Chapter 14 - Internetworking: Emergence 1985-1988
Sales and profits of 3Com grew substantially in 1986. The last minute break-up of the proposed merger with Convergent Technologies in March 1986, however, left 3Com management uncertain as to the focus of their core strategy: a workgroup or communications company. As Bill Krause, Bob Metcalfe and other key managers met, they supported two goals. Krause remembers:
The primary goal was to create a company that would withstand the test of time, and live beyond its founders. This was our emotional carry-over I had from my HP experience. I really wanted to be part of building something that became an icon in Silicon Valley. Goal two was that I had seen too many of my colleagues overstay their time. It was because it was easy to start companies at a young age and we didn’t have the natural, built-in age barrier that more mature companies had where you became president at 50 and retired at 60, so at the end of 10 years, you’re out of there, and the company got some new, fresh thinking. So I made a commitment that, at the end of ten years, “I’m out of here, and I encourage you guys to do the same thing.” So this all sort of fit in with the fact that there were three of four more years to go before ten years was up for me and we needed to get somebody in place to be our potential successor.
Was it possible to imagine both goals being met with either core strategy? The Board of Directors wanted a resolution to the uncertainty and one core focus. When the Board met in January 1987, a decision was reached: to become the second largest communication company. Conceding leadership only to DEC.
Soon afterwards, Krause remembers a call from Bert Nordin of Digital Communication Associates (DCA):
Bert Nordin was chasing everybody. He badly, badly wanted to merge with 3Com. He flew me down to Atlanta and gave a big pitch and argued the merits of merging, and then he took be out of dinner. I explained the situation to Bob, because Bob and Howard were fully aware that I was going down there. So we go to the Board.
The Board realized market consolidation was inevitable and encouraged Krause and Metcalfe to analyze the best options for 3Com. They were also decisively against any combination with DCA.
By this time, Krause and Metcalfe had been meeting frequently with Bill Carrico and Judith Estrin of Bridge Communications. Estrin explains:
We had been talking off and on for years, because first, we did joint development with them, and I knew Bob Metcalfe, and we were located nearby. Then we had a reference sell arrangement with them, and then we OEMed their product. Metcalfe, Krause, Bill and I used to get together for lunch every couple of months, just to talk about the relationship. You know, how was the OEM relationship? How can we do these things? Every once in a while it [a merger for example] came up, and it was never the right time and no one wanted to talk about it. This time, it was kind of the right time for both companies, and I think Krause called Bill.
Concurrently, Carrico and Estrin had also been assessing how to create an enduring strategy. Carrico remembers:
We were convinced that we had covered the one segment of the marketplace very well, what we call ‘the general purpose LAN segment.’ There was another segment of the LAN market, which we called ‘the system vendor segment,’ which is DEC with its networking equipment. The third piece was ‘PC networking,’ which was really very distinct, because the PC networking was focused on application sharing over the network, where the general purpose was focused much more on communications and connectivity. So the customer said: “Wait a minute. I’ve got these PC networks and I’ve got these general-purpose multi-vendor networks. I don’t want to have to buy this from two vendors.
Listening and, like exceptional entrepreneurs, acting, Carrico and Estrin had been having serious conversations to combine with Novell, 3Com’s principal competitor. In early 1987, however, the parties terminated conversations. So when Krause called Carrico after 3Com’s January decision, it required little imagination for merger conversations to come up. Carrico opines:
I don’t think there was any issue in our minds about the strategic benefit. From that perspective, we’d do it again.
Wasting little time, on July 27, 1987, 3Com and Bridge Communications (Bridge) announced a merger valued at $193 million.75 When the merger was finalized on September 29, the value of $151 million was significantly lower due to the decline in the market price of 3Com’s stock. Nonetheless, the fiscal four months ending September 30, 1987, 3Com’s sales were $42.3 million and Bridge’s $25.8 million giving, after accounting eliminations, combined sales of $67.9 million and net income of $4.1 million. The financial markets were valuing the “new” 3Com at a little more than two times sales, a far cry from the venture capital multiples enjoyed just a few years earlier.
In a report on Bridge Communications (Bridge) by Datapro, dated a month earlier, June 1987, the significant investment required to participate in the general-purpose LAN market is mirrored in pages of products. In contrast, a similarly composed list of 3Com’s products would barely fill a single page. Noteworthy, Bridge had introduced four Data Link level bridges, both local and remote. The merging of these two companies had clearly created a leading communications company with an early footprint in the Internetworking market.
Krause, who retained overall management responsibility as the CEO of 3Com, had seemingly found his successor when Carrico was named President and COO of the combined companies. On a personal level, Krause could easily entertain thoughts of soon leaving 3Com – just as he had imagined. Estrin became one of six general managers reporting to Carrico.
Metcalfe assumed the title of the general manager of the Distributed Systems Division – euphemistic for workgroup computing. How was communications to be the focus of the company while investments continued to be made in workgroup computing, the vision of the founder of the company – Metcalfe’s vision?76 Krause laments:
Then we had this moment of uncertainty about whether or not we should be a computer company or a communication company. And I bet on the wrong idea, but the right guy, who was one and the same. Carrico had the right idea, which was become a communication company. Metcalfe wanted to continue being a computing company and continue with the 3Station project. He thought we were on the right track. So I bet on Metcalfe’s strategy, which was the wrong thing to do, but Metcalfe was the right guy, because it turned out that Carrico recognized, and to Bill’s credit he recognized it, that he was an entrepreneur and that he should bail out and go start another company.
Carrico remembers the challenge of merging the two companies:
What was the big surprise was the culture clash was much more than I ever imagined it would be. I certainly knew that there were culture differences. I knew what I was getting into, but it was just real hard. Also it was hard because Judy and I had gotten very used to running a company more directly, where I was, at Bridge, more involved in the day-to-day activities, and overnight, I was managing through six general managers. It wasn’t as much fun. Judy, on the other hand, went the opposite direction, in that Judy had been second in command at Bridge, and now was just another general manager at 3Com.
So in May 1988, Carrico and Estrin resigned, to briefly rest, and then to research another fertile market into which to launch another start-up. Krause, on the other hand, again assumed the mantle of President and once again the ponderous and tiring responsibility of resolving the unresolved decision of company focus. He remembers:
So Bill left. We didn’t replace Bill. I took Bill’s presidency back, and we formed the divisions, and Eric [Benhamou] moved over to head up the software division, and Bob was heading up the distributed systems division. I had chosen Bob, and Bill had opted out. So we were off to go do our workgroup computing strategy.
The superb financial results of 3Com continued with sales for fiscal year ending May 1988 of $252 million, up from $156 million, or up 62 %, and net income of $22.5 million, up from $16.2 million, or up 39%.
Not all was a walk in the park. The challenges of merging two different sales forces, and the disappointing results of the LAN Manager network operating system were forcing Krause to reconsider the choices that had been made. He reflects:
What I underestimated – didn’t recognize – was the conviction of the customer to use industry standard products. That was mistake 1. Mistake 2 was underestimating the capability of our own company. I had concluded that I had made a serious strategic error in trying to become a workgroup computing company, because we really didn’t have the horses to compete with people like IBM and Compaq and Dell and AST and all these other guys. We just didn’t have it.
3Com did have a significant footprint in the Internetworking market, with a market share of 19% of the installed base of bridges and routers, thanks largely to the products inherited from Bridge Communications. However, the indecisiveness over the company strategy, more specifically, the unwillingness to focus on computer communications, did not hold well for its Internetworking future.