time, it is instructive to see what happened in the 1930s. The U.S. was a net exporter of office machines, so it was not interested in protectionism in this sector, of course. Most of the drive for protection came from nations that imported office machinery—but these polices were often the result of a tit-for-tat elsewhere in the economy. The world's two biggest exporters of office machinery in the 1930s were the U.S. and Germany. Most other advanced countries, such as Britain and France, had their own office machine industries, but they found it difficult to compete at the best of times. Their response in the depression was to impose "ad valorem" import duties of 25% or 50%. In these countries import duties combined with a general lack of business investment made office machines formidably costly, and the domestic products were not always an adequate substitute. Although the import duties on office machinery may have briefly helped domestic manufacturers, retaliatory protectionist measures in other industries simply led to a downward spiral of economic activity. At the height of the depression in 1932, office machine consumption worldwide was down a staggering 60%. It is a difficult lesson, but selective protectionism did not help in the Great Depression and it won't help today.

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IBM and NCR

The cases of IBM and NCR make interesting contrasts in weathering the economic storm.^a NCR fared badly—it didn't go out of business, but it was not until World War II that it fully recovered. In 1928, the year before the crash, NCR was ranked the world's second largest office machine firm (after Remington Rand) with annual sales of $49 million; IBM was ranked the fourth largest with sales of less than $20 million. A decade later, and well into the recovery, NCR sales were only $37 million, whereas IBM had sales approaching $40 million and it was the largest office machine supplier in the world.

The depression years 1929–1932 were a desperate time for NCR. Before the crash it had been a wonderful firm to work for. Headquartered in Dayton, Ohio, it had built a "daylight factory" set in urban parkland in the 1890s and it had pioneered in employee welfare, with all kinds of health, recreational, and cultural benefits. During the depression years NCR's sales fell catastrophically. Overseas sales, which had formerly amounted to 45% of total sales, were badly affected by protectionism. According to the then-CEO Edward Deeds "commercial treaties, tariff barriers, trades restrictions, and money complications" took "productivity from the Dayton factory." It had to cut its work force by more than half in order to survive—from 8,600 down to 3,500 workers. At the worst of times, all that could be done was to sponsor a relief kitchen, run by the NCR Women's Club, to feed the unemployed and their families. Mirroring the fall in business, NCR's shares fell from a peak of $165 in 1928 to $6.79 in 1932. Recovery was very slow, and was only fully achieved with the coming of World War II when NCR was put to work making armaments, analog computer bombsights, and code-breaking machinery.

The story of IBM in the Great Depression could hardly be more different than NCR's. IBM's main product line between the wars was punched card accounting equipment, which was the most "high-tech" office machinery. There were machines for punching and verifying cards, others for sorting and rearranging them, and the most complex machine—the tabulator—could perform sophisticated accounting procedures and report generation. Although orders for new machines fell drastically, IBM's president Thomas J. Watson, Sr. decided to maintain the manufacturing operation. Watson reasoned that rather than disband IBM's skilled design and manufacturing work force it would be more economical, as well as socially desirable, to stockpile machines for when the upturn came. For IBM, the upturn came in 1935 when President Franklin D. Roosevelt launched the New Deal and the Social Security Administration. The new administration was hailed as the "world's biggest bookkeeping operation." IBM turned out to be the only office machine firm left that had an adequate inventory of machines to service the operation and it supplied 400 accounting machines to the government. It was a turning point for IBM and its profits soared for the remainder of the 1930s. Watson was justly celebrated for his faith in the future. He became a confidant of Roosevelt and chairman of the International Chamber of Commerce.

Heroic as Watson's strategy was, it would not have been possible for NCR, Remington Rand, or Burroughs to do the same. IBM had an income that was practically recession-proof. First, IBM's machines were not sold but leased. The manufacturing cost of an accounting machine was recovered in the first one or two year's rental, and after that, apart from the cost of maintenance, the machine revenue was pure profit. The accounting machines had an average life of at least 10 years, so it was an extremely profitable business. During the depression, although new orders stalled, very few firms gave up their accounting machines—not only were they dependent on the equipment, but they needed them more than ever to improve efficiency. During the depression years, while IBM did not lease many new machines, it was kept afloat by the revenues from those already in the field.

IBM's second big revenue source was the sale of punched cards. IBM enforced a rule—and got away with it until an antitrust suit in 1936—that only IBM cards could be used on IBM machines. Cards were sold for $1.40 a thousand, far more than they cost to produce. Card revenues accounted for an astounding 30% of IBM's total revenues and an even higher percentage of its profits. Because cards were a consumable, firms had to continually purchase them so long as they were still in business.

The key difference between NCR and IBM was that NCR made almost all its money from the sale of new machines, whereas IBM made its money from two sources: leasing and the sale of punched card consumables. Looking back at the NCR and IBM experiences with the benefit of hindsight, we can see it was an early incarnation of the product-versus-services business models. When they start out, product firms have the advantage that they get a very rapid return on investment. In a single sale, the firm gets all the returns it will ever get from a customer. This helps a firm to grow organically in its early years. In contrast, when a services firm takes a new order it gets a modest annual income extending over many years. This slower rate of return makes it difficult for a firm to retain profits to achieve organic growth and it may need access to capital until it starts to generate a positive income. But the slower growth and steady income makes for much less volatility. As Communications columnist Michael Cusumano noted in 2003—writing in the aftermath of the dot-com bust—the trick for survival of all firms is getting the right mix of products and services.^b Products generate a rapid return on investment, but services provide a steady income that gives some immunity against recessions. It's not easy to get the balance right, but IBM did it in the 1930s.

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