Bill Gates
Appearances
Acquired
Microsoft Volume II
I'm a little hoarse today, so hopefully we don't have to do a lot of talking.
Acquired
Microsoft Volume II
What are they smoking? Keep going. So here's how to pull it apart. Yahoo had about 15% market share of search, which I think was number two. Google was way, way, way ahead. And so on the face of it, you're thinking, wait, $47 billion to buy 15% market share in search? But there's actually two other assets in here. There's Yahoo Japan. Yep. And there's a stake in Alibaba. Not just a stake.
Acquired
Microsoft Volume II
So collectively, those two assets together are worth over $30 billion. So if you back it out, it's really only like $15 billion to buy 15% of the search market.
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Microsoft Volume II
So would you want to pay a billion dollars per percent of market share of that market? Yeah, sure. It's just money. Why not? I mean, it's the craziest thing. This would have been ludicrously profitable to spend only $15 to buy 15% of the search market, which is way bigger than $100 billion and still growing.
Acquired
Microsoft Volume II
Yes. Now, because this is counterfactual and we actually don't know what would have happened, Yahoo completely went away. They sold for $5 billion in their most recent transaction to be co-owned by Verizon and Apollo. So there's this real question of like, okay, if Microsoft bought all that traffic, would they actually have been able to harness it and build a Google-like business?
Acquired
Microsoft Volume II
Or would it have just gone the way that Yahoo was going to go anyway? But to make the bull case on that, Bing is a good business. It just has a small market share. Microsoft succeeded finally in 2009 at attracting all the right talent and taking it really seriously and building a super viable search engine that does, I don't know, something like a billion a year in profit.
Acquired
Microsoft Volume II
Where did you find that? It's in his book. Oh, my gosh. It's in Hit Refresh. I always thought he was in the marketing side. Well, at Microsoft, product managers are marketers. They don't live in the engineering org.
Acquired
Microsoft Volume II
Fascinating. There's so many things about his history that are not a part of the common narrative. Like he, I think, worked in Dynamics, their Salesforce competitor, their CRM for a while.
Acquired
Microsoft Volume II
Okay, all right. Pause, pause. Okay, some of the other fun tidbits of this Yahoo deal. So Bing powers Yahoo search. Microsoft does the ad sales for both sides. So while Microsoft doesn't get the user, you know, they don't have the direct relationship with the users, they do get to build up their marketplace liquidity on the advertiser side, right?
Acquired
Microsoft Volume II
And as you mentioned, there's a huge data advantage of actually powering the search.
Acquired
Microsoft Volume II
While Yahoo gets 88% of the revenue in the deal for the first five years, arguably the value from this basically all accrued to Microsoft because they ended up building out not only a proper advertising business, which now is used on a number of different sites, I think even in partnership with Netflix for their ad-supported tier,
Acquired
Microsoft Volume II
Bing, once it had all the Yahoo traffic, needed to be a scaled web service. Yes. Like a distributed computing system that operated at 24-7 uptime with super low latency, fast response time, and huge scale. God, that sure sounds like the cloud. It sure sounds like the cloud. So you've got Xbox Live, where they have 40 million users.
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Microsoft Volume II
You have a scale search engine, which is like the number one most difficult distributed computing problem that if you get good at that, you can get good at lots of other stuff. The ingredients are really starting to come together for the right talent and DNA at the company to do well in building out the cloud. Yeah.
Acquired
Microsoft Volume II
Yep. Okay, so at the end of all this, you might be wondering, why was search so important? How did Microsoft get so obsessed with the search engine? Why are they still running Bing today? Why has it been this sort of white whale for them where they continue to try over and over and over again to do search deals or acquisitions or things like that? Well, search monetizes incredibly well.
Acquired
Microsoft Volume II
So Microsoft is sitting there realizing, okay, we're a technology company, right? Historically, what we've done is sell licenses of our software and people have paid us directly. But there's this new business model emerging that appears to just scale infinitely, where you can make three times or more off of each user, again, using software, but not selling the software to them.
Acquired
Microsoft Volume II
That's a much better business. If I could take 7 billion people in the world and sell them Windows, or I can take 7 billion people in the world and have them use my search engine for free and then make the money from the advertisers, I'm going to make 3 to 5x more money from the advertisers than I actually would selling them software.
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Microsoft Volume II
So suddenly this kind of becomes existential where the Windows revenue isn't going away, but actually the next generation of... Economics generated from software is not selling the licenses. It is monetizing via advertising.
Acquired
Microsoft Volume II
Yep. And the offline economy is much bigger than the software economy. And so everyone has to acquire customers, whether you make software or tents or airline tickets. And there's only a small set of dollars that goes to software. So if I just pull up my credit card statement each month, How much software am I paying for versus how much everything else am I paying for?
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Microsoft Volume II
And even if you say, well, that's not really fair because it's advertising for everything else. It's not everything else directly. Even a small percentage of my everything else turns out to be way bigger than my software budget. So at the end of the day, Microsoft made a browser. They didn't monetize that browser. They monetized using it to defend an operating system. that they sold licenses to.
Acquired
Microsoft Volume II
Eventually, Google comes along and creates a browser. They also don't sell that browser, but they monetize all the traffic coming through that browser, and they do it way better than Microsoft does at monetizing selling licenses. Maybe put it more simply, Microsoft built a browser, had a bunch of share, and then kind of looked around and said, we don't really know what to do with it.
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Microsoft Volume II
But it was this way for scientists to basically trade research and you're starting to get some cool entertainment use cases. But there's certainly no business or business interest or commercial. It's all just like the way that academics communicate with each other.
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Microsoft Volume II
I guess we'll use it for defense. And Google built a browser and said, we know exactly what to do with this. And they used it for offense.
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Microsoft Volume II
They do, David. Should we take a brief aside to talk about Microsoft's intertwined history with Facebook?
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Microsoft Volume II
So it's October of 2007. Microsoft is missing search, and they're realizing social seems to be a wave that's coming five, six years after search. Also a great online advertising business. We now deeply understand and regret not being a bigger player in that business. We can't let it happen again. So what do we do? We're not going to build one of these internally.
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Microsoft Volume II
We know better than to do Google+. And so we are not capital constrained. And so we are very willing to try to do large acquisitions because we've got money lying around, but we don't have talent lying around, and we don't have...
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Microsoft Volume II
DNA and brand to be able to do this right exactly so what do you do you try to buy Facebook Microsoft puts an offer on the table it's a very complex deal structure but effectively what it does is it lets Facebook shareholders cash out over a long period of time as the company's value grew so you're not taking all your money off the table today it's
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Microsoft Volume II
And so the important thing to take away, though, is a very big dollar valuation. News outlets reported it to be worth $24 billion. And again, this is way back in 2007, three years after the founding of Facebook.
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Microsoft Volume II
Exactly. Facebook's not interested. I'm pretty sure Zuck doesn't even respond to the offer. Some of Zuck's lieutenants have been meeting with Microsoft people saying, if you get the number in this range, blah, blah, blah, blah, blah.
Acquired
Microsoft Volume II
We will. No dice. So instead, they work out an investment and a commercial deal. So the terms of the deal are in October 2007, Microsoft invests $240 million for 1.6% of Facebook. So for those trying to do the math at home, that is a $15 billion valuation on the deal. Microsoft... will get the exclusive right to sell banner ads on Facebook internationally until 2011.
Acquired
Microsoft Volume II
So again, Microsoft cleverly is using this as a way to bootstrap the advertiser side of their marketplace now that they have all this inventory to sell. Now, it's interesting to think about, much, David, like your comment about Alibaba. If Microsoft sold all of it at IPO, which I don't think it did, that would be a 7x. Okay.
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Microsoft Volume II
Not bad. Right. From 2007 to Facebook's IPO in 2012. Yeah. Five years, 7x.
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Microsoft Volume II
That's great. I'll take that. If they held for another two years and sold in 2014, that would have been a 14x. Yeah. I actually don't know when they sold, but I feel like these are helpful guardrails to understand what this appreciation could have been. Either way, it's not really relevant to Microsoft.
Acquired
Microsoft Volume II
Right. They're constrained by talent, execution ability, DNA to pull it off, focus, but they're not constrained by cash. So who cares if you 10x your $240 million over five to seven years? So it seems like the actual interesting part of this deal is the fact that they had the right to sell Facebook's international ads for four years. And the companies kind of became friendly.
Acquired
Microsoft Volume II
So Facebook on the pages for businesses would use Bing Maps. And there was all this sort of reciprocal things that the company did together.
Acquired
Microsoft Volume II
Yep. So right around this time, June of 2008, Bill Gates leaves the company full-time. It is an actual retirement. I'm no longer chief software architect. I am still chairman of the board, but I'm going to go be the... Full-time at the foundation. Exactly, at the Bill and Melinda Gates Foundation.
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Microsoft Volume II
But that was sort of the view at the time. I mean, this really shows you how irrelevant people thought Microsoft was.
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Microsoft Volume II
No one would have been saying this about Microsoft in the Windows 95 timeframe, but after the obsession with enterprise, the complete failure in consumer markets, but importantly, the complete ignoring of what the exciting developer platforms were at the time, open source, the web.
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Microsoft Volume II
I mean, if you think about where all the development efforts were going, it was the LAMP stack, the Linux, Apache, MySQL, PHP, the stuff Facebook was written on. That's in a different universe from Microsoft's enterprise developer customers. So I just think you need developer excitement if you're going to have consumer excitement.
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Microsoft Volume II
I mean, or you need to develop every interesting app on your platform yourself, but that's just not how it goes. So that consumer and developer excitement goes hand in hand.
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Microsoft Volume II
Yeah, I think that's right. I think a set of technologies were breaking through. People were just going to use those devices and that software no matter what. The era today is one where users have way more choice in what they use at work than they did in that early 2000s era, and the iPhone sort of forced that door open.
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Microsoft Volume II
It's so funny. Microsoft history is told through a series of memos. Every milestone is some executive publishing a company-wide memo.
Acquired
Microsoft Volume II
Or they were developing cool new stuff that would then get killed because it's not a part of the Windows machine. I mean, you look at Courier, you look at Kin in mobile, you look at all these things that they would let them get so far and then they'd be like, ah, you guys don't get it. Windows is the center of everything.
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Microsoft Volume II
And if it doesn't make Windows look great or it competes with Windows, that's not what we're doing. And I think that DNA was too strong to overcome disruptive innovations.
Acquired
Microsoft Volume II
Okay. So let's rewind. What was Microsoft doing in mobile so far? A lot, actually. A lot actually is right. Microsoft was obsessed with all sorts of things, particularly Bill Gates, for decades before they became true.
Acquired
Microsoft Volume II
One of which was Bill Gates was always talking about mobile computing, so much so that in the key slide in the Windows XP presentation, one of the big bullet points is mobile computing.
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Microsoft Volume II
all the way back in 2001. And Gates thought natural user interfaces was going to be a thing, multi-touch, tablet computing, pen computing.
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Microsoft Volume II
Yeah, from the early 2000s and sometimes even before that, these were Bill Gates' visions of the future that he thought were pretty close. And so in the world of, I suppose they were early smartphones, Microsoft had developed Windows Mobile. So what was this? Is it like iOS? Not really. No. What Windows Mobile was, was an operating system for handset makers to adopt and put on their handsets.
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Microsoft Volume II
And, you know, these things kind of looked like BlackBerrys or mostly keys with a little screen. And when you looked at it, it looked like Windows. It had a little start menu and it was much like the rest of the enterprise strategy, David. designed around all working seamlessly together with your Windows PC and Exchange and your corporate network.
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Microsoft Volume II
Because surely people at home, consumers, were not using smartphones. These were for business people who, you know, these were issued by their enterprise. So it fits pretty squarely into the enterprise category. Now, how did Microsoft think about this product? They thought about it as an ingredient into the handset maker's product.
Acquired
Microsoft Volume II
Microsoft was somewhat at the whim of an OEM in the computer ecosystem. You know, Dell could install some more stuff on top of Windows and customize the installation, but it was still Windows XP. No matter who the PC was from, it was a pretty standard thing. That really wasn't the case with Windows mobile phones. The handset makers could modify the code of Windows mobile.
Acquired
Microsoft Volume II
So when you bought a handset, first and foremost, you were trusting the product quality of the people at the handset maker. And they had several OSs that they could buy and effectively start from, one of which was Microsoft. We're handset makers. We make a phone. And we know how to interconnect and do all the carrier stuff with the carriers because they're our partners.
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Microsoft Volume II
And we kind of needed to do a bunch of computer stuff too, like email and stuff. So can you guys do all that? Yeah. And then we'll make sure when we get that from you that we'll start changing your code to make it work with our phone, and we'll do all the phony stuff. Not an iPhone. What was Microsoft's position in mobile?
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Microsoft Volume II
Yes, they had Windows Mobile, but no, it was nothing like what smartphones would become because of the way that the iPhone reset everything.
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Microsoft Volume II
Which was awesome. You like pushed a button and then it would like flip around and suddenly you were on a sideways keyboard.
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Microsoft Volume II
Which would be the very thing that would sort of destroy their mobile business.
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Microsoft Volume II
But let's get there. So 2007, in January, the iPhone is announced. It won't come out until July. The iPhone comes out. It's the most spectacular technology demo since the mother of all demos, the old Doug Engelbart one way back in the day. It
Acquired
Microsoft Volume II
consumers are all in awe the existing mobile industry people can't really believe it's real the founder of blackberry basically said i think his exact quote is how did they do that then later says we'll be fine you have palm who was already saying things like i believe the ceo even before the announcement said the pc guys are not just going to figure this out they're not just going to walk in famously david i know you have it steve ballmer has a quote after the announcement
Acquired
Microsoft Volume II
phones at this point in time flagship phones were costing like a hundred dollars with carrier subsidies and steve's like five hundred dollars that price like who's gonna buy that right there is actually two quite interesting things about this quote one steve is being the company salesperson if a competitor drops this amazing bomb and you're interviewed and you have a whole bunch of enterprise customers who are sort of looking to you what do you say you say i'm
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Microsoft Volume II
Are things still great? Are things really expensive? Of course you say that. You are literally always selling all the time. And so I always take some issue with that. Two, Apple legitimately had a business model innovation there with the carrier subsidy.
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Microsoft Volume II
I think the 3G... I mean, the mobile industry to this point had been, how do I make the cheapest possible phone? It's certainly not a scaled-down version of a Mac, which is what the iPhone was. So that was a completely different paradigm. This is a tiny computer, not a... kind of crappy embedded system that is optimizing for pennies.
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Microsoft Volume II
And Apple basically said, we don't care if it's really expensive. We just think this is the user experience bar and we will figure the business model out. And eventually, my God, did they figure the business model out and the carrier subsidies were that innovation. But Windows Mobile was that old paradigm.
Acquired
Microsoft Volume II
Embedded systems, cheap as possible hardware were a couple cents either way determines whether your phone's going to sell or not. And so it was pretty shocking. So iPhones start selling. They're selling well. It's 2008. Apps start coming out. It's 2009. Sales start really picking up. And finally, Microsoft decides, hey, what we're going to do is we have this old asset, Windows Mobile.
Acquired
Microsoft Volume II
We can repurpose some of that to make this new thing called Windows Phone. But unfortunately, everything we're optimizing for is different. The new ecosystem expectation is a super high quality user experience. Yeah. And so there's this way that we used to work with all of our hardware partners, which basically said, we will make the software work on whatever.
Acquired
Microsoft Volume II
You can come up with the crappiest hardware you can think of and we'll make it work. It's kind of like the Roku strategy, the way that they work with all the embedded TV makers. And the new strategy had to be, we will dictate really intense hardware requirements because now with Windows Phone, we are making a promise to users to compete with the iPhone where Microsoft is backing that up.
Acquired
Microsoft Volume II
The Microsoft brand is first, and we're defining a really breakthrough new user interface called Metro that actually came from the Zune, which is funny that that's its lineage. Now, how did it actually play out? Microsoft tried to use their existing business model. We will sell you an operating system. We will charge you a royalty.
Acquired
Microsoft Volume II
Correct. And you sell that phone. People want good phones now, so you can probably generate some nice margins on that good phone because the iPhone really set the bar. There's just one problem with trying to maintain your old business model, and It's that you don't have the same competitive set that you used to. You now have Google. Google has acquired Android.
Acquired
Microsoft Volume II
Google has transformed Android from a BlackBerry clone into an iPhone clone. The software is open source. And so Google's value proposition is they go to all those same manufacturers that Microsoft used to work with, HTC, Motorola.
Acquired
Microsoft Volume II
Well, not really, but the answer is nuanced. Finally, today, we dive into it all. Oh, and listeners, we have just one announcement for you here today. Yes. We told you before that September 10th, we are doing the biggest thing in Acquired's history, and we're doing it in the city of San Francisco.
Acquired
Microsoft Volume II
Deal point number one, here you go. It's free. Deal point number two, you can even have the source code. Deal point number three, we aren't Microsoft. Look at what they did to the PC makers. Do not let them do that to you. You know those PC makers? They make no money. Zero the profit dollars in the value chain accrue to these PC makers. They all accrue to the software vendor.
Acquired
Microsoft Volume II
It's literally the same people who did that to the PC makers. Why would you let them do that to you? And remember, in this mobile world, every cent matters. And so Microsoft is trying to ask for, you know, whatever it is, some single digit number of dollars for a licensing fee to the U.S. I mean, I think I'm undershooting, but let's even say it's five bucks.
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Microsoft Volume II
That is a mountain of difference between zero dollars and five dollars.
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Microsoft Volume II
Yeah, I think at first it was you can have it open source, but you don't get any of our services. Or you can take the whole thing and you take all of our services, but our services are great. And guess what? The Play Store is one of our services. So if you want all the apps, then you have to take all the other Google services too.
Acquired
Microsoft Volume II
Now, keep in mind, how does Google make money? They make money on search. So Google, from the moment they figured out, hey, we can run a, call it 2002, when Google's search business model was really hardened, and it was evident this will scale, it's ludicrously profitable, it's very high value per user, Google's going to be the number one at it,
Acquired
Microsoft Volume II
It's almost like if you really thought about it, you could have figured out that Microsoft wouldn't win in mobile.
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Microsoft Volume II
It's a really circuitous path. But if step one is Google makes a ton of money on search, then step two is Google should try to get all the searches. So then step three is Google needs to have the front door to search. And so you have to count on Google being the actor that figures this all out.
Acquired
Microsoft Volume II
Oh, wow. I had no idea that was kind of the impetus of him taking it seriously. I mean, think back to everything we talked about in the last episode. The whole concept of Microsoft is founded on the idea that Moore's Law is a thing, and therefore we can develop software that people have never dreamed of that in just a few years will be usable.
Acquired
Microsoft Volume II
Step four is Google figures out what the next platform is and makes sure that they are guaranteeing all the search volume comes to Google from them. So what do they do? They invent or buy a mobile operating system. What do they do after that? The next step, they give it away for free because, again, all they care about is all the search volume.
Acquired
Microsoft Volume II
And so therefore, unless Microsoft adopts Google's business model, they're immediately screwed.
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Microsoft Volume II
Yeah. It's a little bit butterfly flaps its wingsy, but there is a direct line over a 10-year period from Google finds its web-based search business model and Microsoft cannot employ its traditional business model and win in mobile. Microsoft will lose in mobile. And there's some pivots in there.
Acquired
Microsoft Volume II
I think the biggest moment when the door really shut is when Verizon freaked out after the Apple and AT&T deal and said, we need an answer. And they decided that answer was Droid. And they put like a gajillion dollars behind the Droid advertising campaign.
Acquired
Microsoft Volume II
Yeah. And so I think at that point, it was sort of a two-horse race. Microsoft probably could have figured out a way to get in before that, but it is all related to Google finding that orthogonal business model.
Acquired
Microsoft Volume II
And it would have taken a big culture shift at Microsoft to say, we're an advertising company.
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Microsoft Volume II
Microsoft is not a company that is, at least at this point in time, comfortable with their bread being buttered from advertising. I mean, they're the PC company. They want to sell software to people using PCs. They're the software company.
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Microsoft Volume II
Yep. So then, if you really believe this step-by-step-by-step thing, then actually what Google should keep doing is finding things that Microsoft sells and figure out which ones are the cheapest per user to run and then give those away for free. And so, Outlook, Exchange, geez, Gmail, hmm, Word, Excel, PowerPoint, oh, G Suite, Workspace.
Acquired
Microsoft Volume II
And all they're doing is they're just looking at Microsoft's core value propositions they charge money for. And Google says, would it really be that expensive if we just gave that away for free? And the more of those that they do, A, it's good for Google's business model because they just get more data, a closer relationship with you.
Acquired
Microsoft Volume II
You're doing either more queries or you're interacting on their platforms in ways where they have other ways to show you ads. Maybe while you're off platform, now they know a lot about you from data they've collected, blah, blah, blah.
Acquired
Microsoft Volume II
But even if it doesn't actually make more money for Google, they make so much money in their core business that if it hampers Microsoft, then it's a good thing to do.
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Microsoft Volume II
Yes. And Google has really not figured out how to be an enterprise company.
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Microsoft Volume II
Globally, you think? Yeah. I guess because most consumers don't actually use spreadsheets. Yeah, yeah.
Acquired
Microsoft Volume II
Yeah, Nokia is our coda. What it does bring us to is a realization from the very top of Microsoft that the profit pools in mobile are changing. And this is a thing that I think Steve Ballmer also doesn't get credit for. Bill Gates was obsessed, correctly, with being the software company.
Acquired
Microsoft Volume II
It was a brilliant business strategy to be the software platform, and then everything around you had to interoperate with you. And again, the profit pools in the PC world just accrued to software vendors. It was remarkable how the PC manufacturers over time had no profits and Microsoft had tremendous profits.
Acquired
Microsoft Volume II
Steve Ballmer realized pretty early, I think because of the Google Android thing, mobile was going to shake out differently. Future hardware platforms were not guaranteed to have the same profits in the value chain the way that the PC did. And so he was pretty aggressive about, actually, we need to be in the hardware business.
Acquired
Microsoft Volume II
And I know that seems really unattractive to us as a company because we've been in the software business. There's this great general rule that it's really hard for any business to enter a lower margin business than the one they are currently in.
Acquired
Microsoft Volume II
Right. Amazon can go anywhere. But for Microsoft, you know, you're selling software licenses. It's hard to even get into cloud because cloud is a lower margin business. You know, you have to operate those data centers than just selling licenses.
Acquired
Microsoft Volume II
So if you're Microsoft and you've been making software all these years and you've been enjoying those margins and suddenly you're realizing, uh-oh, we have to be in the hardware business. or at least if we're not in the hardware business or the search business, we're not going to enjoy any of the profits in the mobile era. That's a difficult conundrum.
Acquired
Microsoft Volume II
But to Steve's credit, he acted. They released Surface. They tried to buy Nokia.
Acquired
Microsoft Volume II
Mind-bending that three years in advance, a date is set and then 6,000 people ship on that date no matter what.
Acquired
Microsoft Volume II
Everyone's like, hey, it's like XP, but modern. Or it's like Vista without all that random stuff and all the regressions that Vista had. Yeah.
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Microsoft Volume II
Nice, easy start button in the lower corner. Normal, predictable menu. Fast search. Fast file system. I honestly can't tell you a feature that launched in Windows 7.
Acquired
Microsoft Volume II
Yep, it ran everything the way you expected it to. And so the product that Sanofsky shipped there was just as much the new organization as it was the actual product that customers experienced. It was a much more slimmed down team. It was dev test PM. It was ability to hit a ship date. It was a proper planning and vision process.
Acquired
Microsoft Volume II
A lot of what the team was doing with Windows 7 was, yeah, yeah, yeah, we feel like we can do 7 with our arms tied behind our back, but let's start thinking about the future, about what we're really going to do now that we have all the infrastructure in place to really ship an interesting product.
Acquired
Microsoft Volume II
Yeah, so Windows 8 vision had kicked off. The planning process for what it's going to be had kicked off. And they're starting to play. Actually, Stephen puts these videos on YouTube. They're awesome to watch, the original vision of what Windows 8 should be. And they're kind of out on a limb. They're saying the future is touch. The future is tablets.
Acquired
Microsoft Volume II
We think that's going to be a dominant computing paradigm. And on the one hand, Bill Gates has been saying this for years. So there's sort of like a cultural acceptance with the idea. On the other hand, it really hasn't manifested in the market.
Acquired
Microsoft Volume II
But you're right. The iPad coming out really validates, whoa, big tablets... with multi-touch actually might be the computing paradigm for the future. And oh my God, we've been in planning. We've been in development for a year or two already. This thing hits the market. We're right. We are so right. We've been validated.
Acquired
Microsoft Volume II
Now, there was a little bit of a folly in believing that the iPad was the PC of the future. Standing here today, we all can look at unit sales and realize, oh, the iPad was not the PC of the future. It had its place, but it did not in any way replace PCs. And it turns out that Apple scaling up the iPhone metaphor...
Acquired
Microsoft Volume II
The other thing that's happening around this time is, I've said this a number of times, but Windows, despite having great revenue, great profits, massive penetration in the enterprise, and momentum, almost just like staying power in consumers because people were just used to it, it was not relevant for the next frontier.
Acquired
Microsoft Volume II
It did not have hearts and minds. It was not where the excitement was. It was not what people were building for. So there's sort of a two birds with one stone attempt with Windows 8. One, touch tablets. We are going to get out ahead of Apple. I mean, we're going to try to out Apple Apple here. And we're not going to let what happened in phone happen to us in our core market of PCs.
Acquired
Microsoft Volume II
And so you get the opportunity to team up with an industry legend, of course.
Acquired
Microsoft Volume II
Everyone's building for the web. Web is agnostic to what operating system it runs on. Can we create a platform that is so exciting for developers that they're going to use it? And we should lean into the technologies people are already using. So the Windows 8 touch mode Metro UI development environment was HTML5 because all these web developers are already writing their web apps.
Acquired
Microsoft Volume II
We want to support that too. And we're going to build a whole new tool chain so that their HTML5 Windows 8 apps run really well on ARM processors because these tablets are going to run on ARM processors.
Acquired
Microsoft Volume II
Yes. So that's the two-headed dragon of Windows 8 is new developer platform and touch-first.
Acquired
Microsoft Volume II
Now, in practice, it's not hard to find the desktop. You learn it in like five seconds. You're like, oh, okay, I see. The start screen is actually the start menu, but full screen. So if I click in the bottom left corner, I can collapse it. I can enter the desktop mode and then it's like it doesn't even exist. I can run my Win32 apps, blah, blah, blah. But there is a learning curve.
Acquired
Microsoft Volume II
Yeah, and it is a little confusing. I used it for a long time when I worked at Microsoft and figuring out how to app switch between things that are part of the Metro modern UI versus the legacy apps and what's sitting on my desktop and what's sitting in the... tablet-optimized app switcher. It mixed two metaphors. Now, the question is, why did it mix two metaphors?
Acquired
Microsoft Volume II
And it took me a while to figure this out. But what ended up happening was the original vision for the Windows 8 Touch thing that we're all talking about, these live tiles, that was supposed to only ship for tablets as it was originally dreamed up. And there was a version of Windows 8 that did not have that that was going to ship for desktop PCs.
Acquired
Microsoft Volume II
Word comes down from on high, Windows is Windows. We need to ship Windows across all devices. So what happens? All this effort has gone into, and momentum and political capital and betting your career has gone into this HTML5 developer community, the Metro UI community. And so that is the desktop version that ships.
Acquired
Microsoft Volume II
Yep. And what you have is not as bad as Vista, but man, the rollout was pretty bungled. It's confusing. The reception was poor. Interestingly, not by the tech pundits, like the tech pundits who actually spent some time and figured it out were trained up pretty quickly. But the cat was out of the bag even before they got to review it on people who were angry.
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Microsoft Volume II
What do the Microsoft people refer to them as? People that... Oh, the basement. The basement. Yes, the 0.001% power users who are the loudest, of course, on the internet. And so that kind of taints the product. OEMs hate it because, frankly, OEMs weren't signed up to make these touch devices, but now Microsoft's putting all this energy behind touch-optimized operating system.
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Microsoft Volume II
So there's this mixed message to consumers. It's like, are there even good laptops available? Am I supposed to use touch on my desktop? They have to run ARM, right?
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Microsoft Volume II
Yeah, my dream machine is, you know those Lenovo Yogas that can flip all the way around? Yes, yeah, yeah, yeah. My complete dream machine is my 13-inch M3 MacBook Air that when I flip it all the way around, they do something like universal binary with the apps where all the same apps that I had installed on my Mac, they now run their iOS counterpart.
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Microsoft Volume II
They grab all the data that's stored in the same places. So all my apps, you know, it knows which Google sheet I'm looking for. It has the YouTube videos cached. It, you know, does whatever, but it just turns into an iPad with an iOS interface UI, that is the dream. I can't figure out if I'm like a super nerd for wanting that. And most people wouldn't actually want that.
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Microsoft Volume II
But I travel with an iPhone and an iPad and a MacBook. And I think I could just do two. I think a lot of people would want it. Yeah. So one takeaway may just be, hey, it was too early. The other takeaway might be, look, it turns out that tablets should have been a scaled up phone, not a scaled down PC. That was certainly true at the time. Yeah.
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Microsoft Volume II
Certainly at the time. So complete commercial failure. The ecosystem of Windows 8 apps did not really galvanize. And where we're left is the state of the Windows app developer ecosystem in the 2013-14 time period is right back where we started. No one's terribly interested in targeting that as a developer platform. All the energy is actually just going to go into the web app.
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Microsoft Volume II
No doubt. Undeniably. Zune failed. Bing, small market share. Windows Phone lost to Android.
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Microsoft Volume II
This is dark. This 2012, 13 time period, this is dark. And at the same time... Well, it's funny. It's dark. And revenues and profits have grown tremendously. The enterprise motion of Microsoft has basically never had a down year. I mean, 2008 in the Great Recession. But other than that, like, chug, chug, chug, chug, chug, even through the bad Windows releases.
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Microsoft Volume II
Yes. In retrospect, you've got to be looking at them thinking, how dense are you? Marc Andreessen is the person in the world who understands what a crazy exponential phenomena the internet is, the web is, what it can be. I mean, Marc had, I think by this point, already put the image tag into HTML so they can now send images that render in browsers.
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Microsoft Volume II
Yes, absolutely. As the general public is concerned, Steve Ballmer was obsessed with Windows. He built the enterprise business. He left. Satya Nadella came in and launched Azure, and Azure has been great. Not exactly. That's not really what happened.
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Microsoft Volume II
And realistically, you can't replace Bill Gates with one person. So we need two bills.
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Microsoft Volume II
This is so fascinating. I never put 2 and 2 together, but Lotus 1, 2, 3 and Lotus Notes were not like peers together. Lotus 1, 2, 3 was developed by Lotus. Lotus Notes is actually Ray's company. It's almost like the way a game studio works. Ray and his company are building it. Their publisher is Lotus, but... Ray can have agreements with Microsoft where he's privy to information that Lotus is not.
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Microsoft Volume II
And so Ray's like really close in the fold with the Microsoft folks. I think he was even a contractor working on, maybe the project was Landman, but he was actively contributing to other Microsoft products.
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Microsoft Volume II
And essentially what's going on is Bill and Steve kind of look at Ray and they say, you figure out the vision. We've got all these assets. We've got a killer business. Got all this great talent. In the coming world, the next generation of technology, why don't you figure out how Microsoft fits in and what our play is?
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Microsoft Volume II
And when Jim Clark emails him, they decide to go do the information superhighway and not to do the internet.
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Microsoft Volume II
that businesses may want to basically rent capacity from big data centers to just deploy their applications and not worry about the capex of buying the servers and racking them all and maintaining the data center and handling the privacy and blah-de-blah-de-blah.
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Microsoft Volume II
Microsoft has a group that produces a product called Windows Server, and that is an operating system that runs on other people's servers. And that group is not the group that produced Azure, the cloud service that runs, at the time, Windows Server.
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Microsoft Volume II
Not to mention these end enterprises in some ways are actually the OEMs customers. Yeah, these Dell servers are running Windows Server, but Dell sold a bunch of servers, probably through Accenture, to the end customer. There's that whole issue of upsetting the apple cart. There's also the internal rewards issue and KPI issue.
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Microsoft Volume II
windows and enterprise land ultimately their kpi is how many copies of windows can we sell to end customers and generate the licensing revenue on windows and this new thing if we actually pursue a cloud strategy is how can we spend a whole ton of money building out a data center buying other people's servers generating zero licensing dollars and hoping people use the servers so we can charge them later
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Microsoft Volume II
Yeah, we're going to build out a gigantic server farm and rent usage to people. That doesn't fit into anyone's current KPI or compensation.
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Microsoft Volume II
No one builds hardcore enterprise-ready, close-to-the-metal code than Dave. Dave was the architect on Windows NT.
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Microsoft Volume II
Well, it's funny. I disagree that it's a bet the company move because of two reasons. One, it's only money that they're spending. Cash is never a resource constraint. The bigger concern is Ray Ozzie and Dave Cutler are working on this. That is why it would be bet the company. Two, in its initial incarnation, Azure did not threaten the Windows-centric approach.
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Microsoft Volume II
And for good reason. I mean, at the end of the day, basically, Microsoft charged for things that open source was giving away for free, from operating systems to programming languages to development environments to servers. I mean, everything about it. It was like, oh, my God, is there a future where everyone just expects all of our value to be free?
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Microsoft Volume II
And they managed to combat that and build a great business despite that. But they never embraced open source. They never at all embraced wanted to be a part of anything that open source developers were doing until... A couple of years into Azure. Not until 2014, 15.
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Microsoft Volume II
Yep, that's a fair pushback. But Azure came in with an aggressive point of view. We are platform as a service, which was distinctly different than AWS, which was we are infrastructure as a service.
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Microsoft Volume II
Meanwhile, it's hilarious that we keep talking about the information superhighway because it never happened. There were these little tests done with cable companies that would wire up 300 houses or something, but it never happened anywhere at any sort of scale.
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Microsoft Volume II
And not carry the baggage of all the success from the previous iteration.
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Microsoft Volume II
And from what I can tell, it's just as motivated by Azure is the future and it needs a new leader as it is Satya is a really talented, rising executive in this company and needs to be put on an important project.
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Microsoft Volume II
And so when you're listening to this and you keep trying to figure out like, sorry, what exactly was the information superhighway and like, what did it look like? Nobody knows because it never happened.
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Microsoft Volume II
Wow. Crazy. It is worth not to pour cold water at all because I think the high level point stands.
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Microsoft Volume II
Intelligent Cloud includes SQL Server and Windows Server. So these are big legacy businesses.
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Microsoft Volume II
And increasingly, the offline economy is becoming some sort of cloud-dependent service. I mean, it's crazy to just see cars rely on the cloud and restaurants rely on the cloud. Like anything that you interface with in the physical world, you expect to have some digital component. At the very least, take credit cards.
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Microsoft Volume II
And all of these things, point-of-sale systems, all of these things are routed through the cloud at some point. And so... David, I think you're making the same point about the cloud today that I was about Microsoft in the PC era. Microsoft was lucky to own 90% market share and in cloud they own, you know, meaningfully less than that. Right.
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Microsoft Volume II
And the fact that even Mark himself didn't pound the table for, no, the internet's going to be the thing, that really shows you how the human brain is not wired to understand compounding. theoretically, this network should continue to get more nodes. The technology should evolve little by little. Moore's law is happening on the compute side.
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Microsoft Volume II
But it's still basically a tracker on the growth of an insane secular tailwind that is just an inevitability in the world. It's probably a 30, 40 year wave that they get to keep riding. Yeah.
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Microsoft Volume II
Yep. So to review how it came to be, interestingly, it was Ray Ozzie in an incubation group doing it outside the bounds of the business units. Beginning in 2006. Beginning in 2006. Yeah. with Steve's buy-in and the air cover from Steve to make it happen organizationally. You look at where all the talent came from. Bing taught them how to do distributed systems.
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Microsoft Volume II
Xbox Live was a always-on cloud service, real-time, zero latency, with 40 million subscribers. MSN was a super high-traffic web property with 750 million registered users online. Hotmail was a web application that hundreds of millions relied on. They had SharePoint and Exchange. There was knowledge of how to do server-based application software for the enterprise.
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Microsoft Volume II
I mean, there was some conflict business model-wise with Windows Server, since Azure would be an orthogonal business model. But the technical chops were there. I mean, these are hardcore server OS people. Of course, that group is going to be capable of doing things like hypervisors. So...
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I just think the ingredients were remarkably there from all these other things that Microsoft had been doing over the years. They were kind of the only one who could pull this off at this scale with this set of enterprise relationships to migrate all these people to the cloud as they built out the product suite.
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Microsoft Volume II
Yeah. There was seven years before Steve Ballmer handed the reins to Satya where Azure development was happening under him.
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Microsoft Volume II
I could see if you were an Azure doubter and you were sitting there at the top of Microsoft enjoying the Windows monopoly, the tremendous business that is Windows and Office, and thinking, why would I do anything to jeopardize this? I mean, Windows has self-reinforcing network effects everywhere.
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Microsoft Volume II
Huge switching costs for the enterprise, super profitable, high margin, one of the greatest businesses of all time. And now there's this idea that you want me to spend the money to run servers. People can run their own software on my servers, even if it's open source, so it's not feeding into my Windows-centric ecosystem. Yeah. There's a chance they're not paying for Windows licenses. Right.
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Microsoft Volume II
You know, there's some reason to think that bandwidth is going to be available to homes in the same way it's available to like universities and companies. But still, it just wasn't obvious enough to continue down that path. It was almost like, great, I've made a name for myself doing this toy thing that probably isn't the future.
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Microsoft Volume II
It's not even as good a business. It's not zero marginal costs. Running servers, running these big data centers has huge costs. And even if you say, oh, those are fixed costs to rack them and you amortize them over a course of years. But like energy has a real cost.
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Microsoft Volume II
It's kind of shocking that they eventually did embrace this very unproven new business that could potentially be way worse than their current business.
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Microsoft Volume II
Yep. Now, I will say, the company stayed the Windows-centric company for too long.
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Microsoft Volume II
I mean, Azure was being built, so it was successful enough that it sort of erases everything else. But a lot of listeners know this, but I worked at Microsoft from 2011 to 2014. My internship in 2011 was on the Word web app in the Office 365 suite, but before it was called 365. And then my real job was I worked on, when I came back, Office for iPad. which was super secret at the time.
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Microsoft Volume II
It was really counter-strategy because we were the Windows company. But at the same time, what users wanted in this world in 2012 was, I want to access my documents on any device that I'm on. We have moved to a world where I have multiple devices. I just want to be able to use your application on my device, please.
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Microsoft Volume II
And absolutely 100% something that happened is all 200 of us worked for multiple years to get these things ready. We had a ship date. Well, we had what we thought was a ship date. Actually, what happened was we were told that actually we're going to shelve it. And instead of a ship party, we had a shelf party because the product got canceled.
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Microsoft Volume II
And so now we'll go do the big boy stuff because that's what all the experts are saying.
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Microsoft Volume II
And basically it was, hey, we just released Windows 8. We just released the Surface. And we want the marketing message for those things to be that Office is first and best on Windows. And the only tablet in the world... that can run real Office is the Surface. And I, of course, am too biased and too personal to really think through this, but I was like, oh, this company has its head in the sand.
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Microsoft Volume II
This is ridiculous. What users want is we have a good version of Word, Excel, PowerPoint that people can run on their iPads, and we've decided not to ship it to try and advantage Surface and other Windows 8 devices. Yes. The year later, we did ship it actually right after Satya became CEO. That was one of the first things he did.
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Microsoft Volume II
So ultimately that decision didn't happen that much later than it would have otherwise. And kind of an open question of whether it was a mistake. Like did Microsoft ever lose a dollar for deciding to hold office for iPad another year? Probably not.
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Microsoft Volume II
At the time, I held this belief we have stayed the Windows company for far too long and need to embrace users where they are. Now, with all this hindsight, I understand why you wouldn't make the decision when you feel like the iPad could be the end of you.
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Microsoft Volume II
Why would we go all in on that now and put our finest products to advantage that thing when we don't know if that thing is going to kill us or not? So there's the big downside. There's not much upside to launching it. What, am I going to renew a few more enterprise agreements because of it? Probably not. Perhaps young Ben working at Microsoft at that period of time
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Microsoft Volume II
failed to understand how important it is to think like an incumbent when you are the incumbent. And this was a low upside to doing it right away, plenty of downsides to doing it right away, really no risk on sitting on it.
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Microsoft Volume II
We have shifted from a devices and services company to a cloud-first, mobile-first company. I believe that was the message.
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Microsoft Volume II
Yeah. In fact, it's not that they were giving away for free. They were willing to pay people to take it. I mean, if you think about it, I'm sure there was money that they spent on the Droid marketing campaign. I'm sure there was money that they paid to the carriers to pay to their salespeople to incentivize people to buy it versus the iPhone in stores.
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Microsoft Volume II
That was a common practice in the mobile industry. So I think less than free is actually the correct way to frame Android.
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Microsoft Volume II
Well, sort of. I mean, Nokia basically had Symbian as its OS. They tried to start another OS because Symbian was sort of reaching the end of its life. That wasn't going well. And so they were kind of left without a platform. And so they either needed to pick Windows Phone or Android as their platform of the future, despite being what used to be the dominant phone maker for all cell phones.
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Microsoft Volume II
That is actually the right way to think about it. We've been joking about it's only money. But honestly, what was Microsoft's market cap at this time?
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Microsoft Volume II
So that is 2.3% of the company. You're willing to give up 2.3% of your company for some particular bet. I actually think that's a very reasonable way to think about this, Aquantive, Skype, which we didn't talk about, which actually was a pretty good deal, especially because of the tax treatment, Yahoo, Facebook. You should think of these things as a percentage of market cap.
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Microsoft Volume II
It's funny, I delivered you a technically correct answer and you delivered me back a very pragmatic one. Yes, right, right. Which is, that's not accruing to your market cap anyway, so you may as well spend it.
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Microsoft Volume II
When it doesn't cost you focus or your best people or whatever the scarce resources are and it only costs you cash, then you should totally think about it as, am I willing to bet 2.3% of my company or whatever percent of the cash that I'm not getting any credit for if something could go really right? It's a venture capital bet, you know?
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Microsoft Volume II
And so my understanding of the timeline is there's a $7.5 billion offer on the table. Steve mulls it over, plays with it, is for it, proposes it to the board. And exactly, the board comes back and says, hey, there's not support for this.
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Microsoft Volume II
Yeah, there was a lot of baggage. I mean, it's just, what, 40 years of baggage. Bill, Steve, old wars, antitrust, bad releases of Windows. Like, you just gotta get it out to move on. And it was Bill and Steve leaving in one fell swoop to clear the path.
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Microsoft Volume II
Yeah, it'll be a night to remember with a few different phases of the evening. There's going to be lots of opportunities to meet other acquired listeners from around the world. And a big show like this deserves a big special guest. And that special guest is the one and only Mark Zuckerberg.
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Microsoft Volume II
Whoa, whoa, whoa. This is volume three, David. Don't. Yeah, yeah, yeah.
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Microsoft Volume II
Great. And listeners, you should be paying attention to something David just said there. He said it's the Mosaic Corporation, and then you said it's Mosaic Navigator. Even though it's called Mosaic, because Marc Andreessen wanted to draft off the success of the previous project he had done called Mosaic, this is completely new code. They founded a company. They started writing code from scratch.
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Microsoft Volume II
I'm sure someone's looking down at their podcast player right now like, why are they acting like they're done? There's so much time after this. Are they just going to play some music?
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Microsoft Volume II
Okay, I have got some start and finish stats on Steve's tenure as CEO. Oh, great. This episode, we started a little bit before Steve took over because we wanted to put the internet chapter in and the antitrust chapter in. But I think everyone kind of feels it by this point. The question really is like, what happened when Steve was running the company? And so here are the numbers.
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Microsoft Volume II
And this is the timeframe from 2000 when he was announced as CEO until 2014 when Satya was announced. So a 14-year period. Revenue went from $23 billion to $84 billion. That's a 3.5x over 14 years. Operating income went from $12 billion to $30 billion, so almost a 3x. Important to pay attention to is the price-to-earnings ratio when Steve was announced as CEO was a 75x. That's high.
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Microsoft Volume II
It was real close to an all-time high, which was in the month prior at an 80x. So it is worth pointing out, it still has not been that high to this day. Even today, with all the excitement around Microsoft, AI, everything going on, 40x. Right.
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Microsoft Volume II
And the dot-com bubble is exploding. Yes. And you're taking over from Bill Gates.
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Microsoft Volume II
Essentially, if you're doing an analysis of what happened in Steve's tenure and you're trying to grade that, you are implicitly saying, did Steve make a good investment? To be honest, I think Steve took one for the team in taking over as CEO in that moment. He was handed a bit of a garbage sandwich, inheriting something when it is valued that highly.
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Microsoft Volume II
Completely. So I worked at Microsoft during this period. I was a big open source guy. I was a big Apple guy. I was all these things. And I hated Steve's Windows strategy. And frankly, I didn't like using any Windows products. I felt like they were all crap.
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Microsoft Volume II
And it is still true that it's totally insane to evaluate how did someone do with an asset that they were sort of forced into buying at 75x earnings. Yep. So at the end of his term, it was 14x. The P.E. multiple went from 75x to 14x. The market cap when he was announced went from $600 billion to when he left at $330 billion.
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Microsoft Volume II
A lot of that is basically the price-to-earnings multiple rationalizing in that first year. And then after it did that, the stock price was basically flat again. for his entire tenure, no matter how much the revenue or the profits grew. And so one crazy stat on this is you could have bought Microsoft in 2009 for 2.1 X annual revenue.
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Microsoft Volume II
They had the experience of writing Mosaic, the thing owned by the university and the NCSA before. This is a new thing called Mosaic that does the same thing, architected for commercial use.
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Microsoft Volume II
Listeners are slight of hand here. We switched from earnings to revenue, but David, I thought that too. I was like 2009. Come on. In 2013, you could have bought Microsoft stock for three X revenue.
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Microsoft Volume II
Wow. And so the question is, why? Why did investors give Steve zero credit for any of this growth? Cut off that first year when the multiple was coming down. Why is it that effectively what happened from 2001 to 2014 is for any gains that they got in revenue or profits, it was offset by multiple compression coming down and saying the asset's still worth the same thing.
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Microsoft Volume II
One is, very legitimately, the investors had little belief in Microsoft's long-term relevance. Not the place for user excitement, not the place for developers. They doubted that there was real vision from leadership.
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Microsoft Volume II
I mean, you went from Gates, this guy who created it all, to someone that everyone was chalking up to be the sales and marketing guy, and there's the product strategies all over the place, and Windows isn't getting any more relevant. They're trying all these new things that are failing. Search passes you by, social passes you by, blah, blah, blah.
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Microsoft Volume II
But the interesting thing is investors basically didn't think Windows and Office businesses were sticky, and they were only valuing the newer bets, which was super wrong. Windows and Office have proven to be these ridiculously durable franchises generating more revenue today than ever.
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Microsoft Volume II
So, I mean, it is ultimately on the CEO to help shareholders understand where the value is, but shareholders obviously did not price in the retention and growth within the existing Windows and Office customers through a new era of technology. I think people were just betting that Microsoft would lose it, and they didn't. They held on to these durable franchises.
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Microsoft Volume II
Yeah. I mean, consumers had no idea what Microsoft's strategy was and neither did developers, so neither did investors.
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Microsoft Volume II
Sort of, but they were probably like, what's going on in search and what's going on?
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Microsoft Volume II
Sorry, what's Zune? Is it winning against iPod? Oh, it's losing. Oh, mobile, it's losing too? Huh.
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Microsoft Volume II
Anyone who's listening who's a leader at a company right now knows that the right amount of repeating yourself to do is about 10 times more than you think it is. You need to keep delivering the same message over and over and over again, and that wins. The other way to sort of look at Steve Ballmer's tenure is comparing against what else was going on in technology from 2000 to 2014.
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Microsoft Volume II
So on the one hand, like we've been talking about, you have the rise of Google and search and you have social networking with Facebook. And yes, you absolutely can compare a CEO to these category defining startups that are in adjacent fields. But that's a little bit of an odd way to evaluate a CEO. Like, how did you do against... They aren't even really competitors of yours in your exact market.
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Microsoft Volume II
And by the way, they created the best businesses in history that were also the fastest growing and capital efficient. How did you do versus those two particular sort of related outliers? I think this is sort of a funny measure, even though this is the measure we kind of all use. But if you actually just look at the peer set, what other big companies were there in 2000 in tech? You had Yahoo, AOL.
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Microsoft Volume II
It's a pile of code, millions of users. Mark doesn't work there anymore, but it seems to be working.
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Microsoft Volume II
The whole cable and media sector, you had HP, Nortel. I mean, so many of the great companies of the previous era completely fell apart. The three who actually survived and potentially thrived were Microsoft, Dell, and only Apple after Microsoft bailed them out and Steve Jobs came back personally.
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Microsoft Volume II
Yeah, Oracle. Yeah. But I mean, surviving puts you in the top 5% against the peer set of that era. So even if you overlook all the revenue and profit growth and you just look at pure enterprise value and relevance, there is actually a success in that the core asset was preserved.
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Microsoft Volume II
This whole notion you have, David, that Satya came in and we were great and then we sucked for a while and then we were great again. Even just setting up, we preserved the talent asset and that we had continuity in our businesses for another 15 years on what is already a 30-year-old business. I don't know. That's way better than anybody else does.
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Microsoft Volume II
So anyway, this is all kind of analyzing the tenure from a business perspective. I am very amenable to the idea that products completely languished. Like I had no interest in using any Microsoft products during this period.
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Microsoft Volume II
Yeah. I'm very amenable to arguments of like, yeah, but they didn't make anything good.
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Microsoft Volume II
And they did make some good, you know, Xbox is good. I actually thought Windows Phone, particularly Windows Phone 8, was a beautiful new crack at what does a phone look like. I thought it worked well. But I guess what I'm saying is the products that ended up being their big profit drivers were never their good products.
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Microsoft Volume II
Right. They weren't good for me as a user. They met the needs of customers.
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Microsoft Volume II
So the state of play is you've got the old Mosaic, which Spyglass has the right to license for commercial use. You have a new thing that will become Netscape called Mosaic that is totally separate code. And Mosaic, Marc Andreessen's new Mosaic, keeps trying to go do deals, like sell their server software. And every time they'd find a customer, Spyglass, they'd threaten to sue.
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Microsoft Volume II
Seven powers. So listeners, this is the part of the show analysis broadly, where we analyze the business sort of after we've completed the story. And the first one is a section called seven powers, which is named after Hamilton Helmer's book.
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Microsoft Volume II
And the question that he sort of poses is, what is it that enables the business to achieve persistent differential returns, or put it another way, to be more profitable than their closest competitor and do so sustainably? And there are seven different powers, sort of categories that it can fall into.
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Microsoft Volume II
There's counter-positioning, scale economies, switching costs, network economies, process power, branding, and cornered resource.
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Microsoft Volume II
Right. That's the interesting thing. Once you're an incumbent, you can almost never have counter-positioning.
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Microsoft Volume II
Yeah, they were getting counter-positioned in mobile. I mean, Google was saying, we'll give it to you free.
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Microsoft Volume II
Yeah. All right, perhaps the single greatest asset they have is scale economies. With the number of users and customers they have, any investment that they make gets amortized over such a massive user base that it's worth it. If they can charge a dollar more on EAs, they should do almost any amount of incremental R&D or acquisitions.
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Microsoft Volume II
Yeah, the cloud era even more. I think there's crazy returns to scale on cloud economics.
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Microsoft Volume II
Yeah, they went from knowing how to ship the most beloved operating system of all time with Windows 95, managing to pretty much do it again, even during the antitrust thing with Windows XP, with, I think, zero blunders in between. I mean, they had ME, but that wasn't a blunder as much as like a, I don't know, fresh coat of paint that wasn't really real.
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Microsoft Volume II
And then, yeah, with Longhorn and Windows 8, separate problems, but completely forgot why those franchises have economic value.
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Microsoft Volume II
Yeah, the question is, did they become more trusted by the enterprise, where if you're offered the exact same service from Microsoft and AWS, are you more willing to pay Microsoft for it?
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Microsoft Volume II
Yeah. Microsoft has unbelievable switching costs. The EA, you just can't switch now. You have to switch sometime in the future. And when that time comes, you're probably not going to switch then either because the next EA is going to offer even more value.
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Microsoft Volume II
Yep, you're so right. It's so funny you reflected it back to the DOJ. It's been so long now since we covered that. Hours ago, I kind of forgot about it. In that era, there were literal switching costs to getting a different browser.
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Microsoft Volume II
The one that came with your computer was the one you were going to use because a different browser was going to take like five to 24 hours to download over your internet connection in the dial-up days. It was good for consumers to receive a browser with their computer because getting another one was almost prohibitively difficult.
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Microsoft Volume II
And they basically blow up the deal because they keep calling each customer and saying, yeah, we're going to sue. Yep. Yep. And so this is obviously very frustrating and technically illegal. Mark Andreessen's Mosaic realizes that this is going to be a existential problem for them unless they do something about it. They actually sue Spyglass. You guys got to stop. So there is a settlement.
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Microsoft Volume II
as interoperability becomes a thing, as file format standardized, and I can open the same documents on Macs and PCs, it's like, okay, file formats stop being a network economy that accrues only to the operating system.
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Microsoft Volume II
I'm trying to think, are there any other, like if you were an enterprise and become a Microsoft customer and I'm an enterprise and I become a Microsoft customer, do we really benefit from each other being? I don't think so. Yeah, I don't either. That just leaves cornered resource. Yep. No, I don't think they have that meaningfully. No, I don't think so.
Acquired
Microsoft Volume II
I guess this power, I mean, the fact that we came up with, they don't really counter position. They have great scale economies. They have a lot of switching costs. And that's kind of it. That's pretty illustrative of why you kind of feel like this is the lost era of Microsoft.
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Well, the first one that talks to mind that I want to address a little bit more specifically is this idea of a cultural shift. Because we've mentioned it many times on the episode. Oh, with the DOJ, there was a cultural shift. Oh, with the new leadership, there was a culture shift. But what does it actually mean and how do you go about quantifying that?
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The thing that I kept hearing in all the research interviews we were doing was that when the stock price was flat and flat for a long time, people became convinced it's just going to stay flat.
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So basically, whatever the cause of that was, it created a zero-sum environment. Nothing I do is going to make the company more valuable, right? So therefore, my value, the only way to grow value accruing to me is to win at the expense of someone else at this company. I'm going to get promoted over them. My product's going to eat their product. My team's going to eat their team.
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I get kudos at the expense of them looking like an idiot. That's the kind of incentive.
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Right. And of course, it's amplified by stack ranking, which I don't have a problem with stack ranking generally. But famously at the company, everybody was ranked one to five. Every manager was only allowed so many ones and so many twos. And so...
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Ultimately, it was an environment where everyone every six or 12 months, sometimes over mid-year check-ins, was kind of being baked off against your immediate peers in your group. And because the company wasn't growing in value, you had to out-compete your friends to win.
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right the pie was not growing right so why was the pie not growing we talked a lot about that there's a lot of reasons you could argue why it wasn't but the culture is an effect of that there's a big one i've been thinking on which is how to go about placing your bets for the future as a company and i think in the 2000s microsoft was viciously trying to fight against the tide
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There was open source. There was the web. There's all these things people wanted to do. Ultimately, over time, you cannot fight what people want to do as a company. You can put up all these barriers. You can steer them back into your ecosystem. But ironically, the playbook that Satya is now running is a return to a classic Microsoft one, Embrace and Extend. Yes.
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Rather than fight what users are doing, I want to use open source software or whatever. I want to make web apps. I want to host a web app. You just figure out what people want. You embrace it. And then you figure out what product you can build with a business model that extends that existing user behavior.
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But it does require you to be clever and outcompete a lot of other people to invent that new business model that, you know, is created on top of new user behavior.
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Yep. And the trick is figuring out how to make money when you lean into what people want. Because ultimately, like, if you just reduce it all to economics, what people want is free value. But you can't actually build a business on giving away free value. Yes. You know, I can give you a dollar for 90 cents, but ultimately, I'm just going to go out of business.
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And so I need to figure out some way that you're happy from value creation and willing to pay me more than it cost me to.
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Yes. There's this other one of what was going on given that the ideas were good. And this is going to sound harsh, but timing, implementation, and taste at Microsoft from call it Windows 98 on were just terrible. Or maybe put another way, they had the right ideas, but late timing and bad execution. Strategically correct, but tactically misguided.
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I mean, Bill was super right that touch computing was going to be a thing. He referred to this idea of a natural user interface very often. Bill was super right that interactive TV was going to be a thing. I mean, think about how I watch Netflix. I will watch Netflix tonight after we record on my Apple TV upstairs.
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Bill was right on mobile that that was going to be a huge part of the computing landscape. And yet, all of these started at Microsoft five to 20 years before the tech was actually ready, and they would often bet on the wrong standard or paradigm. I mean, touch computing ended up being capacitive, not resistive with a stylus.
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Tablets have proven to be a cousin of phones scaled up, not PCs scaled down. Interactive TV came after the internet, not before, and only once there was a tremendous amount of bandwidth.
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I mean, think about how much more bandwidth it consumes for all of us to ad hoc start Netflix streams versus there's one broadcast happening and we all just tune in when we tune in and we just catch whatever part of the broadcast is over anyway.
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Totally. Mobile was five years early and it was more akin to embedded devices than it was to scaled down PCOS. So something was off in Microsoft's ability to leverage their future predicting into creating the right products. Right. Which is weird because historically they have been good at it.
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Well, they at least employed the one Microsoft employee referred to it as bracketing. You basically develop two products concurrently, one aimed below what the current technical capabilities are and one aimed above.
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And as you get closer to shipping or as you get closer to like letting the market play out, you kind of pick whether you're going to make the low end one better or you're going to sort of start reducing functionality of the high end one. And so in the IBM days, you know, you had Windows and OS2. And in the internet era, you had, like, the web browser versus all the interactive TV stuff.
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Or Longhorn, which was supposed to be little and iterative, versus Blackcomb, which was so ambitious it actually got canceled.
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Yeah. Or like the bets somehow couldn't continue to flourish internally. I don't really know why, but it seems like for some reason bracketing worked well for a while. And then eventually their ability to take a good idea and implement it at the right time, the right way fell apart.
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Which, of course, is apocryphal because he had no means of going to Stanford at the time. He lived in the Midwest. He was going to go to a state school. No one recognized his genius at the time. Yeah, yeah, yeah.
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My next one is the idea of positive sum leadership. This one's a little bit more personal than our playbook themes typically are, but I think it's an important takeaway. Bill Gates plus Steve Ballmer in the right roles, with the right level of respect for each other and who made which decisions, when that was all humming, that was way more valuable than Bill alone or Steve alone.
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This is actually pretty common among teams. Most high-performing teams are so much better together than they could possibly be apart.
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Bill alone, at least in this era, was totally at risk of getting too excited about theoretical technologies like WinFS. That's the perfect illustration of this. And, you know, Steve needs a great technology partner, and... one who kind of has the extreme loyalty of the thousands of brilliant engineers at the company, so they'll sort of align and follow the vision.
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And Steve also needed someone willing to change their mind in the face of new data. Bill was... constantly processing new information and as new things came in he would say i don't care how in motion things are if you're right which is rare usually bill's right but if you're right and you're arguing something to me like screw it we got to change everything new data new thing
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The internet tidal wave. And Steve was much more like, we have to align an entire aircraft carrier in the company and then all the aircraft carriers outside the company. So we are going to make a decision and then we are going to implement and execute. And I think together there was some magic where there was just the right amount of stick-to-itiveness versus adaptability.
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My next one is being extremely partner-focused is a gift and a curse. Microsoft is an extremely partner-oriented company. There are far more profits who have accrued to Microsoft's independent software vendors, resellers, retail partners, than just to Microsoft itself. But it basically makes it impossible to reset. I mean, Apple, when Jobs came back, hit a full reset.
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All new developer tools, all new products, all new software, all new platforms. But when you have all these externalities depending on you, you actually can't really hit a reset button to adapt for a new era. You have a whole ecosystem to preserve. And I think this is the more nuanced view of the idea that, well, if you miss one wave, then you're actually well-suited for the next wave.
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People often say the only reason Apple was able to win in mobile is because they totally lost in desktop or whatever. And I think really what the answer is, is the more externalities you have depending on you, the more difficult it is to reset. And usually a next generation... The more switching costs you have. Right. A next generation technology requires you to hit a big reset button.
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Let's do that now. Listeners, we've been trying out this new way of ending episodes. How do we land the plane? What is the one takeaway that is really sitting with me after having done all this research, talked through it with David, hardened our thinking by bouncing ideas off of each other? What is the thing that you can't get out of your mind?
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So in addition to being the central figure in some of the greatest acquisitions of all time that we have covered right here on Acquired, Mark and Meta are also playing a big role in defining the next decade of computing with AI, too. So it's shaping up to be a total blast. We really hope you can join us.
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So I think it was late 93 or early 94, but this was a seminal moment where the AOLs of the world interconnected with the internet. And now you could not just navigate the proprietary services, but also surf the open web.
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Yeah, irrelevant, failing, can't do consumer. The counterfactual is Amazon. If they had a consistent message that they went forward with, such as, we're a company who invents and wanders. Amazon has failed at so many things. So many things. Publicly, huge bets that have totally failed, and yet... Huge consumer failures.
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People are like, what a beautiful thing that Jeff Bezos has imbued into this company. This idea that we invent and wander, we make these bold bets, we embrace failure. I mean, Kindle Fire, or I guess Kindle Fire kind of counts. Certainly the phone...
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Maybe. If LLMs hadn't become a thing, I'd be with you. It turns out it might be good distribution for a good LLM if they actually... Yeah, sure.
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There's grocery, Amazon Go, local. I mean, all the restaurant stuff. It's a narrative problem.
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You're right. I think yours is better than mine. Now that's my new land the plane. Do you want to hear what mine was before? Yeah, tell me what was on your mind. All right. Ultimately, Bill Gates is right. Technology companies are always extremely at risk of disruption.
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Even if you won the battle today, even if you're the most dominant company today, it is so easy for you to lose and become irrelevant tomorrow. You may keep a great business because these things are sticky. As we know, IBM made a lot of money for a long time. But even without the whole DOJ thing... Microsoft probably would have vested themselves.
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Microsoft almost certainly would have missed mobile because there's no chance they would have realized that the business model that Google had meant that they were going to win in mobile when they came in from the side and gave away the software for less than free. Microsoft was going to have these huge downstream misses because technology moves so fast and is such a dynamic landscape.
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If all this era did was give them a free option to play in the cloud and AI era, or even just say the AI era, that would have been great. But also what they did was they tripled revenue and profits.
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Awesome. I have two and they're like the most absolutely basic products of all time. And I'm okay with that. The first I mentioned earlier, M3 MacBook Air. It's the finest computer I've ever owned, which I say every time I get a new Mac.
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I know. I'm rocking the M1 MacBook Pro at home, and it's a 16-inch, and gosh, that thing is just a beast to fly with. And so for all the travel we've been doing recently, David, it has been awesome to have this incredibly lightweight, incredibly fast, just beautiful machine for flights and all sorts of travel stuff. Nice. So it's my on-the-go.
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And then sticking with this theme of staying incredibly basic and predictable, the Tesla Model Y is an awesome car.
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Yeah. We just took a weekend and drove up to Orcas Island, and it was so sweet. I never once charged it. You know, drove multiple hours, took a ferry, were on an island that's sparsely populated, hung out for the weekend, drove all over the island, did the whole thing back, got back with 18% battery.
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Yeah, and it's unbelievably fast and fun to drive. And I finally get the, it's an iPhone with wheels. Like it just feels, whenever I drive my other car, it feels kind of icky. And this one feels clean. It's perfect. Yeah, it's amazing. I get it. I get it, Tesla people.
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Yeah, we have a huge set of thank yous. First, of course, is our sponsors, JP Morgan Payments, ServiceNow, and Pilot. You can click the link in the show notes to learn more and tell them that Ben and David sent you when you get in touch. I was trying to count, David. It's definitely over 20 people that we talked with this time. So on my end, thanks so much to Brad Silverberg.
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Brad led Windows for a while, notably the development of the Windows 95 product and that team. Thomas Reardon, who was one of the original team members on Internet Explorer, and actually went on years later to start Control Labs, which sold to Meta and is a part of Meta's effort now to do the neural interface. You can sort of twitch your hands and I don't know.
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We haven't actually seen a product yet, so we'll have to see what that looks like. But that was Thomas Reardon in his next act. Steven Sanofsky, who led Windows in Windows 7 and 8 and led Office before that. And David, you read quite a bit of Steven's words to prepare for this.
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Yep. Julie Larson-Green was also great. She worked closely with Stephen in Office and also on Windows. My old coworker, Anand Rajaswaran, who worked with me on Office for iPad, helped refresh my memory on what the blow-by-blow was like in those days where we almost shipped the product, then didn't, then got a new CEO, then did.
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Huge thank you to Fritz Landman, who worked in some strategy and corp dev roles at Microsoft. Just an awesome guy. Actually, now he is the CEO of the combined company ClassPass and MindBody. And talk about a person with multiple lives and careers. He was great. Someone that he worked closely with at Microsoft, Charlie Songhurst. Charlie's one of the smartest people I've ever met.
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Absolutely brilliant, mind-expanding person. John Rubenstein, who led engineering at Apple and actually went on to lead Palm. It was fun talking with him about what was it like from the Apple side, from the competitive perspective, competing against Microsoft all these years. Huge thank you to Ray Ozzie, who David and I both spoke with.
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Yeah. More on my side to Rob Glazer, who worked at Microsoft in the 90s and founded and ran Real Networks. To Joe Belfiore, who played a large role in Windows and Windows Phone. And actually, he demoed Windows XP in the way back when, 2001, in the launch announcement to Regis Fieldman. That's like how the second half of the keynote works, is Joe is demoing features to Regis.
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Yes. So Joe's got this beautiful, long history at Microsoft and was just really great. To Vivek Varma, who was at Microsoft, deeply involved in sort of the comms and legal stuff during the antitrust era. Of course, to Steve Ballmer, being very generous with his time and helpful in helping us sharpen some of our thinking today.
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That's right. Our good friend who runs the Science of Hitting, it's a great substack that does investment analysis and just was very generous sharing a large spreadsheet of historical data from Microsoft. It's very easy to parse and look things up live while we're doing the episode. And finally, last one from me to Todd Bishop at GeekWire.
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Todd has these unreleased recordings from when he was covering Microsoft at the Seattle PI way back in the early 2000s. And he sent me the raw recordings, you know, when he was standing there with Bill and Steve just being a reporter. And it's very fun to hear their voices in ways that I don't think were ever released or publicly heard.
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Wow. Oh, and I have one more. Thanks to good friend Arvind at Worldly Partners for some of the research that he provided as well. So thanks, Arvind. Well, with that, you should check out our previous episode, Microsoft Volume 1. If you've already heard that, check out our AWS episode. We also recommend our NVIDIA series.
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Part 1 intersects nicely with this era of Microsoft, and we tell some of the PC gaming story from the NVIDIA angle. Lastly, of course, if you are sitting around right now and you're thinking, oh no, what should I do next? The answer is acquired.fm slash sf. We cannot wait to see you at the Chase Center. Mark freaking Zuckerberg is going to be there.
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It's going to be the event of the century in the acquired world. So stay tuned. If you've always thought like, oh, I've always wanted to go to something like Omaha, you know, for the Berkshire Hathaway annual meeting, where I've just wanted to celebrate with other business and technology nerds who also like Acquired, this is going to be the greatest way you could ever imagine to do that. Yes.
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Well, David, I'm glad you took the bait. I am here to tell you that that is the public narrative. And very close to the truth. But there's some more nuance here.
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Yes, all of that technically true. It is just not quite as meaningful as you think it is. So as with all of these things, it's not just like Bill Gates and Steven Sanofsky are having a think and the rest of Microsoft is sitting around waiting for the think to finish and then an edict comes down and then they go and do the work.
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There are a lot of people with a lot of ideas working on a lot of stuff in parallel. And that is why Microsoft's history is so delightfully messy is there's a zillion initiatives going on and it's never clear if your thing is going to become the next company strategy or not. So here is a slightly different version of this history with different players.
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And I want to underscore it for one big reason. It will come up later in antitrust.
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So, some of the Windows 95 team in late 94, led by Thomas Reardon, is pulled off before it ships to start thinking about what should we do after Windows 95 ships? What would the next marquee investments be for what at the time they're calling Windows 97? Which, of course, there was never a Windows 97. So the group's opinion is all internet all the time.
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You know, how could the next iteration of Windows be extremely internet native in a very embedded way? And there's tons of proposals in this little group. There's virtual meeting software, think Zoom type things. There's an email client specifically built for the internet rather than for your company's corporate network, which at the time was novel. Then there's, of course, a browser.
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But the big vision was, what if the whole Windows shell is a browser. Every visual thing that you interact with in Windows, what if that actually was like an HTML rendered server communicating online thing? And the team technically kind of looked at it this way.
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We're pumped. We'll see you there. This show is not investment advice. David and I may have investments in the companies that we discuss, and so do all of you if you own index funds. And this show is for informational and entertainment purposes only. Okay, David, the middle chapter of Microsoft.
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We should build HTTP directly into the operating system since it was just another protocol on top of the TCP IP protocol that the internet is based on. we should provide reusable UI component to any application that wants to display HTML. That's a good engineering building block to build is this HTML renderer that any application can sort of frame in and use.
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So of course, Microsoft, the strategy here is we will develop a browser application that used the building block that others could also use to render HTML. So they actually go to Netscape and say, hey, we have this great HTTP stack, we have the HTML engine, we have these wrappers to go around it. Instead of rewriting all of it, just use our off-the-shelf code that we intend to ship with Windows.
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Famously, Netscape did not do that. And so IE, Internet Explorer, actually ends up being kind of the only application that used all these Windows components And once they got going on the browser, they convinced the Windows leadership that actually we can do this fast. We should get this done as a part of Windows 95, not wait for the next big release.
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Yes. So anyway, how does NCSA, Mosaic, and Spyglass come into this? Well, the nuance is Spyglass had actually massively changed the Mosaic code. They were trying to create the Spyglass browser that was sort of based on this NCSA code base, but it wasn't very good. And so that is what Microsoft was able to get their hands on. They could not license the original NCSA version.
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That was gone or at least not available for license. And so they sort of tried backing out a lot of the Spyglass stuff, Ultimately, it wasn't that helpful in creating Internet Explorer, and they spent just as much time trying to undo a lot of it and then build the Internet Explorer stuff on top. So ultimately, did it actually accelerate their path to market?
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And was it actually Mark Andreessen's code? Some of it was in there, but, you know, it's not like they grabbed it off the shelf and now it's IE.
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David's holding to it. It's just so delicious. It is delicious. And the two big takeaways here, at least from this additional version of the story, is one, what they actually wanted to do was make Windows web-enabled in a really deep, integrated way, not just have this one little application called a browser. And technically, there was a lot of commingling there, a lot of what became...
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The code underpinning Internet Explorer was actually Windows code implemented in Windows operating system to do these protocols. And two, still a lot of work to make IE after the deal.
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Netscape, we should say, goes from 1 million to 15 million users in one year. I mean, just instant product market fit. It was so clear that people wanted to browse the web. A lot of the time in technology in this ecosystem, we're always looking around like, is that going to become a thing? Is that going to become a thing? That was from 1994 onward, never a question about the internet.
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It's such a good quote. And there's so much behind it, too. If you really dwell in that quote, what does it mean? If one of the things he's saying is Windows is a platform upon which independent software vendors write applications. So Windows is the way that currently people write software for businesses and consumers to use.
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And if we are going to reduce Windows to a poorly debugged set of device drivers, what I'm implying is these crappy static web pages that get served right now, that is merely a step on our journey to enabling rich web applications. Think JavaScript, CSS, eventually Java and Flash. The web will be a way... that developers write their applications. That's right there implicit in the quote.
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And so when they're saying we're going to reduce Windows, blah, blah, blah, it's saying, okay, Windows has all this stuff right now for developers, but essentially you're going to use Windows or any operating system just to boot it up, connect to all your peripherals and your screen and your mouse and your keyboard and everything, and you'll open your browser and you'll do everything through the browser.
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Not specifically this quote, but Microsoft had come to the same conclusion too of, oh my God, if the web becomes the platform of the future, all the reasons why we have all this incredible business, you know, people feeling the need to use our operating system to be able to get access to their favorite software and for developers to build applications on our platform to get access to the users, that could go away.
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And in the same memo that you were quoting earlier, the internet tidal wave, Bill Gates famously says, and when I say famously, it's because the Department of Justice later grabbed this quote and used it as an exhibit. Bill writes, "...a new competitor born on the internet is Netscape.
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Their browser is dominant with a 70% usage share, allowing them to determine which network extensions will catch on." They are pursuing a multi-platform strategy where they move the key API, the application programming interface, into the client to commoditize the underlying operating system. I mean, they got it immediately. The web is an application platform that completely reduces our value.
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And how amazing is this? It's an application platform of the future that is distributed as a Windows app. I mean, Windows had huge market share at this point. I don't know, 80, 90 percent, eventually over 90 percent market share. The way that Netscape could get to consumers was because Microsoft had all these computers out there running Windows.
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It was like this ultimate Trojan horse that they could build the platform of the future through Microsoft.
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Right. If Microsoft's goal is to cut off the air supply, David, as you already quoted, of Netscape, the goal is ubiquity instantly. And we don't care about making money. We just need to get this thing out so the Internet doesn't kneecap our business and we can sort of embrace and control it or perhaps embrace and extend it.
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And I don't think making very much money on their server software yet. All the market cap creation is attributable to people believing they have the dominant platform of the future and not based on their current financials.
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That's true. What's our tracker for the internet? Netscape. Everybody pile in.
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Yep. And for good reason. I mean, there's a very difficult to learn lesson, but you learn it once, you never forget it. If your distribution decides to compete with you and decides to make that a priority, your business is over in a minute.
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dead which is the next chapter of this story is how on earth did they lose that monopoly that they had in the browser but before that there's this interesting moment of reflection here why did Netscape's business dry up because their business was made from selling server software and Well, the way to have the best server software is to also control the client.
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People are very interested in making sure that their websites run perfectly using the experience that everyone has. And when you can no longer claim, hey, a whole bunch of internet users actually use our browser, do I really want to buy my server software from you or should I just...
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be open to buying it from anyone that I can sort of, it's the lowest cost and the best value with the most features, all that. So they sort of lose the competitive edge in the revenue side of the company. On top of that, it's just really hard to recover for companies that have an 80% drawdown or whatever in their stock price. There was a lot of excitement around the company that then goes away.
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Suddenly, all these employees are undercompensated. It's a company-killing event.
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Right. So to this point, Microsoft has not changed their business model. They simply vanquished a potential future that was dangerous for them. They're still doing the same thing as ever, selling Windows licenses through OEMs and to consumers at retail.
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Welcome to Season 14, Episode 6, the season finale of Acquired, the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Well, listeners, here we are, Microsoft Volume 2 at long last.
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Which, by the way, saved Apple. The company would have been completely out of business because it was so existentially important to anyone using an Apple computer to use Office that if Microsoft decides, oh, we're going to stop developing Office, people stop buying Macs. And the company's already in such a tenuous financial position, it's just over.
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Well, it's funny. I actually do have some color on why he did the deal. Steve Jobs wanted to message this as Microsoft believes in the Mac as a great way to use the Office suite. They believe in us as a company, and so they're investing $150 million and making this commitment to help us get through this difficult time.
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And this money, by the way, just to help people understand, Apple was worth about $2 billion at the time. So this is Microsoft buying 8% of Apple. Yeah.
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Steve cleverly identified this moment as a time to call Microsoft and say, hey, I know we're through all the patent issues, that big lawsuit. I have more. I think you guys are using some of our stuff. I don't want to sue you. I know the DOJ is sort of looking at you guys for antitrust right now.
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Apple was aware that Microsoft would be interested in appearing collaborative with another major player in the ecosystem. And so we sort of have the leverage to say, hey, what if you guys invested in us and did this big commitment to Office for Mac? It's super important to help us get through this difficult time. And Microsoft said back, well, it's really important to us to have IE everywhere.
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And so they rolled it all into one big deal. No one's going to sue anyone. All the IP is cross-licensed. And Microsoft gets the win with IE. Apple gets the win with the investment in Office. And we can all walk away.
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Apple is saved. Truly, Apple would have gone out of business had Steve Jobs not seized this opportunity.
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Yeah, David, you're burying the lead here a little bit. We talked to probably four to five times as many people as the next highest episode. I'm looking at our little thank you list. It's like 20-something people long.
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Google is three years from being founded. Facebook is nine years from being founded.
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There's real competition in the enterprise at this point, Sun, Oracle. But in terms of what your point is, the consumer technology landscape, yeah, they had ultimate power. Yep. Yeah, but David, I don't know. The whole thing of you can just decide to and then you completely vanquish your biggest existential threat by cutting off their air supply. Shouldn't that be illegal?
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Well... To lead you a little bit into our next section. Yeah. Well, listeners, I think you know what is coming next based on David and I coyly alluding to it. But before we get there, we've really been talking about this idea of development platforms.
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We were talking about the web as a potential development platform of the future, even as far back as 1994, people building web applications or, you know, Windows 95 in its heading. But what makes for a great development platform? Well, this is a great time to thank our friends at JPMorgan Payments to talk about their developer platform.
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To build a great one, it requires a culture focused on empowering others and investing with a long time horizon. And JPMorgan Payments knows this well. We've talked about how they're much more than a global bank. They're now investing $17 billion a year in technology and R&D. But you may not know that they've also been investing heavily in their developer ecosystem.
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And over the last year, they've really embraced this dev-first mentality with their API-powered payment solutions.
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Yes, we know that many of you listening are developers who will be excited to learn about J.P. Morgan's new Payments Developer Portal that's essentially a one-stop shop to build solutions for your business on top of their trusted and scaled platforms. While this is just a first step in a long journey for their developer portal, J.P.
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Morgan is really taking a long view in investing for the future, working hand-in-hand with their clients, dev teams, beta testers, and payment industry experts to launch, learn, and iterate.
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And they've got a robust end-to-end roadmap of payment APIs coming in the future across treasury, commerce, embedded finance, and even value-added services like account validation that are going to be truly unique in the industry.
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which is great. I can speak from my past experience as a developer that it is very nice when your head's down, you can just use self-serve, well-documented APIs and code samples. I actually read through the quick start guide and thought it was very easy to follow.
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Not to mention 200 years of banking experience, your payments just work the first and every time. You get security in huge scale. We've said it before, JPMorgan moves $10 trillion a day. Over 50% of all e-commerce transactions in the United States pass through their platform.
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We encourage you to learn more about their API-powered solutions built for developers at jpmorgan.com slash acquired, and let us know if you've tested out their new payments developer portal in the Slack. If any listeners are heading to FinTech DevCon in August, you'll be able to learn more about all of this directly from their team. OK, David, so we've arrived.
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The famous 1998 Microsoft versus the U.S. Department of Justice antitrust trial.
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Right. We're getting into a whole bunch of very interesting questions here. And I asked it exactly to sort of pop open the can of worms. But there's a question of what actually is legal in the US? What actually is legal in the EU? Then there's this interesting question sort of emotionally for everyone who is working on software at Microsoft.
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the vast, vast majority of people are not really focused on what is the business and competitive strategy. Most people who worked on any of this stuff, their whole goal was, I want to ship great software and make things that people love to use, and I want to work with people that I love making it with.
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And so if you ask most people who worked on any of this, their opinion is, I don't know, we were trying to just make the best software out there, which is very interesting to square with this growing demand public perception that Microsoft is being a bully, especially public generated by their competitors. Right. And then the literal legal question of, did they do something illegal?
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Because the actual antitrust laws are a super different thing than, ooh, does this feel anti-competitive in some way to me?
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Well, David, now you're cracking open the issue of consumer harm, the consumer welfare standard that the whole thing is based on. So take us into the story.
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This centered on the notion of per-processor licensing, which we discussed in our last Microsoft episode.
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Yep. Because theoretically, they could have examined any monopolistic practice at this point. And they said, just the one narrow thing that we were worried about, they agreed to stop doing. And we, in voting 2-2, we see no other issues that we need to investigate.
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Exactly. And this is so messy because I think, David, you just used the exact language, which is they cannot tie these application products in a bundled sale. However, they absolutely can integrate new features. Yes.
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And this also looks the other way at the whole idea of software development and platforms, which is it is a continuously changing landscape where over time, in the interest of users, platforms do more and more and more things that applications used to do.
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Yes. It's so funny because we sort of intentionally left all the internet components out of Windows 95 in the previous episode because once you start talking about the internet, you're really talking about the next chapter of Microsoft and you can't help but dive into it all.
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And so the whole notion that they're going to write that sentence and then call it good, what is an application today might be a feature years down the line, but the law is written and we have to pay attention to that sentence constantly re-evaluated in the context of the current time.
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Well, is it a feature? It's actually, it's literally an application. It is a bundled application as it exists today. So this is the gray area.
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clearly motivated by the idea that we want our windows platform to maintain the power it enjoys from its monopoly market share so there's a sympathetic view for sure of hey this is core functionality to an operating system whether it's a feature or an application that we bundle and also clearly the reason you are incentivized to ship your own browser is to cut off the air supply of potential competitors that develop the platform of the future yes
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And it's important to know what they're basically asking is, this is not about future versions. You know, we know you're doing some kind of Windows 98 thing. We're saying right now, stop shipping IE bundled into Windows. Microsoft insists this is an integrated product. You cannot do that.
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And it's not even necessarily a legal argument yet of we're allowed to do this because it's an integrated feature. They're saying we ship a pile of code and you actually cannot just rip out Explorer. And if you remember at this time, you could do all sorts of crazy stuff. Like you could paste a web address anywhere. in Windows Explorer, and it would render even though it wasn't Internet Explorer.
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But in retrospect, the thing that mattered about Windows 95 all these years later is that's the platform that everyone started using the internet on. And everything that we talked about in the last episode, yeah, it's all important, but it's not nearly as important as it being the internet operating system. So how did this come to be?
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So there actually was like, if you think back to that sort of vision of the browser is integrated into the Windows shell, and it sort of happened, a browser was not really, at least Internet Explorer, was not really its own standalone thing. It was deeply integrated. Now, could they have pulled it apart is a different question if they really wanted to.
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Right. So the federal judge, Thomas Penfield Jackson, orders them to do it anyway. Or more specifically, he ordered Microsoft to ship a version of Windows to the PC makers, the OEMs or original equipment manufacturers. That didn't include IE so that those OEMs could load those onto the PCs that they were going to ship to customers if they wanted to.
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And Microsoft said, we told you we can't do that, but you're a judge and you're ordering us to. So they do. And surprise, surprise, when you just disable a bunch of code that other code depends on, it doesn't work. So then, of course, two things happen.
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Judge Jackson is not pleased, since it appears Microsoft is complying with the letter of the law but violating the spirit and sort of thumbing its nose and being arrogant. So that's thing one. Thing two is obviously the PC makers don't actually ship this version of Windows, so it never sees the light of day. And so things get real petty, real fast.
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And this is interesting because this is when it really hammers home the idea of what we, the U.S. courts, care about is consumer welfare. We haven't explored the idea of if Microsoft is a monopoly or not yet. But for now, what we are saying is as long as what they are doing is in the consumer best interest, they're not causing harm, they're not raising prices, then it's okay.
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Really bad. And it's worth decoupling did they do anything wrong from just legal strategy by holding a very firm line early of we're appealing this decision. We couldn't possibly be doing anything wrong here. Microsoft is starting to take this super aggressive stance. And the Department of Justice is then like, wait, you didn't give an inch?
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You're not open to just this one thing, the tying of Internet Explorer and Windows? Okay, we're going to look at everything.
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Yeah. And Microsoft folks at the time, too, are starting to get this inkling of, why are they doing this? Are consumers really mad at us? Who's being helped here? And they're starting to realize, hmm, there is a lot of lobbying going on behind the scenes of Netscape and everyone else we're competing against trying to find a way to call us anti-competitive.
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Which, we should say, is always true in these big antitrust lawsuits, but that was certainly happening in this one.
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So the first question that everyone is sort of wondering is, did Microsoft have a monopoly here? Well, the fact is that they had over 90% of PC operating system sales. So, you know, I'm not a judge, but at first glance there, you think like, okay, they have market power. So in August of 1998, Judge Jackson issues a pretrial order that all depositions...
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And so for folks who aren't in this world or looked at lawsuits before, a deposition is when the counsel goes and does a bunch of interviews beforehand. You're not being called as a witness in the trial, but it's basically information gathering. Yeah. Interview process. Yes. So on August 27th, Bill Gates is deposed by the DOJ's appointed prosecutor, David Boies, for 20 hours.
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And I think this happens over multiple days. Actually, on YouTube, which is interesting to note, you can watch 12 of the 20 hours. I think I've watched eight or nine of it, but it's just hours and hours and hours of... Just some, you know, light bedtime viewing. ...of Bill Gates being asked questions.
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So the strategy that Gates and the Microsoft legal team used was one that was tailored for this pretrial ruling. If you watch the video, you can see that the strategy is essentially never give an inch, avoid saying anything that can be used against you. And Microsoft walked out of it feeling like they were pretty successful in this.
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Right. And yet I just watched the video on YouTube, so what's going on here?
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Yeah. So if you're watching the video, though, it's very easy to think this guy is rude, pedantic, and disrespectful. I'm not out on a limb saying that opinion. If anybody watches this video, that is just the obvious takeaway.
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Yes. So a couple examples. I'm not exaggerating here. The deposition really does come across as just showing pure disdain for the prosecutor and the questions he's asking. Bill Gates rat holes on things like refusing to answer questions about memorandums since they were not memos, but emails. So I couldn't possibly answer you on the question about the memorandum.
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At one point, he does look at David Boies and ask him how he would define the word definition, of course, while smirking the whole time. And so the whole thing is like very obviously tailored with this idea that I'm going to give you pages and pages and pages of which you will have nothing that can be used against me. And that is the whole strategy. I don't care how I come across.
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I don't care how ticky tacky the language is. You know, he sits and pauses forever. He'll say, well, you asked me what the person who sent this was referring to. How should I know what they're referring to? I didn't write the email. You'd have to ask them. I don't know. And so it's 20 hours of this.
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Well, somehow, and I actually don't really know how this happened, after the deposition is recorded, on October 9th, the judge then issued a reversal saying that videotaped depositions are indeed allowed to be used in court. Oof. Yeah. How did this hold up? And if you give a great prosecutor like David Boies this opportunity, he uses it masterfully.
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And so throughout the trial, he'd show little clips at strategic moments in the trial where he either wanted to give the press something juicy to write about that day because there's a whole press section in the back going and listening to all the witnesses every single day. Or he would play something he knows is going to get a rise out of the judge.
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Yeah. For consumers, it was kind of a similar experience. You could get content on your computer. But the main difference was how to put content on that network. It wasn't like anyone could just plug in a server and then boom, you have a website. It was like you had to have some negotiating power and know someone at AOL to go do a deal to get your content on their platform.
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And if the judge makes an expression, then the press writes about, oh, the judge is leaning this way or that way. Also, he would use it any time there was an opportunity to feel sympathetic for Gates or anyone at Microsoft, and then he would show a clip that sort of clearly causes you to lose any sympathy or leaning. And so it was just dripped out in this really clever way.
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That is a great question, David. And one of the things that I read to prepare for this episode is a book called World War 3.0, which is exclusively about this trial. And the author has this comment on it. Microsoft feared that Judge Jackson was a foe. He had made a number of pretrial rulings deemed hostile to the company.
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They were especially unhappy that he modified the pretrial order that depositions shall only be submitted in transcript form, issuing a new order allowing videotaped depositions. Microsoft suspected that Justice had somehow prevailed on Jackson to amend his earlier court ruling. Jackson categorically denied this, but does not recall exactly why he issued the October 9th ruling.
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They groused, but only in the most unguarded private moments because they were terrified of offending him that Jackson was biased and would rule in favor of the government. So your question of how does it hold up? I guess there was no formal challenge of that change in rule.
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And part of it probably was just because they realized they had a long way to go with the judge and didn't want to agitate too much.
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And more specifically, the finding was that the network effects from the large installed base... so that's users, and large body of applications, so apps, makes it prohibitively expensive for a competitor to develop its PC operating system into an acceptable substitute for Windows. Which, yeah, of course, obviously. That's what our whole episode one was about. Correct. Right.
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So the finding of fact is, hey, it's monopoly, but again, not necessarily illegal to be a monopoly, only illegal to abuse monopoly power. Right.
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Also, what? This is completely lost to history unless you are a tech old-timer. Microsoft was ordered, that was the ruling by the court, to split up.
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And there's a whole bunch of additional provisions in this. Steve Ballmer had to work at one company and Bill Gates had to work at the other. They could not work at the same company. Each of those two, after they picked their companies, had to divest all of their shares from the one that was not their employer. So they couldn't have this conflict of interest.
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It is crazy imagining this world that could have been. I mean, clearly this didn't happen, but for a moment in time, this was the position of the United States government.
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After the ancient history of Volume 1, we now get to the stuff that you grew up with, the internet, Windows XP, Xbox, the browser, search, and mobile. And in this era, Microsoft had a lot of the right ideas. with a lot of the wrong timing and execution on everything from the Zune to Bing.
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It's also worth pointing out from late 1999, when the findings of fact came out, over the next 12 months, Microsoft's market cap dropped from $600 billion to $270 billion, which was a 55% drop. Now, this coincided with the dot-com bubble and the CEO change that we're going to talk about shortly. But the perception of Microsoft, this super high flyer, completely fell off a cliff from this ruling.
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Yeah. Not exactly the same thing, of course, because this is not about devices.
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Of course. It was discovered later in June 2000 that Judge Jackson had secretly been meeting with reporters in his chambers before the rulings were delivered. It's not allowed. And so Judge Jackson was removed from the case. Yes. The reporters all had these embargoed stories they could drop immediately afterwards. And everyone was like, how did you, what? Wow. That's wild. Yeah.
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So this is June of 2000, by the way. The appeal then takes a long time. So there's a meaningful moment in history, I think about 15, 16 months, where the official ruling is Microsoft should be going through the preparations to do their breakup.
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Especially 9-11 happens, and then I think that's a galvanizing factor to pull the parties into the room and say, hey, this has gone on too long, and we need to put this behind us.
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Also, can we just say, this case is brought against Windows 95, Windows 98 comes out, and then before we have a resolution, Windows XP comes out.
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But, like, insane, right? And the whole time, Internet Explorer shipping with Windows.
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So November 2nd, 2001, the settlement is proposed. At this moment in time, Internet Explorer has right around 90% market share.
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Right, an innovative company that built the most important product for that technology phase. Meanwhile, there's this whole new thing going on with the internet, and we need to figure out how to legally navigate that transition.
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Right. So 2002, the settlement is finally approved. It reverses the order to be split up. Obviously, Microsoft is still one company. Officially, the ruling that Microsoft did indeed have a monopoly is upheld. They put in place a five-year consent decree, and the terms are that Microsoft is not allowed to enter into contracts with PC makers that excluded competitors. I mean, fine.
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Two, Windows had to be interoperable with non-Microsoft software, which, of course, it does.
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It's a developer platform. They have to write API documentation and make their APIs such that developers can build applications on top of them. That is the purpose of the company. So, okay. Three, an independent technical committee was created to field complaints from competitors. Okay. They created a call line. That is it.
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Oh, that is a take right there. I think that we will debate at the end of the episode.
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Yeah, it exposes the difference, too, in the legal strategy of both sides, where Microsoft's strategy was to refute point by point every allegation brought against them to the point where they were trying to refute Netscape. We don't view Netscape as an existential threat to us.
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And they should have just probably acknowledged, you know, Bill literally wrote a letter that got published, a memo saying that Netscape is a competitive threat born on the Internet. but they wanted to refute every single point and knock of an inch.
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Meanwhile, all David Boies and the DOJ wanted to do was destroy Microsoft's credibility so that every time they brought a witness, there were emails or there was a deposition that basically called into question Are they really telling the truth on the stand? Can they really not remember that? And it just blow by blow made Microsoft look like they were duplicitous.
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And that has to leak into the company culture. That has to make you, on the one hand, feel like your government is attacking you. But on the other hand, start to question and say, why did we do this again? I thought we were just trying to make the best software. Were we trying to do something illegal and I just didn't know about it?
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It's worth talking about some of the other pieces of fallout. It did slow Microsoft down. There were huge amounts of protocol documentation that needed to happen. So if anyone's running a software company, you know that if your iteration times are slower and you just have permanent new drag on your development process, you are going to fall behind.
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And I think that was one that was felt by a lot of employees and managers who suddenly can do less with the same amount of resources that they have. There was also a bunch of private lawsuits. Sun, AOL, Real Networks. Microsoft was paying out billions of dollars in these private settlements that followed the DOJ, their civil suits.
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Many of the state AGs for years who brought the suit together with the DOJ did not accept this reversal. And so they tried to continue independently suing Microsoft, which was painful for another five-ish years. We made it all the way to 2009 before they settled their EU version of this antitrust case. I mean, that's another, what, seven years after the reversal.
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So there's a little sleight of hand that you just did there. You said it becomes MSN. Marvel, when it initially was conceived, was a proprietary online service. Eventually, when that completely failed, which you're about to get to, they repurposed the name MSN for their internet-based media property. Complete shift in strategy.
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And in May 2011, that is when the final consent decree finally expired. So basically from 1990 until 2011, 21 years of the company's life, the majority of the company's life had been spent under some sort of antitrust scrutiny or active litigation.
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But were consumers ever harmed? I continue to wonder this. It was horrible for Microsoft, even though there weren't any real material changes they had to make. But effectively, they won. Which I guess they should have, because it's not clear that there was negative impact to consumers. There was all kinds of negative impact to existing competitors or future potential competitors.
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Yeah, Microsoft had one competitive advantage that no other company had, and that was Bill Gates.
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Yeah. Going through something like this has to feel personal and has to change you forever. I can't imagine how it wouldn't. Totally. Especially when, again, it's not clear to me how consumers were harmed. So this constant battle, this war that was waged on forever and ever and ever and ever, It totally distracted Microsoft.
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And as anybody can attest, especially in the tech industry, if you are distracted, you just fail because you need to have all of your best resources making stuff, building stuff focused on a firing on all cylinders, clear North Star strategy. And so if you tie up a company for five years and you lose your leader through it.
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Yeah. It's not fair to blame everything we're about to talk about, all the future consumer failings on this, but it is helpful to keep this in mind and say, okay, why perhaps did they not fully have their wits about them?
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It's actually shocking they held on to as much talent as they did in a 15-month period of people assuming the company was about to be split.
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And you kind of need a new set of people to do that. It's kind of amazing that Steve was part of the old guard and the new guard to do this, because how can you say I'm going to put how unfair I feel this was aside and and just focus on moving forward. That is an extremely difficult compartmentalization exercise.
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And so for Brad to come in and say, like, I'm going to be the guy who is able to disregard the past and figure out how we – and I used this phrase in the first episode – become a trusted partner to governments around the free world. I mean, how crazy is it that this Microsoft that we just talked about for the last hour – became the Microsoft that can do no wrong from a regulatory perspective.
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The only one that's not under active antitrust investigation today by the federal government. The one that is a massive provider of software and services to the U.S. and its allies at the government level.
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And Bill Gates is still chairman of the board. Like, not only is he a full-time employee being the chief software architect here, It's not that it's like a sham that he's not the CEO, but he is a very present voice at the table in these big decision-making moments.
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And so for how do we become a company that continues to innovate and make great products despite all this, he still has Bill as the technical leader of the future products.
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So then the question becomes, how did Microsoft build this phenomenal enterprise business? And along with that, release XP, the most successful Windows operating system ever. And then we're going to talk about Vista. And then we're going to talk about Zune and Search and Bing and Windows Mobile. Windows 8 and, yeah, all that.
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But before we do, we would like to thank huge partners of ours here in this season of Acquired ServiceNow.
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And speaking of Microsoft and ServiceNow, they just announced a huge expansion of their partnership, specifically integrating the two companies' enterprise AI assistants. Starting in the fall, customers will be able to interact with ServiceNow's NowAssist AI assistant directly within Microsoft Copilot.
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Yes. And like that historic announcement from Bill committing to Microsoft Office for the Mac, this partnership is also huge. ServiceNow's Now Assist will be integrated with Microsoft Copilot and will be available directly from Office apps starting with Microsoft Teams in August. the AIs are integrated into one seamless user experience without actually sharing data.
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So if, for example, a user asks Copilot in Teams about how the company's laptop policy works, behind the scenes, Copilot shares that request and context with Now Assist, and Now Assist accesses internal company policy with the right permissions for that user and returns the answer to Copilot in a rich card with options for the user to kick off a workflow via Now Assist.
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In the future, Microsoft Copilot will also be integrated the other way into Now Assist so it can automatically generate Office files like PowerPoint presentations and Excel spreadsheets directly from assets and knowledge in the ServiceNow platform.
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All right, so to contextualize how this enterprise business was built, it is worth understanding the shape of Microsoft's business, like the divisions, what products generated what revenue, even before all this DOJ stuff. So if we go back to 1996, Bill Gates gave a great interview where he was talking about the kind of four businesses that they're in today.
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Yes, it's on YouTube. It's great. It is great. So there's Windows, which he calls one business. There's NT slash back office. There's office, which he calls a $4 billion a year business. And those three businesses together are over 90%. So you can think about it as Windows. And he said NT slash back office, but this is the enterprise and office.
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It really exposes that Steve was the one who had the passion for the enterprise. Bill was like, it's like this stuff that businesses buy, but I'm going to refer to it by its Microsoft product name of one of the products we sell, which is NT. And then the last 10% is everything else. So there's MSN, e-commerce, games, encyclopedia, maps, joint ventures, DreamWorks, and NBC.
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Well, think about the number of things required to create some sort of networked entertainment interactive thing. You would need screens. You would need some way to control those screens to create a feedback mechanism. You would need content. You would need infrastructure connecting people's homes. all of those already existed by the cable companies and their endpoints, the televisions.
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So he's talking about the interesting thing, the server business, which is a different way he refers to NT slash back office. All the way back in 96, it's the fastest growing business, even faster than Windows or Office. So they sort of know they're onto something, but they haven't quite cracked the go-to-market motion, the pricing, the service, organizationally, how do they sort of fit it in?
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NT basically was enterprise-ready. It was very networked for workgroups. It ran on only the most high-power PCs. But you're right, David. It was designed for the thing that the first 25 years of Microsoft was all about, which is PCs. It's not like, oh, we're a systems company that makes stuff for all use cases all over your enterprise. No, we make stuff that runs on a box sitting in front of you.
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And one benefit from this, which of course, if you're Microsoft, you don't want to lean on this benefit, but they end up doing it, is if you make everything integrated together work well and come from one vendor, nothing actually has to be best of breed. And so you're no longer competing with any point solutions. You offer the whole thing.
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And if you pitched me on the idea that actually everyone's going to go buy a brand new device, like a PC, like a computer, and we're going to have a different set of wires that actually bring all of that to the home, or maybe we'll repurpose some of the same wires, but gosh, we need to like bring in new networking equipment everywhere along the way.
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Sure, yeah, you can consider going and buying that other vendor's directory service or that other vendor's email server. But are you really? Because you buy everything from us and it all works pretty well together.
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It all has Active Directory that syncs across everything. In doing all this research, it seemed to me that once a enterprise adopted Active Directory, they were going to tip and they were going to buy the rest of the software too.
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Because whoever manages the source of truth for who are all the people and what are all the resources, you know, devices and everything that my company owns, everything else needs to reference that canonical set of proper nouns, whether it's email, whether it's calendar. So that was this incredible sticky product that then you could just keep attaching more and more stuff to. Any enterprise need?
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Fascinating. I don't think I quite understood that. And so basically, you then have NT as the operating system, SQL as the database, and then you've got all these other applications that basically run on that stack.
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Oh, and there's going to be completely different content companies that figure out how to create the content for their... It's like, all of that falls flat. Of course you're going to use all the existing infrastructure and content. You're not going to bank on standing it all up new from whole cloth.
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Yeah, it's pretty incredible. That's all on the sort of why it's good for customers. On the why it's good for Microsoft, Steve also pioneered this bundling idea, which is once you sign the enterprise agreement, you get access to all of this.
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And if you're a customer that's only using 30% of the things in the bundle, if you have business needs that involve some Microsoft product that comes for free in your bundle, you're going to adopt that. And guess what? You just became a stickier Microsoft customer. I feel like this often goes overlooked in the like, oh, Microsoft's a big, boring enterprise company right now.
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There was a tremendous amount of business model innovation in figuring out that bundling like that with additional products can create stickiness, which eventually creates more enterprise value for your company because you've got these long, durable, compounding revenue streams. Oh, and all your customers are growing, so you have the whole land and expand thing there.
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And the thing underpinning it all is the software itself has zero marginal costs. So you can bundle in all this stuff for free because it actually doesn't cost you anything.
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Inclusive of Windows and Office. I mean, it's not just, you know, a salesman comes to you and sells you Windows. This is Microsoft amortizing their go-to-market costs across all of their products because when you show up at an enterprise, you've got lots of stuff to sell them.
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And a key feature of the EA is that it is a three-year agreement, which means that you really need everything to be aligned to pull this off. There's something pretty convenient that you may have noticed about Windows and Office. They both tend to release an operating system or a new package of Office once every three years or so.
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And so every customer, no matter when they sign the agreement, is essentially guaranteed one upgrade during their lifetime.
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Yeah, you're willing to make tradeoffs like if you can get a little bit more efficiency but trade off some security, that's fine. If you can, you know, maybe use some pirated software, but it makes you better at your job, that's also fine. You're acting with your own agency, not necessarily the company's best interests in mind.
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Yes. But now, David, you're starting to expose a couple features of enterprise adoption which have trade-offs if you're Microsoft.
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First of all, if you are a user, you want the latest and greatest software with all the most innovative features. Your IT administrator has a lot of incentive to say, I don't really want to go train everyone on anything new. So if the software never confused anyone, that's a win, even if it means we never get any new features.
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Microsoft Volume II
And so suddenly, and I have a direct quote from someone who is an executive in office, told me, when I was in office, I always thought we could stop bundling new features for 10 years and it would be fine. No one would notice.
Acquired
Microsoft Volume II
Office got to this point where, and I think Steven Sanofsky even writes about this in Hardcore Software in his book and on his Substack, that at some point they were trying to ship features that the PMs thought were great and users would love. They would do this user research. They would hear that people want them. And then the sales force would run back to them and say, no, no, no, no.
Acquired
Microsoft Volume II
But despite that, from 1995, where we start our story, to 2014, where we will end this episode, Microsoft grew their annual revenue from $6 billion to $80 billion. They became a phenomenally successful company and really cracked the code on selling enterprise software. I began the research thinking our part one episode would be about the rise and this episode would be about the fall.
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Microsoft Volume II
Do not include that. Are you kidding me? I'm going to have all these objections in my sale if you make me take this new feature or take this ribbon or take this, you know, any big UI change. Everything has to be small and iterative and not add any training or confusion.
Acquired
Microsoft Volume II
The other big thing that you are talking about, which you were hinting at with VBA macros, the key to enterprise is backward compatibility. Saying, look, we don't necessarily need to promise you anything too groundbreaking. We need to meet your needs today and be the most cost efficient.
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Microsoft Volume II
efficient, you know, total cost of ownership driven system that meets your needs and your employees are fine with. And from here on out, everything's going to stay compatible. Any modifications you make enterprise or software you use and rely on, we won't break no matter what.
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Microsoft Volume II
Yes. And enterprises love that. And we're going to put a pin in this right now, and we're going to bring it back toward the end of this episode in a really illustrative way that it can deeply, deeply hold you back if you are Microsoft and you have built an entire brand and reputation around your backwards compatibility.
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Microsoft Volume II
By 2007. So, I mean, it was really the first seven years of Steve's tenure as CEO. Yes. Already tipped the balance into majority.
Acquired
Microsoft Volume II
Yeah, it's funny. I wasn't going to bring this up here, but since you brought up OEMs, the OEM business model is completely transformational for Microsoft. When they figured out, actually, we shouldn't be just selling software directly to consumers. Instead, we should be selling them to the PC maker, and the PC maker should do our distribution. So here's a couple stats.
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Microsoft Volume II
In the 90s, the box software that Microsoft would use to sell Windows... Their gross margin on a copy of Windows was 29%. Oof, that's not good. They had to print the disk, which had actual real costs, especially on floppies. You had to put it in the box. You had to ship it to the retailer. You had to split profits with the retailer. You had to pay the sales and marketing costs.
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Microsoft Volume II
I mean, it's like real material. This is not a zero distribution cost, zero marginal cost business in the box software retail world. But when they're selling through an OEM channel, their gross margin was 75% because you just ship the bits to the OS once and then the PC manufacturer takes it from there. Not only is it amazing because you get that 75% versus 29% of gross margin, but
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Microsoft Volume II
It's also an amazing way to scale because you do a deal with every OEM, you know, as you're going down the line, it's the Visa networks of networks thing that I think we alluded to this last episode too. You just get each of them scaling on their own can accrue to you without you doing additional work to do the scaling yourself. And so, David, it's interesting.
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Microsoft Volume II
You're talking about how 85% of the business by 2007 was either enterprise sales of the EA or OEM. I mean, they'd basically kicked the can to the curb on that crappy retail box software model, and they're just doing the whale hunting with their sales force and doing these enterprise agreements, which of course have great margin structures, and the OEMs.
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Microsoft Volume II
Exactly. Way better business model in every way. They pivoted the whole business to the two best ways to sell software and completely eliminated the bad way to sell software.
Acquired
Microsoft Volume II
Yeah. what was going on with Windows releases during that time. And I think through storytelling the Windows releases, we can then understand the state of the company. So, Windows XP. Why was Windows XP such a big deal?
Acquired
Microsoft Volume II
Well, it was a big deal technologically, it was a big deal for users, and it was a big deal because it's pretty wild that Microsoft, amidst all the antitrust stuff we were just talking about, During the 1998 to 1999, the rulings in 2000, the settlement proposal in 2001, they developed and released an operating system amidst all of that.
Acquired
Microsoft Volume II
Yeah. So what was Windows XP technically? Well, for the previous better part of a decade, they had two parallel development efforts going on. There was Windows NT for the enterprise, and there was Windows 9X. Windows 95, Windows 98 for consumers. And both of these had the same API that developers could write their applications for.
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Microsoft Volume II
But ultimately, the way they were implemented, the way interoperability worked, compatibility worked, user experience, everything about it was actually completely different because it was a completely different implementation of those APIs. And so the knock against NT was always, well, you need really beefy enterprise-grade PCs to run it, and it's not as nice and intuitive.
Acquired
Microsoft Volume II
And the knock against the Windows 9X, call it 95, was that, yeah, it looks pretty, but it's not powerful. I can't actually do anything. It was like a friendly interface, but not a powerful set of functionality that came with the operating system. And so XP... did the impossible, where they figured out how to take the ease of use of the 9X interface and make it run on top of NT.
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Microsoft Volume II
The whole thing is built on the NT kernel, and it has the friendly, approachable ease of use that you are used to in Windows 95 and 98.
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Microsoft Volume II
Amazing. So the lineage of that 9X code base that came all the way from Windows 3.0 or maybe even 1 or 2, I don't know how long code lived, but... Interface manager. Right. Exactly. Is now dead. And so you had the NT lineage of, I guess, maybe even you could say it started with OS 2, but Windows NT, Windows 2000, and then Windows XP. So everybody's running XP now. There's two editions.
Acquired
Microsoft Volume II
It came with all kinds of great stuff. They've got this great slide. It's a fun announcement to watch. The emphasis on digital photography, digital music, digital video, home networking. It ushered us into this age of you probably have media that you're using on your computer. Apple famously owned this as a corporate identity with their digital hub strategy.
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Microsoft Volume II
But, you know, Windows XP, plenty of people were importing digital photos off their camera to Windows XP. That was a sort of big, exciting use case for it.
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Microsoft Volume II
A lot of Napster clients, yes. So, like I did for every Microsoft Windows release, I went and watched the Keynote. The keynote is extremely strange. Think about what a Steve Jobs keynote was back in the day, or what a WWDC keynote is like today, or a Google I.O. This keynote opens with a gospel choir singing America the Beautiful.
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Microsoft Volume II
and is followed by Bill Gates and Rudy Giuliani walking out on stage together and talking about how bad terrorism is.
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Microsoft Volume II
Yes. So this happens one month after 9-11 in New York City. And it really underscores what a strange time it was in the U.S. If you had this once-in-three-years product release, and it was going to be in New York October of 2001, you'd probably have this question, should we even do it? Should we make it all about the first responders? Yes.
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Microsoft Volume II
It grounds the whole thing in a very specific moment in history when you're watching it in a way that no other tech event really ever has been grounded in history before. So a few other things that jump out during the keynote. Bill Gates is not the CEO. Steve Ballmer is. And yet, Bill Gates is the one walking out with Rudy Giuliani to kick things off.
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Microsoft Volume II
And that's a strange and somewhat telling element of what Bill's role at the company was. Now, you could argue he was the public-facing figure. He was the founder of the company. It seems very natural. But also, at some point, why isn't the CEO the one doing the keynote? Another thing about Windows XP, there was a new release of Office... right at the same time as XP.
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Microsoft Volume II
This is a classic Microsoft move. They are able to create great applications available on day one, which makes the OS more valuable. And so from the applications perspective, they're able to ensure that they get great market share since they're always adopting the latest and greatest Windows platform right away. So Windows success begets Office success. And it's important to remember that.
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Microsoft Volume II
That worked for many, many years. And if you remember back to the last episode, Lotus 1.2.3 and WordPerfect smoked Microsoft in Microsoft's own backyard. During the DOS era, Microsoft's productivity apps did not get real adoption in DOS, which is crazy. So when they were making Windows, they basically swore never again.
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Microsoft Volume II
They ensured that they were going to be very early with applications on those platforms. And so as Windows took off, Office also got huge market share. And it's smart to remember this lesson and carry it forward for years, maybe a decade. But again, they may have been on this strategy a few years too long. Forever, it kind of became gospel at Microsoft. So with Windows goes the company.
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Microsoft Volume II
Well, this is so interesting because we're talking about this general idea of interactive computing involving other people. And Microsoft so far has two initiatives, Marvel and the information superhighway, neither of which are the internet or the web browser. Yes, correct.
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Microsoft Volume II
And so you need to do things to make sure that Windows is going to continue to succeed because that is our company's platform and livelihood. It's almost like the old Disney adage. So with animation goes the company. And until 2014, Microsoft felt the same way.
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Microsoft Volume II
And so there's strong incentives everywhere for Microsoft to ensure that Windows is the standardized platform that everyone wants to have on their PCs. because it kind of makes everything else work. And so, of course, they're going to release a new version of Office that shows off the latest and greatest of Windows.
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Microsoft Volume II
And I think this XP timeframe is the showcase moment of when that was a great strategy, and we'll contrast that later.
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Microsoft Volume II
The other thing to know about this XP timeframe is last episode we talked about the incredible secular growth trend of the PC that was this crazy tailwind for Microsoft. One of the greatest tailwinds you could ride in business history. PC shipments, I believe the stat, David, was that they grew 98% per year over the 11 years between the founding in 1975 and the IPO in 1986.
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Microsoft Volume II
The crazier thing is, even as late as 2001 with Windows XP, they were still riding this tailwind. The US household penetration of personal computers, again, flashing back pre-IPO, was only 8%. So that whole doubling year over year over year... By Microsoft's IPO, they still only got to around 10% of penetrating the U.S. By 1997, 13 years later, it grew to 37%.
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Microsoft Volume II
And after a couple years of XP being in market, 2003, it had grown to 62%. So I think the craziest stat is actually that last one. 2003 feels like a modern moment in history, but PCs were still only in 62% of U.S. homes.
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Microsoft Volume II
You're already getting this picture of Microsoft's business strategy, which is until we know exactly what the future looks like, start placing bets that approximate so that we're sort of in the mix, even though we don't know exactly what the future is.
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Microsoft Volume II
The PC wave is just one of the greatest secular trends in history, particularly if you have a monopoly share of that market. Yeah. And they, as defined by the U.S. government, did. Ben, define define for me. I mean, there's just no question of as this market grows, are you going to be able to continue to participate in it? It's like, yeah, we basically are a tracker for that market.
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Microsoft Volume II
Well, it's important to know Microsoft didn't start in gaming with the Xbox. Windows 95, they shipped DirectX. That changed the world. They became a real gaming platform. Because of that is this unbelievably clever set of APIs that went entirely around Windows. Amazing piece of technology.
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Microsoft Volume II
You put Microsoft on the map and you have the whole rise in PC gaming for the next six years, even before the Xbox.
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Microsoft Volume II
And how crazy is this? They thought they were getting broken up. Right, as they're launching a video game console. And this operating system that they've been working toward for like eight years.
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Microsoft Volume II
Yeah. Okay, while we're in Xbox land, should we finish our Xboxiness right now for this episode? Sure. Xbox has become an important part of our world, but not an important part of Microsoft's business. Agree. David and I sort of heard people utter things in our research like Xbox has kind of been a lifetime breakeven business or it's never meaningfully contributed to Microsoft.
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Microsoft Volume II
So I tried to figure out as much as I could from financial statements. And I got to thank Alex at the Science of Hitting, it's a great sub stack, for helping me with this. If you look, there was a division called Entertainment and Devices that was part of their old reporting structure. And if you look at the E&D reporting over time, let's start back in 2006.
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Microsoft Volume II
They generated $4 billion in revenue, lost $1.4 billion operating loss. So this is five years after the Xbox has come out loss-making. 2008, they do $8 billion in revenue, $400 million in profit. So even as it's becoming a real business at steady state... Yeah, as 360 is coming into... Teeny margins.
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Microsoft Volume II
2009, $8 billion in revenue, $100 million in operating income. 2010, another $8 billion in revenue, $700 million. This is $700 million to Microsoft. In this time frame, they do call it $20 billion of profit. Yeah. What's 600, you know, 700 million?
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Microsoft Volume II
Yes, David, that is exactly the right point. Microsoft, since year two or three, has never been capital constrained. And Bill Gates says this in an interview, anytime we've thought about making an investment, it's just, do we have enough talented people to pull that off?
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Microsoft Volume II
On any given year, I can't deploy all of the dollars available as a CEO, as a capital allocator, because I'm constrained by the amount of smart people we have to pull it off. That is a much different position than most businesses are in.
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Microsoft Volume II
Right. In fact, you're making my point for me. If I had to make the case of why Xbox has been somewhat of a folly and perhaps not worthy of a full acquired episode, it would be there was a lot of Microsoft's best people worked on Xbox. Right. This is a group of people that went and created Xbox Live that by 2012 had 40 million subscribers.
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Microsoft Volume II
So people who built a core competency of running a big online service. I mean, these are some of the best product people. The aesthetics of Xbox from a physical perspective, but also the software. I just think it was a sinkhole of some of Microsoft's best product people. And just hardest working people.
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Microsoft Volume II
The culture at Xbox was so hard driving to produce, at least in this point in history, up to the 2010 timeframe, very little in the way of contributing to Microsoft's business, but soaking up a huge amount of the talent. Imagine if that sort of product design sensibility was deployed across the rest of Microsoft.
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Microsoft Volume II
I mean, yes. I think there are two gigantic benefits. Look, the gaming market is massive and important. And if you could try to own one market in the world today, in the world of entertainment, it's gaming. I'm just saying Microsoft didn't up until that, at least this point in history. But it's the right market to go after.
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Microsoft Volume II
They were not successful in capturing value from it at this moment in history. But you're right, the two big things that they were able to do is build out a core competency of running a big online service, which totally led to Azure, which we'll talk about later.
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Microsoft Volume II
And two, it really did make Microsoft relevant with a whole new set of consumers when Microsoft was completely irrelevant in their lives.
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Microsoft Volume II
Of course, like the beautiful ski mountain real close to Vancouver. A lot of Seattleites go there. It's a favorite of many a Microsoft employee.
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Microsoft Volume II
The ski mountain right next to Whistler is, yes, Blackcomb, which became the name for the theoretical release that they wanted to do like just a year or two after Vista. We're going to follow hot on the heels of that. Oh boy. But Blackcomb started becoming pretty technically hairy. So they decided to push the date out.
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Microsoft Volume II
Another reason they had to push the date out was Windows XP for all of its usability and reliability was very insecure. And so Microsoft had a whole thing where they thought they were going to spend like three months putting out a service pack.
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Microsoft Volume II
They spent the better part of two years iterating on Windows XP to come out with a release that really people at enterprises could trust as no viruses, you know, this is safe to deploy in your enterprise.
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Microsoft Volume II
Windows XP SP2 is the stuff of legend. Like, that's the good one. So that pushes Blackcomb's date out. And it also ties up a lot of the talent that Microsoft needs to start working on the next generation operating system, which, again, they thought was going to be a fast follow.
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Microsoft Volume II
For anyone who's skied up there, there's this great ski lodge restaurant right between the two mountains called the Longhorn Saloon.
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Microsoft Volume II
Well, this was part of the belief behind Longhorn. They wanted to market all the cool stuff they were doing for it through these sort of like developer blogs and fan blogs, even though the product didn't have a ship date yet. And so everyone got really well versed in what was coming in Longhorn. And then everyone was kind of sitting on their hands like, where's Longhorn?
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Microsoft Volume II
They've been really telling us about Longhorn in a way that you would never see today. No one's dripping out the features of something that is potentially still years away from a release. And ultimately then years go by, five years go by.
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Microsoft Volume II
I mean, the funny thing is they actually kind of did that this year with all the AI features. All of those are coming soon over the next year, dot, dot, dot. Which I'm not saying that's a bad strategy in the current environment, but it is a different strategy for Apple. Anyway, Longhorn is teased for five years. All the David Rosenthal's out there are kind of like, What the heck, Microsoft?
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Microsoft Volume II
I've been excited for all this crazy stuff you're showing me. What's going on? Well, what happened behind the scenes? David, what was the initial technical spark that was supposed to be the cornerstone of Longhorn?
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Microsoft Volume II
Yeah, this is one of these moments on an Acquired episode where we have just a delightfully concrete illustration of this year it was unclear, the next year it was extremely clear. And David, look up in the indexes of both of those books the number of references to the internet.
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Microsoft Volume II
Yeah, that's more or less it. All these code names ended up referring to multiple things because it was emblematic of the organizational disarray inside the Windows development team. But anyway, it sounds great, right? We can render all these really great graphics as a part of the operating system because it's GPU accelerated. Who doesn't want better graphics? Of course, right?
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Microsoft Volume II
The thing that ultimately happened is the OEMs were all trying to make netbooks. And so they're furious at Microsoft about saying the next new release of Windows, which is five years since Windows XP. They really, really are counting on a new version of Windows to drive PC sales. And the one that they're getting requires pretty good GPUs.
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Microsoft Volume II
Yeah. So it was like a kind of a total miss with what their OEM partners were looking for. But if you did buy a nice PC and you did eventually end up with a copy of Windows Vista, this is why you got to see the new, what did they call the... Oh, the Aero interface. Aero, that's right. The blue, shiny sort of thing that was like kind of ripping off Mac OS's Aqua. Yeah.
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Microsoft Volume II
Well, I'm just saying, like, if you run a company where you make all your own hardware and your own software, then it's much easier for you to hardware accelerate all the graphics in the operating system. But when you're counting on OEM partners, you need really good communication there.
Acquired
Microsoft Volume II
Ultimately, there was a very fundamental architecture shift that just did not pan out. If you remember from the last episode, we talked about Chicago, Windows 95, and Cairo, this theoretical thing that never shipped, that was going to be the next generation operating system. Well, they basically... They tried it again. ...did the same thing again.
Acquired
Microsoft Volume II
Yeah, I think Bill Gates was a big fan of this vision because it was really technically ambitious where they had an object-oriented file system where the file system could specify data types. And then every application would plug directly into the data types that the file system knew about.
Acquired
Microsoft Volume II
So there was these sort of standards, like a calendar invites a calendar invite, and the operating system has its own standards. fields for date and time and notes. And that means you're not always traversing directory trees whenever you're trying to search through stuff.
Acquired
Microsoft Volume II
And also it meant that the operating system could actually reach into the data within files that were being stored by applications. So it was sort of a standard way of storing files in an easy to search way.
Acquired
Microsoft Volume II
Yes. Ultimately, WinFS, they tried to build it many times. There was a lot of off-sites and architecture reviews and talking about how great it was when, in practice, there was never any pull from application developers that they wanted this in the first place. And this was a huge part of the wheel spinning of, well, we can't
Acquired
Microsoft Volume II
do all this other stuff in the operating system until we figure out the spec and the implementation for WinFS. And then once we have that, then we can start to do all this other stuff. Part of the other stuff was the .NET development team wanted to bake .NET directly into the bits of the operating system that shipped in the box and on your PCs, so .NET was everywhere.
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Microsoft Volume II
So ultimately, what happened here is, and I heard this from a developer, there was many different groups who were all compiling their own subprojects and they could sort of run them. But when it came time to try to actually do a build of this operating system and say, hey, we've had too many offsites and architecture reviews and restarts and this is in, this is out.
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Microsoft Volume II
Let's just try to do like a build of the OS that we could deliver. They never built Longhorn.
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Microsoft Volume II
They could not integrate all the different projects into one. And they ended up reforking from an old Windows Server version or something and adding things in one by one piecemeal to try to figure out, you know, in year four, how can we get something shippable out to consumers so we can say this is our next generation operating system?
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Microsoft Volume II
And what is the minimum acceptable set of stuff that we can put in such that it looks and feels new?
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Microsoft Volume II
Well, so 100% it is, but they were trying to talk about it like it wasn't. So I watched the launch announcement for this too. They kind of have to. they can't really say like nobody should upgrade to this. So they come out, first of all, it's Bill Gates again in 2006, six years after Steve Ballmer has become CEO.
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Microsoft Volume II
My opinion on this is they clearly had no idea what to talk about in the keynote because the one feature that I can kind of really remember as a flagship feature is that
Acquired
Microsoft Volume II
alt tab switcher that was 3d that kept bringing the windows closer and closer and closer to you you know they've got the widgets they've got the sidebar it's arrow they had one feature that people hated there was a revolt called user access control which the theory makes sense protecting users from running malicious blah blah blah but in practice it would just overwhelm you with dialogue boxes all the time and everyone's just trying to figure out how do i turn off the dialogue boxes
Acquired
Microsoft Volume II
So they're standing up there at the keynote. The whole thing, the marketing message is the wow starts now. Oh, boy.
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Microsoft Volume II
Just brutal. This was kind of the Windows culture at its worst. I worked in Office, so I have a bias here when I was at Microsoft, but they weren't super ship date driven, whereas Office would set a ship date three years in advance and then they would hit it exactly. Office had all these really robust...
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Microsoft Volume II
procedures for shipping, you know, a triage process, an escalation process, a zero bug bounce. Everything was run in this dev test PM triads. The excuse was this general guise that this is too hard to use your processes. Like we're doing alchemy over here. And because we're doing systems level programming, none of your software development principles work on us. And so...
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Microsoft Volume II
Ultimately, this was the failure mode of a process that really did work for a while, really did enable technical genius, really did enable solving hard computer science problems. And this is effectively the company smoking their own supply and just believing they were smarter than everyone else. And what consumers wanted didn't matter.
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Microsoft Volume II
And if they could come up with some hallucinated, cool, technical thing, then that is what they should spend years doing and fighting about and then force into the market. And the market just didn't take it one bit.
Acquired
Microsoft Volume II
And if he's only spending his time on technical decisions, you need some introduction into that feedback loop, some governor on how deep to go in re-architecting Windows for re-architecting Windows' sake.
Acquired
Microsoft Volume II
The issue with Microsoft is that there is only one Bill Gates. Bill was the best engineer. Bill was the best lawyer. Bill was the best deal negotiator to figure out what the right BD situations were. Bill was not the best... enterprise relationship builder. I don't think Bill had a passion for empowering the enterprise and, you know, making sure that businesses succeeded the way that Steve was.
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Microsoft Volume II
But nobody should ever sell Bill Gates short and say he was just the technical genius. That would be wrong.
Acquired
Microsoft Volume II
And the part that really hurt about all those Mac versus PC ads is so many were just straight-up true. Yeah. oh, you know, I'm a PC and I crashed again. To be in the halls at Apple when they're firing at all cylinders, Steve Jobs is back. The iPod was a smash hit. You're developing the digital hub strategy. Macs are starting to sell because of that.
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Microsoft Volume II
Your iPod attach rate with Macs is actually working. People are buying Macs Macs are becoming the option that students are starting to pick as they're picking their college computer. Market share is rising. And Microsoft comes out with Vista? You just have to be besides yourself with this gift you've been given. Like, oh my God, look at this opening.
Acquired
Microsoft Volume II
Right, yeah, because there was this pent-up demand. I remember people in 2005 and 2006 when the rumors started, there was this almost like glint in people's eyes, what if Apple made a phone? Wouldn't that be awesome? And it is remarkable, like the iPhone delivered on all that promise, but there actually was, wow, what if we had technology as good as the stuff that Apple makes?
Acquired
Microsoft Volume II
in the form of a phone, wouldn't that be great? Because phones are so crappy. So I think, yeah, you're right. There's something there. There was a training of associating the Apple brand with.
Acquired
Microsoft Volume II
Well, yeah, I think that's correct. There's a lot to talk about in their consumer technology offerings. I also think this is the death of Microsoft as an interesting platform for developers. Who is writing Vista apps? The Win32 API as a potential target for my new, interesting, innovative application, it's just not a thing anymore.
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Microsoft Volume II
You have to write a Windows desktop app at this point in history because it's where a bunch of the users are. If you need a desktop app for real, for real, but probably you're just writing a web app. You've lost developer hearts and minds, which is the path to losing relevance.
Acquired
Microsoft Volume II
Yeah, that's a great point. That is the exception. And of course, anyone that had big legacy applications for Mac and Windows. So Adobe is a great example of they're going to keep that up forever forever. But where these new disruptive software players are coming from, they're just not going to have Windows apps.
Acquired
Microsoft Volume II
Correct. So the biggest things to hurt Microsoft coming out of Vista are what we just talked about losing developers, what we just talked about losing users. I mean, consumers who are excited to buy a computer, they're just not excited to buy a Windows Vista PC. But the biggest thing is they lost... years of their very best talent. I mean, Vista was a black hole.
Acquired
Microsoft Volume II
As it just kept growing and growing and growing, it would suck in more teams. And as it sucked in more teams, you would get the talent that it would suck in. But then it also would suck in executive and distinguished engineer talent from elsewhere to come fix it.
Acquired
Microsoft Volume II
And so Microsoft is about to be in a place where they need to compete and understand a changing landscape in social, in mobile, in search. They still have to fight the browser war. I mean, IE is peaking and about to start falling off a cliff and are completely consumed by Vista. So I think a lot of the consumer stuff can be answered by Steve Ballmer wasn't really a consumer-oriented technologist.
Acquired
Microsoft Volume II
Vista consumed a bunch of the smartest people, even if they had the right vision to be chasing. And the DOJ had just crippled the culture, among many other things. And they were still recovering from that.
Acquired
Microsoft Volume II
Cultural problems, failed consumer products, antitrust, but it's really not that straightforward. And after spending months unpacking it all, I actually don't think that's the right framing anyway. And on Microsoft's 1998 antitrust suit against the Department of Justice, everyone knows of this case, but most people really have no idea what actually happened. Did Microsoft lose?
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Microsoft Volume II
Right. Money's not a scarce resource. So bad acquisitions, whatever. Who cares? It's just money. But consuming a huge percentage of Microsoft's most talented engineers, that's company killing.
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Microsoft Volume II
Brutal. One other Microsoft exec put it to me. It hurt so bad that a bunch of our best systems people were leaving the company and driving across the lake, going to work for an online bookseller, and then building that online bookseller into the market-leading enterprise compute company. That is a black eye right there.
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Microsoft Volume II
And David, unexpectedly, there is a through line through all of them. There's a cohesive story that leads to Azure here.
Acquired
Microsoft Volume II
But before we do that, this is the perfect time for another one of our favorite companies and longtime acquired partners, Pilot.com. For startups and growth companies of all kinds, Pilot handles all of your company's accounting, tax, and bookkeeping needs and is by far the largest startup-focused accounting firm in the entire U.S.
Acquired
Microsoft Volume II
Yep. So back to Pilot. And speaking of Bill, we talk all the time on Acquired about one of his Seattle neighbors, Jeff Bezos, and the AWS-inspired axiom that startups should focus on what makes your beer taste better.
Acquired
Microsoft Volume II
In other words, only spend your limited time and resources on what's actually going to move the needle for your company, for your product, for your customers, and outsource everything else that you need to do that doesn't fit that bill. And accounting is just example number one of this. Every company needs it. It needs to be done by a professional.
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Microsoft Volume II
You don't want to take any risk of something going wrong, but at the same time, it has zero impact on your product or customers.
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And when you say thousands of startups, Pilot has done this for OpenAI, Airtable, Scale, as well as large e-commerce and other companies. So it's not just that they have experience across startups. They can also keep working with you as you scale to the growth phase and beyond.
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So if your company wants to start focusing on what makes your beer taste better, go to pilot.com slash acquired and tell them that Ben and David sent you. Thank you to Pilot. Okay, so search. And the alternate title of this chapter could be an acquisition that wasn't. I think that's a lost to history moment is the acquisition that almost happened here for $47 billion.
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So I'm just actually curious. Do you know the company I'm referring to? Do you know the deal?
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Yes, yes. Okay, so let's set some context before we get to this 2008 Yahoo attempted acquisition. So there were two companies that had developed programmatic advertising technology to serve and target online ads, especially in search. There was DoubleClick, the market leader, and and there was a Quantiv. Microsoft had lost the DoubleClick acquisition to Google.
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They bought a Quantiv, and that didn't go well. It was $7 billion, and they ended up declaring basically the whole thing a write-off. So Microsoft is desperate for search market share, and between their internal efforts with MSN Search and I believe it was called Windows Live Search, they were not making much progress there. And at the same time, Internet Explorer had totally languished.
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Bye, they're effectively competitors and political enemies. But the embrace and extend thing is actually a brilliant business strategy. There's already a whole bunch of people who love this thing. We want to embrace that new behavior. There's sort of no product market fit risk because we can clearly already see it happening.
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Microsoft had completely taken their eye off the ball of the browser wars from 10 years earlier. And IE was just widely regarded as a garbage browser. And web developers hated it because it made you write a bunch of weird custom stuff so randomly things wouldn't work in IE. Users hated it because basically nothing new was coming.
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Every time a new version of the operating system would ship, it just felt like it's the same old Internet Explorer over and over again. And you have Firefox coming on the scene starting around 2007, where it was really making a dent, and Google was the default search from Firefox.
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You know, Safari, I don't think Safari had tabs either. Chrome wasn't a thing yet. And so I know I'm on the one hand talking about search, on the other hand talking about the browser, but it's the same pot of gold. But it's the same thing. Right.
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Yes. So the thing that you kind of have to realize is the browser is the front door to search. Search is heavily, heavily monetizable. And if you're Google and you can monetize it directly, that's great. But let's say you're not Google.
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Let's say you're Firefox or Microsoft or Apple and you don't have this incredible business model of people bidding on the keywords for search and all the R&D to go into making search good, but you actually do have the user attention, the front door. Well, you get to monetize it too.
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The rumors are that Apple makes something on the order of $20 billion a year today in 2024 from Google as being the front door to Google, sending all of the iPhone search traffic to Google.
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Absolutely. And so if you can be in the business of operating a scale search engine, or you can be in the business of directing traffic to a scaled search engine who is willing to pay you for that traffic, it's going to be a great business. So David, as you just said, the way to monetize the browser is owning and operating or directing to a search engine. So search isn't going well at Microsoft.
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At first, it was sort of because they just didn't take it seriously enough. When Google first started in 1998, I think there was a lot of skepticism that the auction based advertising business would really work. And then there was skepticism that it would really scale. And then when it went public, people were sort of looking at it, almost freaked out at how profitable it was.
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People want to use this browser thing to access hypertext on the internet. We're going to embrace that and we're going to figure out a way to work it into our business model to extend the functionality in a way that we can make money on.
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And then even after that, people didn't really realize that being the market leader at search was way better than being number two. There's these massive, massive returns to scale. And the reason for that is just pure marketplace liquidity. If you have the most searches, you can create the best data from the searches and you can return all the best results because you have the most data.
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And on the advertiser side, you have the most advertisers who are willing to come in and bid to the highest possible price. You just get to make the most money by a country mile versus other search engines.
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Google's search as monetized by an ad-based auction is one of the world's true marvels. It's one of capitalism's greatest discoveries.
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Yeah, it's criminal that we haven't. So Microsoft is really nowhere to be seen in search. And part of it was just thinking, oh, well, search is just a feature of MSN. But there's all these other reasons to come to MSN. Or, hey, this is a product in the portfolio of Windows Live, and we can kind of do it with the talent that we have here.
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Ultimately, someone needed to grab leadership at Microsoft early, 2002, 2003, shake them and say, nothing else matters in the next five years except you figuring out how to meaningfully participate in search revenue because that is just the next big wave in technology and it's a fantastic business. Yeah.
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So in 2008, Microsoft puts a deal on the table that gets bid all the way up to $47 billion to buy Yahoo. This was effectively their last Hail Mary to become relevant in search. They actually didn't launch Bing until 2009. Google was started in 1998 and went public in 2004. And Microsoft got serious about a branded search engine in 2009.
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After a bunch of negotiating and flying back and forth, finally, both David Filo and Jerry Yang fly up to Seattle, and Steve Ballmer goes to Boeing Field, and they have a meeting at the airport. This is one of the great what-if scenarios.
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Right? It's totally right. There's conflicting reports of what happened. From what I can tell, Bill and Steve kind of looked the Yahoo guys in the eye and decided... These guys are kind of jerking us around. They really don't actually want to be a part of Microsoft at all.
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And this has gotten so expensive that if we execute the transaction, or God forbid they even try to negotiate up even higher, it's just not going to go well because it's going to be an organ rejection here. So the deal completely falls apart. It's interesting to try to look at the deal and figure out, even at that high price of $47 billion, was it a good deal for Microsoft?