SILICON VALLEY SUCCESS STORY FINDS IT HARD TO TURN A PROFIT But father and son who run the company say they can change


SAN JOSE, Calif. -- One of Silicon Valley's least-known but most striking success stories isn't in the valley at all but high on a hill overlooking Santa Cruz.

Considering the accomplishments of the Santa Cruz Operation during the 12 years since its founding, one would think that these should be the very best of times.

SCO pioneered and now dominates one of computing's fastest-growing niches -- putting the Unix operating system on Intel-based desktop computers. Thousands of businesses, from small floral shops and real estate offices to huge chains such as Radio Shack and Taco Bell, run big chunks of their operations on SCO software every day.

Privately held SCO's revenues were $135 million for its most recent fiscal year, up 30 percent from last year, putting it in the top flight of U.S. software companies. With 800 workers, the firm is one of the largest private employers in its namesake county, as well as a virtual hiring hall for computer graduates from the University of California, Santa Cruz.

But these are troubled days at SCO.

Unlike firms such as Microsoft Corp. or Novell Inc., SCO has been unable to parlay an early technology lead and a big customer base into a secure industry position. Now the company is under assault.

Among the concerns:

* In part because of its disproportionately large payroll, which most people blame on a can't-say-no approach to new projects, SCO has never been consistently profitable -- despite its big sales. That fact amazes others in the software business, where revenues a tenth of SCO's often put firms in the black.

* In the most dramatic evidence of tough times, SCO is going through the wrenching process of paring its work force, which stood at 1,300 people earlier this year. It has dismissed one in six employees in two rounds of layoffs, the most recent occurring last week.

* While it once had the field of Intel-based Unix software to itself, SCO faces new and formidable competition in its main line of business, notably from recent entries by Sun Microsystems Inc. and Novell, both of which are routinely described as better-financed and better-managed.

* The computer industry's Advanced Computing Environment initiative, a hoped-for star to which SCO had earlier this year hitched its wagon, appears to be fading. That could foil SCO's plans to expand into bigger markets.

SCO's founders, principal owners and top managers are the father-son team of Larry and Doug Michels. Larry Michels, 60, is the firm's deal-maker; Doug Michels, 37, its strategy-setter and daily manager.

Industry executives and former SCO employees say the Michelses have the assets and liabilities of classic high-tech entrepreneurs -- on one hand driven and visionary, on the other overpowering and unwilling to cede responsibilities.

But the elder Michels, SCO's president, said he recognizes the challenges facing the firm and is upbeat about triumphing over them, setting out to cut costs and emphasize profits. He also predicted a lessened role for himself and his son.

Larry Michels draws some of his optimism from recent personal experience.

Last March, seized by intimations of mortality, Mr. Michels began a diet. By exercising every morning and avoiding fatty foods, he has lost 75 pounds, with 30 to go.

"The human body is extremely adaptable," he said. "That's a lot like what we are doing with SCO. Over the years, the company developed in a way that's not right for today's market, and we are trying to change it."

SCO was founded in 1979 by the elder Michels, who had sold his credit-checking business to TRW Inc. and started a consulting company.

After Larry Michels spent a few years writing versions of the Unix software system to run on minicomputers, Doug Michels, who had become a Unix zealot at UC-Santa Cruz, hit on the idea of doing the same for the IBM and compatible machines that were just beginning to dominate desktop computing.

That plan didn't pay off, though, until the mid-1980s and the widespread acceptance of the Intel 80286 processor, which gave personal computers the oomph necessary to run the powerful but demanding Unix operating system.

Since then, SCO's Unix has become a favorite of specialized computer dealers who put together custom software packages for small businesses. SCO has about a 75 percent share of this Fortune 10,000 marketplace.

Along the way, though, the company apparently picked up some bad habits. In its attempt to popularize the still-fledgling Unix operating system, it undertook writing many application programs itself, boosting head count, often with no discernible effect on profits.

"It's a company that attacks in all directions," said Dataquest analyst Paul Cubbage.

Larry Michels concedes that SCO is unfocused and, while refusing to discuss profits, said SCO is undertaking to concentrate on its core businesses.

Despite the challenges, Mr. Michels said SCO's future is bright.

The company, he said, just had its best quarter ever. A series of reorganizations has streamlined operations; the company has also brought in a number of top managers from other high-tech firms.

Mr. Michels also said that shorn of unprofitable divisions, SCO can now begin concentrating less on mom-and-pop outfits and more on "major accounts," such as Northwest Airlines and K mart, both of which recently chose SCO software.

And while he's mum about plans for going public, he said, the recent moves could be interpreted as early steps toward an initial public offering of stock.

So, too, could Mr. Michels' efforts to downplay the role he and his son will play in the future.

His son's role, Mr. Michels said, "is diminishing." As for himself? "I am anxious to be SCO's statesman."

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