Steve Ballmer
Appearances
Acquired
Microsoft Volume I
They're basically trying to co-opt the PC movement back into IBM proprietary land.
Acquired
Microsoft Volume I
Yeah, so we have to thank Brad Silverberg for helping us with this section. Brad led the Windows 3.1 team. He came in right after the 3.0 release and would eventually go on to lead the Windows 95 effort as the VP of the Personal Systems Division. So Brad comes in, Windows 3.0 has just shipped.
Acquired
Microsoft Volume I
And the first thing that is super, super obvious is as Brad sort of observed everything going on with OS2 land and everything going on with the core Microsoft culture, it was a complete clash. It was impossible for the pace of Microsoft. This is like a super young group. I mean, all in their 20s, some people in their 30s, but mostly 20s who just want to push the cutting edge ship stuff.
Acquired
Microsoft Volume I
It was almost like think about Google in the early 2000s. Just hire all the smartest people you can and set them loose and have creativity and everything. bump up against the edge of what's possible, both in terms of pushing the hardware, but also pushing, I mean, even like laws as we would later see, let's just do what users love and see what happens.
Acquired
Microsoft Volume I
Let's just do what technology enables us to do and see what happens. That's like the opposite of IBM's culture at this point. So there's this huge cultural rift between what IBM sort of needs and who Microsoft is at this point. And so what ended up happening with 3.0, it was unexpectedly loved. Microsoft was not really prepared for how much people were going to love the GUI.
Acquired
Microsoft Volume I
And with 3.1, it got really good. There was a small offsite of the executives, and Bill and Steve basically decided that it was time to bet on Windows. That was the new strategy. Windows had always been plan B, and now suddenly it was plan A. And when I say plan B, I don't mean like... thought they had a prayer of being plan A. I mean, it was 65 people that shipped Windows 3.1.
Acquired
Microsoft Volume I
These were like the misfits. It was not prestigious. I mean, the prestigious thing to work on at Microsoft was OS2 and eventually Windows NT. But the Windows team in the Windows 3 era, it's almost like the Mac team over at Apple. They were sort of flying the rebel flag. They valued creativity over bureaucracy, even if it meant they weren't working on the prestigious thing.
Acquired
Microsoft Volume I
And so suddenly there's this huge strategic opportunity to become the standard independent of IBM if the platform is good enough. And then boom, the early reception to Windows is so good. It gives this glimmer of that may seem really ambitious, but that opportunity is actually ours if we want to go seize it. So everyone took a big gulp and said, the GUI is the next big thing. Users love this.
Acquired
Microsoft Volume I
And the press is making a big deal out of Bill Gates. You know, boy wonder, he's the youngest ever billionaire at age 31. And by the way, when Bill Gates became a billionaire, there were not lots of billionaires. There were like 50 billionaires. All this lore around the company, it's like they can do no wrong. But inside the company, I think they're like, we don't know the future of technology.
Acquired
Microsoft Volume I
Any wave could break against us at any moment. And this is all tenuous. I think that chasm kept getting wider and wider and wider of internally feeling like they're screwed and externally it's seeming like this is the next great thing.
Acquired
Microsoft Volume I
Which, by the way, the way that they won that, a judge basically looked at the paper and said, Apple, you totally said in all the future versions of Windows, they can use your UI paradigms. And so for most of the counts, they're covered. And for these other things that you're trying to ask them about, those are not actually defensible.
Acquired
Microsoft Volume I
It's just widely accepted that these are UI paradigms now, and you can't enforce any ownership over those. So it basically got thrown out. Apple tried to appeal all the way up to the Supreme Court, who said no.
Acquired
Microsoft Volume I
Wow. Listeners, there's some unauthorized biographies that we tried to corroborate as many of the facts as we can, but the ones where David's saying he doesn't know a source, it's sort of these unauthorized ones.
Acquired
Microsoft Volume I
It's nuts. And so suddenly Microsoft feels the full weight of everything that you have to do to build a platform and be a steward of an ecosystem. So suddenly this huge effort began to try and make developers successful. That's how Windows would be successful if it was a great platform for application developers to thrive on.
Acquired
Microsoft Volume I
So Cameron Myhrvold led the developer relations group basically to try and figure out what do people want out of a platform and how do we provide the APIs for them and the support and everything in order to do that. All the documentation, all the help, everything.
Acquired
Microsoft Volume I
And at the same time, Microsoft basically knew establishing a platform is brutal and requires bootstrapping a multi-sided network of developers, users, and PC manufacturers. And so 3.1 had users excited, but it was still very early. They could have lost that throne. Developers were not really yet targeting Windows. Microsoft sort of had to show, we make great applications for Windows too.
Acquired
Microsoft Volume I
And in 1968, Seattle, I mean, this is like a provincial little town. I'm standing here right now. It's a major city and a huge economy in the United States. But at the time, kind of a podunk, forgotten, sleepy, faraway place. Totally.
Acquired
Microsoft Volume I
Exactly. So you've got this big developer relations group effort that spins up. Meanwhile, there's a huge push with OEMs to get them to install Windows. At this point, they were still installing DOS, or some people were actually installing nothing and requiring users to put operating systems on. So there's a conceded push there. to get the OEMs to install 3.1.
Acquired
Microsoft Volume I
Okay, so this happened from 1988 to 1994. David, explain the per-processor licensing agreement.
Acquired
Microsoft Volume I
They have 49 years of history making software for consumers and enterprises, making hardware, gaming systems, gaming studios, Windows apps, iPad apps, Mac apps, operating systems, mobile operating systems, MP3 players, search engines, cloud computing services on cloud computing, programming languages, development environments, the list goes on. But it did not start out that way.
Acquired
Microsoft Volume I
Yeah, basically, you're going to pay for two different operating systems, even though you're only putting one on if you ever load a different operating system on. So yes, it very strongly incentivizes you to never, ever, ever ship any other operating systems on your computers as a company.
Acquired
Microsoft Volume I
Now, this is, of course, the way that regulators would look at it in 1994, and that would get Microsoft in some hot water, and they had to agree to stop doing this practice. The way Microsoft would look at it is, we're just helping our customers, right?
Acquired
Microsoft Volume I
Do you really think that these companies want to keep a whole separate ledger of what machines they shipped DOS on or Windows on versus what machines they shipped period? Wouldn't it just be easier if once a month or once a quarter they could just report to us their total shipments like they have to report to their investors anyway? And then we'll just send them an invoice for all their machines.
Acquired
Microsoft Volume I
And we should say this is the classic low-end disruption playbook. I mean, this is what Clayton Christensen was talking about. Going from mainframe to midi computers, I'm going to make something that's worse for most things, but better for some new things that new customers and new markets are going to care a lot about.
Acquired
Microsoft Volume I
Right. If this had happened earlier, you could see how this would be more of a compelling way to get market share. But by the time they started doing it, they were already sort of running away with the market.
Acquired
Microsoft Volume I
Totally. They wanted to make the stuff that people wanted to use the most, and that's how they would win. Their goal was make the very best products, the best software we possibly can in the ways that people want to use and buy software, and then we'll make a bunch of money.
Acquired
Microsoft Volume I
And the thing they were sort of realizing is, well, we have made software that people like to use, so they're using it in businesses. They always kind of wanted that to be the goal, but now it was happening. People are doing their work in Excel. People are bringing PCs to the office. Maybe businesses are buying their PCs, but people are actually buying them themselves and using them in the office.
Acquired
Microsoft Volume I
And so it just made them that much more efficient. And so Microsoft really had to figure out how to sell to businesses... But we actually have no idea how to do that. And it sounds crazy today. The Microsoft you know today, as late as the mid-90s, really had no idea how to sell or build software for businesses.
Acquired
Microsoft Volume I
In part because prior to this, personal computers were not used by enterprises. It was just not an enterprise tool. So now that it was happening, Microsoft had to figure out how to be the ones that would benefit from it.
Acquired
Microsoft Volume I
And IBM's going to look at it and go, that can't do any of the things that are important to our customers. And that's exactly why it works.
Acquired
Microsoft Volume I
Right. And there really isn't yet a business server that couples nicely with the PC on the desk. And so you have this weird thing where there's a mainframe that is where the companies like real enterprise applications run, but people are bringing PCs and those PCs don't actually communicate well with anything else yet.
Acquired
Microsoft Volume I
They just are there for the employee to do their own work on a spreadsheet or something, print it out, because finally 3.1 had printer drivers, and then deliver that. But it wasn't like a system that operated with other systems in your enterprise.
Acquired
Microsoft Volume I
Right. It wasn't like, hey, let's sell something to businesses that they want to buy. It's, hey, let's convince businesses that PCs are a good idea for their workforce to adopt. Right.
Acquired
Microsoft Volume I
And all of this stuff is pretty out of scope for this episode, including all the software systems you would need to build for the enterprise, like Windows NT Server and Exchange and SQL Server and Active Directory, like the classic mid-2000s Microsoft stuff that they got known for. But that is what this would all evolve into.
Acquired
Microsoft Volume I
And it really just started with everyone kind of looking at Steve and saying, can you figure this out? We've all to date basically just been either running dev teams or running marketing or running product groups and been selling through retail or distributors in the application side or mostly through OEMs.
Acquired
Microsoft Volume I
on the systems and operating system side, but can you go figure out how to sell everything we make in a completely different way to a completely different buyer profile and keep us posted on how that needs to change all the products we make in order to do that? That's a pretty crazy change.
Acquired
Microsoft Volume I
Well, it's painfully obvious. It's Microsoft Office. And it's the fact that the whole workforce is already using Microsoft Office.
Acquired
Microsoft Volume I
And everyone loves to talk about product-led growth and how it's this new thing in the late 2010s and how Slack and Atlassian and Trello, everyone figured out PLG in this bottoms-up workforce-adopted way rather than selling to procurement or IT or the central administrator. And it's just not new. No, this has always been the case. And Microsoft invented it.
Acquired
Microsoft Volume I
All the employees wanted to use Excel and Word and they just had to figure they were doing it anyway. And at some point, Microsoft needed to figure out how to take advantage of selling it centrally and how you do business with other businesses rather than selling a zillion retail copies of people who are using it kind of illegally for their work.
Acquired
Microsoft Volume I
Yep, absolutely. And next episode is going to be all about the enormous success of becoming an enterprise company and the enterprise agreement and cloud and everything that sort of came after that. But we have two chapters left in this episode, and they happen concurrently within the systems group by two very, very different teams, and that is Windows 95 and Windows NT.
Acquired
Microsoft Volume I
So David, let's start with NT, and then our little cherry on top can be 95 to close us out. How did Windows NT happen?
Acquired
Microsoft Volume I
Even though they don't yet have an enterprise product to sell. They've got DOS and early Windows, which is essentially consumer targeted. But now they've got this guy, Dave.
Acquired
Microsoft Volume I
And we should say, Dave, this is really the first time they brought in someone who had real industry experience. I mean, in 88, Microsoft was 13 years old, so Bill Gates would have been 33. Everyone is in their late 20s and early 30s, and Dave's mid-40s. He's like, I've seen a few things.
Acquired
Microsoft Volume I
Right. It enables all of your desktop computers at the company to join and network together in a compliant way. It enables an internal server that everything communicates with. It enables a directory of all the devices on the network and all the people in your organization.
Acquired
Microsoft Volume I
So the other important takeaway on NT is it was going to take a long time to build. It was going to take a long time to test. It was going to take a long time to sell and deploy. And it was going to have really strict requirements for what it could work on because it's a power-hungry operating system built for enterprise IT administrators. And so that is... not your short-term product strategy.
Acquired
Microsoft Volume I
That is a long-term bet that a team is going to work on concurrently while you're figuring out what to do after Windows 3.1. So in 1991, Bill Gates sums this up in a memo where he says, "...our strategy is Windows. One evolving architecture, a couple of implementations, and an immense number of great applications from Microsoft and others."
Acquired
Microsoft Volume I
And every word in that sentence does a bunch of heavy lifting. So you got one architecture, okay? I think what that basically ends up meaning a few years later is one application programming interface, API, that developers can target so that when they want to write a Windows app, it works on both NT and whatever the evolution of 3.1 is.
Acquired
Microsoft Volume I
Okay, so that's one architecture, but it says one evolving architecture. So that buys Microsoft a little bit more fluidity in the one architecture that's being targeted. Then you hear a couple of implementations. So this basically says, even though developers are targeting what became the Win32 API with one way that we write applications, there's two different implementations.
Acquired
Microsoft Volume I
And so for many years, they would display very differently on NT systems versus, spoiler alert, Windows 95, the successor to Windows 3.1. Oh, yeah.
Acquired
Microsoft Volume I
Yes, I do. But it's so much sexier to say Windows 95 and name it after the year that it actually ships versus... Yes. But yes, an immense number of great applications from Microsoft and others. That sort of sheds light on the DRG, the Developer Relations Group strategy of we got to go out, be massive evangelists,
Acquired
Microsoft Volume I
And everyone in the systems group is looking over at the apps group going, did you see that? Bill Gates just said our strategy is Windows. We're now the Windows company, and that includes great applications from Microsoft and others. And so what does that mean, applications group? Like, let's go first and best on Windows. Get to it.
Acquired
Microsoft Volume I
I just think that sentence kind of says it all for what we're looking at 1991 through call it 2000 or so.
Acquired
Microsoft Volume I
Totally. I mean, even before Windows 95 shipped, they had 75 million Windows users. This is even before you get plug and play or multimedia or networking. Like this is on Windows 3.1. Yeah. Crazy. Okay. So we've been leading up to it. We've been building hype Windows 95, or should I say Chicago? Yeah.
Acquired
Microsoft Volume I
So the Chicago name, for those of you out there who were paying attention when this was under development and you were all excited about what Windows 95 would become, and it's probably 1% of our audience or something who knows the Chicago codename, they wanted to create an OS for the everyman, one that was easy to get to, a nice quality of life when you're there, it was affordable.
Acquired
Microsoft Volume I
Chicago is the perfect name in every way. And it is also kind of a contrast to what was going on in a different part of Microsoft, where there was the codename of Cairo for a very ambitious next-generation operating system. Now, mind you, NT had already come out in 1993. So Cairo is sort of this general bucket of...
Acquired
Microsoft Volume I
Maybe it's post-NT, maybe it's part of NT, but this is like a really sophisticated, crazy set of technologies that we're going to eventually bake into an operating system. It doesn't really have a release date. No one really believes in any of the release dates that are proposed.
Acquired
Microsoft Volume I
But the Windows 95 team, the Windows 4 team, the Chicago team loved contrasting this idea of like a far-flung land relationship. That's really ambitious. And who knows what it'll actually be like with this. Chicago is something we know quite well. You get on I-90 from Seattle, you drive for three days and you're there. And that is sort of like the goal. That's the spiritual thing about Windows 95.
Acquired
Microsoft Volume I
A hundred percent. We should say Cairo never shipped. So there's a lesson in that.
Acquired
Microsoft Volume I
We are getting ahead of ourselves. So, okay. Windows 95, let's start with the launch event itself. It was a huge, ridiculous, insane day in Redmond, Washington. They set up tents all over Microsoft's campus. They flew in journalists, beta testers. There was a movement around Windows 95 in a way that you would not believe. It was an operating system launch and Jay Leno launched it.
Acquired
Microsoft Volume I
It wasn't like Jay Leno did some stand-up. It was like Jay Leno for 90 minutes in a tightly scripted environment co-hosted with Bill Gates all of the fanfare and festivities.
Acquired
Microsoft Volume I
It might be like the peak moment of pure joy to celebrate technology before a lot of the sort of skepticism came in and the tech haters.
Acquired
Microsoft Volume I
Totally. It was unabashed celebration of software is probably the best way to put it. Microsoft licensed Start Me Up famously from the Rolling Stones.
Acquired
Microsoft Volume I
Totally. The other thing that's happening in 1995 is the internet hype is starting to build, but we will table that for next episode. Right at this point in history, only 14% of Americans had internet access. It was still very early. So there was no guarantee that any story posted online would actually reach the masses.
Acquired
Microsoft Volume I
And so Microsoft had really relied on traditional broadcast coverage of this event and brought in all these journalists and all these print magazines and all these newspapers to kind of build the hype.
Acquired
Microsoft Volume I
I watched the whole keynote yesterday, and at the end, they ripped down the sort of back of the tent behind the stage, and there's the entire development team in the red, yellow, green, and blue squares of the Windows logo sort of sitting outside on the big sports field on Redmond's campus.
Acquired
Microsoft Volume I
And there's only 360 people that built Windows 95, so it's still kind of a small team, but they're all there. They're fired up. They're part of the moment. Okay, so that's the launch event. In Redmond, at least. Around the world, people are lined up around the block to buy an operating system. There's a lot of news coverage of that. It was basically the iPhone launch of its day. Yes.
Acquired
Microsoft Volume I
They lit up the CN Tower, the Tower of London. This date, August 24th, 1995, they basically treated an operating system launch the way that you would launch a movie or a new Madonna album. Right. it was a marketing case study, so much so that the folks from Coca-Cola actually reached out to Microsoft to ask them, how do you do marketing this well in the new age? Oh,
Acquired
Microsoft Volume I
Yes. This is a company that freaking invented Santa Claus to sell us all sugar water. And they're calling Microsoft asking, how do you market in this new era? It was that successful. They launched concurrently worldwide in eight languages. So this thread that Microsoft had of early international continued all the way through to this moment.
Acquired
Microsoft Volume I
They invested heavily in doing all of the localization and help stuff. so that the whole world really could adopt something all at one time. It really was the perfect product at the right time. The internet, games, all of that.
Acquired
Microsoft Volume I
Yes, that's the takeaway. They thought about software in a completely different way. And yes, the start menu, while it got cluttered and complicated and messed up over time, the idea of a button that you click to start using your computer was very appealing to people.
Acquired
Microsoft Volume I
Oh, yeah. I mean, the Mac just never had any real PC penetration. From the IBM PC forward, it never had big market share.
Acquired
Microsoft Volume I
And that is how they tried to market it. They marketed it as people on job sites using Windows. They marketed it as people doing crafts. And there's like someone who's modeling something for an F1 car. It's just fun watching all these old videos and seeing all the different personas.
Acquired
Microsoft Volume I
Yep. Now, I must say, this all pains me deeply as someone who never owned a PC, grew up using a Mac, loved every bit of my Mac, was even an apologist in the sort of OS 9 era of... This isn't very good, but I'm still going to say it's good. And, you know, I was on the OS 10 public beta. I only clicked a start menu when I was like fixing a teacher's computer at school.
Acquired
Microsoft Volume I
Even though the takeaway here is everyone thought this was a great operating system and it won the market. I always looked at it like, well, it's not a Mac.
Acquired
Microsoft Volume I
The way that Apple products became mainstream always felt odd to me as someone who was using them when they weren't. But it's been interesting gaining a new appreciation for Microsoft through studying their history that I absolutely did not have as a user during this era.
Acquired
Microsoft Volume I
And it was the wrong strategy for Apple, and it was the right strategy for Microsoft. I mean, Apple has always, at least in my opinion, created a better computing experience by being completely integrated. I mean, it's the Alan Kay quote, anyone who cares about making great software needs to build their own hardware.
Acquired
Microsoft Volume I
And the complete integrated package that Apple offers, I have always found to be the best computing experience. And it doesn't scale.
Acquired
Microsoft Volume I
In that era, yeah. The way to scale is make the software that is going to get distributed on the most PCs, and then that is the most interesting to software developers, and it is the most interesting to consumers who want the software and IT buyers who want to buy the standard thing.
Acquired
Microsoft Volume I
Apple's strategy versus Microsoft's strategy in this era, Apple was always going to be a bit player rather than the sort of scale winner. And the trade-off is lots of PCs had blue screens to death. Apple never had blue screens to death. Like what do blue screens come from? It's driver problems.
Acquired
Microsoft Volume I
It's that the printer is not speaking the same language as your particular computer and what the operating system knows about your computer. And are the device drivers right for your particular version of whatever's on your motherboard? Like Apple never had those issues, but they also had very few units shipped and, you know, much more expensive product. Yeah.
Acquired
Microsoft Volume I
Yep. So a little bit more on Windows 95 before we finish the story here. It is remarkable to reflect that it took, what, five, six years to go from Windows' plan B to Microsoft being extremely right that that was the franchise, like that was the bet to bet the entire company on.
Acquired
Microsoft Volume I
There is a fantastic photo, listeners, that we will tweet of Bill and Paul sitting in the computer room at Lakeside. And Bill, I think he's like 13, 14. He looks like he's about eight. I think on the wall, there's this almost like printed out magazine thing that says The Bug Slayer that they've hung up over the wall. It's amazing.
Acquired
Microsoft Volume I
And as Brad Silverberg put it this way to me, he said, Windows 95 cemented Windows as the franchise product for Microsoft, which interestingly, it was not yet. And David, this is crazy. It would remain the franchise product for the next 20 years, perhaps five or 10 years too long, but we'll save that story.
Acquired
Microsoft Volume I
Yeah, it's crazy. From a product perspective, there was just so much that really got smoothed here. This was a user experience where they finally had time to think, what actually do users want to do with an operating system? What features should be part of the OS and what should we delegate to applications? What are modern networking technologies that we should bring in?
Acquired
Microsoft Volume I
I don't want to foreshadow too much, but how should the internet be in a modern operating system? That was a huge thing. The multimedia, the video stuff, an operating system really showed up and said, we thought about this experience for you. You're looking for where to start. You're looking for cool stuff to do, and you're looking for it to not break on you.
Acquired
Microsoft Volume I
So a couple of interesting technical notes. It was basically all new technology. If you try to look this up, it will tell you Windows 95 was DOS based. It still used DOS in fallback situations for older DOS applications or drivers. But for most of the time, it was no longer true anymore. that Windows was just an operating environment on top of the DOS operating system.
Acquired
Microsoft Volume I
Windows had now become a true 32-bit operating system of its own. Windows did all the heavy lifting. It had its own file system. It accomplished a lot of the sort of user experience magic and speed that it was praised for by rewriting a lot of this from scratch. So this was kind of the beginning of Windows as its own OS.
Acquired
Microsoft Volume I
And you can see that actually change in the marketing messages that change from operating environment to operating system. So, David, that brings us to the end of our chapter one. We've got plenty of analysis here to do, but my God, what a first 20 years for the company.
Acquired
Microsoft Volume I
Right, and there's all this stuff we miss. Like, I didn't mention Microsoft Research. Microsoft Research was a lot of people and a lot of money. Right.
Acquired
Microsoft Volume I
Actually, the start of research is interesting. I'll say this real quick. In 91, Nathan Myhrvold started Microsoft Research, and the logic is fascinating. Basically... Everything Microsoft had done until that point was taking things from mainframes and minicomputers and adapting those tasks, those jobs to be done for personal computers.
Acquired
Microsoft Volume I
And at some point, they kind of looked around and said, all right, well, we did it. All the personal and business applications can now be run on personal computers. So we have to come up with uses for future technologies in order to continue to drive the ecosystem forward. There's no more low-hanging fruit.
Acquired
Microsoft Volume I
And I thought that was an interesting thesis of why to spin up a research division at that point in history.
Acquired
Microsoft Volume I
Okay, great. So, playbook. The big interesting one that I want to start with, and it actually involves a chapter from the story that we just sort of glossed over, is capital efficiency allows founders to control their own destinies in a way that you just don't get when you're selling off huge chunks of the company in order to accomplish your mission.
Acquired
Microsoft Volume I
Let's just talk through the cap table over time and how the company went public. So we talked about the partnership being 64% Gates, 36% Paul Allen. 1980, Steve Ballbar comes in and gets 8.5%, 8.75%, something like that percent of the company. So dilutes Gates and Allen down. Then in 1981, just a year later, they take the VC investment for 5% of the company from TVI.
Acquired
Microsoft Volume I
This also, I'm guessing around 5%, trying to reverse engineer some of the numbers, they also created an option pool where they were then creating opportunity for basically rewarding management, which is how there were 10,000 millionaires created in the Seattle area from Microsoft.
Acquired
Microsoft Volume I
Right. Yes. At IPO, so even with all this dilution, so you've got the Balmer dilution, the VC dilution, and the option pool dilution, Bill Gates still owned 49% of the company. Wow. I mean, that's pretty unprecedented. And he wasn't the only one with a big chunk. Paul Allen owned 28% of the company. Steve had 7.5% of the company.
Acquired
Microsoft Volume I
This company was basically owned by the three more or less co-founders, a little tiny option pool, and then a VC who ended up with 6.1%. I think Dave got some more shares from being on the board. You just don't see companies that look like this anymore.
Acquired
Microsoft Volume I
Yeah, absolutely. I'm trying to figure out why they were able to be so capital efficient. Is it just that software was such an unbelievably good business model compared to everything else that existed? Like they didn't need a lot of working capital, everything was high margin, they could grow really fast, or it was just an era... before much competition.
Acquired
Microsoft Volume I
And so they didn't need to out-raise their competitors. Once they got a little bit ahead, there was really no way for anybody else to close the gap, assuming that they executed well.
Acquired
Microsoft Volume I
That's so, so, so insane. And there was no one else really with the knowledge either. Even if someone else came in with a big $1 million check and gave it to a competitor, in 75, like how many people could really write these language interpreters?
Acquired
Microsoft Volume I
They had an obsession and an obscure skill that turned out to be one of the most valuable in the world in an area where there was a freak law of nature in play with Moore's law that was so unintuitive that you had to think from real first principles to understand the impacts of it.
Acquired
Microsoft Volume I
Yeah, that's true. It's this like complete perfect storm that enabled them to build a highly defensible business without really any investment ever. This is the largest company in the world, the most valuable company in the world that was entirely bootstrapped.
Acquired
Microsoft Volume I
No, I mean, in 86, when they actually did go public, they raised $45 million and they never spent that because they generated much more free cash flow than that that year.
Acquired
Microsoft Volume I
Right. There was not this multi-sided network of you've got developers making applications and then you've got users of those applications. No. Everybody who used a computer was a programmer.
Acquired
Microsoft Volume I
And they needed to for the reason that they had been granting so many stock options from that little option pool to employees that they were going to blow the SEC's 500 shareholder cap by, they projected, 1987. So they wanted to go public on their own terms in 86, not when they sort of had to by SEC rules.
Acquired
Microsoft Volume I
Maybe. In this era, especially. Maybe. Yeah. I don't know. I'd agree with you if you had a bunch of short-term capital interests that owned your company. But if it's all founder-owned, there are great large private companies in the world. Yeah, fair, true. Coke Industries is a trusted company by a whole bunch of their customers. Cargill is even bigger than that.
Acquired
Microsoft Volume I
There's a bunch of European industrial and shipping companies. Rolex. There are privately held big important companies in the world.
Acquired
Microsoft Volume I
That's true. That's very fair. And especially getting to the stage that they eventually got to being the trusted partner to governments around the free world. That requires being a public company.
Acquired
Microsoft Volume I
that has like unique economic conditions that have never existed before to create these magical businesses you could never fathom before this new technology thing existed. It's an impossible thing to wish for. Like it may never happen again. We may never get another Google either.
Acquired
Microsoft Volume I
But how many things can you collapse to zero? I think that's the question. With Microsoft, they were able to collapse their marginal cost to zero, but they still had distribution costs. And then Google collapsed distribution costs to zero with the internet. So what's a big cost that a company has now? Maybe AI will collapse... You know, you no longer need 50,000 employees.
Acquired
Microsoft Volume I
You can have five employees. Maybe it can collapse that to zero. But you need something of that scale, which is like, where does a company spend most of its money that suddenly it can spend no money on?
Acquired
Microsoft Volume I
I suppose, actually, it is on the human capital. You just look at big, successful companies and look at what they spend money on, and those are the candidates.
Acquired
Microsoft Volume I
Yep. Other fun things on the IPO. Do you know who IPO'd the day before Microsoft did? Ooh, no. Oracle. Aha. And Oracle had a nice pop, which actually helped Microsoft price a little bit higher in their IPO. That is another episode we have to do.
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Another thing adds yet another layer to the insanity of everything that we've been talking about of why they were able to build such a successful company on such little capital. I don't think there has ever been a tailwind in history like the one that Microsoft had with the secular growth of the personal computer wave.
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And the only thing I can think of that is comparable is Amazon with the growth of the internet, sort of powering their early growth. But here's the stat. From 1975 to 1986, 11 years prior to their IPO, so founding to IPO, PCs grew at a compound annual growth rate of 98%. It grew from 4,000 units per year to 9 million units per year shipped.
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Right. They managed to make themselves the point of integration for the whole industry. Yes. So oftentimes I find myself when we're looking at these companies that are like among the most successful in the world or like Microsoft, the most successful in the world. It's basically like a multidimensional multiplication problem where you're like, okay,
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They had this unbelievable one in a zillion thing going for them, which you can sort of multiply by this other one in a zillion thing. And so it's the like zero marginal cost, zero distribution costs, unbelievable secular growth of the PC, Moore's law happening. They're the single choke point for the whole industry. It's just crazy how many things you multiply together.
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And personal computers, like creating software for desktop computers was a really good idea, and they wanted to be the best at it.
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Yeah, you're right. It's both the hedging, but also then the ability to read the world and quickly, entirely change your strategy if you need to, and having your hedge be far enough along that you can jump quickly to it and shift your whole organization to get on board with it. That's a hard leadership thing to do.
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Today, we will tell the story of the desktop software company. Before the enterprise, before IT, before the internet, before being a trusted partner to governments around the free world, and really, before people even knew what to do with personal computers, this is the story of a bunch of ragtag geniuses in their 20s pushing what was possible. Welcome to Microsoft, the PC era.
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Right. Which I think you're seeing play out with most CEOs today. There's a big difference between a founder CEO and the stuff that they can do. Zuckerberg with the metaverse or Jensen with betting the whole company and going all in again on AI versus Tim Cook or Sundar Pichai, certainly very different type of CEO. Satya is interesting.
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He's almost, despite the fact that he doesn't own half the company, he's got a lot of founder-like control, which I think is pretty interesting. Yeah.
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Moving along. Other playbook themes. A big one that jumps out to me is that new generations of technologies enable market dislocations. And unless you are in a transformational moment in terms of a new technology came out that enables something that wasn't possible before that's going to rearrange the whole value chain and open up new markets... It's pretty hard to go challenge an incumbent.
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No one was going to challenge IBM really until the microcomputer, even the minicomputer people. Did DEC really challenge IBM? Not really. It never made a dent.
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Yes. And there's these little blips of it, like the GUI, I think, meaningfully reshuffled the DECs. But those are the moments where you can have meaningful new entrants. And otherwise, you kind of have to bide your time and just build your hedges and see.
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Related, even if you are the incumbent being disrupted, it is possible to have a very, very large and durable revenue stream that can go on for a very long time. And what I'm referring to in this particular example is despite all of the dethroning that we just talked about, Microsoft would not eclipse IBM in revenue. You mentioned market cap, David, but in revenue until the year 2015. Wow.
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But I think that's the point, right? It's like Microsoft's perception by the market. I'm sure they were growing faster. I'm sure they had better gross margins. I'm sure there was a better story there. And so there's multiple that comes out of story. I'm sure there's lots of good reasons why Microsoft became more valuable than IBM very early. But IBM's revenue did not peak until 2012. Wow. What?
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It's this like long after public perception moves on, customers still get value from something created by incumbents for a very long time. And I think that's something we often forget about in the sort of buzzy Twitterverse of like, oh, that thing's over. It's like, it might still grow for another 20 years before it's over.
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Yeah, that totally comes through. I asked Brad, why did Windows 95 work? And, you know, there's lots of structural reasons, but he said we basically did two things. One, we laid out principles for product and then pushed responsibility down. Developers were often their own PMs.
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So there's sort of this idea of once you got the principles, we don't need to write a zillion specs and design something three times and pass it through three functions. Just like, you know, the principles make great software that follows the principles. And two was he said that everyone felt personally responsible for the product, and it really showed.
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Yep. Something we touched on a little bit is the benefit of scaling with OEMs. This was sort of the contrast against Apple, where I said Apple was sort of always going to be a niche player by the way that they designed and built and packaged everything themselves. Apple is in many ways like the Amex, where Microsoft is the Visa.
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Yeah, on our Visa episode, it just became so clear that Visa could sort of quickly take over the world at MasterCard by being an open network where they didn't have to do all the work to scale themselves.
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They could distribute to a bank, partner with a bank, and then boom, each of the banks that was on their network could independently scale at their own rate, which created, obviously, compounding effects for how fast Visa and MasterCard could scale. The same can be said of Windows.
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I think the Microsoft OEM team for Windows was like 20 people or something. Before the enterprise, in this era that we're talking about, the group of people responsible for go-to-market for Windows was really small. They sold some retail, but the team was just about, hey, make sure HP and... Compaq and Dell and Gateway. Exactly.
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That was their go-to-market, and it makes your scaling unbelievably efficient.
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Dude, you are getting a Dell. Yeah. Similarly, I think the fact that they went international early was this very powerful constraint where it meant that every time they shipped software, they had to make it globally ready quickly.
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Which is reasonably high level in terms of how abstract it is. Like, you're not writing machine language. You don't have to know how to address memory and registers and all that. It reads kind of like English. You know how to add numbers together.
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And so that meant that if there was any sort of network effects to your software, like anything becoming a standard, Microsoft was just way better positioned to become the standard than anyone else was. And on top of there being network effects, there's also scale economies where A word processor is a word processor.
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The fact that they forced themselves to be international early meant that every product after that also had to figure out how to do all the localization and training and all of that to get all those effects too.
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Yes, exactly. And they just realized that so early. They also realized that most people who were doing some sort of localization would do a shoddy job. They would think about it as lesser than the US market. And so they just did a good job at localization. They just cared.
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They thought of it as like, this is a strategic pillar that in every country, everyone experiences our software to the same quality because it's our brand everywhere. And I don't know, I just think that is not how the rest of the industry thought about it.
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On top of all of this, the way that they executed it through subsidiaries was pretty genius. Redmond did not control international. They spun up country managers and subsidiaries in each of these countries in a ton of countries.
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And so while Redmond did the product development and then did the engineering work to do localization to all the strings files and everything for those countries, the actual marketing messaging and the sales strategy and the sales structure... happened in country that was owned by a person who lived there.
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So they actually could think through what is the best way for people to receive this software here, which again, that's just going to yield way better results than if you're sitting there armchair quarterbacking at Redmond thinking about how a person in Chile is going to receive your marketing message.
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And one other that I have is this one that we didn't really talk about, but Microsoft famously was not first to market with basically any of their applications. They aren't even really today in most cases. I mean, you think about the strategy that they had early on, spreadsheets, word processing, all these were copycats at their outset.
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It's not an elegant language, and it's a very verbose language, but if you sort of look at it with your eyes as a person who speaks English and knows basic math, you're like, I kind of understand what this program does. So there's a meaningful amount of translation done by a basic interpreter that takes you from the basic code you have to write to what is actually running on the machine.
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I mean, sometimes they would do an acquisition, but most of the time they just look at a our software should do the same thing. And they would copy it. They had no shame in doing that. They had their eyes everywhere looking for good ideas, and they had reverence for the good ones, and then they would just incorporate them.
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And on top of that, they wanted to make the software very easy to switch to. So a lot of the keyboard shortcuts in Excel to this day are there because they were originally the Lotus 1-2-3 shortcuts, and they wanted people to have the same muscle memory that just worked. So fundamentally, what this does for you as a business is it just leads to better risk-adjusted returns.
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You already know what's going to work before you ship it. You don't really take market risk. So you're not going to be the first to the market with early adopters, but most of the time, you actually don't need to be to win. And I think Microsoft, I don't know, they sort of own that idea. Most of the time, people are sheepish about it. Steve Jobs famously said, Microsoft has no taste.
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Right. That's a good point. It's also different. I mean, the Lotus 1-2-3 multi-plan thing in that era, Microsoft just didn't have great distribution yet. And so Lotus 1-2-3 just got pretty far ahead of them and Microsoft had no way to catch up. A few years after that, that would basically never be true again.
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I will say you touched on something that's an interesting corollary to this is their first versions of software famously are not good. You look at Windows 1.0 and 2.0. They know that it's part of the strategy and they were world class at learning from customers and integrating customer feedback into subsequent versions.
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And so there's always this like saying of Microsoft doesn't have a very good first or second version, but the third version of something is typically pretty good. And I think that fact pattern definitely follows.
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I was, but it was such a different era in that 2012 to 14 era. It's not, I guess, 2011 is when I started as an intern. I'll have a lot of thoughts on it next episode.
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Which, of course, if you own the hardware, you definitely think of it more of like, well, we ship them the big cabinet of things and we install it and we fix it if it's broken, but we sold them hardware. The software is required to run it, but the thing we sold them is the hardware. And if you're a pure software company, you think about the world differently.
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You're like, well, I can always ship you another CD, another floppy disk, you know, over the internet. It's obviously very different. But because there weren't really software companies before them, of course, people didn't come from that mindset.
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Yes. So listeners who are new to the show, we do this section based on Hamilton Helmer's seven powers framework. And the question is, what is it that enables a business to achieve persistent differential returns, or to put it another way, to be more profitable than your closest competitor and do so sustainably?
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And the seven are counter-positioning, scale economies, switching costs, network economies, process power, branding, cornered resource. And David, I am pretty sure I could make a case somewhere between 1975 and 1995 at Microsoft for all seven of these.
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It's one of the most defensible businesses that they built in history. So of course they would have all seven of the powers.
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Great. Counter-positioning. I think the biggest example of this comes through where Microsoft was basically willing to jump on the microcomputer revolution before the incumbents were. IBM did not want microcomputers to happen. And then when they started to happen, IBM tried to figure out how to slow it down and reintegrate it into their old business model. And Microsoft basically had no baggage.
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It's sort of the Python of its day. I think the way Python is now, where you sort of joke that Python is so flexible, you know, you can like accidentally write a program by writing English and it can kind of forgive a lot of mistakes and it reads kind of like English.
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And I mean, this is kind of classic innovators dilemma stuff. They could say, well, we don't need to make any money on hardware. We don't need to even make hardware. We are free to become the whole point of integration for the entire ecosystem just by shipping bits. And that is crazy. Yeah.
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We keep talking about Microsoft as the point of integration or choke point or dependency or standard for the whole ecosystem. Given that, it is quite remarkable how much value they created on top of the platform versus just captured for themselves. There's that famous sort of Bill Gates line, you want your ecosystem around you to be generating more revenue than you are taking for yourself.
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They did a ton of that. It's the OEMs and it's the application developers.
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It's unbelievable. You know, when Microsoft has an install base of 100 million people using Excel, in this episode, let's just say 10 million people who were using Excel. And suddenly some up and coming spreadsheet comes out with a cool feature like auto sum or like fill down or like draw borders around the cells or whatever.
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Suddenly Microsoft does a tiny bit of dev work and they can reap tons and tons and tons of value for doing that that the tiny company cannot do.
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Yes. Switching costs. Well, funny thing about monopoly is there's nothing to switch to.
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It's a reasonable parallel to draw it way back when with BASIC, where you say, look, you can understand it as a layman, but also it's used in a broad set of business applications.
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There's not a classic network, Facebook or AT&T style network here in terms of one user can contact every other user, but more users being on Windows incentivizes more developers to make great applications for Windows, which enables Microsoft to sell more copies to more users, etc.
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Oh, you're right. I didn't even think about that. The document formats are a huge network effect thing, even before the internet, even before organizations were networked and computers were networked outside of an organization. File formats, you're right. There's huge network economies to file formats.
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It's elusive. This is a little bit later in history, but I did always think it was absolutely incredible when I was at Microsoft and we would ship a version of Office every three years. I worked on Office 15, that the entire 6,000-person organization had a process in place where we could release to manufacturing, RTM, on a date that we planned three years in advance and actually hit it.
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Like the process of the ads cuts meetings and the zero bug bounce and the testing schedule and the triage when you had things that people wanted to introduce late in the schedule. It was a remarkable product, especially with all these teams that needed all their code to interoperate. I worked on a shared experiences team that would check things in that would...
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be a dependency that Word, Excel, PowerPoint, all of them took on the shared code. And we knew our ship date three years in advance and would hit it. It's crazy.
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It's funny. The process power, I would say, is stronger in Office than Windows. Now my colors are showing. Windows always notoriously miss their ship dates. But I'm actually less sure that process power existed in that early days. I think they were a bunch of smart people, but I'm not sure that they had a unique way of creating software. But I think that got built over time. Yep, agree.
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Well, that's true. Windows 95 built a consumer brand. The idea of a consumer brand of operating systems was, you know, there was Apple, but they were tiny, and that was more around the hardware.
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But branding is probably the thing that they rely on the least. Interestingly enough, there are other structural reasons that they're entrenched where even if Microsoft had a crappy brand in this era, they probably still would have won. Yep. The magic of getting the whole deal with the IBM PC and then getting to sell licenses to all the other OEMs.
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Yeah. It didn't start as a cornered resource, but as soon as IBM started shipping it on the IBM PCs, it was over. I'll say it again. IBM's distribution created demand for DOS, and then Microsoft just got to capture value from everyone else who wanted it. All right. Well, we would do bear and bull listeners, but we kind of know what happened after this.
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So the bull case is that the party continues and Microsoft continues shipping amazing operating systems after amazing operating systems. And that stays the important thing in the world. And the bear case is something else becomes an important thing in the world. And just having this super locked in operating system is not actually the way to bet your whole company for the future.
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The IBM deal. I can't unsee it. Microsoft figured out a way to take someone else's dominance and wholesale transfer that into their dominance for the next generation. The fact that IBM called the project chess is so deeply ironic because Bill Gates was playing chess and they played checkers.
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they just didn't end up capturing any value out of it yep and if i could make a less cheeky comment on it i would say it's that a new technology generation when something becomes possible and opens up a new market it enables a shift in the point of integration in a value chain the old value chain of ibm if you shipped the mainframe you had all the power
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But in this new world of PCs, if you controlled the operating system that all the users were familiar with and all the developers wanted to target, you had all the power. I think that is not necessarily obvious unless you went through it and have the hindsight of history to be able to articulate it.
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I mean, you watch every early interview with Bill, and you read a lot of his writing, and he's a great writer. I mean, it's awesome that so many of his memos leaked, whether intentionally or unintentionally, over time.
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Yes. He really did view himself as a steward of the software ecosystem and had this steadfast belief that software was magic and was going to change the world. Over the next 20 years, from 75 to 95, software did change the world and Microsoft enabled it to happen.
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So again, good, bad, or ugly, whatever you think of the company, they were sincere in... I think the ugly part is a lot of people want to hate on the value capture because, God, did they capture value. But they were sincere in their desire and ability to create, too.
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Listeners who are new to the show, we've been iterating on how we end episodes. And we decided on this recently of, you know, how should we land the plane? It's to talk about the thing that we can't stop thinking about.
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So Dave had watched Bill present many years earlier at none other than the Homebrew Computer Club at Stanford. Yes! The very place that is part of the Apple lore with Jobs and Woz showing off the early Apple computer. Apparently, Bill also went and made a presentation there and would hang out there, and that is where Dave first came across him.
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That's cool. It's really hard because all hardware fails eventually. So, you know, at some point there will be zero computers out there that can run Windows 3.1 that will boot. And the only way to experience any of these things is through an emulator. And so it's kind of like... I don't know, to be able to capture, you know, high res footage and stuff of those machines while they still work.
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Yep. I love that. Have you ever heard the phrase, go out when the top row at the back of the auditorium is empty?
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I think it's a Seinfeld quote. I might misattribute it. Drop a note in the Slack if I did. But yeah, I think it's a Seinfeld quote. You can let one row be empty, but you don't want to wait too long.
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All right, I have three, and they're all sort of different. We've sort of had a tradition on the recent episodes of doing multiple carve-outs, and all of them sort of are different genres. So my product that I've really been loving, my physical product, is the Meta Ray-Bans.
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I bet. It's a pretty delightful product. I bought them because I was in Hawaii and with my four-month-old son, we were in the pool and stuff. My iPhone's waterproof, but I kind of want a different angle, and I don't necessarily want to be holding my phone. It's very cool to be able to take pictures and record video of what I actually see to be able to relive that moment.
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And I did a bunch of photos and video, and we were on vacation that way. And then I discovered a thing that they're actually just awesome for, I think even better than AirPods, is phone calls. The speakers are great. I wouldn't say necessarily they're the best for listening to music. The bass is obviously not as good as headphone bass. They project the sound down toward your ears.
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So unless you're standing really close to me, you can't really hear, or unless I have the volume all the way up, but the microphones are great too. So I was on a long walk on the beach with the wind whipping by on a call with my mom. And I was like, does this sound really bad and distorted to you? She's like, not at all. Wow.
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And so I was really impressed and will definitely be using them for more calls. I think that style of headphone over the ear, there's many things that it's not good for, like when you're on an airplane or something like you want to plug your ears or if you're in a super loud environment. But unless you're in one of those environments, it's a nice break for your ears versus having AirPods jammed in.
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And it's a great call experience. So They're great. The battery is great. They're like four hour battery. So it's like a low key, more subtle, augmented reality experience. There's no heads up display. You don't see anything. But when you get a text message, it'll read it to you.
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Totally. Yeah. It basically is like you have AirPods in, but you don't actually have AirPods in. And you have a pretty good photo video camera on your face.
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Yes. It's not super bright. I'm not sure everybody really knows when you are, but if you know what to look for, you know if it's on or off. Cool. So I've been loving it. I think it's a great product. I intend to wear them a lot this summer.
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My second one is a thank you to a very, very good designer, Julia Rundberg, who worked with David and I on a recent project for some design work, some of which is actually featured as we speak on Apple Podcasts. And she did a bunch of other stuff with us too, and she's really excellent.
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So if you're looking for someone who's good at visual identity, branding, slide decks, websites, I've worked with her on a few projects before, and she's just awesome. So I wanted to recommend her. My third, this is kind of community spotlight to go all the way back to like nine years ago acquired.
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It was a listener who runs a company called Summer Health reached out and said, I heard you say that you have a baby. I've got this great company that is for new parents. And here's some info on it. And I am now a paying member. It is a on-demand texting relationship with a pediatrician.
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It is like crack for parents. It's crazy. And you can hook up multiple phones. So my wife and I both have a direct line to like, something weird is going on. Will you help me through it? Including we had a 2 a.m. wake up the other night and everything ended up being fine. But as I'm sure any other new parents can relate to. You really want to make sure in the middle of the night.
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If you're not sure if everything's fine, you would like to figure out the right steps to make sure everything's fine. So having a virtual doctor on demand is totally amazing. So Summer Health, if you are a new parent, we've been loving it.
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Well, we have a lot of thank yous on this one, as you can imagine. People were really generous with their time, pointing us to different resources, explaining their recollection of history as it happened. And, you know, being in Seattle, active in the venture community here, both through PSL and David, you're in my shared history at Madrona, me working at Microsoft.
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A lot of good opportunities to learn what really happened from folks. So a huge thank you to Mike Slade, who spent the time with me. Mike spent two different stints at Microsoft and then at Next and Apple in between.
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Yep. And one of the few people in the world who both spent a ton of time with Steve and with Bill and worked closely with both of them. So, so great to get his perspective, especially about the early days of office and the applications group. Very helpful. Similarly, Pete Higgins worked closely with Mike.
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Pete, I think, ran Excel for a long time and oversaw a lot of the different stuff in the applications group. and I believe also ran Office. It's kind of funny how many different people picked up the mantle over time as these things traded around groups.
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But frankly, I think that's a huge part of the Microsoft story is the company very quickly adapted and changed its structure depending on the current needs of technology and competitors and et cetera. Huge thanks to Tren Griffin, who is actually a lifelong... Seattleite and sort of close friend to the whole Gates family. Bill Gates Sr. was his mentor.
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I'm sure you've seen Trenn's prolific tweets online about Microsoft history. So Trenn, and actually Trenn I think currently works at Microsoft in a strategy role. So thanks Trenn for your help as well. David, I know you've got a bunch.
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I read like 20 of Steven's hardcore software posts. And then when David and I were dividing up what belongs in what episode, I realized like 19 of them belong in next episode. So Steven, thank you for your early prep work for part two.
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Yeah, when I was there, Terry was EVP over, I think, Windows and Windows Phone.
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Yep. And how different the go-to-market motions were for Windows and Office. I think Terry was the one that sort of gave us the insight of Windows, especially in the early days, was basically an OEM game, small group doing an OEM thing.
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Yep. Obviously, Brad Silverberg, who we mentioned a bunch. It was very fun seeing after spending some time talking with Brad and texting a lot with him to see the end of the Windows 95 announcement after Bill and Jay Leno are done for Brad to sort of come out and finish it off. It's fun. It's like watching a time machine, watching that thing. It's really cool.
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Soma, Soma Segar at Madrona is someone that David and I love crossing paths with in the Seattle entrepreneurship ecosystem.
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Yep. And lastly, huge thank you to Steve Ballmer. To be honest, it was a little bit surreal chatting and hearing about his experience over the whole thing because, I don't know, there's nobody, including Bill Gates, that bleeds Microsoft more than Steve Ballmer. And his just unabashed, pure pride in what they built is infectious.
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Totally. And I mean, to be frank, I had a very opposite strategy in mind, but I was a new hire out of college, individual contributor PM. And, you know, it was still the Windows company then. And Steve was championing the Windows strategy. And I was a guy working on Office for iPad. Well, with that, our huge thank you to JP Morgan Payments, ServiceNow, and Pilot.
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You can click the link in the show notes to learn more about any of those great partners of Acquired. If you like this episode, I was thinking of ones to recommend. It would be pretty funny to go listen to the forethought acquisition, given all of this context. I mean, it's a short episode when David and I were not good at this yet, and we did our very best.
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But it is from our early days, and it covers overlapping source material.
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Yep. If you are new to the show and looking for great recent episodes that we've done, I highly recommend the Visa one as discussed earlier in sort of the network of networks idea, if you haven't heard that, or perhaps the Nintendo or Nvidia episodes, all of which will be right up your alley if you liked this one.
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Yep. If you want to know every time an episode drops, get hints at the next episode topic, and get episode corrections and follow-up, you can sign up at acquire.fm slash email. Come discuss this episode with everyone else who's chatting about it at acquire.fm slash Slack.
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And if you're looking for another episode, go check out our second show, ACQ2, where we will have actually some very awesome tech CEO guests coming out over the next month or so that are absolutely worth watching. listening to especially if you're interested in semiconductor and tech history. Now, if you want some sweet Acquired merch, go to acquired.fm slash store.
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They've identified a market opportunity, and that opportunity is reducing traffic.
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Of course you were. But I kind of feel like a David Rosenthal move is that you might have been listening to Start Me Up whether we were doing Microsoft or not. That's a very squarely in your genre song.
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Well, listeners, if you want to know every time an episode drops, you can get hints at the next topic and follow up. You can sign up at acquired.fm slash email. Come talk about this episode with the community at acquired.fm slash slack.
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Great. Big market. And listeners, are you kind of sensing what's happening here? Mainframe, mini computer, microprocessor. We kind of have to keep using smaller and smaller words to represent the fact that the computer is getting smaller and smaller here.
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And it is funny that it kind of stopped there. The computers that are sitting on all of our desks are microcomputers.
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They're doing the same thing. It's funny. In many ways, at this point in history, getting a manual was actually much more valuable than getting the processor itself, because the processor would arrive, and unless there was documentation, you would have no idea how to interact with it to take advantage of its power. But if you had a manual...
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Well, sure, you couldn't actually test the stuff you wrote for it on the hardware.
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But if you wrote an emulator on a bigger, more powerful computer that could sort of mimic the computer that you're actually targeting, you could go years before actually ever running the software on the target device and just work off of what the manual says, as long as the manual is correct and matches how it actually works.
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If you want more from David and I, you should check out our second show, ACQ2, where we interview founders, investors, and experts, often as a deeper dive into topics we cover on the main show. And before we dive in, we want to briefly thank our presenting sponsor, JPMorgan Payments.
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But spoiler alert, that totally becomes Microsoft. The seeds of Microsoft are selling language interpreters for new processors, new hardware, new computers that enable you to write familiar programming languages on that new hardware.
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Yeah, he cared a little bit less about programming languages and a little bit more about operating systems. So that's how they diverge for the few years here.
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It's so good. This quote is incredible because basically Paul Allen brings up Moore's law to Bill Gates. They don't use that language there. But in 1971, that is what's happening. And for Paul, this is just an observation of, hey, there's an exponential thing happening here. Seems like it's going to keep happening. It's been happening. And Bill's shaking. And he's like, What?
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Exponential phenomena don't just happen. That's incredibly, incredibly rare and immediately gets Bill's wheels turning on. What does this mean for the world? If that's actually true, we need to act and do something profoundly different than anyone's ever done before because this enables new things that no one ever thought could be possible.
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Yeah. And it's also the reason why Microsoft is going to form into such a different type of company that's ever come before it. Why they can break all the rules, why they can sell just software, even though that's never been a thing before, why their business model can be so much different than everyone else's business model.
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I mean, in prepping for this episode, we got to talk with Pete Higgins, who ran Excel and was an executive overseeing Office for a long time in the early days. And he had this great quote to us, which was, computer on every desk was wackadoo stuff. People laughed at it. It was absolutely wild.
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People thought, I don't know, maybe one in 10 people in their finance group or something will have one at some point. This is the profoundness of an exponential decrease in price or increase in power of computing is it's going to become universal.
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So with that, this show is not investment advice. David and I may have investments in the companies we discuss, and likely all of you if you hold any index funds. And this show is for informational and entertainment purposes only. David, where on earth do we start the Microsoft story?
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It's literally a quote from Paul Allen. So Bill was the number one math student in the state of Washington. And he gets there, and he does this theoretical math class, Math 55, and gets a B. And Paul says, when it came to higher mathematics, he might have been one in 100,000 or better. But there were people who were one in a million or one in 10 million, and some of them wound up at Harvard.
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Bill would never be the smartest guy in the room, and I think that hurt his motivation. He eventually switched his major to applied math. Ha, ha, ha, ha.
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He's gregarious. Anyone who's ever met Steve or seen a video of Steve, you are well aware that this man has presence. But the thing that people don't know about him is he is so unbelievably analytical. Steve is the guy that outscored Bill Gates on the Putnam exam.
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Yeah, Steve isn't a programmer, but he is every bit the mathematician that Bill Gates is. And that is one of these things where I think when people try to set it up as, well, you know, you've got the brilliant programmer genius and the marketing guy. It's just like those are the roles they took.
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But I think when you're getting a sense of who the original crew was at Microsoft, they were all brainiacs and they were all wildly analytical.
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Yep. And this is really where Bill Gates commits to computers to be his life's work. I think what's often lost in the story is Bill, even though he was good at computers and spent tons of time programming computers, he never fancied himself a computer guy until this moment in history. He went to Harvard because he felt like
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hey, if I ever want to be a lawyer or something else, like they've got a lot of great programs there. And this was the moment where I think it really clicked for him that I'm just in the middle of the right place at the right time with the right skill set. And this is my way of having the most impact on the world.
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Well, it's so funny he thinks they're already behind because clearly they're not. History would show, I think Bill Gates even says, we might have actually started a year or two too early. The market actually hadn't materialized yet. And the funniest thing is the starting gun went off and Bill and Paul ran and everyone else is still standing around.
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Yes. Just like Bill's vision of Microsoft to put a computer on every desk and in every home, J.P. Morgan has a vision for making payments real-time, 24-7, everywhere, and in every currency. So JP Morgan has experienced a massive digital transformation and is now much more than just a global bank. They invest $15 billion a year into technology and R&D.
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So with JP Morgan Payments, you are getting their history of service, stability, and scale, but also innovation and new technology.
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It's basically a B2B marketplace that connects their clients with the broader payments and technology ecosystem, such as treasury management systems, ERPs, point-of-sale hardware solutions, payment gateways, and so much more. And given JPMorgan's scale, you can imagine the value that comes with unlocking access to their industry-leading partners and technology.
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Woo! Across any industry, the most successful companies we've talked about are the ones who think and invest strategically through a long-term lens. Like Hermes, durability and reliability are paramount for building 100-year companies that can reinvent and continue to grow. And that is the case for J.P. Morgan Payments.
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Their history of trusted solutions and investments in technology bring clients and new fintech companies together to drive innovation and growth for businesses of all sizes.
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But it's a market test. They want to know, like, what's the response if this were true? Exactly. Exactly.
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And this is a big deal for MITS, too, if this works, because right now they've just announced a machine for which you can't really do anything on it. The hardware is powerful, but they're not going to have a lot of customers unless there's stuff you can do on the machine.
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And a BASIC interpreter running on it, you know, it's quite valuable to then make the claim you can program BASIC on our computer. So they're very excited about this, even though they're kind of playing coy.
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So in order to use it, you got to hook up your own teletype. You got to get the manual. You got to hope that the manual is right. And you got to code to the machine instructions, like literally the assembly language for the chip inside for the Intel 8080.
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So he does the same thing again. They get the manual and they have an emulator and they write it against an emulator.
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On paper, by hand, he is hand-coding octal, not even assembly language instructions, like he's hand-coding in pure octal the instructions to load their basic interpreter program into memory.
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And Ed actually has more eggs in this basket than he sort of let on because when Bill and Paul call and say, hey, can you give us the teletype instructions? He reveals they're actually the only ones who called about that. So everyone else who said they were writing a basic never got far enough to ask, how do we actually interact with your computer?
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And their little gambit worked and got a couple of college kids to pounce.
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I mean, either the list price is like wildly wrong or they were cutting deals all over the place. Or one thing it could have been is just that, and I'm totally speculating, but Chips are the ultimate high fixed cost investment, low marginal costs next to software.
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You could imagine maybe Intel had already put all the money into the fixed cost of spinning up the fabs and was expecting a certain amount of market demand and they weren't seeing it. They were like, crap, we got to recoup our investment. I don't know, lower the price, let them just sell. Maybe we'll make it up in volume.
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New Beyonce. Oh, New Beyonce. I haven't heard it yet. How is it? I really like it. Nice. I think it is reductionist to call it country.
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And at decent margins too. I mean, if they're getting the processor for 72 bucks and they're selling it for, what did you say?
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So, I mean, everything else in there is much cheaper than the processor. So I don't know, depending on how much they have to give to the sales channel they're selling through, if it's retail or distributors.
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Yeah. So it's decent margin business. Unlike what the PC business would become over time, they managed to have nice margins.
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Yeah, software department of one. But, you know, he's got his buddy Bill Gates, who is not employed, but Bill's definitely working on software for the altar as well.
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And as we record this, that was 49 years and one day ago. So we are sitting here on April 5th recording. That was April 4th, 1975. And it is very funny to look back at some of the original signatures when Bill writes on letters. It's Bill Gates, the general partner of micro-soft, which is great. I think it's actually a Paul Allen name where he wants to put together microcomputer and software.
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New York Times, Hermes, where it was sort of passed to the son-in-law to continue to run the business. That was not the case with Mary Maxwell.
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And Bill's like, that's perfect. We're immediately just going to run with it. As it was a partnership, originally they were going to call it something like Allen and Gates. And then they ultimately are like, no, Microsoft is perfect.
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I will say like, it's a nice clarifying North Star because it really draws the line in the sand and says, we're in the software business. And Gates makes this really clear to Paul Allen, who is often tempted to do hardware stuff. And Bill is very hardcore about saying, no, what we're uniquely good at in the world is software and we should stick to that.
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I also suspect Bill is starting to realize there's an amazing business model here, if we can pull it off, where we don't have to make the hardware and we can charge for every copy of the software sold. But that insight, I would say, has not yet fully materialized.
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Yep. And Bill's case that he makes on that to Paul is, hey, you took a job and you were doing this on the side. I was all in. And Paul's an agreeable guy and 36 is still a nice percent. And so he says, sure.
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Which, why would they ever do any sub-licensing deals? Like, why would you give it to your competitors?
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Or phrased another way, it's we will give you $180,000 for you to hand over exclusive rights to all that cool basic stuff you just wrote to us. But if we sell fewer than X machines, we're actually going to pay it out to you on a prorated basis at $30 a pop rather than giving you the full $180,000.
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Right. Kind of a great deal for them too, given the position they're in.
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And this is a pretty interesting time to pause and say, well, are they pirating software?
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This is 1975. So piracy implies that you are running afoul of some particular legal protection for the good. And you might say, well, with today's legal frameworks and hindsight, you would say, of course, if they're copying the software and not paying the money for it, it's piracy. That was actually not established yet. And this is the craziest thing.
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So Bill basically has an opinion that it's piracy, and he writes letters to the computer community.
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Yes. And tries to basically guilt trip people. He tries to use that as a recruiting method and say, if you're so excited about pirating our software, maybe you should just come work with us. And nothing would make me happier than making the best software in the world. And please join us on this mission.
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But ultimately, the legal standing that he has to say, hey, what you're doing is illegal is not fully established. And so it would actually take a couple of years for the courts to look at software and say, What about this is protectable? And if you think about it, it is a little bit weird. So you've got source code that looks kind of like English, you know, basic, it's letters and numbers.
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It gets translated to machine code. That machine code ends up running and it's basically electrons. It's voltages that are flipped up and down. And so what about that are we trying to protect? Ultimately, the way it gets litigated through some case law from court cases is that the source code is a copyrightable creative work that is expressed through some sort of tangible medium.
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That's the important thing about copyright law. It's a creative work expressed through a tangible medium. So a book, the creative work is the words and the tangible medium is printed on paper. And so with software, it actually took until 1980, Congress...
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changed the law we'll put a link in the show notes to like the literal congressional change that happened and it is in title 17 copyrights chapter 1 subject matter and scope of copyright in 1980 they include a defined term which is a quote-unquote computer program is a set of statements or instructions to be used directly or indirectly in a computer in order to bring about a certain result and
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And once you have that passed by Congress, codified into law, you now have the standing legal framework that all the whole computer industry used going forward, in particular the software industry, a computer program is copyrightable work. Wow, I didn't know all that. That's awesome. It's totally crazy how recent that is.
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But when you think about it, why would that have any legal, you know, software is such an abstract idea. Before, the whole business model of computers was good luck just replicating an IBM PC and everything that comes with it. You don't need any legal standing. But if you're going to pursue this software-only business model, what's the protection around your abstract product?
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This is the first time. Right. Certainly to build like a legitimate business around it. The other thing that's useful to know is when you're selling an IBM PC, you're literally selling a PC to a customer the same way that when I'm selling you this glass from Crate and Barrel, I am selling you the glass and the glass is now yours. I've transferred property to you. Software is not that.
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So the whole world of software is built on a license agreement. So the source code, that computer program, the actual right of that is retained by the creator, and you license the copyright to your customer to be able to use that on their machine. So there's this dual idea that Computer software is copyrightable and you can grant a license under certain conditions for customers to use it.
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That is the legal framework for which the next 50 years of technology at large would operate under. For the moment, though, they got a piracy problem.
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machine right should be a royalty right the problem is that is not the deal that they had with mitts right or framed differently instead of saying hey consumer do you want to buy something else too and make a new purchase decision they should be saying hey computer manufacturer we make your thing actually useful so pay us for it yes so during 75 and 76
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Absolutely. And Bill Gates Sr. was the prominent attorney in the region. And so it's quite the power couple.
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Oh, and the press just latches on to them. Whenever Bill has a leaked memo or something where he talks about all this war terminology, those all become headlines.
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Yeah. Well, Bill Gates was just constantly underestimated, which kind of worked to his advantage in those early days. Yes, totally. This is the thing about Microsoft. People kind of forget how insanely young Bill was. He was just 20. And to put that in context, he's only seven years older than Jensen Huang.
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but they feel an entire generation apart since Microsoft was started almost 20 years before NVIDIA. When you start bending your mind around like, oh, Bill Gates is still pretty young considering what an institution Microsoft has become in the world.
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And that's the first deal that happens between the companies. I mean, there's so many deals done both directions, commercial deals, equity deals, legal disputes in both directions. And this is the very first time that they do something together.
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Of course. Bill Gates Sr., we should say, too, basically galvanized the entrepreneurial community in Seattle. He started the Tech Alliance. He was a huge angel investor. He really did organize, you know, angel investors, people who want to put high-risk capital to work into startups.
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Fascinating. I actually didn't know that started this early. And one correction there, you don't know for a fact it's only going to run on Microsoft's basic interpreter, but you do know for a fact that it will run on Microsoft's basic interpreter. And so if it's cheap enough, why would you take the chance on a clone that might have one or two things wrong with it?
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And it's interesting. In the earliest days, what was stopping someone else from writing a basic interpreter and licensing it to Apple or RadioShack? Nothing. There were other smart people out there. And so it was just a very good business decision to say, we got to close that door.
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We just got to make this a no-brainer for people to buy from us because if we're value maximizing and it's starting to feel expensive, they're going to turn elsewhere until we get a lead. Right.
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just because it's important to establish there's trade-offs for everything. If you're running a startup right now, you might think to yourself, oh, great, I'll just run that exact strategy. The important thing here is, A, most of the work was already done for the original basic. B, Bill was doing it himself, Bill and Paul.
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And, you know, his heart was there, obviously, through his law practice long before Bill Gates III became the prodigy he became.
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So the importance of technical co-founders and their overhead was crazy low. And so they could do these deals where they don't make very much money because they were, I think at the end of 77, they were five employees, right? So their overhead was just so unbelievably low that they could take a really long lens.
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Because he got, I think, three speeding tickets in one day, two of which were from the same police officer.
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Yeah, that's interesting. I also think this moment galvanized something important, which is Bill and Paul could sort of look around and see there is going to be so much value created by microcomputers and by software. They really found religion around software is magic.
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the things that people can create now that we've done this basic interpreter and these machines are cheap and plentiful, the magic will take care of itself as long as we ensure this industry can just exist and do its thing. And so they flipped from this mode of we need to bite and scratch and claw and make sure that we win in deals to, huh, how can we enable software as a thing to thrive?
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And I'm sure we can position ourselves well to capture some or a lot of that. And I think they became almost stewards of the software industry and evangelists from this point forward.
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Also, how crazy is it you've got five people, you're operating out of Albuquerque, you just finally expanded from having one customer, and you're like, you know what we should do this year? Let's open in Japan and become an international company.
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It's unbelievable. And it stayed at that very high run rate of international being a huge chunk, you know, close to half always, basically forever. This is a huge cornerstone of Microsoft's success that they were an international company from year three of their existence.
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Right. And so he's got three reasons for why Seattle in particular. And by the way, it worked. Every single person except for his secretary did make the move. So one, he grew up in Seattle. He's like, I just want to go home. And then he justifies it in two other ways, which I found pretty fascinating. This is from an interview in the early 90s that he did.
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He said it basically came down to Seattle or Silicon Valley. And in Silicon Valley, it's hard to keep secrets because there's a rumor mill. And in Seattle, we can be a little bit more removed and we can announce things when we want to announce them. And two, in Silicon Valley, people switch around companies. I don't want that. I want people to just work at Microsoft.
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There was a disadvantage to not being able to recruit from your competitors, but... For a while, they were really the only game in town in Seattle.
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Oh, and then Bill, of course, reinvested in that flywheel, donating tons of money to the university. I mean, there's buildings, there's whole new schools.
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But unlike other top computer science programs, it's a state school, so it just has huge volumes. I think more students come out of the University of Washington and go to big tech than any other program in the country. That has stayed this amazing advantage.
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I mean, at age 13, with his best friend, who we will talk about very soon, he brought up the idea, I wonder what company I will be the CEO of when I grow up. What industry will I go after? What problems will I tackle? It wasn't a question of if, but which.
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It's crazy. You have this absolute behemoth partnering with someone that's not really relevant. And if you're standing here today, it sounds like I'm talking about Microsoft partnering with IBM. But at the time, it was IBM partnering with Microsoft.
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It was the only computer company that mattered in the entire world, got themselves into a particular situation where they came to Microsoft looking for help. It's the craziest set of events that made this possible. I can't wait to dive into it.
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Yep. Employees can get answers quickly with smarter self-service like changing 401k contributions directly through AI-powered chat, or developers can build apps faster with AI-powered code generation, and service agents can use AI to notify you that someone's product needs replacing before they even chat with you about it. With the ServiceNow platform, your business is 100% ready for AI.
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Yes. David, are you going to attribute that quote or are you going to leave listeners just hanging?
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Yes, and it's hard to imagine a better person to get their perspective on what IBM meant to the world at this point in time, because 1980 was also the year that Steve joined Microsoft. So literally at the same time in 1980, you've got the management team coming together with Steve and Bill and Paul Allen, and you've got the IBM thing going on, and you've got them moving to Seattle.
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And we haven't even talked about Charles Simone yet, but this was the year he joined.
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Okay, so why is IBM, the sun, the moon, and the stars of computing, why are they getting into this PC? It's way cheaper than anything else they sell. It seems to be like a totally different business strategy, a different customer set. What's going on?
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It's effectively a bandwidth limitation, where if you're in a single clock cycle trying to do some particular instruction, it's a very, very small amount of data that you can move through the arithmetic logic unit or that you can move through the processor in that clock cycle.
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Which is why they only cost $375 or whatever for an Altair. Right. In late 1979,
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In 16 bits, you can represent numbers up to 65,536. So that's two to the 16th. You can do interesting things passing 16 bits around at once.
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The further we get in the computing world, the more abstract stuff becomes. So it's always fun to go back in history when these concepts were so grounded in our physical reality that's sort of easily observable since everything was so much bigger too.
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And the thing that they're observing about the microcomputer market is it's exploding. People in our industry know about DEC. People in the broader world never knew about DEC. But I think it's a very different rate of adoption and rate of demand with microcomputers where IBM started to kind of look at it and go, oh, this might be like a real market, like a really big computer market for people.
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Yeah, even inflation adjusted. It's interesting that the rate of growth of the most valuable companies in the world in terms of market cap has far outpaced inflation.
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Well, both things can be true. He was the number one math student in the state of Washington. He was a nerdy kid and a brilliant kid and also fiercely competitive. His childhood friend and co-founder of Microsoft, Paul Allen, would say about him, you could tell three things about Bill Gates pretty quickly. He was really smart. He was really competitive. He wanted to show you how smart he was.
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And the question is, are they playing from behind and thus have to adopt a flawed strategy? Or is this strategy of assembling with all off the shelf components actually a good strategy if it works?
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Now, interpreters are notably different than operating systems, but Microsoft definitely had sort of raised the flag and everyone could see if I want to go buy software for my computers, broadly, they're an interesting group to talk to.
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Yes. Bill really, really wanted to bring Steve on, knew him from the Harvard days, knew what an asset he could be. He is the yin to Bill's yang. Yes. And so, I mean, frankly, 8.5%, it's a big grant. Who's out there running a 30-person company and you're giving away 8.5% slugs? It just doesn't happen. Those are founder shares.
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And this is really a sort of reflection that the way that Bill thought about Steve was as a founder. In fact, it created some tension with Paul Allen where Bill asked Paul if they could go to 5%. Paul said, sure. And then Bill actually offered him 8.5%. And Paul got upset. And Bill said, I'll eat the 3.5%. It can come out of my share because I want him that bad.
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Yes. And specifically, they ask Microsoft for programming languages. They're like, we're making this great PC. We're going to need a basic. We think you guys are working on a COBOL. We'd like some COBOL.
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God, they were so bad. Every single thing that's been named to this point, except for the company Microsoft, was a horrible name. Oh, the processor is 8008, and now it's 8080, but the machine is 8800 that the processor is inside. Give me a break, everyone. It's horrible naming.
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Yeah, it does seem like very few people are thinking about their products as something they really need to build a brand around with consumers. Yes. Hence the naming schemes.
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And he signed hefty, hefty NDAs. So he cannot say who it is, but he's like, you really should take this seriously.
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Welcome to Season 14, Episode 4 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. We often remark that selling software is the best business model of all time. Well, today, finally, we tell the story of the company that created that business, Microsoft.
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And in particular, they would have to do some customizing. But part of what IBM wants is a customized version of an operating system for the IBM PC. They don't want this to be fully off the shelf. Yes.
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And just to add one more stir-the-pot of history here, there is another version of this story where Gary does actually have a conversation with IBM, and it blows up over licensing terms, that what Gary really wants is a significant royalty of every IBM PC sold, and IBM walks over that.
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So whether that happened or whether it's just an NDA issue, either way, I think we all know the IBM PC did not end up running the CPM operating system.
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Incredible. Which, of course, later they would drop the Q and call it DOS, the disk operating system. Something about dirty didn't have a ring to it when you're selling it to IBM.
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So Microsoft would eventually generate billions of dollars on DOS-based products. Now, you're exactly right in the same way that Instagram today is a much different code base than Instagram and much larger code base than Instagram when it was purchased. But my God, $75,000 to buy DOS to get this whole thing started. I mean, until Windows 95, all of the Windows operating systems were DOS-based.
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Yep. Also, David, I got to say, I just looked it up. The address of Seattle Computer Products on the original business card for Seattle Computer Products, where I presume QDOS was written, the space is available.
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Yes. So this is in Paul Allen's memoir. IBM paid Microsoft $75,000 for testing and consultation, $45,000 for DOS. $45,000 and $310,000 for an array of 16-bit language interpreters and compilers. So all told, bundled together, that is $430,000 fixed that IBM paid Microsoft with no ongoing obligation.
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And you might say, what? Didn't Bill learn his lesson? Why would he ever agree to this?
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It's so interesting because what ended up happening that Bill Gates masterminded was once we distribute our operating system through IBM's PC, that's going to become the thing everyone buys. And now in the 16-bit generation, when there are people building programs for computers, not just developers, once those application developers who are writing programs are targeting an operating system...
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then that is the operating system that every other OEM, every other computer maker is also going to want and really need. And we're going to be the ones that they have to come to to buy it. And I can't figure out Did IBM miss this fact, or did they know it? Basically, what IBM did was they were the one place where every business needed to go for their computer needs.
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And what they did in this negotiation was they actually handed that over to Microsoft. And they said, we are going to become a commodity, just like every other hardware manufacturer, and you are going to be the point of integration for the whole ecosystem. You're going to be the linchpin that everyone has to target for their applications.
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Because then they have the sort of plausible deniability of how could we possibly have a monopoly? We're buying off the shelf.
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IBM failed to see the value of software, and they certainly failed to understand what a software platform business model would be. Which makes sense. I mean, why would they? Right. It's almost like their experience... They're the computing company. Yes.
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Their experience in selling mainframes with everything bundled in was the wrong experience to go off of in understanding the way the future would unfold. And Bill's very modest experience watching the Altair and all these sort of Altair clone type machines, or even if they're not Altair clones, just more microcomputers that need more software, that actually was the useful...
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Yeah, the deal that Bill Gates made with IBM for the IBM PC is the greatest deal in at least computer industry history, if not all business history, full stop.
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IBM was right that it was by far and away the most successful personal computer on the market as soon as they released it.
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It's fascinating. And you know what? To give them a little bit more credit too, they did try to enforce that there's some amount of lock-in to the IBM PC. And they did that in two ways. One is, we're simplifying and calling it DOS. It was PC DOS, which is different than MS-DOS, which would get licensed to other computer makers.
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I don't know exactly what happened, but it basically seems like it just wasn't different enough to... to be meaningful to application developers. So that's one piece of it. The second is IBM did actually have proprietary BIOS. So that was another part where they kind of thought that that might provide them some protection where they could stay a linchpin in the ecosystem.
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And it wasn't just all off the shelf. They actually did have something that was theirs that was proprietary.
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It is basically why Compaq worked is what it comes down to. So Compaq was formed basically to clone the IBM PC. They saw the market opportunity and they realized they could buy from all the same equipment vendors. So let's go eat their margin is basically the plan. However...
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The one thing that was not off the shelf is the BIOS, the basic input-output system, which is effectively the thing that decides to load the operating system when you turn the machine on. And so there's some proprietary magic that happens to call upon the operating system to do its thing.
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So, Compaq reverse engineered the BIOS, and the way that they did it was very similar to Trip Hawkins and the story that he told us about his reverse engineering at Electronic Arts.
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Yes. So Compaq had two engineers and one engineer went in and fully dissected the code for the IBM PC BIOS and basically saw all the proprietary calls that it made and documented each of those calls without writing the implementation steps. Then he handed, hey, here's what the BIOS needs to interface with over to the other engineer.
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And the other engineer, on their own, just went through and thought of an implementation. And they have no idea if it's the same implementation. So it's not breaking any sort of infringement. They're basically saying, I'm just seeing the requirements for this product, and I'm coming up with my own implementation of that product.
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They basically figured out how to exactly clone the IBM PC and buy the very same operating system. And to go back to quoting Ben Thompson, because this is from his great piece again, the result was a company that came to dominate the market.
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Yes. This is a very early place to make the point. Microsoft is the result of tremendous intelligence, brilliant strategy, fierce competition, and an unbelievable amount of luck. Bill Gates was born in 1955, the same year as Steve Jobs, to come into adulthood just as the personal computer wave is starting. And...
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Compaq was the fastest startup to ever hit $100 million in revenue, then the youngest firm to break into the Fortune 500, then the fastest company to hit a billion in revenue. And by 1994, Compaq was the largest PC maker in the world.
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Is it just cheaper? Like, basically, this is the IBM PC, but for less money?
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And so begins the race to the bottom of PC hardware. Completely undifferentiated, all the value accrues to the software layer.
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Microsoft used IBM to generate demand for their software, and then they used every other PC manufacturer to capture the value that all that demand created.
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Yes. And they combined two magical principles together, this infinite replicatability, zero marginal costs of software, and becoming the linchpin of the ecosystem. They are now the software that everyone needs to target, which gives them pricing power.
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So that pricing power raises your top line, and you have no costs. It's unbelievable.
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The fact that he was at a middle school and had this much privilege where he could get access to a PDP-10 at this point in his life to help him understand how important computers would become. I mean, there are dozens of people in America who are as well-situated as Bill is, and that might be overly generous.
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So it says a lot about this period in time that you could do a 1x revenue deal in a high margin software company. I mean, I actually don't think this shows a weakness in Microsoft. Oh, they didn't have leverage or something like that. That wasn't it at all. It was just the deals sucked.
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Now, you know, it's only 5%. So good on Microsoft. Spoiler alert, this is the only dilution that they would ever take. So that's also extremely different than today. But yes, a $20 million valuation at this stage is frankly ludicrous.
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Hey, that's Forex multiple expansion off the last time they raised money.
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So Bill Gates and Warren Buffett did a conversation at the University of Washington in 1998. So this is as late as 1998. This thing that we're talking about, the magic of the software business model and how it should be reflected in a company's valuation, especially when it's a high growth company, was still not understood even by Bill Gates himself. So here's the quote.
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Bill Gates says, I think the multiples of technology stocks should be quite a bit lower than the multiples of stocks like Coke and Gillette because we are subject to complete changes in the rules. I know very well that in the next 10 years, if Microsoft is still a leader, we will have had to weather at least three crises. So Bill Gates is essentially making an argument.
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Now, granted, this is in the middle of all the antitrust stuff, so he's very prime for this.
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He's basically making the argument that disruptive forces come at you so fast in the technology industry that even though you can grow extremely fast and it's this extremely scalable thing, distributing software at zero distribution costs, and even though the margins are unbelievable because you have zero marginal costs, they still shouldn't be valued as highly as like a CPG company, which is so different than the way that people think about it today.
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Companies that are less susceptible to disruption, more predictable in terms of high growth, high margin revenue, deserve a premium. But Gates is basically arguing everyone else doesn't. So let's flash all the way back to 1981 and talk about this venture capital investment, this one-on-20 that TVI does. Good work if you can get it, man. How does this come to be?
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So even a whole year before, in the fall of 1980, Dave Marquardt, one of the partners and the founders at TVI, flies up to Seattle, not to meet Bill Gates, but to meet Steve Ballmer. Because they were classmates at GSB, right? They weren't quite classmates, but because I think they were two years apart, so they didn't overlap, but they had some of the same social circles.
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And Steve was effectively the screener for anyone who wanted to come and talk to Bill and try and invest in the business. T.A. Associates had been up, Sutter Hill had been up, Hambrick and Quist had been up, Xerox Ventures, and all of them only ever got to meet with Steve Ballmer and never got passed on to Bill Gates. Steve would basically just bounce them off.
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And I know all this because there's a great oral history from the Computer History Museum where this whole thing's in a transcript with an interview with Dave Marquardt kind of recalling the whole thing. So Dave flies up to meet with Steve and Steve says, you're asking really interesting questions. You're thinking about our strategy the right way. You don't just want to do a transactional deal.
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You really think this is something special. Why don't you meet with Bill? Bill, of course, doesn't have any extra time in his schedule. He says, but I am going to the UW Arizona football game at Husky Stadium. Why don't you come and talk to me there? So of course they go. Bill doesn't pay attention to the game at all. He's just laying out the strategy and grilling Dave and
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Talking about software the whole time. So this is fall of 1980. So that's a whole year before the deal gets done. And Dave's remarking at this point in 1980, they're doing $5 million in revenue, $2 to $3 million in profit. They don't need VC money. And yet he was able to get in. So here's the quote. I was just sort of helping them out with the business.
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In the venture business, you're buying and you're selling at the same time. You're trying to figure out, are these guys crazy? Are they ever going to do anything really interesting? And if so, how do I get myself positioned to be able to help them do it? And so I spent a lot of time up there helping recruit people. I helped to recruit Charles Simone, who was an early key guy.
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Charles Simone would go on, this is an aside, to write Microsoft Word. And Charles was at Xerox PARC inventing the GUI.
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Yes. And he says, and I was working with Steve on business strategy, they had these OEM customers, the PC manufacturers, and they had started to engage with IBM on this operating system. And then are we just going to become a low-cost contract programming shop for IBM, an outsourced sweatshop, or is there some way we can build a business out of this?
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Which led to the fixed fee to IBM, the retention of the code, which then we could sell to other people, and that's what created the PC industry, basically. So that is his recollection of the whole thing, that he was sort of very helpful in this transformative time for the company. Now, at the same time, you have to look at everyone else's incentives.
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So Dave is only 29 years old, but everyone else is like 23. And so he actually is kind of adult supervision. At the same time, the partnership was still just a partnership and there was a handshake deal for the equity. And so if you're Steve Ballmer at this point in history...
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It would be nice to have a forcing function to actually turn this into a corporation so that we can get some shares granted here. So there's a little bit of incentive to say, hey, if we take on an outside investor, we're going to have to restructure.
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Yes. So this would create a little bit of board and governance. So it's not just Bill all the time. Now, Bill, of course, I think is still the controlling shareholder just by the amount of stock that he owns. But there's a board. It's Bill and it's Dave and it's Kei Nishi. It's a three-person board.
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Yep. So on this venture investment, it's pretty fascinating. None of these are terribly compelling reasons other than like, I guess it would be nice to have a little bit of capital associated with us formalizing the corporation, but they don't need money at all. They're printing cash. They've been printing cash ever since that one tight period in Albuquerque. Dave charmed them.
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It's pretty crazy. I think part of it too had to do with the fact that Microsoft was up in Seattle. So the VCs just weren't traveling. Right. And Dave was young and he was single.
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It's crazy. Dave Marquardt, I think most weekends is flying up to Seattle to hang out with Bill and Steve. It was a real sell. And he said, I was young and I was single and I had nothing better to do. And it was really fun and intellectually interesting. So I did it.
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And that resulted in, depending how long TV I held, one of, if not the best venture capital return in history. Hard to argue with that one.
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And it's quite telling. It's called the consumer products division to make applications. Even though they're competing to make these applications that today we would view as business tools, spreadsheets and word processing, that is not how they referred to it.
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Yes. If you ask anybody in our ecosystem, save for the 1% of people who actually know this, what happened at Xerox PARC? they will tell you they invented the mouse. They invented the graphical user interface. And then Steve Jobs walked in and he saw it all and he said, oh my God, we have to have it. And then he went off and he made the Lisa, which had a graphical user interface and a mouse.
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And then that failed. But what succeeded was the Macintosh. And it's a wholesale ripoff of Xerox PARC that lives on today in Apple. And that is the story that you will hear from basically everyone.
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Yeah, the value of a network scaling proportionally to the square of the number of inputs. Right.
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Right. So you should have a little bit more generosity for the East Coast management at Xerox for failing to commercialize this.
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In fact, the year that Microsoft went public, Lotus had more revenue than Microsoft at the IPO.
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Wild. Yeah, it's crazy. So Lotus 1.2.3 had some graphics, but it was still in character mode. It was a powerful spreadsheet that could start to do some graphics, even though there wasn't actually a GUI operating system yet, which is interesting. So Lotus 1.2.3 was faster, it had bigger spreadsheets, and it was just more powerful. Microsoft Multiplan was still targeting the older 8-bit.
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And so Multiplan, despite Microsoft's best efforts, is completely left in the dust. Microsoft's trying to figure out, what should we learn from this? And in talking with Pete Higgins and Mike Slade, who were both early leaders in the development and the marketing of the applications division—actually, Mike Slade went on to work directly for Steve Jobs at Next and Apple for many years—
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Yes. Ben Thompson has a fantastic quote on this. He has an article called, What is a Tech Company? And here's his comment. 50 years ago, what is a tech company was an easy question to answer. IBM was the tech company, and everybody else was IBM's customers. That may be a slight exaggeration, but not by much. IBM built the hardware, at that time the System 360.
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But in chatting with both of them, what basically became apparent is Microsoft learned with our applications, we should not be targeting the current platforms at all. The lesson to learn is never leave yourself open to the next generation of technology. They're learning the Moore's Law lesson again.
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Right. Even if that platform is not the one you own. Right. That's the interesting thing about when they're evaluating multi-plan and they say, how do we not get Lotus 1, 2, 3'd again? Basically, the applications team gets the freedom to look around and say, okay...
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No matter what our overall company strategy is right now, or no matter what the systems division is doing, what is the most cutting-edge platform that is going to be so interesting to people that we can develop the most envelope-pushing technology for it? And that becomes the mandate for applications.
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You kind of have to counter position. If 123 is the best spreadsheet out there for the current technology generation, you just can't compete with them. You need to wait for the next big leap forward in order to find a new competitive vector.
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And who's about to come out with the very best instantiation of a graphical user interface? Apple Computer.
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Yes. The next chapter of our Microsoft story is the Macintosh in 1984. So fun. But before we do that, this is the perfect time to talk about another one of our favorite companies and longtime acquired partners who are back, Pilot.com.
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For startups and growth companies of all kinds, Pilot handles all of your company's accounting, tax, and bookkeeping needs, and is in fact now by far the largest startup-focused accounting firm in the entire U.S.
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Yes. Very fun. Well, back to Pilot. And speaking of incredibly successful Seattle business people, we talk all the time on Acquired about Jeff Bezos' AWS-inspired axiom that startups should focus on what makes their beer taste better. i.e.
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only spend your limited time and resources on what is actually going to move the needle for you, your product, your customers, and outsource everything else that you need to do as a company but doesn't fit that bill. And accounting is example number one of what he's talking about.
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They wrote the software, including the operating system and the application, and provided services, including training, ongoing maintenance, and custom line-of-business software.
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Every company needs this, but it needs to be done by a professional, and you don't want to take any risk of something going wrong. But at the same time, it actually has zero impact on your product or your customers.
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Yep. These are now companies like OpenAI, Airtable, Scale, as well as large e-commerce companies. So it's not just that they have the 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 go back to focusing on what makes your beer taste better, go on over to pilot.com slash acquired and tell them that Ben and David sent you. All right, so David, why are we talking about the Mac?
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Totally. Far and away, the first thing to point out is the first version of Microsoft Excel was for the Mac. It's especially crazy for all the finance people today who are like, oh, Mac Excel isn't real Excel. Excel has to happen on Windows. No, Excel was on the Mac. That was it. Yes.
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And the logic basically was Microsoft was really coming around to the idea that the next big thing in computing was the graphical user interface. And the reason they were coming around to this was because They knew from Xerox PARC just as well as Apple did, and they were rapidly trying to figure out how to get all of that Xerox PARCiness into their product line too.
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That's the other half of this sort of untold Xerox PARC story. And one of the first ways that they see to bring the graphical user interface to their products is launching Excel for the Mac, because they basically see... The way that we got destroyed with Lotus 1.2.3, we can't compete with Lotus on the IBM PC. So we're going to shelve multi-plan and kind of start over.
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And Excel is going to come out in the graphical user interface. And we're going to try to be first and best on the GUI.
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Yep. And of course, Apple loves this. The Macintosh came out in 1984 and everybody remembers the great intro video and the hello script. And I've watched that Steve Jobs keynote because of course I have. And it's this magical moment in computing history where finally something that's insanely great comes out. And it's like, The beginning of Steve Jobs' unbelievable presentation prowess.
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It's so fun to watch it. And it's, of course, a product that eventually people really loved. But at first... It doesn't have the killer app. No. It's a product that was supposed to ship in 82. It didn't. It shipped in 84. And so at the time, what they were targeting for 82 was like a pretty great set of technologies. By 84, it's kind of an aging set of technologies.
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So it debuts with 128K of memory, which basically isn't enough to create any interesting applications. And so developers are kind of ignoring it as an interesting platform to develop on. Within 12 months, they kind of figure it out and come out with a better version that's 512K. And that's kind of the version that people now really think about
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Yes, exactly. But in the meantime, Microsoft, the applications group, is working their ass off to make something really great for the Macintosh, and they come up with Excel. And so what ends up happening is Apple's really trying to promote the sales of this machine, and... they kind of view Excel and PageMaker as the killer apps, as reasons that people should buy this thing.
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Because once you run through a lot of the demo apps and the stuff that Apple built, you're like, okay, what else is here? It's kind of crickets.
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And so I'm not sure this has ever been publicly disclosed before, but Apple spent just as much marketing Excel as Microsoft did. They matched Microsoft's marketing spend with their own campaign for it and split the bill.
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It's been daunting. You know, we wanted to do it for a while, but it takes some chutzpah to tackle Microsoft.
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So you've got a couple of concurrent things going on in applications land. You've got Excel coming out for Mac to take advantage of the GUI. Meanwhile, and this strategy is just all over the place. I think that's an interesting thing to underscore about Microsoft in this era. They're trying a ton of stuff because they're paranoid. They don't want to miss the next wave.
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It's like ASML machines. You don't just go ship them off to TSMC and say, good luck making semiconductors. Exactly. It's a full solution, full service thing. But an important thing that was also happening this year, 1968, was that IBM was undergoing some antitrust scrutiny over that huge bundle that I just told you about. I mean, doesn't it smell like antitrust? They do...
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Meanwhile, also in the applications group, Charles Simone has written Word. This is about a year before in 1983. Microsoft Word comes out for DOS.
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Yes. So this is like, okay, we see the Xerox PARC stuff coming out in the Mac. Great. Excel will be for that. We want to develop Word. We're going to do that for DOS. Oh, but I can imagine how useful the mouse is going to be in a word processing environment. So they actually ship a mouse tied to the application that's not a part of DOS.
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And so this is how early we were in figuring out kind of what the split between applications and platforms were at this point in history. Microsoft thought maybe a mouse makes sense just for this one application, even though it doesn't do anything else for the rest of the command line interface.
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Yes. So the decision for the Excel team is to focus on GUI. The whole marketing message is Excel on a Mac is better than Lotus 1, 2, 3 on a PC.
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You're starting to see truly divergent cultures at Microsoft between the systems group, which is currently making DOS and will soon make Windows or soon partner with IBM or soon do something else that we're getting into here in the next chapter of the story, and the applications group, which is
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is also currently a bunch of disparate applications and teams targeting disparate platforms, but is also about to become unified in their next chapter. And within the applications group, that next chapter is Microsoft Office. So in 1985, in January, the bundle is released. And it was originally called the Business Pack for Microsoft. And it started on the Mac.
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Totally does. Now, they haven't acquired PowerPoint yet, or forethought, as we talked about eight years ago on Acquired, way back in history. So there's no PowerPoint. It's not part of the bundle. And so what you've got here on the Mac in the first version of Office is Word, which they've developed in-house, File, Chart, and Multiplan. This is this first notion of a suite.
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So today we're very familiar with suite, creative suite over at Adobe. Software is sold this way. This was kind of the first time. And so what was actually happening is all of the bundling was happening in pricing, in marketing, and in manufacturing. And so you sort of had a single box that that they would ship with the different applications. By 1988 or 89, it was Word, Excel, PowerPoint.
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They're very different things, but they're getting sort of bundled together in a way to be sold to customers. But there's no product integration. And so you don't have the ability to do this very nice copy-paste from an Excel table and just paste that into Word. That whole idea is pretty far away. So in this earliest Microsoft Office, it was just, how can we...
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Everything from the hardware to the software to the operating system, the service, the support, they are the whole market. They're starting to get concerned. And so proactively, they unbundled hardware, software, and services, and they started selling those separately for the first time, which was not a problem at first.
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bundle something for a cheaper price if you buy all three and make marketing easier for us to kind of have this unified message.
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So we've now sort of set the stage of Microsoft's doing a lot of stuff. They're hedging a lot of bets. They're not totally sure which strategy is going to win out. They're not sure which platform is going to win out. They're not sure if they're more of a systems company or an application company. But what they are unified on is we make great software for personal computers.
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And I think anything that fell into that purview, they were willing to explore. They didn't really have hard boundaries between we'll do anything to make our operating systems great, or we'll do anything to advantage our applications, or even we think we're an enterprise company, we think we're a consumer company. They just didn't have well-formed opinions yet.
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Right. Lotus Notes was crazy. It was a word processor, an email service, and it was a platform on which you could write other applications.
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But what it did was it cracked the door for customers to say, oh, I can buy hardware from IBM and software from someone else. And other people were not exploiting this, but it was possible.
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Which is so funny. I don't think at this point in history, the lines were clearly formed among the executives yet. Like Steve wasn't running the global sales force and Microsoft wasn't an enterprise company.
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Steve was one of the smart executives and they were a software company and someone had to manage getting the software out the door. So Windows 1.0 comes out. It's bad.
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Yeah, the idea of Windows overlapping on top of each other, that was a sort of uniquely Mac thing and a thing that smart engineers at Apple figured out how to do that in a performant way that offers good user experience. I would classify Windows 1.0 as like a half step between command line and an actual graphical user interface.
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Yes, that's right. Apple does do a deal to license a lot of, quote-unquote, their intellectual property, which of course came from Xerox, to Microsoft. Apple, I think, was under the impression that it was just for Windows 1.0, but the actual terms of the agreement are this and all future versions of Windows, which comes back to haunt Apple later. But yes, they totally get the license.
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Yes. But this is where the seeds are sown of what is the exploitable opportunity when Bill Gates is ready to do something.
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Isn't it crazy? In all of their early marketing, they referred to it as Windows, a graphical operating environment that runs on the Microsoft MS-DOS operating system. Yes. And actually, it was not until Windows 95 that Windows was its own operating system. It was in Windows 1, 2, 3, 3.1, and Windows for Workgroups. It was a graphical operating environment. Yeah. But here's the question.
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Why is Microsoft doing Windows? Obviously here, Microsoft knows they need to evolve DOS. They need to figure something out for the graphical world. And so, David, are you telling me that Windows is the widely agreed upon future of the company and it's just a straight line?
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Well, I mean, the IBM PC was such a big deal last time around, you would think that whatever IBM wants to do next is a pretty good way to ally yourself.
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Yep. Well, listeners, Microsoft today is sprawling and massive. It is the world's most valuable company worth over $3 trillion.
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This is such a crazy part of the story to me because we just talked about how Microsoft discovered this amazing business model and with everyone needing to license DOS from them, they're taking over the world and they're becoming the standard development platform. Why on earth, if all that is true, are they going to develop some software that's going to be locked to IBM computers?
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And so even though Microsoft's doing all these little hedges... Windows, this tiny little team, I think it's 30 people or something. It's not the most prestigious place at the company. The people in the applications division may as well be on another planet by this point from the systems division. They're trying all kinds of crazy stuff.
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And the company motto at this point is, the next big thing is OS2 and IBM, and we are the software vendor for that.
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Well, you say it was good, but not great. Bill Gates said it was brain-dead.
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That's right. That was like a bet the company move where Microsoft was like, hey, Compaq, go make 386 stuff because we're going to make a really great 386 software. And we need someone to be all in on that because IBM's not.