Sad Tales off Silicon Valley

By Alexander L Taylor III

High-tech companies encounter the hardest truths of the marketplace

To outsiders, California's Silicon Valley looks like a contemporary El Dorado. Once given over to fruit orchards, its 150 sq. mi. in Santa Clara County are home to some of America's most successful and innovative companies, including Hewlett-Packard, Intel and Apple Computer. Hundreds of other high-technology firms are trying to mimic their success. While the vast majority have prospered, quite a few are now discovering that not all the streets in the valley are paved with profits. For them, the earlier dreams of success and overnight riches have crumbled.

The problems that such companies face reflect recent dramatic changes in the marketplace for high technology. In particular, the demand for personal computers and computer software is turning out to be far weaker than numerous companies had supposed. Sales of computers and software are now expected to grow only 28% a year until 1989, according to InfoCorp, a San Jose market-research firm. That is a robust rate for most industries but a brutal disappointment for many of the valley's optimistic entrepreneurs, who were hoping for annual growth of more than 50%. Says InfoCorp Analyst Bob Lefkowits: "Eighteen months ago, everybody was predicting nothing but a rosy future. Now we're beginning to get a more realistic view."

Many developments have conspired to change the overly cheery outlook. Much of the initial enthusiasm for computers was generated by buffs and hobbyists who by now have already bought their machines. "Early market forecasting was extrapolated from that lunatic fringe," says Bill Coggshall, president of Software Access International, a market-research firm. In addition, some industry observers contend that the personal-computer revolution has been oversold and that potential customers are resisting purchases because the machines are hard to use.

Such misgivings have helped lay the hardest blows on makers of small machines. As the number of personal-computer companies grew from a handful five years ago to more than 180 today, competition became ferocious. Except for a few leaders, the firms are scrambling for shelf space in stores at a time when sales have hit an unexpected lull. Quips Fred Hoar, a former Apple executive and now vice president of Raychem, a specialty chemical company: "The personal-computer industry has reached a new chapter in its history: Chapter 11."

The marketplace is full of ailing companies. Gavilan Computer in Campbell raised $23.9 million in venture capital two years ago to help launch its first product, a 9-lb. lap-size computer, but was slow to develop an improved model. It has laid off 210 of its 280 workers, and is now looking for additional capital. Convergent Technologies has also stumbled over its portable. The Santa Clara firm introduced its lap-size WorkSlate a year ago to enthusiastic reviews. But the company could not make enough of these computers to satisfy the initial demand, and then ran into production snafus. After losing $6.5 million in the second quarter, it announced that it would stop making the WorkSlate and concentrate on its original line of products: desktop office computers.

Like more than a dozen other firms, Eagle Computer of Los Gatos staked its business on machines that are compatible with IBM's and run the same programs. Hit by an IBM lawsuit charging that Eagle copied some of its software, the company was forced to halt shipments during March, and jittery dealers stopped stocking the machine. Says President Ron Mickwee: "We lost a lot of ground and we don't have the capital resources to repurchase it." Eagle has slashed its payroll to 140 employees, compared with 335 last February, and is developing a new marketing plan while trying to satisfy its creditors. Similarly, TeleVideo launched an IBM-work-alike last year but found few buyers. "We just expected sales to take off faster than they did," says Executive Vice President Richard DuBridge. "We spent more on advertising and sales than we should have." Meanwhile, the firm's terminals business is under siege by companies in Taiwan and South Korea.

Even while these relatively experienced companies were battling storms in the marketplace, Mindset Corp. in Sunnyvale decided to set sail. It announced its first personal computer in March, several years behind the competition. Result: though Mindset's IBM-compatible machine was well received, it has not found space in dealers' showrooms. Admits President and Co-Founder Roger Badertscher: "It has been a tough summer. We probably picked the worst time to ship a new computer." Mindset laid off its entire 42-person manufacturing staff in mid-July, and is now trying to clear its shelves and come up with a new product.

Makers of the software for personal computers have also been suffering from slower than expected sales, ruinous competition and an excess of copycat products. Among the victims are two industry giants. VisiCorp, marketer of VisiCalc, a pioneering business program, has shelved plans to create its own software, cut its work force to 72 from a peak of 250 and sold the licensing rights for its troubled VisiOn package to Control Data. Another former pacesetter, Digital Research, has backed away from its ambitious move into the retail market and is focusing again on programs that are built into computers.

Other valley firms are discovering that high technology also involves high risks. Promised breakthroughs can be delayed and then produce few benefits. In addition, the high-tech firms are equally prone to the ailments that afflict all companies: miscalculation, mismanagement and even misfortune. Some electronics and computer firms along Boston's Route 128 are experiencing problems similar to those afflicting the valley.

Perhaps the most spectacular example of the peril of venturing onto technology's edge is Trilogy Ltd. Founded in 1980 by Gene Amdahl, a former IBM engineer, it was to have been a bravura business encore by the man who created Amdahl Corp., a successful maker of big mainframe computers. Amdahl audaciously planned to build a new supercomputer based on a revolutionary semiconductor chip that would be far faster than conventional ones. But, concedes Trilogy President Frederick White, "it was just too much to bite off." The company abandoned plans for both its superchip and its supercomputer earlier this year, and it lost $73.7 million in 1984's first half. Trilogy now contents itself with the production of conventional chips.

Diasonics is another firm that started as a supernova, only to turn into a financial black hole. The Milpitas maker of medical diagnostic equipment attracted some of the San Francisco area's most experienced investors and last year took in $123 million in one of the largest public stock offerings ever. But that sum has dwindled as Diasonics has lost $103.7 million since the beginning of 1983. Troubles in its line of digital X-ray devices distracted management from other problems and sapped funds before the line was sold to another company. Now Diasonics has shaved its work force from 1,700 to 1,100 and hired a cadre of former Texas Instruments executives to try to save the firm.

The once booming videogame business has also been decimated. Industry leader Atari was bought by former Commodore President Jack Tramiel in June after running up losses of $652.9 million. The computer and game maker has given up space in more than 30 office buildings around the valley in an urgent effort to cut costs. Now Activision is also threatened. The firm, whose products include such popular games as Space Shuttle and Pitfall II: Lost Caverns, had a market value of $413 million in 1983 when its stock stood at $12.63. But Activision has lost money for four straight quarters, and its stock now sells for around $1.50 a share.

As profits vanish and companies struggle, the venture-capital firms that helped fuel Silicon Valley's early growth have become stingier. Investment bankers who steer young companies toward the stock market are also cutting back. San Francisco's Hambrecht & Quist recently announced layoffs for 5% of its work force. After arranging initial public offerings for 66 companies, worth $2.2 billion in 1983, Hambrecht & Quist has managed only eight sales worth $96 million so far this year.

No one is saying that the high-tech boom is over, though, or that Silicon Valley is about to short-circuit on its own success. Well-managed companies with strong market niches are thriving, and investors continue to back new ventures in high-growth businesses. Among them: CAD/CAM machines that are used for computer-aided design and manufacturing, and computer-aided engineering equipment. Still, the El Dorado atmosphere has waned. Says Public Relations Executive Richard Moran, a former Atari employee: "A gym teacher in Indianapolis still views Silicon Valley as the promised land. But a lot of people here don't see that any more." While the valley still holds riches, its hazards are now in plain view. --By Alexander L. Taylor III. Reported by Michael Moritz/San Francisco

With reporting by Michael Moritz/San Francisco