(FORTUNE Magazine) – THE MANAGEMENT challenge that Ken Olsen now confronts at Digital Equipment Corp. is taking the measure of his brawny self-assurance. Relying on little more than his own strong will as a lever, the company's founder and chief executive is trying to move an organization of 123,500 souls the way a woodsman might shift a boulder: with a combination of basic engineering and brute force. ''People are always reluctant to change,'' says Olsen, 64, a vividly intelligent man with merry blue eyes and the rounded bulk of a retired lumberjack. ''Teasing them, tricking them, manipulating them -- that's all part of the job of management.'' Digital certainly needs moving. Having risen since its 1957 startup to 27th on the FORTUNE 500 by engineering superior computers and software, the company has fallen victim to its own success. Just as the popularity of its VAX family of computers reached a peak in the late Eighties, a formidable new type of desktop computer -- the workstation -- took the business market by storm. Offering radically increased power at much lower cost, workstation technology inspired corporate buyers to question the value of minicomputers -- much as Digital's minis had challenged low-end mainframes in the 1970s. Instead of rushing to offer competitive workstations, the company initially responded with scorn, losing billions of dollars of potential orders from such loyal customers as Boeing and National Semiconductor. The lesson, though obvious, bears repeating: If anyone is going to make your products obsolete, it had better be you. The Maynard, Massachusetts, company is still paying the penalty for having lost touch with customers. In the fiscal year that ended in June, the company's revenues came in an estimated $1 billion under budget while expenses soared. Says a rueful Olsen: ''You can be sure our plan was perfect -- it's just that the assumptions were wrong.'' Even before a one-time restructuring charge of $550 million, last year's earnings dropped to less than a third of their 1988 level. The price of Digital's stock has been plunging like a falling safe, from $199 per share three years ago to a recent $56. At one point in 1987, shares of Digital, No. 2 in the U.S., and No. 1 IBM were both trading around $165; this December the stock market valued an IBM share at $111, twice Digital's price. Digital's dilemma is how to attract new customers without alienating loyal buyers. Since the spread of cheap workstations, just about the only folks eager to buy a VAX are those who already have invested heavily in the older technology. The VAX customer base includes most of the world's big companies and adds up to over 400,000 systems averaging several computers each. But to grow, Digital needs new customers. Defending itself in the crucial low end of the computer market, Digital has cobbled together its own line of workstations and even resells Tandy PCs. To succeed in the long run, however, the company somehow must integrate the popular features of workstations into its whole array of VAX computers. That is precisely Olsen's plan. He is betting the company's revival on a technological grand design centered on a new product line, including computers code-named Alpha. Designed to match the power of workstations, Alpha represents a financial and technical challenge substantial enough to strain even Digital's hitherto ample resources. But the strategy makes sense, and according to Digital watcher Terry Shannon at International Data Corp., a Massachusetts market research firm, ''They have the technical wherewithal to bring this product to market.'' Even so, the execution won't be easy. Like many technical types who end up running companies, Olsen is what Danny Miller, a Canadian business professor, calls in his book The Icarus Paradox ''a tinkerer,'' who focuses on providing levels of quality that customers may not care about. And if Olsen may produce the right machines, his beleaguered sales force will have to overcome enormous obstacles to market them. At best, his plan probably won't begin to improve earnings greatly until 1992. Digital's financial discomfort is what brings the element of brute force to Olsen's program of change. The company is trying to cut costs by an estimated $1 billion annually. The first layoffs in Digital's 33-year history are expected early in 1991, a move that should improve the company's notoriously low productivity (see chart, last page). ''We're well past the denial phase,'' says William Strecker, head of engineering and a member of Digital's six-man executive committee. ''We don't have to explain to people anymore why they have to change.'' DIGITAL CAME OF AGE selling minicomputers to customers who didn't need much hand-holding, mainly scientific labs and corporate engineering departments. Over the past decade its VAX machines grew to dominate sales so completely -- accounting for up to 90% of the total -- that Digital became almost a one- product-line company. Amid the complexities of big-time computing, the line's simplicity delighted customers. Says Olsen: ''When we had a monolithic product line we really pushed it hard. But a temporary marketing thing is all it was. It was never meant to be a religious issue.'' / With the minicomputer market drying up, traditional mini makers such as Data General and Prime Computer are losing money. Aware that Digital needed to set itself apart, Olsen decided almost ten years ago to push the company out of what then seemed a cozy niche. Henceforth it would try to offer a full range of products and -- just as important -- services, such as the customized system design that big corporate customers often require. That meant playing Avis to IBM's Hertz, taking on a rival five times Digital's size. Innocuous as it may have seemed at the time, Olsen's decision implied a redesign of his entire company. To compete effectively with IBM, Digital is having to alter almost everything: its product line, distribution, pricing, cost structure, organization, even its beliefs. Says Olsen: ''I used to laugh at IBM for changing its organization all the time. Now I respect them.'' Olsen manages Digital as a Japanese might, investing heavily in promising long-term projects at the expense of current results. Late in 1989 the company introduced the first VAX mainframe, the model 9000. Despite widespread doubts about its future, the mainframe business is far from dead; it's the middle of the market that is hurting. The 9000's introduction has been troubled: The first machines were shipped nine months late, and in December the company had to retrofit them to fix a snag. Though Digital's profit margins are being squeezed hard -- the company posted its first-ever quarterly loss in June -- VAX products still generate enormous amounts of cash, and Digital's balance sheet remains nearly debt-free. That has enabled Olsen to spend up to $1.6 billion annually on R&D and $1 billion on capital projects, mostly related to Alpha. The Alpha line is still what software jocks like to call vaporware. According to International Data's Shannon, the first box probably won't be shipped for at least 15 months, and the complete line may not appear for two years after that. So Digital is racing against the clock: By the time Alpha arrives, analysts believe the bountiful VAX revenue stream may have started to diminish. OLSEN'S STRATEGY represents a stunning turnabout. He spent years resisting the idea of ''open systems,'' the industry's hottest buzzword; now he is trying to redefine the term. In a hypothetical open system, everyone agrees, computers and software made by different companies would communicate and share files freely. But Sun Microsystems, the workstation leader, has popularized a much narrower definition: computing built specifically around AT&T's Unix operating system. An operating system is the layer of software that mediates between any computer and the applications software it is running, such as a spreadsheet program. In the PC world, operating systems are what define much of the difference between an IBM-compatible computer and an Apple Macintosh. In the world of what Ken Olsen calls ''real computers,'' producers usually designed new operating systems to go with their new machines, creating a briar patch of incompatible proprietary systems. Like a child, each operating system may be perfectly well behaved within the confines of its own sandbox, but it won't share its toys with the other kids. For a computer maker, the advantage of a proprietary system is that it locks in the customer; that is why so much cash continues to flow in from Digital's older products. Companies such as Bankers Trust spend two-thirds of their computing budgets buying and customizing software, and they usually can't afford to adapt programs and files based on one operating system to make them work with another. According to Domenic LaCava, a Digital vice president, the company's antiquated PDP-11 line, introduced way back in 1969, still generates over $900 million in annual sales. Sheltered from competition, computers running on proprietary systems generally provide profit margins of 60% or more, vs. 40% for standard Unix workstations. DIGITAL HAS SOLD its own version of Unix with VAX machines for years, but 90% of its revenues grow out of its proprietary operating system, called VMS. The most successful system software in history, measured by unit sales, VMS works on every single VAX computer, from workstation to mainframe. That unique degree of commonality made it easy and relatively cheap for VAX customers to expand: They simply bought more VAXs and plugged them in. William Demmer, the vice president in charge of VAX/VMS products, says VMS was designed to last forever. When Sun Microsystems started out in 1982 it had no operating system at all. Shrewdly, the new company adopted AT&T's Unix and pushed it as an industry standard. Although strictly speaking a proprietary system, Unix offers two important advantages. Unlike Digital's VMS, Unix is available to anyone who pays a license fee to AT&T. Another key feature: Unix works with almost any type of hardware, from a PC to a Cray supercomputer. Measured by the ratio of price to performance, Sun's Sparc workstations beat comparable VAX machines by a factor of at least 3 and sometimes as much as 10. Bargain-minded customers flocked to Sun. Many computer buyers came to view Digital's money-minting proprietary system as a bit of a rip-off. The unprecedented power of the Sparc workstations depends on a new architecture for microprocessor chips, called RISC. It breaks complex commands down to a few simple instructions that can be executed at blinding speed. Thus far RISC technology has shown up mainly on workstations running Unix, but there is no necessary connection between RISC and Unix. It also turns out that in many commercial applications, such as transaction processing, Unix is considerably less powerful and reliable than Digital's VMS. In late October, Olsen dropped his first public hints about the Alpha line. Digital, he said, is designing a new generation of VAX machines powered by RISC chips. The company is also drastically revising the VMS operating system and related software to make Alpha compatible not only with all existing VMS programs, but potentially also with software running on Unix and every other major operating system -- even Macintosh and MS-DOS, used on IBM PCs. Suddenly Digital's approach to open systems seems even more open than Sun's: It does not require a single, standardized operating system. Instead, it depends on a set of industry-standard designs for those elements of an operating system that interact with either the computer hardware or the person at the keyboard. CHANGING THE VMS operating system to meet those industry standards is an undertaking of monumental complexity. Thousands of Digital software engineers are involved in the task of rewriting VMS's ten million lines of code -- each of which must work perfectly on every type of VAX -- and applications software that runs on VMS. If they succeed, their efforts will enable Olsen to turn the tables on Sun: A computer running on VMS will be able to swap programs freely with any computer running any operating system that follows the same publicly available standards. ''We're the biggest supporters of open systems,'' claims Olsen. ''That's because almost no one else can afford to do it.'' One who agrees is Marc Schulman, a respected analyst at Union Bank of Switzerland's U.S. securities subsidiary. Says he: ''I believe Digital is intensely committed to open systems. I'm very satisfied that its strategy will produce a pronounced recovery for the company -- not right away, but sometime in calendar 1992.'' That gutsy call is backed by sharp reasoning: The momentum toward open systems is unstoppable, he argues, and the companies with most to gain from it are those, including Digital, with proprietary operating systems. Freer competition should benefit the most powerful products. GETTING ITS NEW message across to customers will be Digital's greatest challenge. From Olsen on down, the company is a marketer's nightmare. Joseph DiNucci, formerly a Digital sales manager, is credited with pushing the company into RISC/Unix workstations; he is now a vice president at MIPS Computer Systems, which sells RISC chips to Digital. DiNucci remembers the first time he heard Olsen speak: ''He said, 'I believe technology is everything -- if you design a good enough product you don't even need a salesman.' I said to myself, 'I came to the wrong company.' '' Like the company he created, Digital's old boy just isn't the marketing type: Self-confident to a fault, he does and says what he wants, sometimes at Digital's expense. ''We always say the customers are right,'' says Olsen, wrinkling his broad nose as if he'd smelled a rotten fish. ''But they are not always right.'' A committed Christian, Olsen hews to basic values in matters of management too. His opposition to layoffs and commission-based pay for salesmen is legendary. He encourages academic-style intellectual freedom among his subordinates, who may debate major decisions for months or years -- while customers go elsewhere. Given Digital's awful stock performance, uncertain prospects, and breathtakingly quirky leadership, some consultants and former employees think the company would be better off if Olsen, now 64, were to retire. No way, responds the founder. ''I plan to be here 20 more years,'' he says with a sly grin. ''I'm always aiming at the company being self-running without me, but it hasn't happened so far.'' In fact Olsen has encouraged so many strong executives to leave that no obviously credible heir remains. The case against Olsen rests on two main criticisms -- that he is out of touch with the industry, and that he lacks the particular management skills a company grown as large as Digital needs. Gordon Bell, one of the strong men Olsen drove out, believes only the first criticism is valid. As head of engineering, Bell led the VAX development team; he later ran the National Science Foundation's computer research program. He is clearly not objective, but his trenchant views are respected. Says Bell: ''Olsen is their No. 1 problem.'' Relevant or not, the proposition that Olsen is out of touch is easy to support. An anachronism in the age of PCs, Olsen doesn't use a computer for business. A poor typist, he even dictates his electronic mail to a secretary. Says Olsen: ''If I find a use for a computer, I'll get one.'' Nevertheless, he was a big backer of Digital's disastrous foray into PCs in 1982. The company produced three machines with three different operating systems, none compatible with the IBMs that became the industry standard. The result: a market share in PCs under 1%. Olsen says the biggest users of Digital-designed PCs are the Soviets, who stole the technology and produced some one million units. OLSEN ALSO KILLED several promising early development programs in workstations and RISC chips. Many talented Digital executives left to work for Sun. Says one: ''Sun would not have existed if Digital had done its job right.'' Olsen concedes the point, but argues that focusing on VAX paid off because it financed the company's stunning growth in the 1980s and the Alpha R&D. The second criticism of Olsen is more chilling. Says Dale Kutnick of Meta Group, a computer consultant to many FORTUNE 500 companies: ''Ken is brilliant and a good leader, but they need plain old management of the kind that IBM builds: big-company professional management. Digital is barely on the edge of control in terms of the way it does business.'' Olsen firmly believes that a more focused organization, not new management, is what's needed to solve Digital's problems. To that end, he is giving P&L responsibility to the account managers assigned to each major customer. He has also been reshuffling executives and has begun retraining the company's 24,000 salespeople. To force costs lower, Olsen is demanding that managers measure the cost of each of the company's products and services against those of the competition and find ways to price them competitively. One thing won't change: Olsen's heavy reliance on Digital's engineering expertise. Digital is the only computer company in history with the technical discipline to integrate so broad a product line around a single operating system; it is widely regarded as the premier provider of complex networked systems. That skill could prove crucial in the new world of open computing, as big companies struggle to tie together their hitherto isolated PCs, Macintoshes, workstations, minis, and mainframes. For all his winning self-deprecation, Olsen is a prideful man, like some of the New England Puritans who are his spiritual inspiration. But his plans appear sound, and his conservative fiscal policies have left Digital remarkably well positioned to finance the corporate reformation he has in mind. If Olsen can hang on to his job and bring his present plans to fruition, he has a real chance to restore the company to its accustomed position of industry leadership.

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