ROCHESTER, MINN. -- IBM's Application System 400 is its wonder machine and it is made here. Developed in half the time of its predecessor, there now are 400,000 of the mid-range systems scattered throughout the world, mostly in small businesses that need help with managing distribution systems or keeping track of grain sales.

Since it hit the market two years ago, its reliability has been so good that its warranty has been extended from three to 12 months. With price tags ranging from $17,000 to $750,000, it's a big revenue producer for International Business Machines Corp. at a time when computer sales across the board are in a slump.

So if the Rochester plant's machine and the other products it makes are so terrific, how come it got passed over last year in the Malcolm Baldrige Quality Award sweepstakes, the Commerce Department citation that business treats as its Oscar?

That was just the question that rankled IBM, and it set the computer company off on a campaign to understand, first, where it had gone wrong and, second, what to do about it. The effort paid off last week when IBM's Rochester operation was one of four recipients of the 1990 Baldrige award, named for the late business leader and Commerce secretary.

As important as the prize, however, is what IBM learned about itself in the process, some of its executives say. Losing the competition the first time signaled IBM that even though it was making a fine product in the middle of a cornfield in Rochester, it was not paying enough attention to what customers wanted. And it had to make quality a much higher priority throughout the company -- beginning at the top.

"Everyone has always been focused on quality and customer satisfaction," said Larry Osterwise, site general manager in Rochester. "The question was the level of our intensity."

The story of how IBM finally won the award has a lot to do with the Rochester plant itself.

The plant was known for its strong Midwestern work ethic, high morale and willingness to try new things. It was there that IBM began to emphasize customer satisfaction as an equal to technological prowess.

Unhappy AS/400 customers found themselves treated as opportunities instead of problems, recruited to help design improvements to new models. Customers got unsolicited calls from retirees like Irene Burke who wanted to know if everything was all right with their AS/400. Special software partnership labs were set up where customers and dealers could spend time in Rochester working on special applications of the computer's software.

Managers, engineers, programmers and technicians went from solving customer problems to "overpowering" them, as IBM put it. One programmer in Rochester, for example, worked nonstop one weekend to add new problem-solving capabilities to a computer to meet a customer's last-minute request. By Monday, the improved system was up and running, Osterwise said.

In the pink-and-white factory areas and "clean rooms" in Rochester, performance evaluations of managers such as Karl Shurson came to depend as much on how much "reworking" of mistakes their workers did rather than how many parts they turned out. Employees began to check the defect rating of their team when they punched in for their shifts.

IBM says it didn't begin its new quality campaign just because it lost the first Baldrige competition, but the timing was close. In fact, last January, as Rochester was racing to prepare its second Baldrige application, the company was making some of the very quality improvement changes that the Baldrige examiners had suggested the previous year.

Needed Corporate Focus "We lacked a corporate focus on quality. We were not supported in Rochester," said Roy Bauer, a manufacturing expert and self-described perfectionist who was picked to lead an eight-month drive to win the Baldrige, a job he handled the year before as well.

Bauer may well have been IBM's secret weapon.

A 45-year-old dyed-in-the-wool, truer-than-blue IBMer, Bauer became known as "Roy Baldrige" around the site. If it took sleeping at work, never seeing his family, sacrificing his health and driving dozens of people to perform, he would do it to win the award and somehow keep smiling.

Bauer doesn't neatly fit the perception of the upwardly mobile executive. He expresses an unabashed love of the Midwest and his desire never to leave it. He doesn't want to climb the corporate ladder. He didn't go to a prestigious college. He has no advanced degrees. He bowls.

In Bauer, IBM picked a mid-level manager willing to do a job that would heap acclaim mostly on his bosses if he succeeded, and never mind the risks if he failed.

More importantly, Bauer understood how to motivate people in Rochester to win the award, woo the judges, keep his bosses on his side and play IBM's sprawling internal bureaucracy like an instrument.

For example, it fell to him and a few others to do a 48-hour deadline rewrite of several sections of the Baldrige application that arrived "in not very good shape." Diplomatically, he waited until the authors of those sections went on vacation. He had to mop up the tears of team members when "corporate" looked at the first draft of their 75-page application and decided Bauer and his team "didn't answer the questions. They didn't even understand the questions."

And there was the bickering. Wasn't the team giving short shrift to the company's legendary employee benefits and human resource policies in writing about IBM's attributes? What should be printed on the white hankies that employees would wave at the celebration party if they won? He thought "customer service" would be nice. The higher-ups disagreed because they feared it would look like people were blowing their nose on IBM's customers.

Learned From Mistakes In an interview, Bauer recalled with embarrassment that IBM's top quality manager from headquarters did not participate in the all-important site visit in Minnesota by the Baldrige examiners the first time around -- a serious error in strategy that the judges picked up on. Bauer further theorizes that the company, with all its worldwide resources, lost "on the intangibles down in Washington" the first time and got beat by companies like Xerox Corp. that heavily promoted their quality strategy and had savvy marketing campaigns.

But this time, things were different.

IBM took pains to deal with its lack of a strong company-wide quality emphasis by installing a detailed plan intended to reduce defects to a minuscule number -- the target for 1994 is to make only 3.4 mistakes per million operations, one of the most ambitious such goals in any U.S. company. Customer satisfaction and involvement in new product design and development were to drive the company's business strategy instead of the latest and fastest in technology. Warranty costs, which totaled a painful $2.4 billion in 1989, had to be pared back.

A new senior vice president of market-driven quality was appointed who reported directly to the chairman of IBM, John F. Akers, who became a convert to the quality cult.

While it worked to improve its operations, the company also took direct aim at winning the prize, studying the application process for the award backward and forward. Rochester team members played the parts of visiting examiners, rehearsing questions they thought they would be asked.

They played the parts well. Bauer and 20 other Rochester employees were in the audience last week when Akers accepted the Malcolm Baldrige trophy from President Bush at a Commerce Department ceremony.

What it looked like to the hundreds of people witnessing the event was that IBM was being rewarded for the uncommonly high quality of the Rochester operations.

Little did they know it was the end of a humbling experience for a company that had tried not once but four times with various divisions to win the prize.

"I was delighted that we lost," Akers said just before he had trophy in hand. "It was important for IBM people to realize we were not as good as we needed to be. The worst thing would have been to win the first time."