OK, time for a bit of a history lesson here.
First of all, Lionel (except for its scale Hudson), Flyer and Marx O-gauge trains were always classified as just toys. The serious adult O-scale hobby was quite seperate from them. Those adults who dabbled in these toys, even modified ones, were not widely regarded as a true part of the O-scale community by the mid 1930's and later became known as Hi-Railers, a subset of hobbyists which MR and RMC both thought so little of after the war that they totally ostracized them from the pages of both magazines, classifying them as not being serious scale modelers.
Concerning the division of the hobby by scale, the following are the statistics for scale modelers , not toy train operators, as published in the pages of The Model Railroader magazine. These typically appeared every year or so, with a final compilation also being published in the March 1950 issue.
xx 1936 37 38 39 40 41 42 43 /47 48 1949
HO 36% 34 37 39 46 46 54 49 59 62 69
- O 58% 50 49 41 38 38 31 36 28 22 22
OO 21% 10 11 17 14 15 14 12 09 07 02
(edit: sorry about the way this table looks, couldn't get it to space out right)
The HO scale locomotives in this era were no mere toys. They were accurately scaled and closely represented existing prototype locomotives from various railroads. Varney, Walthers, Mantua, Gilbert and Roundhouse/MDC were all producing locomotives in this class before WWII, with several of them offering entire lines of HO locomotives. This was in addition to a number of custom builders who, for a price, would make you anything you could desire (these custom engines were on the level of today's brass models).
Indeed, prior to the war, many of these trains were operated via outside third rail and some even by AC power but they had no resemblance to out-of-scale, three rail O-gauge toys sold by Lionel, Flyer, or Marx. By the very late 1930's 2 rail DC was becoming increasingly common and my father had a fully operational 2 rail HO layout in '39.
Regarding the Varney piece, if indeed from 1939, it seems surprising dated in its outlook. Alan Lake Rice had built operating HO trains as early as 1927 and had been publishing articles in the hobby press about them for a decade by then. By the late 30's more than half of all the articles in MR centered around HO. Perhaps the message that the Varney material is attempting to convey is that the hobby, in general, was at that time one best suited to skilled craftsmen and not for idle dabblers. You admittedly needed to create and do an awful lot yourself but the same was just as true whether you were in O, or HO. This was still the age when many layouts operated off 6 volt car batteries wired through old secondhand rheostats!
I suspect that very few hobbyists today have a really clear and accurate understanding of the particulars of the hobby's evolution, which often leads to disbelief and confusion over facts whenever the true situation is presented.
NYW&B