AcquiredMicrosoft Volume I: The Complete History and Strategy of founding through Windows 95 (Audio)
EVERY SPOKEN WORD
150 min read · 30,039 words- 0:00 – 3:37
Season kickoff: Why Microsoft, why now — framing “The PC Era”
- DRDavid Rosenthal
What were you listening to before we hopped on to your walkout music?
- BGBen Gilbert
New Beyoncé.
- DRDavid Rosenthal
Ooh, new Beyoncé! I haven't heard it yet. How is it?
- BGBen Gilbert
I really like it.
- DRDavid Rosenthal
Nice.
- BGBen Gilbert
I think it is reductionist to call it country.
- DRDavid Rosenthal
Ah. I was appropriately enough listening to Start Me Up through the ages. [chuckles]
- BGBen Gilbert
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.
- DRDavid Rosenthal
The Stones, though, man, like, it's crazy. They're in their seventies, eighties.
- BGBen Gilbert
Amazing.
- DRDavid Rosenthal
Man, I hope we're in our seventies and eighties dancing on stage.
- BGBen Gilbert
Season one hundred and twenty-six.
- DRDavid Rosenthal
Yeah. [laughing]
- BGBen Gilbert
[laughing] All right, let's do it.
- DRDavid Rosenthal
Let's do it.
- SPSpeaker
Who got the truth? Is it you? Is it you? Is it you? Who got the truth now? Is it you? Is it you? Is it you? Sit me down, say it straight. Another story on the way. Who got the truth?
- BGBen Gilbert
Welcome to Season fourteen, episode four of Acquired, the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert.
- DRDavid Rosenthal
I'm David Rosenthal.
- BGBen Gilbert
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.
- DRDavid Rosenthal
Finally. We're, like, ten years into Acquired here.
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
We're finally doing it.
- BGBen Gilbert
Uh, it's been daunting. You know, we've wanted to do it for a while, but it takes some chutzpah to tackle Microsoft.
- DRDavid Rosenthal
I'm so fired up. We're ready. It's time.
- BGBen Gilbert
Yep. Well, listeners, Microsoft today is sprawling and massive. It is the world's most valuable company, worth over three trillion dollars. They have forty-nine 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. 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 twenties pushing what was possible. Welcome to Microsoft: The PC Era. 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/email. Come talk about this episode with the community at acquired.fm/slack. 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, J.P. Morgan Payments.
- DRDavid Rosenthal
Yes, just like how we say every company has a story, every company's story is powered by payments, and J.P. Morgan Payments is a part of so many journeys from seed to IPO and beyond.
- BGBen Gilbert
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?
- 3:37 – 9:41
Bill Gates’ formative environment: a power couple, ambition, and competitiveness
- DRDavid Rosenthal
Uh, we're right down the middle on this one. We're gonna start in 1955 in Seattle, Washington, with the-
- BGBen Gilbert
Whoo!
- DRDavid Rosenthal
-birth of Bill Gates III, or Trey, as he's known-
- BGBen Gilbert
Yes
- DRDavid Rosenthal
... growing up. It's so confusing because his dad is the second, but he goes by Senior, and Bill is Junior slash The Third slash Trey. So Bill, in 1955, is born as the second of three children to Bill and Mary Gates. Now, Bill Gates Senior, his father, is from Bremerton, the navy town just across the sound from Seattle, where he grows up in a family that owns and runs a furniture store there. A long way from the software king of the world here. Now, Bill Gates Senior slash The Second, after high school, he joins the Army during World War II, serves during World War II, and then he goes, I presume, on the GI Bill to the University of Washington, where he's the first member of his family to go to college, and there he gets an undergrad and a law degree in four years and then decides to stay in Seattle with his new family and become a practicing attorney. Now, I say family because at the UW, he meets and marries one Mary Maxwell, and Mary, I don't know how to put it other than that she is a force.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
So Mary's family had founded National City Bank, and her father was a senior executive at First Interstate Bank, which later became a big part of Wells Fargo. Now, Mary, despite being the daughter of a successful business family in that day and age, was not cast aside like so many other daughters we've talked about on the show.
- BGBen Gilbert
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.
- DRDavid Rosenthal
No. So after she graduates from the UW, she becomes first the president of the Seattle Junior League, and she starts joining nonprofit boards in Seattle as a very young woman. She joins the Seattle Symphony Board, the Chamber of Commerce, the Children's Hospital, the King County United Way, and she's such a force on these boards that she starts getting asked by her fellow board members to join their company's boards, too, like the corporate boards. They're so impressed with her. So first, she joins the board of First Interstate Bank, the bank that her family's a part of. Then she joins the board of KIRO Television in Seattle. She even ends up joining the Pacific Northwest Bell Telephone board.
- BGBen Gilbert
That's right, part of the AT&T breakup.
- DRDavid Rosenthal
Yeah. Eventually, she joins the Board of Regents of the University of Washington and the whole entire national United Way board. So she never works full-time in a corporate setting, but it is not an overstatement at all to say that Mary Gates-... became one of the most powerful business people in the Pacific Northwest, period.
- BGBen Gilbert
Absolutely, and Bill Gates Sr. was the prominent attorney in the region, and so it's quite the power couple.
- DRDavid Rosenthal
Ben, it's like you're reading my script here. Yes, we don't wanna give Bill Sr. the short shrift here either. He becomes a superstar lawyer, and he becomes a co-founding partner of the firm Preston, Gates & Ellis, which today, I didn't even realize this till I dug into research, that is K&L Gates today, one of the largest law firms in the world.
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
And another fun fact that you probably know about Bill Gates Sr., but we gotta, that's being Acquired, talk about, do you know what corporate board he joined later in life?
- BGBen Gilbert
I do not.
- DRDavid Rosenthal
Costco.
- BGBen Gilbert
[laughing] 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 wanna put high-risk capital to work into startups. And, you know, his heart was there, obviously, through his law practice, long before Bill Gates III became the prodigy he became.
- DRDavid Rosenthal
Totally, and that's the point we wanna land here is, for young Bill, Trey, growing up here, he is growing up [chuckles] in, like, a pretty unique household. He would later talk about being, like, nine or 10 years old, and most nights at dinner at his house, there would be a CEO or a senator or a governor or somebody who's just over for dinner, and Bill would sit there and absorb the business conversation. You know, it's like the Hermès family, the Dumas family that we talked about on that episode. You know, this whole thing, it makes me think of Paul, the main character in the Dune movies [chuckles] and the book. Like, he's kind of bred from birth to be this incredible business mind.
- BGBen Gilbert
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.
- DRDavid Rosenthal
Yes, and it just turned out that he would be the CEO and founder of the biggest company in the biggest industry- [laughing]
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
... ever to exist. The other thing that we gotta say about Bill growing up, he is insanely competitive, so he did not and does not like to lose at anything, and that is putting it mildly, whether it's sports or swimming or computers or school or the classroom. There's a quote in one of the books we read from a childhood friend of his, who says, "Everything Bill did, he did competitively and never simply to relax." I think this used to be more than today. There's kind of this image of Bill Gates, that he was a computer nerd, that he was, like, this shy, little, skinny kid, and the way he looks doesn't help this, but that is not the case at all. This guy had a competitive fire in him, I'm sure still does, like none other.
- BGBen Gilbert
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, and he was really, really persistent."
- 9:41 – 19:48
1968 computing context: teletypes, IBM dominance, and the first crack in bundling
- DRDavid Rosenthal
That sounds about right. So famously, speaking of Paul and where Bill and Paul meet, when Bill is in seventh grade, his parents enroll him at the Lakeside School, which now I think is internationally famous because of Bill. But it is a super rigorous college prep school, middle school, and high school, and Bill ends up writing the scheduling software for class scheduling, and he puts himself in the classes with all the girls. Like, [laughing] oh, funny. But y'all, like, this, [chuckles] Bill, 13 years old, seventh grade, Lakeside, this is when it starts. Obviously, Microsoft doesn't start, but during that year, Bill is 13 years old, the Lakeside Mothers Club raises money to buy the school a teletype and connect it up and rent computer time from a DEC PDP-10 that is located in downtown Seattle and owned by the branch office there of General Electric. Now, probably a bunch of you are like, "I have no idea what any of those words mean," [chuckles] so we gotta set some context. This is 1968. 1968, you know, The Beatles, Vietnam, the Summer of Love. This is not the computer age.
- BGBen Gilbert
2001: A Space Odyssey had just come out.
- DRDavid Rosenthal
Nolan Bushnell has not founded Atari yet. Bob Noyce and Gordon Moore are only just leaving Fairchild Semiconductor to start Intel. Silicon Valley is still dominated by Lockheed. There is no such thing as a microprocessor.
- BGBen Gilbert
The United States would land on the moon one year later.
- DRDavid Rosenthal
Totally. The way computing worked back then, it was basically still the ENIAC days. Like, a computer meant two things: It either meant a massive room-sized machine that had about the computing power of a calculator, [chuckles] or it meant a human. People talked about computers as humans. Did you ever see the movie Hidden Figures about the-
- BGBen Gilbert
Yes
- DRDavid Rosenthal
... Black women who did the calculations?
- BGBen Gilbert
Those women were the computers.
- DRDavid Rosenthal
They were called the computers, yes.
- BGBen Gilbert
'Cause they would sit there and compute.
- DRDavid Rosenthal
This was a totally different era, so the idea that a 13-year-old kid in this high school, this middle school, would get access to share computer time, I can't imagine there are many other secondary schools in the country that were doing this.
- BGBen Gilbert
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-... 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 were as well-situated as Bill is, and that might be overly generous.
- DRDavid Rosenthal
He and Paul got a sneak peek into the future there at Lakeside. Now, it's funny you said, "The personal computer era." [chuckles]
- BGBen Gilbert
We're not there yet. [chuckles]
- DRDavid Rosenthal
We are so far away from the personal computer era. I mean, we got us at the stage, what is computing? I mentioned ENIAC and these room-sized things. Computers did not have screens. You didn't have cursors, you didn't have lights, you didn't have pixels. Everything was done on a teletype. They kind of looked like typewriters, and they were wired up remotely, either in the same facility or, like what Lakeside is doing, you could be remote. I mean, it's almost like the cloud today. [chuckles]
- BGBen Gilbert
And it called over a phone line? That was the teletype.
- DRDavid Rosenthal
Yeah, exactly. Got wired over the phone line, hooked up to these mainframes, and so you typed commands into this teletype, and then the response came back over the phone line or over whatever cable from the mainframe, and it got printed out on a spool of tape [chuckles] on the teletype. But this is power that normal 13-year-olds don't come anywhere near accessing.
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
What is the computing market at this time? It is pretty much... We'll come back to the pretty much in a minute, 100% dominated by IBM.
- BGBen Gilbert
Oh, yes.
- DRDavid Rosenthal
IBM, Big Blue, you know, Big Iron is what it was referred to, like the products that they would produce. They were the industry.
- BGBen Gilbert
Yes. Ben Thompson has a fantastic quote on this. He has an article called "What is a Tech Company?" And here's his comment: "Fifty 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. They wrote the software, including the operating system and the application, and provided services, including training, ongoing maintenance, and custom line-of-business software."
- DRDavid Rosenthal
Yeah, System 360 was a line of solutions, I would say, offered by IBM, and it consisted of the thing, the room-sized thing, the mainframe, and the software, which was System 360, and the consulting, and the implementation. You know, you couldn't just call up UPS and forklift one of these things into a company-
- BGBen Gilbert
[chuckles]
- DRDavid Rosenthal
... and expect it to work. No, you gotta operate this thing, too.
- BGBen Gilbert
Totally, it's like ASML machines. You don't just go ship them off to TSMC and say, "Good luck making semiconductors."
- DRDavid Rosenthal
Exactly.
- BGBen Gilbert
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 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, 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.
- DRDavid Rosenthal
Yeah, interesting. It cracks the door for Microsoft, like, 15 years later, 20 years later. Yeah.
- BGBen Gilbert
Yes, but this is where the seeds are sown of what is the exploitable opportunity when Bill Gates is ready to do something.
- 19:48 – 21:55
Lakeside School: the first “computer on-ramp” and the Lakeside Programmers Group
- DRDavid Rosenthal
So back to Lakeside and the Mothers' Club, raising money for this access here for the school. Bill, remember, he's just started. He's in seventh grade, and Lakeside is a middle school and a high school. The high school is actually in a separate building. The computer room that gets installed with the teletypes, that's over in the high school [chuckles] but Bill, he doesn't care. He gets exposed to it, I think, in a math class one day, and he's like, "Oh, I'm hooked." So he goes over, he's hanging out with the high schoolers, teaches himself how to program, and pretty quickly, he becomes known as one of the very best programmers there. And he and three other kids form what they call themselves the Lakeside Programmers Group, and one of his buddies who he forms it with is, of course, the high schooler, I think the tenth grader at the time, Paul Allen.
- BGBen Gilbert
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, thirteen, fourteen. 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.
- DRDavid Rosenthal
So these high school kids, they start the Lakeside Programmers Group. They call it the Programmers Group because they are programmers. This is another super important thing to land. To use a computer at this time meant to be a programmer.
- BGBen Gilbert
Right.
- DRDavid Rosenthal
There was no packaged software that you bought. The software that IBM was selling was the operating system to make the machines actually function, and it was the programming languages that you could then program on, but you weren't clicking around and using Excel or, like, you know, pulling up apps. Everybody who used a computer wrote their own software.
- BGBen Gilbert
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.
- DRDavid Rosenthal
So the goal of the Lakeside Programmers Group, remember, Bill is this business prodigy, is to use their very valuable and very rare skills as programmers at this time to, you know, make money. [chuckles]
- BGBen Gilbert
Yep.
- 21:55 – 26:14
C-Cubed mentorship, real systems programming, and the first royalties lesson
- DRDavid Rosenthal
Do a business. So turns out, at the same time... I mean, the coincidences here are just crazy. There is a local startup coming out of the University of Washington called the Computer Center Corporation, or C-Cubed, and the business plan behind C-Cubed was that they were gonna get a bunch of DECs, a bunch of PDP-8s, 10s, 11s, whatever, and they were gonna be like AWS. They were gonna just be a computer time-sharing company. So C-Cubed hires the Lakeside Programmers Group, these kids, to come in and find and document bugs in the system, and they're gonna pay them directly in computer time. So when they come into C-Cubed, they learn Fortran, they learn LISP, they learn machine language for the PDPs. Back at Lakeside, they were just using BASIC, the programming language.
- BGBen Gilbert
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. It's not a, uh, 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.
- DRDavid Rosenthal
Yes, but BASIC, we don't want to give the impression that it is just basic or just for kids.
- BGBen Gilbert
No, it was widely used.
- DRDavid Rosenthal
It's gonna become hugely, hugely important. Like, it is both the gateway programming language for everybody, but, like, it's a real programming language, and a lot of stuff is done in it.
- BGBen Gilbert
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. 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.
- DRDavid Rosenthal
Totally. When Bill and Paul and their buddies come into C-Cubed, they're now getting access to learn real hardcore systems programming languages, including machine code for the PDP-10. They're becoming pretty prolific engineers here.
- BGBen Gilbert
They're handwriting assembly code.
- DRDavid Rosenthal
Yes, and they're getting mentored. One of the executives at C-Cubed is a guy named Steve Russell. Did you find this, Ben? Do you know about this?
- BGBen Gilbert
No, uh-uh.
- DRDavid Rosenthal
This is amazing. You're gonna die.... Steve Russell was the guy who wrote Spacewar! when he was at MIT-
- BGBen Gilbert
No way!
- DRDavid Rosenthal
-on the first PDP, the PDP-1. He's, like, a computer science legend.
- BGBen Gilbert
Nolan Bushnell told us about that.
- DRDavid Rosenthal
Yes. Spacewar! was the first video game, first computer game, ever written. It was written as a fun side project by some MIT engineers in the early days of DEC, and then that became Nolan Bushnell's inspiration for starting Atari, and Pong, and Space Invade- Like, yeah, Steve Russell, that guy.
- BGBen Gilbert
Wow!
- DRDavid Rosenthal
He mentored Bill Gates.
- BGBen Gilbert
And he was here at the University of Washington?
- DRDavid Rosenthal
He had come out to the University of Washington, and then left, and was part of one of the execs starting this company.
- BGBen Gilbert
C Cubed, wow, that's, like, a mile from my house.
- DRDavid Rosenthal
Right? Crazy!
- BGBen Gilbert
Wow.
- DRDavid Rosenthal
So after a little while at C Cubed, all of this real expertise that these kids are getting leads to another opportunity at another timeshare computing company based down in Portland. They ask the kids to write a real piece of software, to write a payroll billing program for all their clients that are using the timeshare system. And Bill, now, who's the de facto leader of this group, he negotiates a deal with the help of his dad, [chuckles] Bill Gates Sr., prolific corporate attorney in Seattle, that rather than just being paid hourly for their time, they're gonna get a royalty on the revenue- [chuckles]
- BGBen Gilbert
... [chuckles]
- DRDavid Rosenthal
-that their client makes off the software. [chuckles] They can't believe it. These kids are teenagers. They're figuring out the whole software business model here. They end up making at least $10,000 from these royalties, which the average household income in the US, at the time, was below $10,000. These kids are rolling [chuckles] in money.
- BGBen Gilbert
Wow.
- 26:14 – 37:12
Traf-O-Data and Moore’s Law realization: microprocessors change everything
- DRDavid Rosenthal
So the next year, Paul graduates from Lakeside and goes off to college at Washington State. But he and Bill decide to team up on a new venture that they're gonna do together, called Traf-O-Data.
- BGBen Gilbert
They've identified a market opportunity, and that opportunity is reducing traffic.
- DRDavid Rosenthal
Yes. So the business plan is that municipalities count cars that go through intersections, use that to make decisions about how they're gonna do city planning. Bill and Paul are like, "We can take this new thing that's coming out of Intel, a microprocessor, which is promising to be a full computer on one chip, and we can use that. We can build a machine that is gonna be a computer, and it'll process and analyze that data, and then we can sell it to governments." Like, great, big market.
- BGBen Gilbert
And listeners, are you kind of sensing what's happening here? Mainframe, minicomputer, microprocessor, we kind of have to keep using smaller and smaller words [chuckles] to represent the fact that the computer is getting smaller and smaller here.
- DRDavid Rosenthal
It wasn't until we started doing research for this episode that I finally realized, oh, microcomputers, which is the original term for the personal computer, for the PC, it was called microcomputers before PC caught on, they're called microcomputers 'cause they're based on the microprocessor. [chuckles]
- BGBen Gilbert
Microprocessor. Yes, absolutely.
- DRDavid Rosenthal
It's not just that micro is smaller than mini.
- BGBen Gilbert
And it is funny that it kind of stopped there. The computers that are sitting on all of our desks are microcomputers.
- DRDavid Rosenthal
Right. Yes. So while they're waiting for the 8008, this new first microprocessor from Intel, to come out, or at least for them to get access to it, they wanna get a head start on programming their Traf-O-Data machine and programming this microprocessor. So Paul's like, "I got this. I can find a way to make this happen." He takes the PDP-10 at Washington State, and he writes a whole emulator program to mimic the instruction set for the 8008 from the manual, and they get a full emulator up and running, and they can code even without the microprocessor actually being there and having ac- It's just like NVIDIA, [chuckles] you know? And like, when Jensen was like, "No, we gotta build an emulator and simulate this, and then we're gonna ship it sight unseen." They're doing the same thing.
- BGBen Gilbert
It's funny, in many ways, at this point in history, getting a manual was actually much more valuable than getting the processor itself. 'Cause 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, well, sure, you couldn't actually test the stuff you wrote for it on the hardware, 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.
- DRDavid Rosenthal
Yes, and this is gonna become very important to Microsoft [chuckles] in just a second.
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
So Traf-O-Data is not a huge success. I think I read a few places they make about $20,000 in revenue from it. So, like, again, great money for high school and college kids, but, you know, not world-changing stuff here. This is not what Bill aspires to for the company he's gonna start. But Bill and Paul are getting experience with the microprocessor. Bill actually has the idea for Microsoft when they're working with it. He's like, "Oh, this is a computer. Why don't I go off and write an interpreter for BASIC here, and we can sell the BASIC interpreter for the microprocessor and build a big business?" The 8008 just wasn't powerful enough yet to do that.
- BGBen Gilbert
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.
- DRDavid Rosenthal
Yep, and, you know, Bill and Paul are not the only ones having this insight here, too. Another Seattle guy, named Gary Kildall, who they had intersected with, who they knew from C Cubed and the University of Washington, he kind of had the same idea here, and we're gonna bring up Gary and his company, Digital Research, a little bit later.
- BGBen Gilbert
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.
- DRDavid Rosenthal
Yep. But Bill and Paul-... they absolutely see the vision for what this can grow into and become. Bill has a great quote: "Paul and I had talked about the microprocessor, and it was really his insight that because of semiconductor improvements, things would just keep getting better. I said to him, 'Oh, exponential phenomena are pretty rare, pretty dramatic. Are you serious about this? Because this means, in effect, that we can think of computing as free.' It was a gross exaggeration, but it was probably the easiest way to understand what it means to cut costs like that, and Paul was quite convinced of it."
- BGBen Gilbert
Yes. Is this in the Smithsonian interview?
- DRDavid Rosenthal
Yes. It's so good.
- BGBen Gilbert
It's so good. This quote is incredible, 'cause 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 gonna keep happening. It's been happening." And Bill's shaking, and he's like, "What? 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."
- DRDavid Rosenthal
This moment is the genesis of the vision for Microsoft, that even though Bill doesn't say the words in this quote, the vision of a computer on every desk, in every home, that's the famous part, and then the part that got left off later when the DOJ started sniffing around, was running Microsoft software. But that is the vision here, and it is crazy at the time, like, a computer on every desk and in every home. Bill sees that this is what this exponential phenomenon, what Moore's Law means, that that is going to happen. You know, we're still in the era of teletypes. Nobody else sees this.
- BGBen Gilbert
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. 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. 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.
- DRDavid Rosenthal
So all that said, even Bill and Paul know the 8008, it's not there yet. It's not powerful enough to really be a general-purpose computer on a chip, but they know it's coming. So in the fall of 1973, Bill goes off to college at Harvard, famously. It's funny, at Harvard, you know, kinda like Jim Simons that we talked about at MIT-
- BGBen Gilbert
Yes
- DRDavid Rosenthal
... on the RenTech episode, Bill thinks he's gonna be, like, a world-class mathematician and set the world on fire.
- BGBen Gilbert
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. 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.
- DRDavid Rosenthal
[laughs] Yes. So while Bill's at Harvard, he's also doing a bunch of the typical college kid stuff. He's playing poker, he's cutting classes, he's making friends, and one of the friends he makes there is a kid down the hall from him named Steve, Steve Ballmer. [chuckles] And Ballmer, I mean, everybody knows Ballmer. He's kinda everything that Bill is not. He's super social. He's super outgoing. He's in a final club, which is, like, a big thing in the social scene at Harvard.
- BGBen Gilbert
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.
- DRDavid Rosenthal
Which is the annual math competition for college students.
- BGBen Gilbert
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, 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.
- 37:12 – 52:17
Altair moment: founding Micro-Soft by bluff, emulator, and a plane-written bootloader
- DRDavid Rosenthal
Paul is so convinced that the revolution is coming, that he actually drops out of Washington State, moves to Boston to be close to Bill so that they can be ready when it happens, and that summer, they both get summer jobs at Honeywell as programmers. Paul stays on into the next school year when Bill goes back to school. He's just, like, waiting, waiting, waiting. And then in December 1974, Paul is walking across Harvard Square, and he sees in a newsstand the January issue of Popular Electronics, on whose cover is the Altair 8800, the world's first real, honest-to-God, commercially available for sale microcomputer. And the legend has it that Paul grabs the magazine, runs over to Bill's dorm, throws open the door, throws the magazine on the desk, and is like, "It's here." And Bill just says, "Oh, my God, it's happening without us. We need to get on this right now."
- BGBen Gilbert
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.
- DRDavid Rosenthal
And this is it. This is the moment. The revolution is here. Microsoft is about to be founded. But first, this is a great time to thank our presenting partner this season, J.P. Morgan Payments.
- BGBen Gilbert
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, twenty-four/seven, everywhere, and in every currency. So J.P. Morgan has experienced a massive digital transformation and is now much more than just a global bank. They invest fifteen billion dollars a year into technology and R&D. So with J.P. Morgan Payments, you are getting their history of service, stability, and scale, but also innovation and new technology.
- DRDavid Rosenthal
And scale is really the key word here. Every episode, we talk about Hamilton Helmer's Seven Powers, and boy, does J.P. Morgan have scale economies. [laughing]
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
What's unique about their position in payments is that they can make massive infrastructure investments that benefit their customers in the near term, in addition to the long-term technology bets, like blockchain or quantum computing. Since they move ten trillion dollars a day in a hundred and sixty countries, these investments create a lot of shared value across their large customer base.
- BGBen Gilbert
Yeah, not to mention the second of the seven powers, network economies.
- DRDavid Rosenthal
Yep. If you're a J.P. Morgan Payments customer, whether you're a startup or a Fortune five hundred, you can access their payments partner network. This is a set of third-party integrations across virtually every industry and payment use case. It makes it easy to discover what specific set of tools are best for your business.
- BGBen Gilbert
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 J.P. Morgan's scale, you can imagine the value that comes with unlocking access to their industry-leading partners and technology.
- DRDavid Rosenthal
Let's take Visa, for example, which listeners may remember, we talked a lot on that episode about the power of a network. Well, Visa works with J.P. Morgan to provide global payment processing services, and now through the partner network, you can easily add Visa as an acceptance method through a streamlined implementation with consolidated reporting. Other companies in the partner network include Oracle, American Express, MasterCard, Accenture, and many more, including friends of the show, Modern Treasury.
- BGBen Gilbert
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 hundred-year companies that can reinvent and continue to grow, and that is the case for J.P. Morgan Payments. 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.
- DRDavid Rosenthal
So before we jump back into Bill and Microsoft, who essentially wrote the modern playbook on building platforms, be sure to check out jpmorgan.com/acquired or click on the link in the show notes.
- BGBen Gilbert
So, David, they're like, "It's happening without us." What do they do?
- DRDavid Rosenthal
Well, they do the natural thing that two super excited, ambitious, high-octane college kids would do. They call up the main phone number of Altair's manufacturer, a company called MITS, M-I-T-S, and ask for the president, a man named Ed Roberts. And Bill and Paul, they get him on the phone, and they say, [chuckles] "We have a BASIC interpreter ready to go, ready to ship-
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
... for the 8080 Intel chip, and we want to provide it for you, for your machine," which-
- BGBen Gilbert
Of course, they don't.
- DRDavid Rosenthal
They don't have a single line of code written. They don't have anything.
- BGBen Gilbert
But it's a market test. They wanna know, like, what's the response if this were true?
- DRDavid Rosenthal
Exactly. Ed, he's a bit of a character himself. He says, "Okay, well, guys, a lot of other people are calling me and saying the same thing. What I'm telling them, and I'm gonna tell you, too, is that anybody who can come here to my office in Albuquerque, New Mexico, and demonstrate a working version of BASIC on my Altair will get a contract with us to distribute it when they go on sale."... and so Bill and Paul, they say, "Okay, great! We'll see you soon," [laughs] and hang up. And by see you soon, they mean, "Let's go get to work." [laughs]
- BGBen Gilbert
[laughs] And this is a big deal for MITS, too, if this works, 'cause 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 gonna have a lot of customers unless there's stuff you can do on the machine. 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.
- DRDavid Rosenthal
I was gonna talk about this in a minute, but let's talk about what the Altair is. What did they just announce in the magazine here? This is- the Altair is the first mass-market, commercially available personal computer.
- BGBen Gilbert
Again, no screen or anything.
- DRDavid Rosenthal
Yeah, does not have a screen, does not have a keyboard, doesn't have a display of any kind. What it does have is it has a set of 16 lights on the front of the machine, like Christmas lights, and 16 switches, and you can flip the switches to flip bits, and then the machine will respond by lighting up different patterns of lights. It doesn't come with any software. There's nothing. That's all it is, 16 lights, 16 switches.
- BGBen Gilbert
So in order to use it, you gotta hook up your own teletype, you gotta get the manual, you gotta hope that the manual's right, and you gotta code to the machine instructions, like, literally the assembly language, for the chip inside, for the Intel 8080.
- DRDavid Rosenthal
Now, back to the Traf-O-Data days and Paul writing the emulator for the 8008 at Washington State, Paul's like, "We got this! I'll just write an emulator on the Harvard PDP-10 for the 8080 instruction set."
- BGBen Gilbert
So he does the same thing again. They get the manual, and they have an emulator, and they write it against an emulator.
- DRDavid Rosenthal
Yep, Bill writes the BASIC interpreter, and in a couple weeks, they've got it working, and Ed's like, "Okay, come on out to Albuquerque." So Bill and Paul... remember, Bill still looks like he's 12 at this point in time. They decide that just Paul should go.
- BGBen Gilbert
And does Paul have, like, a rockin' beard at this point yet?
- 52:17 – 1:04:09
The first deal mistake: exclusivity with MITS, piracy, and software copyright’s infancy
- DRDavid Rosenthal
up a partnership. So the founding of Microsoft, at this point, Micro-Soft, is a two-person partnership between Bill and Paul.
- BGBen Gilbert
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, and Bill's like: "That's perfect. We're immediately just gonna run with it." As it was a partnership, originally, they were gonna call it something like Allen and Gates, and then they ultimately are like, "No, Microsoft is perfect."
- DRDavid Rosenthal
Microsoft has become like Kleenex, but like... No, no, it's like Microsoft means microprocessor software. [chuckles]
- BGBen Gilbert
I will say, like, it's a nice clarifying North Star because it really draws a 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." 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.
- DRDavid Rosenthal
Yeah. Oh, okay. Well, let's talk about business model here in one sec. First, though, on the partnership, you know, again, we've been saying all along that Bill is clearly the leader here. They set up the partnership. Initially, it's 60/40 ownership. Bill is 60%, Paul is 40%. Later, it gets changed to Bill is 64%, and Paul is 36%. So, like, yep, Bill is the leader here. [chuckles]
- BGBen Gilbert
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."
- DRDavid Rosenthal
You know, in the long run here, um, everybody gets [laughing] a match, so-
- BGBen Gilbert
[laughing] Yes
- DRDavid Rosenthal
... It's all sort of a rounding error. But to that point, back to the business model. So once the partnership is set up, they sign an exclusive licensing arrangement with MITS. This is super important. This is a big lesson that young Bill and Paul are gonna learn here. So MITS gets exclusive license to the BASIC interpreter, to the BASIC, as they call it, for the 8080, and MITS is the one that can then decide whether to sublicense the BASIC out to other companies or not.
- BGBen Gilbert
Huh.
- DRDavid Rosenthal
Essentially, this is a-... distribution deal with MITS, where MITS becomes the exclusive seller and distributor of Microsoft's BASIC. Microsoft doesn't have any direct sales control here, and it's gonna become a big, big, big issue. And the terms of the deal are Microsoft is to get $30 for each copy of BASIC that MITS sells, plus 50% of the revenue that comes from the sub-licensing deals that MITS may or may not do with other companies who wanna use the BASIC.
- BGBen Gilbert
Which, why would they ever do any sub-licensing deals? Like, why would you give it to your competitors?
- DRDavid Rosenthal
Well, that is a really good question, Ben. [laughing]
- BGBen Gilbert
[laughing] So let's just round that part of the revenue to zero.
- DRDavid Rosenthal
Yeah. This is a big, big, big diverging of interests between Microsoft and MITS. And the kicker on this contract is that the total amount of lifetime revenue that Microsoft can make from the BASIC-
- BGBen Gilbert
Oh, it's capped?
- DRDavid Rosenthal
-uh, from MITS is capped at $180,000.
- BGBen Gilbert
Ha.
- DRDavid Rosenthal
So Ed and MITS really have the upper hand in this deal.
- BGBen Gilbert
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 gonna pay it out to you on a pro-rated basis at $30 a pop, rather than giving you the full 180K."
- DRDavid Rosenthal
Yeah, that is another way to frame it. So definitely, a great deal for MITS. On the other hand, what are Bill and Paul gonna do here? [chuckles]
- BGBen Gilbert
Right, kind of a great deal for them, too, given the position they're in.
- DRDavid Rosenthal
Right, MITS is the industry.
- BGBen Gilbert
Yeah.
- DRDavid Rosenthal
Now, there is one very, very important clause in the contract, though, protecting Microsoft's interests, and that clause is that MITS must use its best efforts to license, promote, and commercialize the BASIC broadly in the marketplace, and that any failure to do so by MITS would be grounds for termination of the contract by Microsoft.
- BGBen Gilbert
Hmm. Thank God Bill's dad is a lawyer.
- DRDavid Rosenthal
Indeed. [laughing]
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
Indeed. So the Altair comes out for sale later in 1975. Microsoft does $16,000 in revenue that year from their $30 a pop, uh, the BASICs that are getting sold with the Altair, which is great, especially the first year that they're starting. And the next year, in 1976, everybody's so excited about this new market, the vision that's happening, the demand, the Altair, the sales, that Paul Allen resigns from MITS to join Microsoft full-time. Bill drops out of Harvard officially, he moves to Albuquerque. They're all in on this. But for the year, in 1976, Microsoft's revenue is still only $22,000. So it was $16,000 the year before, $22,000 in 1976.
- BGBen Gilbert
Not a high-growth company.
- 1:04:09 – 1:16:36
Arbitration win and the 1977 Trinity: standard-setting via cheap licensing
- DRDavid Rosenthal
Yes. So during '75 and '76, MITS pretty much had this new microcomputer market all to themselves. There were a couple other competitors who sprung up, but, you know, nothing made. Like, the Altair and MITS was the microcomputer company. All that changes, though, in a big way in 1977, when what Byte magazine calls, "The 1977 Trinity" hits the market, and that is three machines, the RadioShack TRS-80, Tandy/RadioShack TRS-80, the Commodore Personal Electronic Transactor, or the acronym PET, and the Apple II. All three of which machines were, like the Altair, low-cost, mass market. Unlike the Altair, they were not kits. They were fully assembled, fully functional, right out of the box, and they each had their own major distribution advantages, and in Bill's words, these three machines, the 1977 Trinity, "Ignite volume in the market." Bill loves these really dramatic verbs, like, "We attacked the manual. They ignite the volume in the market."
- BGBen Gilbert
Oh, and the press just latches onto him. Whenever Bill has a leaked memo or something where he talks about all this war terminology, those all become headlines.
- DRDavid Rosenthal
So great. Now, earlier, during 1976, Microsoft had started getting approached by a few of the bigger computing companies, like NCR, National Cash Register, GE, Control Data Systems. "I wanna license Microsoft, your BASIC, for the 8080 microprocessor here so that we can experiment with these things," and each of these deals would've been revenue to Microsoft of, like, $100,000-ish. But Ed and MITS, they keep dragging their feet on negotiating these. They've got the exclusive license. Everything's got to go through MITS, and most of them, they're turning down because, Ben, like you said, they don't want anybody to come in and compete with them.
- BGBen Gilbert
Yep, there's the misaligned incentive.
- DRDavid Rosenthal
There's the misaligned incentive, and there is the clause that Bill and Microsoft, and I presume Bill Sr., [chuckles] put in the original agreement. [laughs] Is MITS using its best efforts to commercialize the BASIC and gain adoption in the market? And you can make a pretty strong argument that they're not. So Ed, though, unbeknownst to Bill and Paul, he has another reason that he's dragging his feet on these deals, which is that he's about to sell the company. So in May of 1977, MITS gets acquired by the tape drive manufacturer, Pertec, for six-and-a-half million dollars, and Ed kind of rides off into the sunset. And Pertec, they know about this dispute with Microsoft, and they sort of come in, and they figure, like, "Who is this Bill Gates? He's a 21-year-old kid, a college dropout. Like, we're a big company. We can deal with this." [chuckles] And Robert says an amazing quote later-... He says, "Perten kept telling me they could deal with this kid." It was a little like Roosevelt telling Churchill that he could deal with Stalin. [laughing]
- BGBen Gilbert
Oh, my God!
- DRDavid Rosenthal
Oh, boy, and I also don't think they realized that this kid's dad is one of the best corporate attorneys in the country. [chuckles]
- BGBen Gilbert
Yeah. Well, Bill Gates was just constantly underestimated, which kind of worked to his advantage in those early days.
- DRDavid Rosenthal
Yes, totally.
- BGBen Gilbert
This is the thing about Microsoft. People kind of forget how insanely young Bill was. He was just twenty, and to put that in context, he's only seven years older than Jensen Huang, but they feel an entire generation apart since Microsoft was started almost twenty 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.
- DRDavid Rosenthal
Right. I mean, Microsoft next year is gonna have its fiftieth anniversary, and I believe that'll also be the same year that Bill turns seventy. That's wild!
- BGBen Gilbert
Yeah.
- DRDavid Rosenthal
So that fall, in 1977, the dispute between MITS/Perten and Microsoft goes to arbitration in Albuquerque, and the interim months while this arbitration is happening are the only moment in Microsoft's history where, like, cash gets tight. They're sort of running out of money 'cause they can't really make any sales here.
- BGBen Gilbert
Right. They don't control their destiny.
- DRDavid Rosenthal
People aren't paying MITS for the BASIC. They're, quote, unquote, "pirating" the software. They can't do deals with all the other computer companies that wanna come licensed directly, and so things get a little tight. Microsoft ends up winning the arbitration, I believe, in maybe like November 1977, meaning they are now totally free to go license BASIC to anybody who wants to buy it on any terms that they want. So they turn around, they immediately license it to the Trinity, you know, Apple, Commodore, RadioShack, and Tandy. They license it to all the big companies, the GEs, the NCRs, who wanna experiment with microcomputers. There's a really funny story with Apple that apparently Woz had more or less written, like, ninety-five percent-
- BGBen Gilbert
Yes
- DRDavid Rosenthal
... of-
- BGBen Gilbert
Of their own BASIC.
- DRDavid Rosenthal
Their own BASIC, but it didn't have floating point-
- BGBen Gilbert
Yep
- DRDavid Rosenthal
... numbers; it only had integer numbers. And Jobs is, like, totally riding Woz, and he's like, "The BASIC, it's really important. Like, can you just finish it? Can you do floating point?" And Woz just doesn't do it, so Jobs has to go license [laughing] Microsoft's BASIC. [laughing] Oh, amazing.
- BGBen Gilbert
And that's the first deal that happens between the companies. I mean, there's so many deals done in both directions, commercial deals, equity deals, legal disputes in both directions, and this is the very first time that they do something together.
- DRDavid Rosenthal
Yep. So Bill and Paul and Microsoft, they do all these deals, and they do them all as cash up front, fixed cost. All you companies, you're gonna pay us, and then you include the BASIC in the machines that you're selling, and we're gonna get all the money up front. Super presciently, though, Bill does not value maximize on these deals.
- BGBen Gilbert
Mm.
- DRDavid Rosenthal
So, like, the Apple deal is thirty-one thousand dollars for eight years of-
- BGBen Gilbert
Whoa
- DRDavid Rosenthal
... access for Apple, for the Apple II-
- BGBen Gilbert
Huh
- DRDavid Rosenthal
... to Microsoft's BASIC. They're not price gouging here because Bill sees... He's like, "The play here is we wanna make it a no-brainer for everybody, everybody who's selling a microcomputer, to have Microsoft's BASIC on it, 'cause we wanna set the standard. If we are the standard programming environment that anybody who's using these computers," and again, anybody who is using these computers is programming them, "they're used to the Microsoft version of BASIC. We're gonna have so much power that it'll become a self-fulfilling prophecy. All of our competitors will just wither away. Nobody will want them, 'cause it's not gonna be compatible with the language everybody knows, and then once people start trading and then ultimately developing and selling software that they've written, it's only gonna run on our BASIC interpreter, not anybody else's."
- BGBen Gilbert
Fascinating. I actually didn't know that started this early. And one correction there, you don't know for a fact it's only gonna 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?
- 1:16:36 – 1:21:12
Going global early: Japan partnership and the move from Albuquerque to Seattle
- DRDavid Rosenthal
Yes. They also do another really prescient thing the next year in 1978, which is they go global.
- BGBen Gilbert
Yes!
- DRDavid Rosenthal
Nobody else is going global yet, and the way that this happens is so fun. Bill gets a call one day-
- BGBen Gilbert
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."
- DRDavid Rosenthal
Yes. Now, the way this happens is, one day, Bill gets a call from a guy named Kazuhiro Nishi, or Kay Nishi, who's a computer enthusiast in Japan, has gotten a hold of Microsoft BASIC, totally shares the same vision as Bill and Paul. He doesn't have a Paul, you know, nor is he technical himself. He's like: "I'm gonna bring you guys to Japan. I'm gonna bring you to all the big computer companies." They agree that Kay will become Microsoft's exclusive distribution partner in Japan, and by the next year, in 1979, half of Microsoft's revenue is coming from Japan, which is wild.
- BGBen Gilbert
It's unbelievable. And it stayed at that very high run rate of, uh, 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.
- DRDavid Rosenthal
Yes, totally. So revenue in 1977, you know, that, like, last month of revenue was almost four hundred thousand dollars. 1978 revenue is one point three million dollars. [chuckles]
- BGBen Gilbert
And they have thirteen employees at this point.
- DRDavid Rosenthal
1979, revenue is two point four million dollars, and at the end of that year, they're like: "All right, we gotta get out of Albuquerque." [chuckles]
- BGBen Gilbert
And they've got twenty-five employees, I believe, at that point.
- DRDavid Rosenthal
Yeah, something like that. And this is when they moved to Seattle. And it's interesting to hear Bill talk about this. He actually really liked Albuquerque, and specifically, there weren't any distractions there.
- BGBen Gilbert
No distractions. Weather was great.
- DRDavid Rosenthal
Yeah. Everybody was happy there, but the big problem was recruiting.
- BGBen Gilbert
Yeah.
- DRDavid Rosenthal
He was like: "You know, if we're gonna build this into the opportunity that I see, the vision that I see, and that Paul shares with me, there's no way we're gonna do that in Albuquerque. We've gotta move to a hub."
- BGBen Gilbert
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 wanna 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. 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. 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.
- DRDavid Rosenthal
Right. But not really, though, because pretty quickly, I mean, Microsoft is such an important part of the industry. They recruit from Silicon Valley, too. We're gonna talk about some of the people who come up, but you're totally right. People stay at Microsoft. They don't leave. This continues right through to this day. And the other thing that I think is really important to say that makes it work for Seattle in a way that I don't know that this could have worked in too many other places in the country, is the University of Washington.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
The computer science department there was really good. There were great people. You know, Steve Russell had come out there. Like, there was real talent, and they were churning out graduates out of the UW that would go on to populate Microsoft for decades to come. [chuckles]
- BGBen Gilbert
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.
- DRDavid Rosenthal
Yes, absolutely, they played right into it.
- BGBen Gilbert
And so today, I mean, it's always a top ten, if not top five, computer science program in the country, 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.
- DRDavid Rosenthal
Yeah, I think the only thing even close to it is Berkeley in the Bay Area, with a lot of the same dynamics, but there's Stanford there, too, so it's kind of like a dual university system in the Bay Area. But yeah, you cannot overstate how important the University of Washington was to this decision and then the ultimate success of coming to Seattle.
- BGBen Gilbert
Yep.
- 1:21:12 – 1:39:36
IBM PC deal setup: IBM’s skunkworks, 16-bit shift, and why Microsoft mattered
- DRDavid Rosenthal
So this brings us to 1980 and the beginning of the year, when they move to Seattle, just in time for, I think you can make a very strong argument, the single most important deal ever done in the history of technology.
- BGBen Gilbert
Absolutely.
- DRDavid Rosenthal
The Microsoft IBM... I mean, it's crazy to even say it now, the Microsoft-IBM PC partnership.
- BGBen Gilbert
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 [chuckles] partnering with IBM, but at the time, it was IBM partnering with Microsoft. 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, and I can't wait to dive into it.
- DRDavid Rosenthal
Oh, me too. But before we do, this is the perfect time to talk about another one of our favorite enterprise software platforms, ServiceNow, who is one of our big partners here in Season 14.
- BGBen Gilbert
Yes. ServiceNow is the AI platform for your enterprise, helping automate processes, improve service delivery, and increase efficiency. Over eighty-five percent of the Fortune 500 runs on them, and they have quickly joined the Microsofts and the Nvidias as one of the most important enterprise technology vendors in the world.
- DRDavid Rosenthal
And just like those companies, ServiceNow has AI baked in everywhere in their platform, and they're also a major partner of both Microsoft and Nvidia. I was at Nvidia's GTC last week, which, by the way, was insane. I felt like a VIP at a Taylor Swift concert.
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
Like, it was crazy. And Jensen brought up ServiceNow and their partnership many times throughout the keynote. So why is ServiceNow so important, both to Nvidia and to Microsoft? Well, AI in the real world is only as good as the bedrock platform infrastructure it runs on, and for enterprises around the world, ServiceNow manages that infrastructure. So all the AI applications for enterprises, whether that's supercharging developers with generative AI, empowering and streamlining customer service, allowing HR to deliver better employee experiences, ServiceNow has already done the hard technical work to make rolling them out not just possible, but easy and fast.
- BGBen Gilbert
Yep. Employees can get answers quickly with smarter self-service, like changing 401 [k] 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 a hundred percent ready for AI. Simply turn it on, and it all works.
- DRDavid Rosenthal
They've built AI directly into their platform, so all the integration work to prepare for it that otherwise would have taken you years is already done. So if you wanna learn more about the ServiceNow platform and how it can turbocharge the time to deploy AI for your business, go on over to servicenow.com/acquired, and when you get in touch, just tell them that Ben and David sent you. So the IBM PC, why is IBM getting into the personal computer here [chuckles] in 1980? A fun quote we heard in our research was that IBM was the sun, the moon, the stars of the computing industry, and that meant the hardcore enterprise mainframe computing industry. [chuckles]
- BGBen Gilbert
Yes. David, are you gonna attribute that quote, or are you gonna leave listeners just hanging?
- DRDavid Rosenthal
All right, I think it's time. We talked to probably 10 early Microsoft people in research and preparation, and one of those folks was Steve Ballmer himself, and he used those words in describing IBM.
- BGBen Gilbert
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, and we haven't even talked about Charles Simonyi yet, but this was the year he joined.
- DRDavid Rosenthal
This is the year.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
I mean, every year for Microsoft until this point is the year, but, like, 1980 is big.
- BGBen Gilbert
... 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?
- DRDavid Rosenthal
So all the early microcomputers we were just talking about, you know, the Altair, the Apple II, the TRS-80, these are all eight-bit machines. They're running the Intel 8080 processor or competitor making a similar eight-bit processor. The problem with an eight-bit processor is that the maximum data size for a given instruction cycle in the processor, this is called a data word in computer science terminology, is 256. You know, two to the eighth. You can't represent any number greater than 256 in any given CPU clock cycle in an eight-bit machine.
- BGBen Gilbert
Right. 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.
- DRDavid Rosenthal
Totally. You could think of it like an hourglass or something. There's, like, all the data sitting there in memory at the top of the hourglass, and then there's the small little, you know, funnel that it goes through. That's the processor, and then it comes out-
- BGBen Gilbert
That's a good analogy. It's gonna take forever.
- DRDavid Rosenthal
Yeah, into the application of the software that the user sees. You're just not really gonna process it that fast.
- BGBen Gilbert
Very primitive machines.
- DRDavid Rosenthal
Yes. And so for a company like IBM, they eclipsed the eight-bit computing cycle a long, long, long time ago. Mainframes, you know, even mini computers with DEC, you know, all these machines are at least 16-bit, if not 32-bit, computing machines. So eight bit just... It's not interesting.
- BGBen Gilbert
Which is why they only cost 375 bucks or whatever for an Altair.
- DRDavid Rosenthal
Right. In late 1979, Intel announces that they're coming out with the 8086 processor, which is a 16-bit microprocessor. With 16 bits, you can really start to do some damage here in terms of the applications that you could put on this thing to eat into business software use cases.
- BGBen Gilbert
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.
- DRDavid Rosenthal
There's some really, really fun aspects to this. If you look at pictures of these processors, what did the 8080, the eight-bit processor, look like? And then you look at, what did the 8086, the 16-bit processor, look like? You can see this in the 8008 processor that's only eight bits. You see only nine pins coming off of the little chip. You know, there's the eight pins for the data bits, and then I think there's one more control pin. If you look at the 8086 processor, it's a much longer rectangle with 16, 17, you know, maybe, like, 20 pins coming off of it. Like, you see this physically represented in the chip.
- BGBen Gilbert
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.
- 1:39:36 – 1:47:57
The OS pivot: CP/M miss, QDOS acquisition, and DOS becomes the platform
- DRDavid Rosenthal
Okay, so the IBM-Microsoft discussions are going along, and IBM's like, "Oh, hey, yeah, we need an operating system." So Bill, and I think from everything we've read and folks we've talked to, kind of in good faith, just does the standard thing he's always done in these situations. He's like: "Oh, yeah, go talk to Gary. Go talk to Digital Research. He can probably do that."
- BGBen Gilbert
Right. We don't have an operating system, so this guy does.
- DRDavid Rosenthal
So what happens next is unclear. [laughing] But what is clear is, however it goes down, this is one of, if not the biggest, business blunder in history. IBM, that team from Project Chess, flies down, I think, directly from Seattle, and talking with Bill and Steve, to Monterey, California, where Digital Research is based at this point, to meet with Gary and his wife, Dorothy, who run the business together. And Bill's called them. He's like: "Hey, got a big OEM client coming down, needs an operating system."
- BGBen Gilbert
And he signed hefty, hefty NDAs, so he cannot say who it is, but he's like, "You really should take this seriously."
- DRDavid Rosenthal
Right. So the team comes down. Obviously, they show up there from IBM. There's a big snafu where Gary does not attend the meeting, and there's conflicting reports about what happened.
- BGBen Gilbert
Wasn't one of them that he's out flying an airplane?
- DRDavid Rosenthal
Yeah, so I'm pretty sure he was flying his personal airplane while this happens. Some reports are he was just out joyriding [chuckles] and missed it. Some reports are, no, he was, like, on a business trip, uh, knew it was happening, but he had another important business meeting, and he didn't know that this was IBM that was coming. Regardless, it doesn't really matter, 'cause IBM just wants the operating system. Dorothy does meet with them. She's unwilling to sign their NDA. There's a lawyer from Digital Research who gets involved, and he doesn't really understand what's going on. The punchline is that IBM sort of leaves this interaction with the belief that Gary and Digital Research aren't up for working with them and, like, aren't capable of producing here. And producing is important because it's not like the existing CP/M OS that they made would work here. They would have to write a new version, a 16-bit version.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
And they hadn't done that yet.
- BGBen Gilbert
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.
- DRDavid Rosenthal
Yes.
- BGBen Gilbert
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. 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 CP/M operating system.
- DRDavid Rosenthal
Oh, that's amazing. I didn't know that. We'll talk about that when we get to the business terms of the Microsoft-IBM deal in a minute.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
But for the moment, there's no deal yet because an operating system needs to be provided here. So IBM goes back to Microsoft, and they're like: "Hey, this guy you referred us to ain't gonna work." The way that I read some quotes from the IBM people here were like, "We just threw the problem back in Microsoft's lap, of you guys deal with this. You source an operating system." [chuckles]
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
Well, I'd like to say that Bill and Steve and Microsoft, you don't need to give them an opportunity twice. In this case, you kind of did need to give them-
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
... an opportunity twice 'cause they almost flubbed it and sent IBM down to see Gary. This time, they don't flub it. They're like: "Okay, we'll get you an operating system."
- BGBen Gilbert
And so enter Seattle Computer Products.
- DRDavid Rosenthal
Yes. So it just so happens that right down the road from Microsoft in the Seattle area... I think they, despite being named Seattle Computer Products, I think this company was actually based in Tukwila, Washington. A programmer named Tim Paterson had just written a 16-bit operating system for the 8086 that Intel had just announced, and he was calling it the Quick and Dirty 16-Bit Operating System, or QDOS for short, [chuckles]
- BGBen Gilbert
[chuckles]
- DRDavid Rosenthal
And had it ready to go. Now, why had he written this? What was this company, Seattle Computer Products? Why did they have an operating system?... They were a component provider to microcomputer manufacturers. They essentially made motherboards, and so when Intel now has announced this new 16-bit processor generation that they're coming out with, well, Seattle Computer Products, they wanna sell motherboards and have them ready for 16-bit. They kind of need to test and play around with these things, and their customers are asking for it, so they had been going to Kildall and Digital Research, too, and badgering them to, like, "Hey, write the 16-bit version of CP/M," and Gary just didn't. So Tim's like: Fine, I'll do a quick and dirty version myself.
- BGBen Gilbert
Amazing.
- DRDavid Rosenthal
And thus, DOS is born.
- BGBen Gilbert
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.
- DRDavid Rosenthal
No. [laughing] No, no, no, no, no. So Bill and Paul and Microsoft, they've learned about this. They know Seattle Computer Products. They know Rod Brock, who's the guy who owns the company. They get in touch with him, and they say, "Hey, can we license QDOS from you and Tim? We've got a big OEM customer that wants a 16-bit operating system." So they work out a deal whereby Microsoft pays Seattle Computer Products twenty-five thousand dollars for the rights to adapt and sell QDOS to the one unnamed original equipment manufacturer who they're working with. Tim, actually, he's jazzed about this. He ends up leaving SCP, Computer Products, and joining Microsoft, and so he, with the rest of the team, he's part of building DOS, taking his initial work and turning it into real DOS. Later on, before this all gets announced and the PC ships, Microsoft would pay Seattle Computer Products another fifty thousand dollars for full rights to own 86-QDOS, sell and license it to anybody else indefinitely. So I believe the total amount of dollars that changed hands here is seventy-five thousand dollars.
- BGBen Gilbert
Unbelievable.
- DRDavid Rosenthal
This is DOS. Now, look, one programmer wrote a, quote, "quick and dirty" operating system, and Microsoft bought the license to that and adapted it into DOS. Tim, when he was at Seattle Computer Products, definitely did not write DOS as DOS becomes. It's not like Microsoft bought all of DOS for seventy-five thousand dollars. They did a lot of work on it, but yeah, [chuckles] this is how it all goes down.
- BGBen Gilbert
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, seventy-five thousand dollars to buy DOS to get this whole thing started for... I mean, until Windows 95, all of the Windows operating systems were DOS-based.
- 1:47:57 – 1:57:53
The masterstroke terms: fixed-fee to IBM, but Microsoft keeps DOS licensing rights
- DRDavid Rosenthal
Okay, so now they've got the operating system. They've got QDOS, or DOS, in place to license to IBM. The only thing that is left to formalize the partnership is the business terms, and, Ben, if what you said is right about the Gary Kildall-IBM negotiations, this is just a masterstroke from Bill here in the licensing with IBM.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
Because there's two really, really big levers, that it looks like Bill is giving big time on one of them, but he is winning big time on the other one.
- BGBen Gilbert
What are they?
- DRDavid Rosenthal
So the one that it looks like he's giving on is he does another fixed cost OEM deal with IBM.
- BGBen Gilbert
Yes. So this is in Paul Allen's memoir, "IBM paid Microsoft seventy-five thousand dollars for testing and consultation, forty-five thousand dollars for DOS-
- DRDavid Rosenthal
Forty-five? [laughing]
- BGBen Gilbert
... and three hundred and ten thousand dollars for an array of sixteen-bit language interpreters and compilers." So all told, bundled together, that is four hundred and thirty thousand dollars fixed that IBM paid Microsoft with no ongoing obligation.
- DRDavid Rosenthal
Yes, no per copy royalties.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
Every copy of DOS that IBM sells, either included as part of systems that they're selling, or they're free to charge independently for DOS, whatever amount they want, Microsoft gets zero dollars. And if it's true that this is where things fell apart with Gary Kildall, crazy that Bill is willing to do this.
- BGBen Gilbert
And you might say, "What? Didn't Bill learn his lesson? Why would he ever agree to this?"
- DRDavid Rosenthal
On the one hand, this is what he was doing with Apple and others. He was doing these fixed-cost deals. You would think, like, "Man, IBM, like, this is the time. People aren't gonna pirate IBM software. Now is the time to really grab the money bags."
- BGBen Gilbert
But Bill saw something that no one else did.
- DRDavid Rosenthal
In exchange, I don't know if it was directly in exchange in the negotiations, but the other lever that he saw, that he pulled, was Microsoft retained-... the rights to own DOS and to own their languages, and license it and them to anyone else they wanted, at any price, on any terms.
- BGBen Gilbert
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, 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 gonna 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, 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 gonna be the linchpin that everyone has to target for their applications."
- DRDavid Rosenthal
So I think there are two things going on here, one small and one big. The small thing is actually related all the way back to the beginning of the episode, what you said, Ben, about the antitrust concerns within IBM. To hear them say it, they actually didn't want ownership of the software. They wanted it to be separate, 'cause it would sort of look better.
- BGBen Gilbert
Oh, 'cause then they have the sort of plausible deniability of, "How could we possibly have a monopoly? We're buying off-the-shelf-
- DRDavid Rosenthal
Part of an ecosystem, blah, blah, blah. Yeah, yeah.
- BGBen Gilbert
Yeah, from a vendor who can sell to anybody else. We have no lock-in.
- DRDavid Rosenthal
And that may well be true. I think the bigger thing that just wasn't in their consideration or mindset was they, I think, assumed that once they entered the PC market, IBM was going to be the dominant player, so it didn't matter.
- BGBen Gilbert
Ah.
- DRDavid Rosenthal
Once IBM is selling PCs, who's gonna buy a PC from anybody else? IBM is going to win this market.
- BGBen Gilbert
Just like they have in every other line of business they've been in.
- DRDavid Rosenthal
And what Bill saw was, he really made a bet that the same dynamics that played out with the Altair were also gonna play out with the IBM PC, that there would be a million hardware manufacturers, flowers blooming here.
- BGBen Gilbert
Building to the same spec.
- DRDavid Rosenthal
And building to the same spec.
- BGBen Gilbert
Using the same processor.
- DRDavid Rosenthal
Which, of course, they could, because it was all off-the-shelf components.
- BGBen Gilbert
Mm.
- 1:57:53 – 2:13:28
Clones, Compaq, and the PC hardware race-to-the-bottom (software wins)
- BGBen Gilbert
Oh, do you know the story of the Compaq BIOS?
- DRDavid Rosenthal
Ooh! Well, I know the Compaq story, but I don't know the story of the BIOS specifically. Enlighten us.
- BGBen Gilbert
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, 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. 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.
- DRDavid Rosenthal
Of the Sega Genesis.
- BGBen Gilbert
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, 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." 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, 'cause this is from his great piece again, "The result was a company that came to dominate the market. Compaq was the fastest startup to ever hit a hundred 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."
- DRDavid Rosenthal
The Compaq story is amazing. So the three people who start Compaq in 1982 are actually Texas Instruments engineers who left, and they wanted to start a company, and I believe, as the legend goes, they were, like, trying to decide what to start. They were considering, like, a restaurant chain and, like, a bunch of different business ideas, and then the IBM PC comes out at the end of 1981, and they're like, "Oh, ho, ho, ho. We can clone this and do everything," you know, the story you just told. So yeah, it's wild. They start the company in 1982, and within the first year, they do $111 million of revenue of selling IBM PC clone hardware.
- BGBen Gilbert
Is it just cheaper? Like, basically, this is the IBM PC, but for less money?
- DRDavid Rosenthal
Yes, exactly. Same thing, cheaper.
- BGBen Gilbert
And so begins the race to the bottom of PC hardware. Completely undifferentiated, all the value accrues to the software layer.
- DRDavid Rosenthal
Totally. Compaq went public the very next year in 1983, well before Microsoft, which is funny. But yeah, Compaq, all these other clone companies that get started, Microsoft licenses DOS to all of them, importantly, critically, on a per-machine-sold basis. This is when they grab the money. The operating system is so deeply embedded and needs to get shipped with the computer itself. Yeah, consumers can go buy operating systems to upgrade and whatnot, but no hardware manufacturer is gonna ship a 16-bit PC without an operating system, so piracy is not an issue here. Microsoft can now do a per-copy-sold, per-machine-sold license with all these clones. My God, it's just like a geyser of money.
- BGBen Gilbert
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.
- DRDavid Rosenthal
Yeah. So I think I have these numbers and timeframes right. I believe that for calendar year 1982, Microsoft's revenue was $25 million, and I think this must have been when they switched to fiscal year end in June 30th, so Microsoft's fiscal year end, starting then and up through now, is June 30th.... So their fiscal 1984, so the year ended June 30th, 1984, so 1983 midpoint to 1984 midpoint, Microsoft does ninety-eight million dollars. In an eighteen-month period from the end of 1982, they go from twenty-five to ninety-eight. It's all on the back of the clones, and unlike Compaq, that, you know, yeah, they did a hundred and eleven million of revenue their first year, they're selling hardware [chuckles] which has serious cogs associated with it. Microsoft, [exhales] one hundred percent, essentially, gross margin, software revenue more than doubling year on year. Uh, it's the best business of all time.
- BGBen Gilbert
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.
- DRDavid Rosenthal
Totally.
- BGBen Gilbert
So that pricing power raises your top line, and you have no costs. It's unbelievable.
- DRDavid Rosenthal
So meanwhile, in the computing industry background, while all this is going on with the launch of the IBM PC and then the clones, Apple had gone public at the end of 1980, in, I think, the biggest and most successful IPO of all time at that point. Remember we talked about Genentech on the-
- BGBen Gilbert
Yep
- DRDavid Rosenthal
... Novo Nordisk episode. They went public, like, right before Apple, and then Apple was bigger. So they're valued at one point eight billion dollars at IPO. Steve Jobs is this multi-hundred millionaire, like, media darling, all this stuff. The next year, in 1981, Microsoft reorganizes from the partnership between Bill and Paul with the handshake deal that Steve's gonna be cut in on the partnership, into a stock company, a C corporation, and as part of doing that, the venture firm Technology Venture Investors, or TVI, invests one million dollars, I believe, for five percent of the company?
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
This is crazy. That's a twenty million dollar post-money valuation. [chuckles]
- BGBen Gilbert
It's a one on twenty post when Microsoft is doing how much in revenue?
- DRDavid Rosenthal
That year, they did seventeen million in revenue, and they're about to do the IBM deal. Like, this is absolutely absurd. [chuckles]
- BGBen Gilbert
So it says a lot about this period in time that you could do a one X revenue deal [chuckles] 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, that wasn't it at all. It was just the deals sucked.
- DRDavid Rosenthal
Yeah, venture capital sucked back then. [chuckles]
- BGBen Gilbert
[chuckles] Yes.
- DRDavid Rosenthal
There's no other way to put it.
- BGBen Gilbert
Now, you know, it's only five percent, 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 twenty million dollar valuation at this stage is frankly ludicrous.
- DRDavid Rosenthal
You know, even among people who should be in the know, the beauty of the software business model still is something people don't understand.
- BGBen Gilbert
That's exactly right.
- DRDavid Rosenthal
The hotness is the hardware. It's like Apple just IPO'd. Apple's worth one point eight billion dollars. Like, ooh, that's the industry. Ooh, it's IBM, et cetera, et cetera. When Microsoft itself would go public a few years later in 1986, they actually go public the same week that they moved to the big campus in Redmond, where they are to this day. Their market cap at IPO is only seven hundred and fifty million dollars, despite having done two hundred million dollars of very high-margin software revenue in the trailing twelve months up to that, growing a hundred percent year over year. It's insane!
- 2:13:28 – 2:36:00
Applications and Xerox PARC’s ‘other half’: Simonyi, Word/Multiplan, and the GUI bet
- DRDavid Rosenthal
Whew, hard to argue with that one. Okay, back to the story. There's a couple more really, really key things that happened in the PC era, and particularly now, once we're into the IBM PC era and the clones, the 16-bit era, and let's start with applications. So you know, kind of like we've been saying all along, the 8-bit era, applications, packaged software aren't really a thing. In 1979, kind of at the tail end of the 8-bit era, two programs come out for the Apple II, VisiCalc and WordStar. VisiCalc is the first software spreadsheet application, and WordStar is a word processor. These applications, by today's standards, are super simple, like Stone Age-type stuff, but they're the first of their kind, particularly VisiCalc and the spreadsheet. They sort of established the potential for business applications on personal computers. There's a joke at one point in the industry that the Apple II was a, quote-unquote, "VisiCalc accessory for small businesses." [laughing]
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
And I think that is part of what IBM is seeing and why they're deciding to now get into the industry with the personal computer. Around this time, Microsoft starts the, quote-unquote, "Consumer Products Division" to compete and make application software themselves.
- BGBen Gilbert
... 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.
- DRDavid Rosenthal
Right. So one of the first people that they hire into this new division to get it going is an engineer, Ben, who you referenced just a minute ago, named Charles Simonyi, and they poach Charles, perhaps with Dave Marcotte's help, away from the legendary Xerox Palo Alto Research Center, or Xerox PARC. And I think this is one of the great misconceptions in technology history.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
Hopefully, we can set the record straight a little bit here.
- BGBen Gilbert
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, and then that failed, but what succeeded was the Macintosh, and it's a wholesale rip-off of Xerox PARC that lives on today in Apple." And that is the story that you will hear from basically everyone.
- DRDavid Rosenthal
I've heard it characterized as something like, "Xerox hosted a picnic in Silicon Valley, and Steve Jobs attended and dined lavishly at the feast." [laughing]
- BGBen Gilbert
Which all of this is true.
- DRDavid Rosenthal
Which is true. That is true. All of that is true.
- BGBen Gilbert
But it's half the story.
- DRDavid Rosenthal
He was not the only person who dined-
- BGBen Gilbert
[chuckles]
- DRDavid Rosenthal
... lavishly at the feast. Microsoft did just as much directly from Xerox, and Charles was one of the main vectors by which this happened. So here is the list of things that were invented, or basically invented, at Xerox PARC: the graphical user interface, the desktop, the mouse, object-oriented programming, Ethernet, laser printing, along with a whole host of other things. Like, this is everything about modern computing invented there. Who were the people who were at Xerox PARC? Well, there was Alan Kay. There was Bob Metcalfe, who would go on to found 3Com. He invented Ethernet, you know, Metcalfe's Law.
- BGBen Gilbert
Yeah, the value of a network scaling proportionally to the square of the number of inputs.
- DRDavid Rosenthal
Yeah, Bob Metcalfe, Xerox PARC; Larry Tesler, who would join Apple; John Warnock, who started Adobe. Eric Schmidt worked at Xerox PARC. Everybody was there. It was a lavish picnic.
- BGBen Gilbert
And Charles Simonyi.
- DRDavid Rosenthal
And Charles Simonyi. Now, the thing about PARC and the computer that they built there to instantiate all these concepts, which was named the Alto, is it really was a research center. So the Alto, go look it up on Wikipedia, go look at pictures. Like, it's the Mac. The Alto is the Mac.
- BGBen Gilbert
It's the Mac with the monitor turned on its side.
- DRDavid Rosenthal
Yes, it's a vertical Mac.
- BGBen Gilbert
It's a three-by-four display, not a four-by-three display.
- DRDavid Rosenthal
Now, they start making it in 1973. So you might be like, "Wait a minute, what's going on here? The Mac doesn't come out till 1984."
- BGBen Gilbert
Eleven years earlier.
- DRDavid Rosenthal
How on earth is Xerox making the Mac in, like, the pre-8-bit era, the pre-microprocessor era? Well, it's not a microprocessor. The Alto is not a microprocessor architecture.
- BGBen Gilbert
Mm.
- DRDavid Rosenthal
It's a minicomputer. So what you see when you look at photos of the Alto is you see the Mac. What you don't see is, under the table or behind it, is a minicomputer.
- BGBen Gilbert
Oh, I never realized that.
- DRDavid Rosenthal
So it is not a personal computer architecture at all. It is a 16-bit, essentially, minicomputer that cost tens of thousands of dollars to make each one of them.
- BGBen Gilbert
Huh.
- 2:36:00 – 3:09:03
Windows vs. OS/2: hedging, ‘riding the bear,’ and Windows 3.x proving the GUI
- DRDavid Rosenthal
... not an operating system. So yeah, it was all kinda dynamic. Speaking of, though, Microsoft here is in bed with Apple, working on the Mac. Bill and the company are big believers in the future of the graphical user interface. Starting in 1983, they're like, "We gotta do our own graphical operating system, or at least user interface," and this is the origins of the Windows product, and they actually announce it in November 1983, before the Mac ends up shipping, which their partner, Apple, is, of course, not happy about.
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
Now, just like development of the Mac was rocky, development of Windows was super freakin' rocky [chuckles] within Microsoft, too. This is around that same time when Paul Allen gets Hodgkin's disease and leaves the company, so his presence as sort of great technical leader is very much missed. But they bring in someone from Xerox to manage the development of Windows. That person ends up not working out. He gets fired. Steve Ballmer gets drafted [chuckles] to come in and be the dev manager for the final push to release Windows 1.0, which is hilarious. You can find amazing YouTube videos from the launch and all joking about how, like, non-technical Steve coming in to save the day and dev manage Windows to launch.
- BGBen Gilbert
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.
- DRDavid Rosenthal
No, no, no, we're gonna get to that later.
- BGBen Gilbert
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.
- DRDavid Rosenthal
It's bad. November 1985, Windows 1.0 is a very, very different thing than you imagine a graphical user interface is today-
- BGBen Gilbert
[chuckles] Yes
- DRDavid Rosenthal
... or what you know of as Windows. It was tiled. It was not overlapping windows that you can drag around and, like, have one over the other. When you opened a program in Windows 1.0, the system created a literal window of it on your screen, and then it dynamically resized the windows as you opened other applications, and so nothing could ever be on top of each other. So as you open more and more stuff, the windows get smaller and smaller and smaller. It's very bizarre.
- BGBen Gilbert
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.
- DRDavid Rosenthal
Yes, 100%, and so I believe Microsoft and Apple actually did, like, a licensing agreement while they-
- BGBen Gilbert
Yes
- DRDavid Rosenthal
... were working together during this time that said, "Hey, Microsoft can use a lot of the stuff that's being developed for Mac for Windows 1.0."
- BGBen Gilbert
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.
- DRDavid Rosenthal
Also, by the time that this agreement actually happens, I think Steve Jobs has been ousted, and so it's Sculley who does this agreement, and people in Apple would look back on this for years and be like, "This was a huge error." The other important thing about Windows during this sort of awkward teenage phase is it's not an operating system. It's just a graphical interface on top of DOS.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
The original name for Windows was Interface Manager. [chuckles]
- BGBen Gilbert
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.
- DRDavid Rosenthal
Yes.
- BGBen Gilbert
And actually, it was not until Windows 95 that Windows was its own operating system. It was in Windows one, two, three, three dot one, and Windows for Workgroups, it was a graphical operating environment.
- DRDavid Rosenthal
Yep.
- BGBen Gilbert
But here's the question: 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?
- DRDavid Rosenthal
[laughing] Well, uh, obviously, that's a setup there.
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
Here's the other thing that's happening in the company at this time, and it's the bigger thing. It's the next phase of the IBM relationship.
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
Windows, the Mac, all of this, these are hedges for the company. Microsoft, and Bill in particular, were masters of hedging their bets in an uncertain technology future. He was so great, and the company was so great at making sure that whichever way the apple fell from the tree, as Jethson Huang put it to us in our interview, Microsoft was gonna be positioned to catch it. A lot of people, including Bill and Microsoft themselves, believe that the way the apple was gonna fall from the tree here was IBM and OS/2. [chuckles]
- BGBen Gilbert
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.
- DRDavid Rosenthal
Right. So what's going on here? IBM, obviously, the PC was a huge success, but losing dominance of the ecosystem to the clones, this was bad, and so IBM wants to find a way to evolve the PC ecosystem back to being more IBM proprietary, and they're gonna make Microsoft come along for the ride here. [chuckles] And the way that they're gonna do this is, with the next generation of the PC ecosystem, they are gonna make a whole new modern operating system. They're gonna get rid of DOS. They're gonna make this operating system in partnership with Microsoft, and it's gonna be called, fittingly, OS/2. And they are gonna lock Microsoft up, that they can't license it to anybody else. OS/2 is gonna be proprietary to IBM hardware, just like the Mac operating system is proprietary to Apple hardware.
- BGBen Gilbert
Ba-na-na.
Episode duration: 4:23:45
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