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Episode: Microsoft Volume II

Author: Ben Gilbert and David Rosenthal
Duration: 04:51:31

Episode Shownotes

In 1999, Microsoft became the most valuable company in the world. And in 2019, Microsoft became the most valuable company in the world, again. But… what happened in the twenty years in between? The answer, as we discovered in our research, is probably not what you think.In this episode we

explore and analyze the browser wars and the DOJ case, Windows XP through 8, Surface, Xbox, search, Yahoo!, Bing, the iPhone, Nokia, mobile, social, Facebook… and oh yeah, a little thing called Azure and the enterprise — which ended up becoming so big that no failures mattered. Tune in for Microsoft, Volume II.Chase Center Live Show in SF:Sign up here to for the pre-sale list before tickets are available to the public. See you there!!Sponsors:Many thanks to our fantastic Season 14 partners:J.P. Morgan PaymentsServiceNowPilotLinks:Bill Gurley on Android’s “Less Than Free” business modelAll episode sourcesCarve Outs:Meta Ray-BansOzlo SleepbudsM3 Macbook AirModel YMore Acquired:Get email updates with hints on next episode and follow-ups from recent episodesJoin the SlackSubscribe to ACQ2Check out the latest swag in the ACQ Merch Store!Note: references to Fortune in ServiceNow sponsor sections are from Fortune ©2023. Used under license.‍Note: Acquired hosts and guests may hold assets discussed in this episode. This podcast is not investment advice, and is intended for informational and entertainment purposes only. You should do your own research and make your own independent decisions when considering any financial transactions.

Summary

In this episode of 'Acquired,' hosts Ben Gilbert and David Rosenthal explore Microsoft's evolution from 1999 to 2019, covering key milestones like the browser wars against Netscape, the antitrust case, and the emergence of Azure. They analyze the cultural and operational shifts within Microsoft, especially under Satya Nadella's leadership, which transformed the company from a bureaucratic entity to a competitive enterprise powerhouse. Key themes include the integration of Internet Explorer into Windows, the rise of cloud computing, and how these elements shaped Microsoft's identity and market value amidst challenges.

Go to PodExtra AI's episode page (Microsoft Volume II) to play and view complete AI-processed content: summary, mindmap, topics, takeaways, transcript, keywords and highlights.

Full Transcript

00:00:00 Speaker_03
I'm a little hoarse today, so hopefully we don't have to do a lot of talking.

00:00:06 Speaker_00
Good luck with that.

00:00:06 Speaker_03
All right, let's do this. Welcome to Season 14, Episode 6, the season finale of Acquired, the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts.

00:00:40 Speaker_03
Well listeners, here we are. Microsoft Volume 2 at long last. After the ancient history of Volume 1, we now get to the stuff that you grew up with. The internet, Windows XP, Xbox, the browser, search, and mobile.

00:00:57 Speaker_03
And in this era, Microsoft had a lot of the right ideas. with a lot of the wrong timing and execution on everything from the Zune to Bing.

00:01:07 Speaker_03
But, despite that, from 1995, where we start our story, to 2014, where we will end this episode, Microsoft grew their annual revenue from $6 billion to $80 billion.

00:01:20 Speaker_03
They became a phenomenally successful company and really cracked the code on selling enterprise software. I began the research thinking our part one episode would be about the rise and this episode would be about the fall.

00:01:33 Speaker_03
Cultural problems, failed consumer products, antitrust. But it's really not that straightforward. And after spending months unpacking it all, I actually don't think that's the right framing anyway.

00:01:44 Speaker_03
And on Microsoft's 1998 antitrust suit against the Department of Justice, everyone knows of this case, but most people really have no idea what actually happened. Did Microsoft lose? Well, not really. But the answer is nuanced.

00:02:00 Speaker_03
Finally today, we dive into it all. Oh, and listeners, we have just one announcement for you here today. Yes. We told you before that September 10th, we are doing the biggest thing in Acquired's history, and we're doing it in the city of San Francisco.

00:02:15 Speaker_00
We're doing a live Acquired show at the Chase Center, which is the brand new basketball arena here in San Francisco, where the Warriors play. We're putting it on with our good friends at JPMorgan Payments.

00:02:26 Speaker_00
And as you can imagine, they know a few people at the Chase Center.

00:02:29 Speaker_03
Yeah, it'll be a night to remember with a few different phases of the evening. There's going to be lots of opportunities to meet other acquired listeners from around the world. And a big show like this deserves a big special guest.

00:02:43 Speaker_03
And that special guest is the one and only Mark Zuckerberg.

00:02:46 Speaker_03
So in addition to being the central figure in some of the greatest acquisitions of all time that we have covered right here on Acquired, Mark and Meta are also playing a big role in defining the next decade of computing with AI too.

00:03:00 Speaker_03
So it's shaping up to be a total blast. We really hope you can join us.

00:03:04 Speaker_00
Yeah, tickets will be available soon and you can sign up at acquired.fm slash sf to get emailed as soon as they go live.

00:03:10 Speaker_03
We're pumped. We'll see you there. This show is not investment advice. David and I may have investments in the companies that we discuss, and so do all of you if you own index funds. And this show is for informational and entertainment purposes only.

00:03:24 Speaker_03
OK, David, the middle chapter of Microsoft.

00:03:27 Speaker_00
The middle chapter, indeed. And boy, is there a lot to discuss. So, Ben, you covered this in your intro, but I think everybody kind of knows the narrative about what happened to Microsoft between, call it, 1995 and 2014 when Satya took over.

00:03:44 Speaker_00
There's even a quote from Satya himself in the very first paragraph of the book that he wrote in 2017 called Hit Refresh, which, I mean, that title kind of gives it away right there.

00:03:56 Speaker_00
He writes, I joined Microsoft in 1992 because I wanted to work for a company filled with people who believed they were on a mission to change the world.

00:04:05 Speaker_00
But after years of outdistancing all our competitors, something was changing, and not for the better. innovation was being replaced by bureaucracy, teamwork was being replaced by internal politics, and we were falling behind."

00:04:19 Speaker_00
And then he references the famous gun-pointing org chart by cartoonist and software engineer Manu Korné that probably listeners many of you are familiar with. We will link to that in the show notes.

00:04:31 Speaker_00
And you can sum this kind of whole narrative up as Microsoft was winning, and then it sucked for a long time, and then it is now winning again, and that's all thanks to Satya.

00:04:40 Speaker_00
And the question we sort of asked as we were doing our research was, is this true? And what we ended up learning from the literally dozens and dozens of people that we talked to surprised us a lot, and I think will probably surprise listeners too.

00:04:53 Speaker_03
Yeah, David, you're burying the lead here a little bit. We talked to probably four to five times as many people as the next highest episode. I'm looking at our little thank you list. It's like 20-something people long.

00:05:06 Speaker_00
All right. So on the last episode, we left off with the, Ben, as you put it, unabashed celebration of software that was the Windows 95 consumer launch in August of 1995. And it was perfect. It had everything. It had Jay Leno. It had the Rolling Stones.

00:05:25 Speaker_00
It had the start button. or actually it had almost everything.

00:05:32 Speaker_00
There was one thing that was missing from Windows 95 at launch, that if you were a consumer user of technology, of software, of products, of operating systems, maybe you kind of wanted to have, and that was an internet browser.

00:05:52 Speaker_03
Yes.

00:05:53 Speaker_03
It's so funny because we sort of intentionally left all the Internet components out of Windows 95 in the previous episode because once you start talking about the Internet, you're really talking about the next chapter of Microsoft and you can't help but dive into it all.

00:06:07 Speaker_03
But in retrospect, the thing that mattered about Windows 95 all these years later is that's the platform that everyone started using the Internet on.

00:06:16 Speaker_03
And everything that we talked about in the last episode, yeah, it's all important, but it's not nearly as important as it being the Internet operating system. So how did this come to be?

00:06:24 Speaker_00
At the time, things were changing so fast. There was this phrase called internet time. Things happened in weeks versus years. But if you rewind just a little bit back to like 92, 93, 94, even into early 95.

00:06:41 Speaker_00
Going online for consumers meant using a service like CompuServe or Prodigy or, of course, the big one, AOL.

00:06:49 Speaker_00
And these services were not what we think of today as the internet, but they were more like walled gardens with proprietary services that were bundled with access via dial-up modems.

00:07:02 Speaker_03
Yeah, for consumers it was kind of a similar experience. You could get content on your computer, but the main difference was how to put content on that network. It wasn't like anyone could just plug in a server and then boom, you have a website.

00:07:17 Speaker_03
It was like you had to have some negotiating power and know someone at AOL to go do a deal to get your content on their platform.

00:07:26 Speaker_00
Yep. I think the best way to sum all this up is, do you know who owned the CompuServe service at the time? No, but I know it was a Columbus-based company. Oh, interesting. It was owned by H&R Block, the tax prep company. Really? Yeah. Whoa, crazy.

00:07:44 Speaker_00
That's what online was like just a few years or months before the Windows 95 launch. So Microsoft, of course, as you know, inheritor of the earth and all things technology, they want to play in this online services arena too.

00:07:57 Speaker_00
So in 1993, they start sniffing around AOL and see if maybe Microsoft could acquire AOL. Steve Case, the founder of AOL, isn't interested in selling.

00:08:07 Speaker_00
But there's this whole thing where Paul Allen goes off by himself and he buys a large stake and that creates all sorts of headaches because Microsoft is like, well, if we can't buy them, we're going to compete with them.

00:08:17 Speaker_00
So they start an internal project called Project Marvel to build their own online service that becomes MSN.

00:08:25 Speaker_03
So there's a little sleight of hand that you just did there. You said it becomes MSN. Marvel, when it initially was conceived, was a proprietary online service.

00:08:34 Speaker_03
Eventually, when that completely failed, which you're about to get to, they repurposed the name MSN for their internet-based media property. Complete shift in strategy.

00:08:45 Speaker_00
At the same time, many people in technology, especially at Microsoft itself, and lots and lots of investors on Wall Street, believe that these walled garden online services were just temporary.

00:08:58 Speaker_00
They were just a bridge to a more utopian networked consumer culture and economy that they called the information superhighway.

00:09:07 Speaker_00
And the specific vision of how this information superhighway utopia was going to work was interactive television, all mediated by the pay television providers.

00:09:17 Speaker_00
So like the cable and satellite companies out there, you know, the Comcast, the charters, the Time Warner cables, the direct TVs on the satellite side. These were going to be the big consumer technology companies. And this wasn't crazy.

00:09:32 Speaker_00
This actually made a ton of sense because television and in particular cable television at the time was the primary existing consumer medium. The internet was not a thing.

00:09:43 Speaker_03
Well think about the number of things required to create some sort of networked entertainment interactive thing. You would need screens. You would need some way to control those screens to create a feedback mechanism. You would need content.

00:09:58 Speaker_03
You would need infrastructure connecting people's homes. all of those already existed by the cable companies and their endpoints, the televisions.

00:10:08 Speaker_03
And if you pitched me on the idea that actually everyone's going to go buy a brand new device, like a PC, like a computer, and we're going to have a different set of wires that actually bring all of that to the home, or maybe we'll repurpose some of the same wires, but gosh, we need to like bring in new networking equipment everywhere along the way.

00:10:28 Speaker_03
Oh, and there's going to be completely different content companies that figure out how to create the content for there. It's like all of that falls flat. Of course, you're going to use all the existing infrastructure and content.

00:10:37 Speaker_03
You're not going to bank on standing it all up new from whole cloth.

00:10:41 Speaker_00
Totally. And Microsoft, just like they had done in entering the PC software market in partnership with IBM, They're going to partner with these big consumer cable companies.

00:10:51 Speaker_00
And so starting in the summer of 1993, there are all these rumors flying around that Microsoft is working on a big JV with the cable companies dubbed CableSoft. You can't make this up.

00:11:04 Speaker_00
And the idea is that, Ben, like you're saying, the cable companies will control the pipes and the customer relationships and probably a lot of the content.

00:11:12 Speaker_00
Microsoft will write the software, both for the set-top boxes in consumers' homes and for the servers on the backend. and this software project is codenamed Tiger.

00:11:23 Speaker_00
And then there's a third company, a third piece of this sort of unholy alliance for the information superhighway, and that was a company called Silicon Graphics that would make all the hardware.

00:11:36 Speaker_00
Cable companies aren't going to make the hardware themselves. You're going to need pretty powerful hardware here, both at the home and on the service side. And SGI, as Silicon Graphics was referred to, was legendary.

00:11:46 Speaker_00
They are the graphics company that enabled the CGI in Jurassic Park. And of course, their founder and chairman was legendary in Silicon Valley when Jim Clark put a pin in that name. So pinned. So Wall Street, of course, like nuts over all this.

00:12:03 Speaker_00
You know, the hype is out of control. It's a trillion dollar opportunity. There's all these spy shots of Bill meeting with John Malone at TCI and Gerald Levin at Time Warner.

00:12:13 Speaker_00
And Bill starts spending time with Michael Ovitz talking about how Microsoft can get in on the

00:12:18 Speaker_03
Content game to either through the MSN project or through other things they're gonna do this leads to MSNBC the cable network That people are probably familiar with well This is so interesting because we're talking about this general idea of interactive computing involving other people and Microsoft so far has two initiatives Marvel and The information superhighway neither of which are the Internet or the web browser.

00:12:42 Speaker_03
Yes, correct. So

00:12:44 Speaker_03
You're already getting this picture of Microsoft's business strategy, which is until we know exactly what the future looks like, start placing bets that approximate so that we're sort of in the mix, even though we don't know exactly what the future is.

00:12:58 Speaker_00
Which, as we talked about in part one, had always worked so well for the company. Yep. And it's going to work really well here, too.

00:13:05 Speaker_00
So Bill actually decides at this point that he needs to write a book for the public to evangelize this information superhighway thing.

00:13:15 Speaker_00
Kind of embarrassingly, given how long the book world takes to actually publish a book, it doesn't come out until November 1995, after the Netscape IPO has already happened and Windows 95 has shipped.

00:13:27 Speaker_00
But in this book called The Road Ahead, I have two copies of it here on my desk, the hardcover copy and the softcover copy, which was revised and came out in 1996.

00:13:35 Speaker_00
The hardcover copy is all about the information superhighway, or as Bill likes to call it, information at your fingertips.

00:13:44 Speaker_00
And then when the softcover version comes out later, basically they control left every instance of information superhighway and replaced it with the internet and the web browser.

00:13:54 Speaker_03
Yeah, this is one of these moments on an Acquired episode where we have just a delightfully concrete illustration of this year it was unclear, the next year it was extremely clear.

00:14:06 Speaker_03
And David, look up in the indexes of both of those books the number of references to the internet.

00:14:12 Speaker_00
In the hardcover version, there are three portions of the book where it is discussed. In the softcover version, the index for the internet takes up an entire page.

00:14:24 Speaker_00
There needs to be an index for all the sub-indexes of the internet in the softcover version. Amazing. So, the hardcover version is the state of play.

00:14:33 Speaker_00
In January 1994, when a young Windows networking engineer named James Allard, or J as he goes by, writes a memo to Bill Gates and to the senior leadership at Microsoft entitled, Windows, the next killer application for the internet.

00:14:54 Speaker_00
And in this memo, he points to a new piece of software coming out of the National Center for Supercomputing Applications at the University of Illinois that is spreading like wildfire and appears to be written by some like kid programmer there by the name of Mark Andreessen.

00:15:12 Speaker_00
In his free time. It's not even like his real job. Yes. And it is called Mosaic. And in this memo, Jay argues that the internet and this software instantiation of it in the Mosaic web browser

00:15:26 Speaker_00
kind of looks like it is going to become an exponential phenomenon, given the rate at which it is growing, and that it represents an enormous opportunity for Microsoft to, quote, embrace and extend the Internet into Windows itself.

00:15:43 Speaker_00
And this is the origin of the embrace and extend mantra. The exact words he uses are embrace, extend, innovate. in popular press and public opinion of Microsoft that would of course get changed to embrace, extend, extinguish.

00:15:59 Speaker_03
by their effectively competitors and political enemies. But the embrace and extend thing is actually a brilliant business strategy. There's already a whole bunch of people who love this thing. We want to embrace that new behavior.

00:16:11 Speaker_03
There's sort of no product market fit risk because we can clearly already see it happening. People want to use this browser thing to access hypertext on the internet.

00:16:18 Speaker_03
We're going to embrace that and we're going to figure out a way to work it into our business model to extend the functionality in a way that we can make money on.

00:16:26 Speaker_00
Right. The business model is we sell Windows through OEMs into businesses and the like and to consumers. And we can just bake this into it.

00:16:33 Speaker_00
Honestly, it's pretty incredible that Jay lays out the whole winning strategy for Microsoft and the Internet here in January 1994.

00:16:43 Speaker_03
This is a few months before Netscape is even founded.

00:16:46 Speaker_00
Yes. Yeah. Netscape as a company does not exist yet. There's just the Mosaic web browser at the University of Illinois. Yep.

00:16:52 Speaker_00
Then, in this sort of exponential growth theme, the very next month, in February 1994, Bill's technical assistant slash shadow, which is a legendary role at Microsoft, now exists at Amazon too, a man named Steven Sinofsky goes on a recruiting trip to his alma mater at Cornell University.

00:17:12 Speaker_00
And while he's there, there's a big snowstorm, he gets stuck on campus, he has to stay on campus for a few extra days.

00:17:17 Speaker_03
It's a very Cornell story.

00:17:18 Speaker_00
Yeah, the most Cornell thing ever. The most Ithaca story ever. He notices that all these kids, especially when the campus is snowed in, they're all using the internet. And he knows what the internet is. You know, it was an academic project for years.

00:17:33 Speaker_00
You know, he was an academic guy before getting into commercial software and joining Microsoft.

00:17:37 Speaker_03
But it was this way for scientists to basically trade research, and you're starting to get some cool entertainment use cases. But there's certainly no business or business interest or commercial.

00:17:50 Speaker_03
It's all just like the way that academics communicate with each other.

00:17:53 Speaker_00
And this is what absolutely floors Steven. He's like, I remember the internet as what you're saying, Ben.

00:18:00 Speaker_00
And now I'm here on campus and all these kids are using it for flirting, registering for classes, messaging each other, sending email that has nothing to do with papers or work or school or academics or anything.

00:18:14 Speaker_00
He gets so excited that he writes another memo to Bill and the leadership team entitled, Cornell is wired! Exclamation point.

00:18:23 Speaker_03
It's so funny. Microsoft's history is told through a series of memos. Every milestone is some executive publishing a company-wide memo.

00:18:32 Speaker_00
Well, it's so funny because some of these memos definitely were like internal memos for exactly what you said. And some of them were like written for publication to the press. Yeah. And Bill has a great quote.

00:18:45 Speaker_00
When I heard Stephen talk about what was happening at Cornell, I began to take the Internet quite seriously.

00:18:51 Speaker_00
So Stephen and Bill organize an Internet offsite, quote unquote, with all the top execs, with Jay, Bill, Stephen, everybody who's investigating this Internet thing.

00:19:02 Speaker_00
And it takes place on April 5th, 1994, which is the very next day after Netscape was incorporated on April 4th. Amazing.

00:19:13 Speaker_00
And at this off site, Bill totally gets religion that the Internet, as Jay said in his initial memo, is actually an exponential phenomenon. And as Bill puts it to the team gathered there and then the whole company later.

00:19:28 Speaker_00
It is a core Microsoft company value that exponential phenomena cannot be ignored.

00:19:35 Speaker_03
Oh, wow. I had no idea that was kind of the impetus of him taking it seriously. I mean, think back to everything we talked about in the last episode.

00:19:43 Speaker_03
The whole concept of Microsoft is founded on the idea that Moore's law is a thing and therefore we can develop software that people have never dreamed of that in just a few years will be usable.

00:19:56 Speaker_00
So, speaking of Netscape being incorporated the day before, remember I said to put a pin in the name Jim Clark? Of course, many listeners already know where we're going here. Jim Clark, legendary founder of SGI, Silicon Valley legend.

00:20:09 Speaker_00
Well, a couple months before that, in February, 94, it's crazy how fast all of this happened. It's just insane. Jim is still at SGI.

00:20:19 Speaker_00
He's really frustrated with the board and the company, though, for not pushing even harder on this information superhighway opportunity. So what does he do? He resigns from the company, kind of like in protest. The company he founded.

00:20:33 Speaker_01
Wow.

00:20:34 Speaker_00
And on his very last day in February 94 at SGI, he cold emails the kid in Illinois, Mark Andreessen.

00:20:43 Speaker_03
And so you get the opportunity to team up with an industry legend, of course.

00:20:49 Speaker_00
Yeah. So Jim in this email writes, you know, I'm impressed with Mosaic and clearly this seems to be getting adoption. You know, if there's any way that you and I, Mark, might be able to collaborate, that would be, quote, of interest to me.

00:21:02 Speaker_00
So the two of them get together and then they found this company on April 4th, 1994, called Electric Media. And the initial goal of Electric Media, soon to be Netscape, is that, oh, Mark is this hotshot programmer.

00:21:16 Speaker_00
Clearly the information superhighway is what this web is going to turn into. We're going to do what SGI was supposed to do. We're going to make set-top boxes for the information superhighway.

00:21:28 Speaker_03
Yes, in retrospect, you've got to be looking at them thinking, how dense are you? Marc Andreessen is the person in the world who understands what a crazy exponential phenomena the internet is, the web is, what it can be.

00:21:42 Speaker_03
I mean, Marc had, I think by this point, already put the image tag into HTML so they can now send images that render in browsers. And when Jim Clark emails him, they decide to go do the information superhighway and not to do the internet.

00:21:58 Speaker_00
Yeah, this is amazing. So the way they're going to do this as a startup, this is so great.

00:22:04 Speaker_00
One of the other big things that SGI had done besides building the graphics workstations that Hollywood ran on and did Jurassic Park and all that was they were Nintendo's technology partner for the N64. They made the graphics engine for the N64.

00:22:23 Speaker_00
And so, Jim, as this relationship with Nintendo, the N64 is going to be coming out. It's going to be this amazing box in the living room attached to TVs in consumers' homes.

00:22:33 Speaker_00
They're going to team up with Nintendo and turn the N64 into an information superhighway box.

00:22:41 Speaker_03
Meanwhile, it's hilarious that we keep talking about the information superhighway because it never happened.

00:22:45 Speaker_03
There were these little tests done with cable companies that would wire up 300 houses or something, but it never happened anywhere at any sort of scale.

00:22:54 Speaker_03
And so when you're listening to this and you keep trying to figure out like, sorry, what exactly was the information superhighway? And like, what did it look like? Nobody knows because it never happened.

00:23:03 Speaker_00
It's such a classic case of way, way, way too many cooks in the kitchen and just total slideware.

00:23:10 Speaker_03
And the fact that even Mark himself didn't pound the table for, no, the internet's going to be the thing. That really shows you how the human brain is not wired to understand compounding. Theoretically, this network should continue to get more nodes.

00:23:25 Speaker_03
The technology should evolve little by little. Moore's law is happening on the compute side. There's some reason to think that bandwidth is going to be available to homes in the same way it's available to universities and companies.

00:23:37 Speaker_03
But still, it just wasn't obvious enough to continue down that path. It was almost like, great, I've made a name for myself doing this toy thing that probably isn't the future.

00:23:45 Speaker_03
And so now we'll go do the big boy stuff, because that's what all the experts are saying.

00:23:49 Speaker_00
Totally. So shortly after this, by late spring 1984, Mosaic now has a million active users. Clearly Bill Gates is paying attention here. So shortly after all this, Jim Clark and Marc Andreessen say, wait a minute, let's just go do this Mosaic thing.

00:24:09 Speaker_00
They scrap the N64 information superhighway, they go raise money from Kleiner Perkins, John Doerr invests, joins the board, most legendary investor of the time, and by October 1994, the newly christened Mosaic Communications Corporation posts the first version of its browser, Mosaic Navigator, for free to download on the web.

00:24:37 Speaker_00
And their business plan is that they're going to give away the consumer browser for free, and they're going to charge companies for server software.

00:24:45 Speaker_00
So if you want to host a website, you know, you're a corporation or whomever, you need server software to do that. They're going to charge companies for the server software.

00:24:54 Speaker_03
Great. And listeners, you should be paying attention to something David just said there. He said it's the Mosaic Corporation, and then you said it's Mosaic Navigator.

00:25:04 Speaker_03
Even though it's called Mosaic, because Marc Andreessen wanted to draft off the success of the previous project he had done called Mosaic, this is completely new code. They founded a company. They started writing code from scratch.

00:25:15 Speaker_03
They had the experience of writing Mosaic, the thing owned by the university and the NCSA before. This is a new thing called Mosaic that does the same thing, architected for commercial use.

00:25:28 Speaker_00
Yes, exactly, Ben. So meanwhile, back at the University of Illinois, even though they're an academic and government institution here, They realize that they've got something valuable in the original Mosaic.

00:25:41 Speaker_03
It's a pile of code, millions of users. Mark doesn't work there anymore, but it seems to be working.

00:25:47 Speaker_00
So they license their Mosaic, the original one, to a local company called Spyglass.

00:25:55 Speaker_03
So the state of play is you've got the old Mosaic, which Spyglass has the right to license for commercial use. You have a new thing that will become Netscape called Mosaic that is totally separate code.

00:26:08 Speaker_03
And Mosaic, Marc Andreessen's new Mosaic, keeps trying to go do deals, like sell their server software. And every time they'd find a customer, Spyglass, they'd threaten to sue.

00:26:21 Speaker_03
And they basically blow up the deal because they keep calling each customer and saying, yeah, we're going to sue. Yep. Yep. And so this is obviously very frustrating and technically illegal.

00:26:33 Speaker_03
Marc Andreessen's Mosaic realizes that this is gonna be a existential problem for them, unless they do something about it. They actually sue Spyglass. You guys gotta stop. So there is a settlement.

00:26:44 Speaker_00
Well, the net of all this is that Marc and Jim's company, let's call it that, changes its name in the fall of 1994 to Netscape. And Mark had a typically great Mark quote about this to the press at the time.

00:27:01 Speaker_00
You go to school, you do your research, you leave, and then they try and cripple your business. Had I known this would happen, I would have gone to Stanford.

00:27:11 Speaker_03
Which, of course, is apocryphal because he had no means of going to Stanford at the time. He lived in the Midwest. He was going to go to a state school. No one recognized his genius yet at the time, so. Yeah, yeah, yeah.

00:27:21 Speaker_00
Totally. It's also the most marked entries in quote ever, which is awesome.

00:27:25 Speaker_02
Yep.

00:27:26 Speaker_00
Anyway, okay. Meanwhile, remember the online services, the CompuServes, you know, Prodigy, AOL, et cetera. They're not blind. They see that the internet and the web is also becoming a thing.

00:27:39 Speaker_00
they want to go license a web browser and incorporate it into their platform.

00:27:44 Speaker_03
So I think it was late 93 or early 94, but this was a seminal moment where the AOLs of the world interconnected with the internet. And now you could not just navigate the proprietary services, but also surf the open web.

00:27:57 Speaker_00
So Netscape isn't interested in licensing because they have their own business model selling web server software and they want to allow free downloads of the navigator client.

00:28:07 Speaker_00
Spyglass, though, they start licensing that original Mosaic, and they start doing deals with the online service providers. And a small startup company called BookLink goes and codes up another browser that they start licensing to companies as well.

00:28:24 Speaker_00
So Bill Gates and Steven Sanofsky, they go and meet with BookLink in May of 1994. So coming right off of this internet retreat, we're gonna make this a core part of Microsoft and a core part of Windows.

00:28:37 Speaker_00
And they're interested in licensing BookLink as well. They start negotiating. They're talking about a, call it $2 million license deal. And all of a sudden, AOL comes in and buys the whole company of BookLink for $30 million.

00:28:53 Speaker_00
So this now leaves Microsoft without a browser. And there are basically only three real browsers on the market. There's BookLink that AOL just bought. There's Netscape Navigator. Netscape Navigator. Which is not available to license.

00:29:09 Speaker_00
And then there's Mosaic and Spyglass. So Microsoft goes to who else? Spyglass. They license the source code for Marc Andreessen's original Mosaic browser from Spyglass software for $2 million.

00:29:30 Speaker_00
And that code base becomes the base upon which Microsoft builds Internet Explorer.

00:29:39 Speaker_03
Well, David, I'm glad you took the bait. I am here to tell you that that is the public narrative, and very close to the truth. But there's some more nuance here.

00:29:51 Speaker_00
You ready to hear it? Well, hey, if you click the About menu in the early versions of Internet Explorer, a text box pops up that says, based on NCSA Mosaic, distributed under a licensing agreement with Spyglass Inc.

00:30:05 Speaker_03
Yes, all of that technically true. It is just not quite as meaningful as you think it is.

00:30:11 Speaker_03
So, as with all of these things, it's not just like Bill Gates and Steven Sinofsky are having a think, and the rest of Microsoft is sitting around waiting for the think to finish, and then an edict comes down, and then they go and do the work.

00:30:25 Speaker_03
There are a lot of people with a lot of ideas working on a lot of stuff in parallel.

00:30:28 Speaker_03
And that is why Microsoft's history is so delightfully messy is there's a zillion initiatives going on and it's never clear if your thing is going to become the next company strategy or not.

00:30:40 Speaker_03
So here is a slightly different version of this history with different players. And I want to underscore it for one big reason. It will come up later in antitrust.

00:30:51 Speaker_00
Okay.

00:30:52 Speaker_03
So some of the Windows 95 team in late 94, led by Thomas Reardon, is pulled off before it ships to start thinking about what should we do after Windows 95 ships?

00:31:03 Speaker_03
What would the next marquee investments be for what at the time they're calling Windows 97, which of course there was never a Windows 97. So the group's opinion is all internet all the time.

00:31:15 Speaker_03
How could the next iteration of Windows be extremely internet native in a very embedded way? And there's tons of proposals in this little group. There's virtual meeting software. Think Zoom type things.

00:31:27 Speaker_03
There's an email client specifically built for the internet rather than for your company's corporate network, which at the time was novel. Then there's, of course, a browser. But the big vision was, what if the whole Windows shell is a browser.

00:31:41 Speaker_03
Every visual thing that you interact with in Windows, what if that actually was like an HTML rendered server communicating online thing? And the team technically kind of looked at it this way.

00:31:55 Speaker_03
We should build HTTP directly into the operating system since it was just another protocol on top of the TCP IP protocol that the internet is based on. we should provide reusable UI component to any application that wants to display HTML.

00:32:13 Speaker_03
That's a good engineering building block to build is this HTML renderer that any application can sort of frame in and use.

00:32:20 Speaker_03
So of course Microsoft, the strategy here is we will develop a browser application that used the building block that others could also use to render HTML. So they actually go to Netscape

00:32:32 Speaker_03
and say, hey, we have this great HTTP stack, we have the HTML engine, we have these wrappers to go around it. Instead of rewriting all of it, just use our off-the-shelf code that we intend to ship with Windows. Famously, Netscape did not do that.

00:32:48 Speaker_03
And so IE, Internet Explorer, actually ends up being kind of the only application that used all these Windows components And once they got going on the browser, they convinced the Windows leadership that actually, we can do this fast.

00:33:00 Speaker_03
We should get this done as a part of Windows 95, not wait for the next big release.

00:33:04 Speaker_00
We're going to get to this in a minute, but when Windows 95 launched, it had either at launch or very shortly thereafter, what was called the Plus Pack. Yes. And Internet Explorer was available as part of the Plus Pack.

00:33:15 Speaker_03
Yes. So anyway, how does NCSA, Mosaic, and Spyglass come into this? Well, the nuance is Spyglass had actually massively changed the Mosaic code.

00:33:26 Speaker_03
They were trying to create the Spyglass browser that was sort of based on this NCSA code base, but it wasn't very good. And so that is what Microsoft was able to get their hands on. They could not license the original NCSA version.

00:33:42 Speaker_03
That was gone or at least not available for license. And so they sort of tried backing out a lot of the Spyglass stuff,

00:33:49 Speaker_03
Ultimately it wasn't that helpful in creating Internet Explorer and they spent just as much time trying to undo a lot of it and then build the Internet Explorer stuff on top.

00:33:59 Speaker_03
So ultimately did it actually accelerate their path to market and was it actually Mark Andreessen's code. Some of it was in there but you know it's not like they grabbed it off the shelf and now it's IE.

00:34:11 Speaker_00
Makes for such a good story though. It sounds like reality is a lot like the DOS acquisition. Yes, Microsoft bought QDOS, Quick and Dirty Operating System, from Seattle Computer Products. Was that the same thing as Microsoft DOS? Sort of.

00:34:31 Speaker_00
A lot of work went into it after the deal. Yeah, as you would expect, same thing here. But it is definitely true that if you click that about box, in the early versions of Internet Explorer.

00:34:42 Speaker_03
It's just so delicious. It is delicious.

00:34:44 Speaker_03
And the two big takeaways here, at least from this additional version of the story, is one, what they actually wanted to do was make Windows web-enabled in a really deep, integrated way, not just have this one little application called a browser.

00:34:59 Speaker_03
And technically, there was a lot of commingling there, a lot of what became the code underpinning Internet Explorer was actually Windows code implemented in Windows operating system to do these protocols.

00:35:10 Speaker_03
And two, still a lot of work to make IE after the deal.

00:35:13 Speaker_00
So this brings us now to the launch preparations for Windows 95. And in the spring leading up to all this, Bill writes another memo, this one intended for publication, so to speak, that is the famous Internet Tidal Wave memo.

00:35:30 Speaker_00
I just want to do a big quote from it here. Perhaps you have already seen memos from me or others here about the importance of the Internet. I have gone through several stages of increasing my views of its importance.

00:35:41 Speaker_00
Now I assign the Internet the highest level of importance. In this memo, I want to make clear that our focus on the Internet is crucial to every part of our business. The Internet is the most important single development

00:35:55 Speaker_00
to come along since the IBM PC was introduced in 1981. It is even more important than the arrival of the graphical user interface. Can't get any more clear than that. Very clear.

00:36:07 Speaker_00
So that brings us to the August 95 Windows 95 launch, scheduled for the 24th. On August 9th, a couple weeks beforehand, Netscape goes public with a market capitalization of $3 billion. Massive IPO. Massive. I mean, this is like 1995 we're talking about.

00:36:28 Speaker_03
Netscape, we should say, goes from 1 million to 15 million users in one year. I mean, just instant product market fit. It was so clear that people wanted to browse the web.

00:36:39 Speaker_03
A lot of the time in technology in this ecosystem, we're always looking around like, is that going to become a thing? Is that going to become a thing? That was from 1994 onward, never a question about the Internet.

00:36:49 Speaker_00
Yeah. In the IPO press cycle, Marc Andreessen is quoted as saying that, quote, Netscape will soon reduce Windows to a poorly debugged set of device drivers.

00:37:04 Speaker_03
It's such a good quote. And there's so much behind it, too. If you really dwell in that quote, what does it mean? If one of the things he's saying is Windows is a platform upon which independent software vendors write applications.

00:37:20 Speaker_03
So Windows is the way that currently people write software for businesses and consumers to use.

00:37:28 Speaker_03
And if we are going to reduce Windows to a poorly debugged set of device drivers, what I'm implying is these crappy static web pages that get served right now, that is merely a step on our journey to enabling rich web applications.

00:37:43 Speaker_03
Think JavaScript, CSS, eventually Java and Flash. The web will be a way that developers write their applications. That's right there implicit in the quote.

00:37:55 Speaker_03
And so when they're saying we're going to reduce Windows, blah, blah, blah, it's saying, OK, Windows has all this stuff right now for developers, but essentially you're going to use Windows or any operating system just to boot it up, connect to all your peripherals and your screen and your mouse, your keyboard and everything, and you'll open your browser and you'll do everything through the browser.

00:38:13 Speaker_03
And that scared the hell out of Microsoft.

00:38:17 Speaker_03
Not specifically this quote, but Microsoft had come to the same conclusion too of, oh my God, if the web becomes the platform of the future, all the reasons why we have all this incredible business, people feeling the need to use our operating system to be able to get access to their favorite software and for developers to build applications on our platform to get access to the users, that could go away.

00:38:42 Speaker_03
And in the same memo that you were quoting earlier, the internet tidal wave, Bill Gates famously says, and when I say famously, it's because the Department of Justice later grabbed this quote and used it as an exhibit.

00:38:54 Speaker_03
Bill writes, a new competitor born on the internet is Netscape. Their browser is dominant with a 70% usage share, allowing them to determine which network extensions will catch on.

00:39:06 Speaker_03
They are pursuing a multi-platform strategy where they move the key API, the Application Programming Interface, into the client to commoditize the underlying operating system. I mean, they got it. Immediately.

00:39:20 Speaker_03
The web is an application platform that completely reduces our value.

00:39:24 Speaker_00
you can see why it was so important to Microsoft to beat Netscape, to bring the internet in the form of Internet Explorer into Windows and have Windows maintain its role as the dominant platform.

00:39:39 Speaker_00
So all this stuff will cut off their air supply, you know, it was existential.

00:39:44 Speaker_03
And how amazing is this? It's an application platform of the future that is distributed as a Windows app. I mean, Windows had huge market share at this point. I don't know, 80, 90%, eventually over 90% market share.

00:39:59 Speaker_03
The way that Netscape could get to consumers was because Microsoft had all these computers out there running Windows. It was like this ultimate Trojan horse that they could build the platform of the future through Microsoft.

00:40:11 Speaker_00
Yeah. So, Windows 95 launches a couple weeks after the Netscape IPO. Internet Explorer is not baked in, at least not in the retail box version.

00:40:23 Speaker_00
You can buy it for $50 as part of the plus pack that I was referencing before and install that and add it into Windows and Microsoft will make money on the sale of that software.

00:40:37 Speaker_00
That, of course, does nothing to make a dent in the free version of Netscape Navigator that is out there.

00:40:42 Speaker_03
Right. If Microsoft's goal is to cut off the air supply, David, as you already quoted, of Netscape, the goal is ubiquity instantly. And we don't care about making money.

00:40:51 Speaker_03
We just need to get this thing out so the Internet doesn't kneecap our business and we can sort of embrace and control it or perhaps embrace and extend it.

00:40:59 Speaker_00
Netscape's run continues. The Netscape stock triples over September, October, November. Netscape is now a $10 billion public company. Insane.

00:41:12 Speaker_03
And I don't think making very much money on their server software yet. All the market cap creation is attributable to people believing they have the dominant platform of the future and not based on their current financials.

00:41:23 Speaker_00
Yeah, basically all of the hype train that had been behind the Information Superhighway has now completely ported over to Netscape.

00:41:31 Speaker_03
That's true. What's our tracker for the internet? Netscape. Everybody pile in.

00:41:34 Speaker_00
Yeah, I could make an analogy to today, but I'm going to spare us all.

00:41:38 Speaker_03
Make this episode timeless, David.

00:41:39 Speaker_00
I'm going to make the episode timeless. Okay. And then on December 7th, 1995, Bill Gates announces that Internet Explorer is now free and it will be bundled in with every single copy of Windows 95 going forward.

00:41:56 Speaker_00
And on that day, Netscape stock drops by about a third and never recovers. That was the high watermark for Netscape. It's over after that.

00:42:07 Speaker_03
Yep, and for good reason. I mean there's a very Difficult to learn lesson, but you learn it once you never forget it if your distribution Decides to compete with you and decides to make that a priority Your business is over in a minute

00:42:23 Speaker_00
Yep, and that's exactly what happened. I mean, this is now the march of Internet Explorer. It doesn't happen overnight, but it's inevitable.

00:42:31 Speaker_00
By the end of the next year, in 1996, Microsoft has now done deals with AOL, CompuServe, and Prodigy, all the old online services, to ditch whatever browsers they were using and bundle in Internet Explorer.

00:42:46 Speaker_00
And by the end of that year, in 96, Internet Explorer passes 20% market share,

00:42:52 Speaker_00
97, it passes 40% market share, 98, it passes 60% market share, and then by the year 2000, Internet Explorer basically has, for all intents and purposes, 100% worldwide browser market share.

00:43:06 Speaker_00
If you look at the Internet Explorer market share chart over time, it is the most perfectly rounded hill that you will ever see. It goes from zero in 95 to like 100 in 2000, and then all the way back down to zero in 2020. dead.

00:43:23 Speaker_03
Which is the next chapter of this story is how on earth did they lose that monopoly that they had in the browser? But before that, there's this interesting moment of reflection here. Why did Netscape's business dry up?

00:43:37 Speaker_03
Because their business was made from selling server software. Well, the way to have the best server software is to also control the client.

00:43:45 Speaker_03
People are very interested in making sure that their websites run perfectly using the experience that everyone has.

00:43:52 Speaker_03
And when you can no longer claim, hey, a whole bunch of internet users actually use our browser, do I really want to buy my server software from you or should I just

00:44:00 Speaker_03
be open to buying it from anyone that I can sort of, it's the lowest cost and the best value with the most features, all that. So they sort of lose the competitive edge in the revenue side of the company.

00:44:11 Speaker_03
On top of that, it's just really hard to recover for companies that have an 80% drawdown or whatever in their stock price. There was a lot of excitement around the company that then goes away. Suddenly all these employees are undercompensated.

00:44:24 Speaker_03
It's a company-killing event.

00:44:26 Speaker_00
And all the market cap and excitement was all on the come. It wasn't because of the revenue.

00:44:31 Speaker_03
Right. So to this point, Microsoft has not changed their business model. They simply vanquished a potential future that was dangerous for them. They're still doing the same thing as ever, selling Windows licenses through OEMs and to consumers at retail.

00:44:47 Speaker_00
There are a couple more fun little tidbits from this era. In August 1997 is when the famous Macworld happens, where Steve Jobs returns to the company, and Bill Gates shows up on the satellite feed.

00:45:02 Speaker_00
And, you know, of course, this moment is legendary, but studying it from this lens, I realized there's this whole other aspect to it that I didn't know before.

00:45:13 Speaker_00
So what Bill and Steve announced on stage, it's also so telling that Bill couldn't even be there in person. He joins by satellite.

00:45:20 Speaker_03
Yeah.

00:45:20 Speaker_00
So there are four points to the partnership. One is the $150 million investment from Microsoft and Apple. Two is the five-year commitment on the part of Microsoft to ship Office for Mac. Yep. And those are the big ones that everybody talks about.

00:45:37 Speaker_03
Which, by the way, saved Apple.

00:45:40 Speaker_03
The company would have been completely out of business because it was so existentially important to anyone using an Apple computer to use Office that if Office, you know, Microsoft decides, oh, we're going to stop developing Office, people stop buying Macs.

00:45:55 Speaker_03
And, you know, the company's already in such a tenuous financial position, it's just over.

00:45:59 Speaker_00
So the third deal point was they agreed to end all patent disputes. So this is the end of all the back and forth we talked about in part one.

00:46:07 Speaker_00
But then the fourth point, which I didn't even remember at all, was that Internet Explorer would become the default browser on the Mac displacing Netscape. And that continued from 1997 until 2003, when Safari became the default browser.

00:46:25 Speaker_00
Oh, don't I know it. And knowing this now, and knowing the headspace that Bill was in, I got to imagine that's the reason he did the deal.

00:46:32 Speaker_03
Well, it's funny. I actually do have some color on why he did the deal. Steve Jobs wanted to message this as Microsoft believes in the Mac as a great way to use the office suite.

00:46:45 Speaker_03
They believe in us and as a company, and so they're investing $150 million and making this commitment to help us get through this difficult time. And this money, by the way, just to help people understand, Apple was worth about $2 billion at the time.

00:47:01 Speaker_03
So this is Microsoft buying 8% of Apple. Yeah.

00:47:05 Speaker_00
Wow.

00:47:07 Speaker_03
Steve cleverly identified this moment. as a time to call Microsoft and say, hey, I know we're through all the patent issues, that big lawsuit. I have more. I think you guys are using some of our stuff. I don't want to sue you.

00:47:25 Speaker_03
I know the DOJ is sort of looking at you guys for antitrust right now. Apple was aware that Microsoft would be interested in appearing collaborative with another major player in the ecosystem.

00:47:40 Speaker_03
And so we sort of have the leverage to say, hey, what if you guys invested in us and did this big commitment to Office for Mac? It's super important to help us get through this difficult time.

00:47:49 Speaker_03
And Microsoft said back, well, it's really important to us to have IE everywhere. And so they rolled it all into one big deal. No one's going to sue anyone. All the IP is cross-licensed. And Microsoft gets the win with IE.

00:48:02 Speaker_03
Apple gets the win with the investment in Office. And we can all walk away.

00:48:06 Speaker_00
Interesting. Interesting.

00:48:08 Speaker_03
Apple is saved. Truly, Apple would have gone out of business had Steve Jobs not seized this opportunity.

00:48:13 Speaker_00
It was a critical business deal for both of them.

00:48:17 Speaker_03
Yeah.

00:48:17 Speaker_00
So to close the book on Netscape, in November 1998, AOL acquires Netscape in an all-stock deal for just over $4 billion, but again, all stock. And this is just a little over a year before the Time Warner merger. And this moment here,

00:48:38 Speaker_00
is just the absolute peak of Microsoft as a consumer technology company. I mean, I think maybe the absolute peak of any consumer technology company ever. I mean, think about the market power that Microsoft has at this point in time.

00:48:55 Speaker_00
Apple has an existential reliance upon them. They have completely crushed Netscape, you know, quote unquote, cut off the air supply. There's nobody else. There is nothing else except Microsoft.

00:49:10 Speaker_03
Google is three years from being founded. Facebook is nine years from being founded.

00:49:14 Speaker_00
Yeah, there's Yahoo, sure.

00:49:17 Speaker_03
There's real competition in the enterprise at this point, Sun, Oracle, but in terms of what your point is, the consumer technology landscape, yeah, they had ultimate power.

00:49:29 Speaker_03
Yeah, but David, I don't know, the whole thing of you can just decide to, and then you completely vanquish your biggest existential threat by cutting off their air supply. Shouldn't that be illegal? Well, to lead you a little bit into our next section.

00:49:45 Speaker_03
Yeah. Well, listeners, I think you know what is coming next based on David and I coyly alluding to it. But before we get there, we've really been talking about this idea of development platforms.

00:49:58 Speaker_03
We were talking about the web as a potential development platform of the future, even as far back as 1994, people building web applications or, you know, Windows 95 and it's hating. But what makes for a great development platform?

00:50:12 Speaker_03
Well, this is a great time to thank our friends at JPMorgan Payments to talk about their developer platform. To build a great one, it requires a culture focused on empowering others and investing with a long time horizon.

00:50:27 Speaker_03
And JPMorgan Payments knows this well. We've talked about how they're much more than a global bank. They're now investing $17 billion a year in technology and R&D.

00:50:36 Speaker_03
But you may not know that they've also been investing heavily in their developer ecosystem. And over the last year, they've really embraced this dev first mentality with their API powered payment solutions.

00:50:45 Speaker_00
Yep. And if you zoom out, it's clear that traditional finance folks aren't the only decision makers anymore.

00:50:51 Speaker_00
It's also your developers, your engineers, your product managers, and so on, who now have a seat at the table when it comes to finding the best payments platform for your company.

00:51:00 Speaker_00
Many of these modern digital first categories like ride sharing, e-commerce, or travel couldn't exist without smooth and seamless payments built into the product experience natively.

00:51:09 Speaker_03
Yes, we know that many of you listening are developers who will be excited to learn about JPMorgan's new Payments Developer Portal that's essentially a one-stop shop to build solutions for your business on top of their trusted and scaled platforms.

00:51:22 Speaker_03
While this is just a first step in a long journey for their developer portal, JPMorgan is really taking a long view in investing for the future, working hand-in-hand with their clients, dev teams, beta testers, and payment industry experts to launch, learn, and iterate.

00:51:36 Speaker_03
And they've got a robust end-to-end roadmap of payment APIs coming in the future across treasury, commerce, embedded finance, and even value-added services like account validation that are going to be truly unique in the industry.

00:51:48 Speaker_00
Anyone can make an account to create projects, collaborate with team members, generate access tokens, and try out payment APIs that help accept, manage, or send payments in a sandbox environment.

00:51:58 Speaker_03
Which is great, I can speak from my past experience as a developer that it is very nice when your head's down, you can just use self-serve, well-documented APIs and code samples.

00:52:06 Speaker_03
I actually read through the quick start guide and thought it was very easy to follow.

00:52:10 Speaker_00
With J.P. Morgan, you get to rely on their experience and security so you can focus on your core functionality.

00:52:15 Speaker_00
This season, we've talked a lot about how they've been powering secure innovation with an ecosystem of payment solutions trusted by some of the world's largest and most innovative companies.

00:52:24 Speaker_03
Not to mention 200 years of banking experience, your payments just work the first and every time. you get security in huge scale. We've said it before, JPMorgan moves $10 trillion a day.

00:52:35 Speaker_03
Over 50% of all e-commerce transactions in the United States pass through their platform.

00:52:40 Speaker_03
We encourage you to learn more about their API-powered solutions built for developers at jpmorgan.com slash acquired, and let us know if you've tested out their new payments developer portal in the Slack.

00:52:51 Speaker_03
If any listeners are heading to FinTech DevCon in August, you'll be able to learn more about all of this directly from their team. Okay, David. So we've arrived. The famous 1998 Microsoft versus the U.S. Department of Justice antitrust trial.

00:53:08 Speaker_00
Yes. And I was thinking about it in the transition at the end of the browser wars there. Boy, you didn't like my snarky comment? Yeah, well, we were being glib about like, oh, this should be illegal. That's really the question here.

00:53:20 Speaker_00
All that power that Microsoft had, it had probably never been concentrated in the hands of one company like that and probably never will be again. And the question is, was that illegal and did Microsoft do anything wrong?

00:53:35 Speaker_03
Right. We're getting into a whole bunch of very interesting questions here. And I asked it exactly to sort of pop open the can of worms. But there is the question of what actually is legal in the US? What actually is legal in the EU?

00:53:48 Speaker_03
Then there's this interesting question sort of emotionally for everyone who is working on software at Microsoft. The vast, vast majority of people are not really focused on what is the business and competitive strategy.

00:54:00 Speaker_03
Most people who worked on any of this stuff, their whole goal was, I want to ship great software and make things that people love to use, and I want to work with people that I love making it with.

00:54:09 Speaker_03
And so if you ask most people who worked on any of this, their opinion is, I don't know, we were trying to just make the best software out there. Which is very interesting to square with this growing

00:54:20 Speaker_03
public perception that Microsoft is being a bully, especially public generated by their competitors. Right. And then the literal legal question of, did they do something illegal?

00:54:31 Speaker_03
Because the actual antitrust laws are a super different thing than, ooh, does this feel anti-competitive in some way to me?

00:54:41 Speaker_00
And then there's the other dimension, too, of, as a consumer, Am I unhappy that I get a world-class web browser included in my operating system?

00:54:50 Speaker_03
Well, David, now you're cracking open the issue of consumer harm, the consumer welfare standard that the whole thing is based on. So take us into the story.

00:54:58 Speaker_00
Yeah. So the Microsoft antitrust saga actually started not with the Department of Justice and not in 1998,

00:55:09 Speaker_00
But with the Federal Trade Commission, the FTC, all the way back in 1990, when they opened an investigation into the company about whether it was violating antitrust laws.

00:55:22 Speaker_03
This centered on the notion of per-processor licensing, which we discussed in our last Microsoft episode.

00:55:29 Speaker_00
Yep. So in July 1993, the FTC commissioners vote on whether Microsoft is a monopoly that deserves further action and penalties, and they deadlock at 2-2, which means essentially a win for Microsoft. No action would be taken against the company.

00:55:45 Speaker_00
This is a huge victory. The antitrust case of the U.S. federal government against Microsoft should be closed at this point in time.

00:55:55 Speaker_03
Yep. Because theoretically, they could have examined any monopolistic practice at this point. And they said, just the one narrow thing that we were worried about, they agreed to stop doing.

00:56:07 Speaker_03
And we, in voting 2-2, we see no other issues that we need to investigate.

00:56:12 Speaker_00
Yep. Microsoft, you are good as far as the U.S. federal government is concerned. However, the very next month, in August 1993, the Department of Justice picks up the case, which is pretty unprecedented. One department in the U.S.

00:56:31 Speaker_00
federal government essentially investigates a company about whether it is abusing its monopoly power. declines to prosecute them for it.

00:56:41 Speaker_00
And then another department within the federal government the very next month says essentially, well, we don't think you did it right. We're going to do it.

00:56:51 Speaker_00
Microsoft is now all of a sudden basically standing trial for the same accused crimes twice Yeah, theoretically double jeopardy is not a thing and in fact several members of the FTC Commission Opposed this whole process and tried to refuse to turn over their notes to the Justice Department.

00:57:07 Speaker_00
Hmm, but nonetheless the DOJ proceeds and The next year in July 1994 Microsoft just settles with them rather than going to trial. They're like, all right We just want to be done. We're going to settle with you, DOJ. We're going to be done with the U.S.

00:57:24 Speaker_00
federal government here. And in that settlement, they agree to enter into what folks may know, the famous words, a consent decree.

00:57:34 Speaker_00
And that means they consent in this case, that they are not going to tie the sale of Microsoft application products to the sale of Windows. Meaning they can't say like, hey OEMs or businesses or consumers or whoever.

00:57:50 Speaker_00
If you're buying Windows, you have to also buy Office or X or whatever else that we're selling in our applications group.

00:57:57 Speaker_00
But importantly, as part of the consent degree, they remain free and clear, Microsoft does, to integrate additional features into the Windows operating system. Which brings us right back to Internet Explorer. Is it a product or is it a feature?

00:58:14 Speaker_03
Exactly. And this is so messy because I think, David, you just used the exact language, which is they cannot tie these application products in a bundled sale. However, they absolutely can integrate new features. Yes.

00:58:30 Speaker_00
So what is Internet Explorer?

00:58:32 Speaker_03
And this also looks the other way at the whole idea of software development and platforms, which is it is a continuously changing landscape where over time, in the interest of users, platforms do more and more and more things that applications used to do.

00:58:50 Speaker_03
And so the whole notion that they're going to write that sentence and then call it good, what is an application today might be a feature years down the line, but the law is written and we have to pay attention to that sentence constantly re-evaluated in the context of the current time.

00:59:08 Speaker_00
Yeah. I mean, today, could you imagine purchasing a device that has an operating system and that device not having an internet browser as part of the core system? No, you can't even imagine that. Of course it's a feature.

00:59:25 Speaker_03
Well, is it a feature? It's actually, it's literally an application. It is a bundled application as it exists today. So this is the gray area.

00:59:32 Speaker_00
This is the gray area. And you know, look, if you ask Bill and Microsoft and Jay Allard all the way back to the original memo, it was absolutely intended to be a core feature of the Windows operating system, having an internet browser as part of it.

00:59:47 Speaker_03
clearly motivated by the idea that we want our Windows platform to maintain the power it enjoys from its monopoly market share.

00:59:56 Speaker_03
So there's a sympathetic view for sure of, hey, this is core functionality to an operating system, whether it's a feature or an application that we bundle.

01:00:04 Speaker_03
And also, clearly the reason you are incentivized to ship your own browser is to cut off the air supply of potential competitors that develop the platform of the future.

01:00:12 Speaker_00
Yes. So, in October 1997, the Justice Department files a motion in federal district court stating that by bundling Internet Explorer with Windows, Microsoft has now violated the 1994 consent decree against product tying.

01:00:29 Speaker_03
And it's important to know what they're basically asking is, this is not about future versions. You know, we know you're doing some kind of Windows 98 thing. We're saying right now, stop shipping, i.e. bundled into Windows.

01:00:41 Speaker_03
Microsoft insists this is an integrated product. You cannot do that. And it's not even necessarily a legal argument yet of we're allowed to do this because it's an integrated feature.

01:00:53 Speaker_03
They're saying we ship a pile of code and you actually cannot just rip out Explorer. And if you remember at this time, you could do all sorts of crazy stuff like you could paste a web address

01:01:06 Speaker_03
in Windows Explorer, and it would render even though it wasn't Internet Explorer. So there actually was like, if you think back to that sort of vision of the browser is integrated into the Windows shell, and it sort of happened.

01:01:19 Speaker_03
A browser was not really, at least Internet Explorer, was not really its own standalone thing. It was deeply integrated. Now, could they have pulled it apart is a different question if they really wanted to.

01:01:30 Speaker_00
And also remember the fact pattern here. isn't exactly great for Microsoft of, well, they did ship Windows 95 without Internet Explorer in the beginning, so.

01:01:40 Speaker_03
Right. So the federal judge, Thomas Penfield Jackson, orders them to do it anyway, or more specifically, he ordered Microsoft to ship a version of Windows to the PC makers, the OEMs, or Original Equipment Manufacturers.

01:01:54 Speaker_03
That didn't include IE, so that those OEMs could load those onto the PCs that they were going to ship to customers if they wanted to. And Microsoft said, we told you we can't do that, but you're a judge and you're ordering us to. So they do.

01:02:06 Speaker_03
And surprise, surprise, when you just disable a bunch of code that other code depends on, it doesn't work. So then, of course, two things happen.

01:02:15 Speaker_03
Judge Jackson is not pleased, since it appears Microsoft is complying with the letter of the law, but violating the spirit and sort of thumbing its nose and being arrogant. So that's thing one.

01:02:25 Speaker_03
Thing two is obviously the PC makers don't actually ship this version of Windows, so it never sees the light of day. And so things get real petty real fast. The DOJ asks the court to hold Microsoft in contempt.

01:02:37 Speaker_00
Yep, a whole bunch of back and forth.

01:02:40 Speaker_00
Microsoft appeals Judge Jackson's order, and in early May 1998, the appellate court rules that Microsoft can continue shipping Windows with IE bundled into it, and also continue to bundle any other features that they want as part of Windows, as long as it benefits consumers.

01:03:00 Speaker_03
And this is interesting, because this is when it really hammers home the idea of what we, the U.S. courts, care about is consumer welfare.

01:03:09 Speaker_03
We haven't explored the idea of if Microsoft is a monopoly or not yet, but for now what we are saying is as long as what they are doing is in the consumer best interest, they're not causing harm, they're not raising prices, then it's okay.

01:03:26 Speaker_00
So then, one week later, on May 18th, 1998, the DOJ announces a brand new enormous, wide-ranging antitrust lawsuit against Microsoft for violating the Sherman Antitrust Act and abusing its monopoly power to suppress competition.

01:03:47 Speaker_03
And this investigation is way bigger than just, is it okay if they tie Internet Explorer with the shipment of Windows? This is, A, is the company a monopoly? And B, are they doing anything across their entire business

01:04:04 Speaker_03
to abuse that monopoly power in the disinterest of consumers.

01:04:10 Speaker_00
It is not necessarily illegal to be a monopoly. It is illegal to abuse your monopoly power.

01:04:15 Speaker_03
Correct.

01:04:15 Speaker_00
So this court is examining both of those questions. One, is Microsoft a monopoly? Two, are they abusing their power? This is really bad for Microsoft.

01:04:26 Speaker_03
Really bad. And it's worth decoupling did they do anything wrong from just legal strategy by holding a very firm line early of we're appealing this decision. We couldn't possibly be doing anything wrong here.

01:04:41 Speaker_03
Microsoft is starting to take this super aggressive stance. And the Department of Justice is then like, wait, you didn't give an inch. You're not open to just this one thing, the tying of Internet Explorer and Windows.

01:04:54 Speaker_03
OK, we're going to look at everything.

01:04:57 Speaker_00
Yeah. You can see how it sort of goads them into like, OK, we're going to bring the big lawsuit. Right. But this whole scene, you can also see from Microsoft's perspective, a feeling of like betrayal by their government.

01:05:12 Speaker_00
You know, like, hey, this is the third time we're being tried for what feels like the same crime. Ben, you said double jeopardy isn't a thing earlier. You know, what is this, triple jeopardy?

01:05:24 Speaker_00
Come on, I thought this was supposed to be a free country where we can build businesses. What the hell?

01:05:30 Speaker_03
Yeah. And Microsoft folks at the time, too, are starting to get this inkling of, why are they doing this? Are consumers really mad at us? Who's being helped here?

01:05:40 Speaker_03
And they're starting to realize, hmm, there is a lot of lobbying going on behind the scenes of Netscape and everyone else we're competing against trying to find a way to call us anti-competitive.

01:05:54 Speaker_00
Yep.

01:05:55 Speaker_03
Which, we should say, is always true in these big antitrust lawsuits, but that was certainly happening in this one.

01:06:01 Speaker_00
Yep. And so for all these reasons, including Ben, as you say, the legal strategy they started with in the first place of we're going to fight everything. They say like, all right, we're fighting this. We're going to fight it hard.

01:06:15 Speaker_03
Yep.

01:06:15 Speaker_00
So Ben, you've talked to a lot of people here. Take us through what happens in this big trial through the fall of 98 and into 99.

01:06:24 Speaker_03
So the first question that everyone is sort of wondering is, did Microsoft have a monopoly here? Well, the fact is that they had over 90 percent of PC operating system sales.

01:06:35 Speaker_03
So, you know, I'm not a judge, but at first glance there, you think like, OK, they have market power. So in August of 1998, Judge Jackson issues a pretrial order that all depositions shall be submitted during the trial only in transcript form.

01:06:53 Speaker_03
And so for folks who aren't in this world or looked at lawsuits before, a deposition is when the counsel goes and does a bunch of interviews beforehand. You're not being called as a witness in the trial, but it's basically information gathering.

01:07:09 Speaker_03
Yeah, interview process. Yes. So on August 27th, Bill Gates is deposed by the DOJ's appointed prosecutor, David Boies, for 20 hours. And I think this happens over multiple days.

01:07:23 Speaker_03
Actually, on YouTube, which is interesting to note, you can watch 12 of the 20 hours. I think I've watched eight or nine of it, but it's just hours and hours and hours of... Just some, you know, light bedtime viewing.

01:07:36 Speaker_03
...of Bill Gates being asked questions. So, the strategy that Gates and the Microsoft legal team used was one that was tailored for this pre-trial ruling.

01:07:46 Speaker_03
If you watch the video, you can see that the strategy is essentially never give an inch, avoid saying anything that can be used against you, and Microsoft walked out of it feeling like they were pretty successful in this.

01:07:59 Speaker_00
And when you say tailored for the pretrial ruling, you mean tailored with the assumption that this is only going to be delivered as a written transcript. Right. There will be no video, no recording of... Right. ...these depositions.

01:08:15 Speaker_03
And yet I just watched the video on YouTube. So what's going on here?

01:08:17 Speaker_00
How did that happen?

01:08:18 Speaker_03
Yeah. So if you're watching the video, though, it's very easy to think this guy is rude, pedantic and disrespectful. I'm not out on a limb saying that opinion. If anybody watches this video, that is just the obvious takeaway.

01:08:34 Speaker_00
At a certain point, they argue over the definition of definition. Is that right?

01:08:39 Speaker_03
Yes. So a couple examples. I'm not exaggerating here. The deposition really does come across as just showing pure disdain for the prosecutor and the questions he's asking.

01:08:47 Speaker_03
Bill Gates rat holes on things like refusing to answer questions about memorandums since they were not memos but emails. So I couldn't possibly answer you on the question about the memorandum.

01:09:00 Speaker_03
At one point, he does look at David Boies and ask him how he would define the word definition, of course, while smirking the whole time.

01:09:09 Speaker_03
And so the whole thing is like very obviously tailored with this idea that I'm going to give you pages and pages and pages of which you will have nothing that can be used against me. And that is the whole strategy. I don't care how I come across.

01:09:23 Speaker_03
I don't care how ticky tacky the language is. He sits and pauses forever. He'll say, well, you asked me what the person who sent this was referring to. How should I know what they're referring to? I didn't write the email. You'd have to ask them.

01:09:37 Speaker_03
I don't know. And so it's 20 hours of this.

01:09:41 Speaker_03
Well, somehow, and I actually don't really know how this happened, after the deposition is recorded, on October 9th, the judge then issued a reversal saying that videotaped depositions are indeed allowed to be used in court. Oof. Yeah.

01:09:58 Speaker_03
How did this hold up? And if you give a great prosecutor like David Boies this opportunity, he uses it masterfully.

01:10:06 Speaker_03
And so throughout the trial, he'd show little clips at strategic moments in the trial where he either wanted to give the press something juicy to write about that day, because there's a whole press section in the back going and listening to all the witnesses every single day, or he would play something he knows is going to get a rise out of the judge.

01:10:22 Speaker_03
And if the judge makes an expression, then the press writes about, oh, the judge is leaning this way or that way. Also, he would use it anytime there was an opportunity to feel sympathetic for Gates or anyone at Microsoft.

01:10:34 Speaker_03
And then he would show a clip that sort of clearly causes you to lose any sympathy or leaning. And so it was just dripped out in this really clever way.

01:10:44 Speaker_00
Yeah. And certainly went a long way towards shaping the decision, but also shaping, more importantly, public opinion about Gates and about Microsoft. Yeah. How did this hold up, though?

01:10:56 Speaker_00
Didn't Microsoft appeal the change from recordings not being allowed for depositions to recordings being allowed?

01:11:03 Speaker_03
That is a great question, David. And one of the things that I read to prepare for this episode is a book called World War 3.0, which is exclusively about this trial. And the author has this comment on it. Microsoft feared that Judge Jackson was a foe.

01:11:17 Speaker_03
He had made a number of pretrial rulings deemed hostile to the company. They were especially unhappy that he modified the pretrial order that depositions shall only be submitted in transcript form, issuing a new order allowing videotaped depositions.

01:11:30 Speaker_03
Microsoft suspected that justice had somehow prevailed on Jackson to amend his earlier court ruling. Jackson categorically denied this, but does not recall exactly why he issued the October 9th ruling.

01:11:43 Speaker_03
They groused, but only in the most unguarded private moments because they were terrified of offending him, that Jackson was biased and would rule in favor of the government.

01:11:53 Speaker_03
So your question of how does it hold up, I guess there was no formal challenge of that change in rule. And part of it probably was just because they realized they had a long way to go with the judge and didn't want to agitate too much.

01:12:07 Speaker_00
Wow. Interesting. It also sounds like maybe they didn't realize yet how disastrous these tapes getting out was going to be for Bill and for the company. Yeah, I think that's right. Hmm. Interesting.

01:12:23 Speaker_00
Okay, all of this starts to culminate in November 1999, these trials take forever, when Judge Jackson issues a finding of fact that Microsoft is indeed a monopoly in the operating systems business. Now remember, it's okay to be a monopoly,

01:12:43 Speaker_00
It's not okay to abuse the power, but simply the fact that the judge has now issued his opinion that it is a monopoly, everybody knows this probably means the other shoe is about to drop.

01:12:57 Speaker_03
And more specifically, the finding was that the network effects from the large installed base

01:13:04 Speaker_03
so that's users, and large body of applications, so apps, makes it prohibitively expensive for a competitor to develop its PC operating system into an acceptable substitute for Windows.

01:13:16 Speaker_03
Which, yeah, of course, obviously, that's what our whole episode one was about. Correct. Right. So the finding of fact is, hey, it's monopoly, but again, not necessarily illegal to be a monopoly, only illegal to abuse monopoly power. Right.

01:13:33 Speaker_00
So a couple months go by after the finding of fact, and then on June 7, 2000, Judge Jackson issues the final judgment in the case, and he rules that Microsoft did indeed abuse its monopoly power.

01:13:51 Speaker_00
And as a remedy for having done so, he orders that Microsoft be broken up.

01:13:59 Speaker_00
into at least two separate companies, separate operating system company and a separate applications company, just like the Standard Oil breakup order, however many years it was before, 90, I think.

01:14:15 Speaker_03
Also, what? This is completely lost to history, unless you are a tech old timer. Microsoft was ordered, that was the ruling by the court, to split up.

01:14:27 Speaker_00
Yes. It wasn't just that, oh, Microsoft lost the DOJ case. No, the ruling was Microsoft will be split up by order of the United States government.

01:14:40 Speaker_03
And there's a whole bunch of additional provisions in this. Steve Ballmer had to work at one company and Bill Gates had to work at the other. They could not work at the same company.

01:14:48 Speaker_03
Each of those two, after they picked their companies, had to divest all of their shares from the one that was not their employer. So they couldn't have this conflict of interest. It is crazy imagining this world that could have been.

01:15:02 Speaker_03
I mean, clearly this didn't happen, but for a moment in time, this was the position of the United States government.

01:15:08 Speaker_00
It's totally wild. I mean, can you imagine if there was like the Gates company and the Ballmer company? I mean, sort of, as we're going to talk about in the rest of this episode, that is what happened, but in a very different way.

01:15:21 Speaker_03
It's also worth pointing out from late 1999, when the findings of fact came out, over the next 12 months, Microsoft's market cap dropped from $600 billion to $270 billion, which was a 55% drop.

01:15:36 Speaker_03
Now, this coincided with the dotcom bubble and the CEO change that we're going to talk about shortly. But the perception of Microsoft, this super high flyer, completely fell off a cliff from this ruling.

01:15:48 Speaker_00
Imagine if a ruling comes out tomorrow that Apple needs to be broken up and iOS needs to be separated from the devices and you need to be able to buy a phone without iOS. What do you think that's going to do to the company's market cap?

01:16:02 Speaker_03
Yeah, not exactly the same thing, of course, because this is not about devices.

01:16:06 Speaker_00
Well, right. But I'm just I'm making a similar type of scale analogy. Right. Like what the impact would be.

01:16:13 Speaker_03
Yes. So do you know the technicality that was discovered?

01:16:17 Speaker_00
No, I don't. I know that Microsoft immediately appeals.

01:16:20 Speaker_03
Of course. It was discovered later in June 2000 that Judge Jackson had secretly been meeting with reporters in his chambers before the rulings were delivered. It's not allowed. And so Judge Jackson was removed from the case. Yes.

01:16:34 Speaker_03
The reporters all had these embargoed stories they could drop immediately afterwards. And everyone was like, how did you, what? Wow. That's wild. Yeah. What a freaking crazy escapade here.

01:16:47 Speaker_00
Like there's no other way to put it.

01:16:49 Speaker_03
So this is June of 2000, by the way. The appeal then takes a long time. So there's a meaningful moment in history, I think about 15, 16 months, where the official ruling is Microsoft should be going through the preparations to do their breakup.

01:17:07 Speaker_00
That is what the world believes, as far as anyone knows. So, the appeals court removes Judge Jackson from the case. They install a new judge to re-adjudicate the matter. She gets up to speed. We're now in the year 2001.

01:17:23 Speaker_00
She starts pushing the parties toward a settlement.

01:17:27 Speaker_03
Especially 9-11 happens, and then I think that's a galvanizing factor to pull the parties into the room and say, hey, this has gone on too long, and we need to put this behind us.

01:17:37 Speaker_00
Also, there was a political administration change from the Clinton administration to the Bush administration.

01:17:43 Speaker_03
Yep.

01:17:44 Speaker_00
So then, in November 2001, just a couple weeks after the Windows XP launch, the DOJ and Microsoft finally completely settled the case.

01:17:55 Speaker_03
Also, can we just say, this case is brought against Windows 95, Windows 98 comes out, and then before we have a resolution, Windows XP comes out.

01:18:04 Speaker_00
Windows 98, you mean the marketing update to sell back-to-school PCs? Yes.

01:18:11 Speaker_03
But like, insane, right? And the whole time, Internet Explorer shipping with Windows.

01:18:17 Speaker_00
Right, the whole time.

01:18:18 Speaker_03
So November 2, 2001, the settlement is proposed. At this moment in time, Internet Explorer has right around 90% market share.

01:18:27 Speaker_00
Right. If you are in the camp of Microsoft was a monopoly, was abusing its monopoly power, you're like, well, this was a complete failure of process because the damage is done, right? Yeah.

01:18:38 Speaker_00
Meanwhile, also, if you're in the Microsoft camp of what the hell is our government doing? You're also like, what the hell? Nobody is happy here.

01:18:47 Speaker_03
Right. An innovative company that built the most important product for that technology phase. Meanwhile, there's this whole new thing going on with the Internet. And like, we need to figure out how to legally navigate that transition.

01:19:01 Speaker_00
Right. Yeah. We have enough existential threat to our business from technology trends happening. Yeah. To try and navigate that with our hands tied behind our back because of these legal proceedings. Like, come on.

01:19:14 Speaker_03
Right. So 2002, the settlement is finally approved. It reverses the order to be split up. Obviously, Microsoft is still one company. Officially, the ruling that Microsoft did indeed have a monopoly is upheld. They put in place a five-year consent decree.

01:19:34 Speaker_03
And the terms are that Microsoft is not allowed to enter into contracts with PC makers that excluded competitors. I mean, fine. Two, Windows had to be interoperable with non-Microsoft software, which of course it does.

01:19:50 Speaker_00
It always was. Yeah.

01:19:52 Speaker_03
It's a developer platform. They have to write API documentation and make their APIs such that developers can build applications on top of them. That is the purpose of the company. So, okay.

01:20:05 Speaker_03
Three, an independent technical committee was created to field complaints from competitors. Okay. They created a call line. That is it.

01:20:16 Speaker_00
Wow. That's it.

01:20:17 Speaker_03
Am I missing something, David? That's my understanding of what it is.

01:20:20 Speaker_00
Yeah, I don't know. I don't have anything else. But, okay, that is the letter of the resolution here. The actual cost of this was immense. Nothing could have been bigger.

01:20:36 Speaker_00
I mean, we spent the whole first section of this episode talking about how Microsoft was so powerful, had never been more powerful, and there probably never will be a more powerful company than Microsoft in the late 1990s. This is what destroyed it.

01:20:53 Speaker_03
Oh, that is a take right there. I think that we will debate at the end of the episode.

01:20:56 Speaker_00
Oh, well, the back half of the episode is about the incredible story about how Microsoft rebuilt itself in a completely new market into, now again, the most valuable company in the world.

01:21:09 Speaker_00
But let's just talk about what the actual cost was, not in terms of money. It certainly didn't actually impact Internet Explorer or Windows.

01:21:18 Speaker_00
XP was a huge success, sells over half a billion copies, gets used over its lifetime on probably a billion PCs, it unifies Windows under the NT architecture, has the Bliss wallpaper, amazing.

01:21:30 Speaker_00
But the true cost is what it did culturally and emotionally to Microsoft. I mean, we talked to all these people and God, it was like death being there.

01:21:41 Speaker_00
I mean, to believe for 16 months that the company was going to be broken up for Bill to have this really embarrassing video of him all over the press and to have the narrative change about Bill, change about the company, change about for every employee working at the company to like, oh, you're the best and brightest in America to you guys are evil.

01:22:01 Speaker_00
And why are you working at this company?

01:22:03 Speaker_03
Yet, it exposes the difference, too, in the legal strategy of both sides, where Microsoft's strategy was to refute, point by point, every allegation brought against them, to the point where they were trying to refute Netscape.

01:22:18 Speaker_03
We don't view Netscape as an existential threat to us. And they should have just probably acknowledged, you know, Bill literally wrote a letter that got published, a memo saying that Netscape is a competitive threat born on the internet.

01:22:31 Speaker_03
But they wanted to refute every single point and not give an inch.

01:22:34 Speaker_03
Meanwhile, all David Boies and the DOJ wanted to do was destroy Microsoft's credibility so that every time they brought a witness, there were emails or there was a deposition that basically called into question.

01:22:46 Speaker_03
Are they really telling the truth on the stand? Can they really not remember that? And it just, blow by blow, made Microsoft look like they were duplicitous. And that has to leak into the company culture.

01:22:57 Speaker_03
That has to make you, on the one hand, feel like your government is attacking you, but on the other hand, start to question and say, why did we do this again? I thought we were just trying to make the best software.

01:23:07 Speaker_03
Were we trying to do something illegal and I just didn't know about it?

01:23:10 Speaker_02
Right.

01:23:11 Speaker_03
It's worth talking about some of the other pieces of fallout. It did slow Microsoft down. There were huge amounts of protocol documentation that needed to happen.

01:23:20 Speaker_03
So if anyone's running a software company, you know that if your iteration times are slower and you just have permanent new drag on your development process, you are going to fall behind.

01:23:30 Speaker_03
And I think that was one that was felt by a lot of employees and managers who suddenly can do less with the same amount of resources that they have. There was also a bunch of private lawsuits.

01:23:41 Speaker_03
Sun, AOL, Real Networks, Microsoft was paying out billions of dollars in these private settlements that followed the DOJ, their civil suits.

01:23:51 Speaker_00
Not to mention, state attorney generals were also suing Microsoft left and right, and international.

01:23:57 Speaker_03
Many of the state AGs for years who brought the suit together with the DOJ did not accept this reversal. And so they tried to continue independently suing Microsoft, which was painful for another five-ish years.

01:24:11 Speaker_03
We made it all the way to 2009 before they settled their EU version of this antitrust case. I mean, that's another, what, seven years after the reversal. And in May 2011, that is when the final consent decree finally expired.

01:24:31 Speaker_03
So basically, from 1990 until 2011, 21 years of the company's life, the majority of the company's life had been spent under some sort of antitrust scrutiny or active litigation.

01:24:45 Speaker_00
Wow. And obviously, the company thrived through much, you know, if not all of that.

01:24:52 Speaker_03
But were consumers ever harmed? I continue to wonder this. It was horrible for Microsoft, even though there weren't any real material changes they had to make.

01:25:01 Speaker_03
But effectively, they won, which I guess they should have, because it's not clear that there was negative impact to consumers. There was all kinds of negative impact to existing competitors or future potential competitors.

01:25:14 Speaker_03
But that is not the US standard for antitrust law, especially at this point in history. I guess the right answer is the right thing happened eventually, but it was awful to get there. And it had all sorts of indirect negative impact on the company.

01:25:34 Speaker_00
So, I said a minute ago, I think it killed Microsoft's immense, dominant consumer technology power. And the biggest reason I say that We didn't talk to Bill Gates as we were preparing for this, but is what this whole thing clearly did to Bill Gates.

01:25:54 Speaker_00
Yeah.

01:25:55 Speaker_03
Yeah, Microsoft had one competitive advantage that no other company had, and that was Bill Gates.

01:26:00 Speaker_00
And for whatever sets of reasons, I mean, I can imagine so many thinking about, like, if I were in that seat going through that, Bill at Microsoft was never the same person after this.

01:26:12 Speaker_03
In fact, Bill stepped down before the final ruling from Judge Jackson.

01:26:18 Speaker_00
Yeah. So in July 98, right as this big, huge DOJ antitrust suit is heating up, Steve Ballmer gets promoted to president of the company. Bill is still CEO, but Steve is now promoted to president and is the clear number two.

01:26:32 Speaker_00
And then they go through the trial, the deposition, the November 99 finding of fact that Microsoft is a monopoly.

01:26:40 Speaker_00
And then Ben, as you're referring to, on January 13th, 2000, Bill Gates announces that he is handing the CEO role of Microsoft over to Steve and that he is moving to a newly created position as chief software architect.

01:26:56 Speaker_00
And he will remain chairman of the company, but he is no longer going to be CEO. And then, of course, it's just a few months later that the breakup verdict comes down.

01:27:07 Speaker_03
Yeah. Going through something like this has to feel personal and has to change you forever. I can't imagine how it wouldn't. Totally. Especially when, again, it's not clear to me how consumers were harmed.

01:27:20 Speaker_03
So this constant battle, this war that was waged on forever and ever and ever and ever, It totally distracted Microsoft.

01:27:29 Speaker_03
And as anybody can attest, especially in the tech industry, if you are distracted, you just fail because you need to have all of your best resources making stuff, building stuff focused on a firing on all cylinders, clear North Star strategy.

01:27:43 Speaker_03
And so if you tie up a company for five years and you lose your leader through it.

01:27:48 Speaker_00
I mean, somebody we talked to characterized this period as like a mental breakdown for the whole company. And I think that's kind of the best way to characterize it.

01:27:57 Speaker_03
Yeah. It's not fair to blame everything we're about to talk about all the future consumer failings on this, but it is helpful to keep this in mind and say, okay, why perhaps did they not fully have their wits about them?

01:28:11 Speaker_00
Yes. And so the transition to Steve Ballmer happens. This is the context under which Steve Ballmer became the CEO of Microsoft.

01:28:22 Speaker_00
So I talked to a whole bunch of people who are at Microsoft in this era, and one thing that every single person brought up that never gets talked about is how much Steve was the emotional rock for the company when this was happening.

01:28:42 Speaker_00
All the stuff, everybody thinks about Steve, you know, the running around on stage, the yelling, the screaming. Developers, developers, developers. When do you think all this happened? The crazy dancing on stage. I love this company.

01:28:57 Speaker_00
That was in September of 2000. when they thought they were going to get broken up. And Steve was there trying to keep everybody moving forward. Everybody we talked to was like, I don't know how he did it, and it meant so much.

01:29:12 Speaker_03
It's actually shocking they held on to as much talent as they did in a 15-month period of people assuming the company was about to be split.

01:29:20 Speaker_00
Right? Knowing that context, for me at least, it completely changed my perception of Steve and of the company during this time. Fascinating. So when Steve takes over, his agenda is three things, and I think in basically priority order.

01:29:37 Speaker_00
Number one, hold the company together emotionally. I love this company. That was job number one, to keep everybody coming to work. Job number two, clean up this antitrust mess.

01:29:51 Speaker_00
And then job number three, I think, was, hey, let's keep this company growing and winning. And I think it's kind of fair to say he did all three. So we just talked about, one, emotionally holding the company together.

01:30:03 Speaker_00
Two, one of the very first things Steve does when he becomes CEO is he promotes Brad Smith to general counsel, who Brad Smith is still, of course, leading all this at Microsoft to this day. He's now president. And Steve tells Brad, go make peace.

01:30:20 Speaker_00
So actually, this is amazing. Brad's final interview with the Microsoft board of directors.

01:30:28 Speaker_03
Oh, I was wondering if you found this.

01:30:30 Speaker_00
Yep. For his job, you know, to be promoted to general counsel, his PowerPoint presentation to the board is just one slide. that has one sentence on it. It's time to make peace. And that is totally what he goes and does.

01:30:45 Speaker_00
And he says, okay, I'm going to figure out what settlements we can live with, and I'm going to go settle everything. And this company just needs to move forward. And it doesn't matter that we all feel it wasn't fair.

01:30:59 Speaker_00
It doesn't matter that we all feel this was a sham of a process. We just have to move on and we have to live in a new reality.

01:31:06 Speaker_03
And you kind of need a new set of people to do that. It's kind of amazing that Steve was part of the old guard and the new guard to do this, because how can you say, I'm going to put how unfair I feel this was aside and just focus on moving forward.

01:31:21 Speaker_03
That is an extremely difficult compartmentalization exercise.

01:31:24 Speaker_03
And so for Brad to come in and say, like, I'm going to be the guy who is able to disregard the past and figure out how we, and I use this phrase in the first episode, become a trusted partner to governments around the free world.

01:31:36 Speaker_03
I mean, how crazy is it that this Microsoft that we just talked about for the last hour became the Microsoft that can do no wrong from a regulatory perspective.

01:31:48 Speaker_03
The only one that's not under active antitrust investigation today by the federal government. The one that is a massive provider of software and services to the U.S. and its allies at the government level.

01:32:00 Speaker_00
Right. The reversal here is it doesn't get talked about enough what an amazing job Brad and the company did to reverse this perception.

01:32:11 Speaker_00
So then that leaves job number three on Steve's agenda of be successful, continue to have Microsoft be a leading technology company and hopefully still grow revenue and profits.

01:32:21 Speaker_03
And Bill Gates is still chairman of the board. Like, not only is he a full time employee being the chief software architect,

01:32:26 Speaker_03
It's not that it's like a sham that he's not the CEO, but he is a very present voice at the table in these big decision-making moments.

01:32:37 Speaker_03
And so for how do we become a company that continues to innovate and make great products despite all this, he still has Bill as the technical leader of the future products.

01:32:48 Speaker_00
Yes. And absolutely Bill was still there and Steve had Bill and they were running the company together. Absolutely.

01:32:55 Speaker_00
But what's so interesting is Microsoft, right at this time, basically starts a transformational journey from a technology company writ large, a consumer and sort of enterprise technology company, to the enterprise technology company.

01:33:11 Speaker_00
And that is a muscle that, as we talked about last episode, Steve had been building for a while, but boy, does he really come into his own here. And Microsoft, the entire enterprise juggernaut that it builds, The bulk of it really is post-DOJ.

01:33:27 Speaker_00
It is like new business and new markets that they are getting into. Yep.

01:33:31 Speaker_03
So then the question becomes, how did Microsoft build this phenomenal enterprise business? And along with that, release XP, the most successful Windows operating system ever.

01:33:44 Speaker_03
And then we're gonna talk about Vista, and then we're gonna talk about Zoom and Search and Bing and Windows Mobile and Windows 8 and yeah, all that.

01:33:52 Speaker_03
But before we do, we would like to thank huge partners of ours here in this season of Acquired ServiceNow.

01:34:00 Speaker_00
Yep, ServiceNow is the AI platform for business transformation, helping automate processes, improve service delivery, and increase efficiency.

01:34:08 Speaker_00
Over 85% of the Fortune 500 runs on them, and over the past few years, they've joined companies like Microsoft as one of the most important enterprise technology vendors in the world.

01:34:18 Speaker_03
And speaking of Microsoft and ServiceNow, they just announced a huge expansion of their partnership, specifically integrating the two companies' enterprise AI assistants.

01:34:27 Speaker_03
Starting in the fall, customers will be able to interact with ServiceNow's Now Assist, AI assistant directly within Microsoft Copilot.

01:34:34 Speaker_00
Yeah, it's telling for the magnitude of this partnership to see Satya Nadella appearing in the keynote at ServiceNow's big annual event, Knowledge, last month. It had echoes of that Bill Gates 1997 Macworld video that put Apple back on the map.

01:34:49 Speaker_00
Not that ServiceNow needed putting back on the map.

01:34:52 Speaker_03
Yes, and like that historic announcement from Bill committing to Microsoft Office for the Mac, this partnership is also huge.

01:34:59 Speaker_03
ServiceNow's Now Assist will be integrated with Microsoft Copilot and will be available directly from Office apps starting with Microsoft Teams in August. the AIs are integrated into one seamless user experience without actually sharing data.

01:35:14 Speaker_03
So if, for example, a user asks Copilot in Teams about how the company's laptop policy works, behind the scenes, Copilot shares that request and context with NowAssist, and NowAssist accesses internal company policy with the right permissions for that user and returns the answer to Copilot in a rich card with options for the user to kick off a workflow via NowAssist.

01:35:38 Speaker_03
In the future, Microsoft Copilot will also be integrated the other way into NowAssist so it can automatically generate Office files like PowerPoint presentations and Excel spreadsheets directly from assets and knowledge in the ServiceNow platform.

01:35:51 Speaker_00
It's pretty awesome for both companies and especially awesome for enterprise users. So if you want to learn more about the ServiceNow platform and how it can work with your company's Microsoft services, go over to servicenow.com slash acquired.

01:36:04 Speaker_00
And when you get in touch, just tell them that Ben and David sent you.

01:36:08 Speaker_03
All right, so to contextualize how this enterprise business was built, it is worth understanding the shape of Microsoft's business, like the divisions, what products generated what revenue, even before all this DOJ stuff.

01:36:20 Speaker_03
So if we go back to 1996, Bill Gates gave a great interview where he was talking about the kind of four businesses that they're in today.

01:36:29 Speaker_00
Oh, this is the Wired interview with Kevin Kelly, right?

01:36:31 Speaker_03
Uh-huh. Yes, it's on YouTube. It's great. It is great. So there's Windows, which he calls one business. There's NT slash Backoffice. There's Office, which he calls a $4 billion a year business. And those three businesses together are over 90%.

01:36:48 Speaker_03
So you can think about it as Windows. And he said NT slash Backoffice. But this is the enterprise in Office.

01:36:53 Speaker_00
Yeah. which is so funny that Bill thought of it as NT slash back office.

01:36:57 Speaker_03
It really exposes that Steve was the one who had the passion for the enterprise. Bill was like, it's like this stuff that businesses buy, but I'm going to refer to it by its Microsoft product name of one of the products we sell, which is NT.

01:37:11 Speaker_03
And then the last 10% is everything else. So there's MSN, e-commerce, games, encyclopedia, maps, joint ventures, DreamWorks, and NBC.

01:37:21 Speaker_03
So he's talking about the interesting thing, the server business, which is a different way he refers to NT slash back office all the way back in 96. It's the fastest growing business, even faster than windows or office.

01:37:33 Speaker_03
So they sort of know they're onto something, but they haven't quite cracked the go to market motion, the pricing, the service organizationally, how do they sort of fit it in? That all comes later.

01:37:48 Speaker_00
Or the products either, really.

01:37:50 Speaker_03
Yes. That's a great point.

01:37:51 Speaker_00
The fact that he calls it back office, this is so telling. Okay, so we did talk last time about NT and Dave Cutler and the heroics that he performed to write NT.

01:38:03 Speaker_00
Windows NT, though, was still a client operating system architecture for a user to use a personal computer with.

01:38:13 Speaker_03
NT basically was enterprise ready. It was like very networked for work groups. It ran on only the most high power PCs, but you're right, David. It was designed for the thing that, you know, the first 25 years of Microsoft was all about, which is PCs.

01:38:31 Speaker_03
It's not like, oh, we're a systems company that makes stuff for all use cases all over your enterprise. It's no, we make stuff that runs on a box sitting in front of you.

01:38:43 Speaker_00
Yes. And discovering this distinction is what Microsoft in this next era really, really nailed. And they discovered that the enterprise is not about users. It's about IT and it's about systems. For better or for worse. Yes.

01:39:06 Speaker_00
And discovering that and the products and the sales motions that Microsoft could then go use to sell to enterprise IT and sell systems.

01:39:17 Speaker_00
was a new, you know, multi-hundred billion dollar market that Microsoft could now go attack and play offense in, in this post-DOJ landscape, whereas they're playing defense everywhere else. Hey, here, our market share is zero.

01:39:31 Speaker_00
We can do whatever we want here.

01:39:32 Speaker_03
Well, it wasn't zero, but They were fighting Sun, IBM, Oracle.

01:39:38 Speaker_00
Yes, really IBM. But Sun, yeah, too. Oracle, et cetera. And it was perfectly suited to Steve's strengths. So, Ben, if you've ever heard of these now sort of strange-sounding Microsoft products, SQL Server.

01:39:53 Speaker_00
Active Directory, Exchange, Dynamics, SharePoint. SharePoint was technically within Office, but it is one of these systems types products.

01:40:02 Speaker_00
These are all, every single one of those names I just mentioned, become multi-billion dollar revenue enterprise IT server products. that are built and sold during the Steve Ballmer era of Microsoft.

01:40:17 Speaker_00
And what's so honestly beautiful about this is they work in concert with Windows and Office on the PC client side. So this is the client-server era that Microsoft really dominates here.

01:40:34 Speaker_00
Microsoft within enterprises, all these new server products work best with Windows operating system devices running Microsoft Office applications on them.

01:40:48 Speaker_00
And those Windows operating system devices and those Office applications work best with the Microsoft server products. You now have a full system solution from one technology vendor as a major enterprise.

01:41:04 Speaker_00
It's like the most incredible three-sided technology flywheel ever built.

01:41:09 Speaker_03
And one benefit from this, which of course, if you're Microsoft, you don't want to lean on this benefit, but they end up doing it, is if you make everything integrated together, work well, and come from one vendor, nothing actually has to be best of breed.

01:41:25 Speaker_03
And so you're no longer competing with any point solutions. You offer the whole thing. Sure, yeah, you can consider going and buying that other vendor's directory service or that other vendor's email server. But are you really?

01:41:38 Speaker_03
Because you buy everything from us and it all works pretty well together.

01:41:42 Speaker_00
The very, very, very best example of this that most listeners can probably tangibly relate to as well is Exchange email and calendaring service and Microsoft Outlook and Windows.

01:41:57 Speaker_03
It all has Active Directory that syncs across everything. In doing all this research, it seemed to me that once a enterprise adopted Active Directory,

01:42:10 Speaker_03
they were going to tip and they were going to buy the rest of the software, too, because whoever manages the source of truth for who are all the people and what are all the resources, you know, devices and everything that my company owns, everything else needs to reference that canonical set of proper nouns, whether it's email, whether it's calendar.

01:42:28 Speaker_03
So that was this incredible sticky product that then you could just keep attaching more and more stuff to any enterprise need. Oh, we got you covered. And hey, it works with Active Directory.

01:42:38 Speaker_00
up and the whole product effort here started with database. In 1998, Microsoft takes SQL Server and it was the first real enterprise-ready database that can rival IBM and mainframe databases, Oracle databases, and of course, unlike IBM,

01:43:01 Speaker_00
It runs on x86 Intel architecture. So the pitch now to enterprise IT is everything we just said about why working with Microsoft Server products is better for the whole ecosystem reasons. Also, total cost of ownership.

01:43:17 Speaker_00
Don't pay IBM tons of money for their mainframes. Just go buy cheap x86 Windows boxes from Dell or whomever, and use that as your IT server architecture.

01:43:29 Speaker_03
Fascinating. I don't think I quite understood that. And so basically, you then have NT as the operating system, SQL as the database, and then you've got all these other applications that basically run on that stack.

01:43:41 Speaker_00
here's where exchange and outlook and everything comes in this is right as email is taking off as like the killer application in enterprises and so now microsoft shows up and says we've got this great new product for you it's called exchange and like maybe you were using lotus notes before which of course

01:44:02 Speaker_00
developed by the legendary Ray Ozzie. He's going to come back up here in a minute. Lotus gets acquired by IBM for $3.5 billion in 1995. You're buying Lotus Notes from IBM. Come take a look at Exchange. Exchange has email. Exchange has calendaring.

01:44:21 Speaker_00
Exchange has address book. Exchange has Outlook.

01:44:26 Speaker_00
It is a first-class, included in the bundle of Microsoft Office, Office application that you, you know, Mr. and Mrs. Enterprise are now gonna get for all your users, and it works just beautifully and perfectly with our Exchange email calendaring and address book service.

01:44:45 Speaker_00
It sells itself, basically. And then you were talking about Active Directory. That led to Active Directory. Oh, okay. Well, now you've got your whole database architecture running on Microsoft.

01:45:00 Speaker_00
You've got your email and your calendaring architecture running on Microsoft. You've got your Windows machines out there.

01:45:07 Speaker_00
Well, you've got all these employees within your company, all these users with all these devices, you kind of need to manage them and you need to know who has what security access and how to find each other and where should the mail get routed and all that.

01:45:21 Speaker_00
Well, we've got this great new product for you. It's called Active Directory.

01:45:24 Speaker_03
Yeah, it's pretty incredible. That's all on the sort of why it's good for customers. On the why it's good for Microsoft, Steve also pioneered this bundling idea, which is once you sign the enterprise agreement, you get access to all of this.

01:45:42 Speaker_03
And if you're a customer that's only using 30% of the things in the bundle, if you have business needs that involve some Microsoft product that comes for free in your bundle, you're going to adopt that. And guess what?

01:45:54 Speaker_03
You just became a stickier Microsoft customer. I feel like this often goes overlooked in the like, oh, Microsoft's a big, boring enterprise company right now.

01:46:03 Speaker_03
There was a tremendous amount of business model innovation in figuring out that bundling like that with additional products can create stickiness, which eventually creates more enterprise value for your company because you've got these long, durable, compounding revenue streams.

01:46:19 Speaker_03
Oh, and all your customers are growing, so you have the whole land and expand thing there. And the thing underpinning it all is the software itself has zero marginal costs.

01:46:28 Speaker_03
So you can bundle in all this stuff for free because it actually doesn't cost you anything.

01:46:33 Speaker_00
I know it's enterprise software, so it's not as sexy or exciting or thought about as much as consumer software.

01:46:38 Speaker_00
But truly, the innovation that was happening here was among the most that has ever happened at a technology company because Microsoft was figuring all this out. Again, these were not lessons that people knew.

01:46:52 Speaker_00
In the IBM era that came before this, in the enterprise, there were no users. Microsoft is now figuring out how to build and sell enterprise technology systems in this new era to businesses where there are users of the technology.

01:47:08 Speaker_00
And on the business side, yeah, what you just said, like, this is crazy. Microsoft said, okay, we're not going to just sell you the software.

01:47:17 Speaker_00
We're going to introduce this thing called an enterprise agreement where you, based on the size of your company, will pay us a certain dollar amount per year per employee. Actually, I think it was per device.

01:47:29 Speaker_00
But in these days, it was like, you know, most employees just had one device. And we've got you covered everything that you would want access to in our whole suite of software products, inclusive of Windows and Office.

01:47:45 Speaker_03
I mean, it's not just, you know, a salesman comes to you and sells you Windows. This is Microsoft amortizing their go to market costs across all of their products, because when you show up at an enterprise, you've got lots of stuff to sell them.

01:47:58 Speaker_00
Yep. So now Microsoft has turned a one-time sale of software into an annual annuity that is going to keep growing every year and is going to grow with headcount.

01:48:09 Speaker_03
And a key feature of the EA is that it is a three-year agreement, which means that you really need everything to be aligned to pull this off. There's something pretty convenient that you may have noticed about Windows and Office.

01:48:23 Speaker_03
They both tend to release an operating system or a new package of Office once every three years or so. And so every customer, no matter when they sign the agreement, is essentially guaranteed one upgrade during their lifetime.

01:48:38 Speaker_00
Totally. Here's something else that you get now as a enterprise IT buyer in the enterprise agreement world with Microsoft. Your needs as IT are actually pretty different than your users. They're actually very different.

01:48:59 Speaker_00
So like if you are an employee of a large company at this time, you are using a Windows PC at your office. What are the set of things that you want from that device? Well, you probably want to be able to procrastinate.

01:49:16 Speaker_00
You might be able to want to play some games. You probably want to poke around the internet, and you definitely want it to be easy to use, and you definitely don't want restrictions on there.

01:49:26 Speaker_03
Yeah, you're willing to make tradeoffs like if you can get a little bit more efficiency, but trade off some security, that's fine. If you can, you know, maybe use some pirated software, but it makes you better at your job, that's also fine.

01:49:41 Speaker_03
You're acting with your own agency, not necessarily the company's best interests in mind.

01:49:46 Speaker_00
Right. You want to run some VBA macros, you know, etc. Okay, now you are a corporate IT administrator and all of a sudden you have to manage all these rogue agents all over your systems. Rogue agents called your employees.

01:50:03 Speaker_00
You want the ability to restrict your users from doing what they can do. You want to say like, no, you cannot upgrade this software without us doing it. You cannot install anything. You cannot run these macros.

01:50:14 Speaker_00
You cannot visit these websites, et cetera, et cetera, et cetera. And part of that is productivity, but a large part of that, Ben, as you said, is security.

01:50:22 Speaker_03
Yeah. Security, privacy, legal, compliance.

01:50:26 Speaker_00
Am I going to get hacked? Am I going to get sued? Are we going to lose data? Well, Microsoft's got a beautiful solution that they can sell you. And with the enterprise agreement, you can customize all of this and we will give you exactly what you want.

01:50:38 Speaker_03
Yes. But now, David, you're starting to expose a couple features of enterprise adoption which have trade-offs, if you're Microsoft.

01:50:49 Speaker_00
Oh, yes. Oh, yes, they do.

01:50:51 Speaker_03
First of all, if you are a user, you want the latest and greatest software with all the most innovative features. Your IT administrator has a lot of incentive to say, I don't really want to go train everyone on anything new.

01:51:06 Speaker_03
So if the software never confused anyone, that's a win, even if it means we never get any new features.

01:51:14 Speaker_03
And so suddenly, and I have a direct quote from someone who is an executive in office, told me, when I was in office, I always thought we could stop bundling new features for 10 years and it would be fine. No one would notice.

01:51:27 Speaker_00
I think people would probably pay more for it.

01:51:30 Speaker_03
Office got to this point where, and I think Stephen Sonosky even writes about this in Hardcore Software in his book and on his sub stack, that at some point they were trying to ship features that the PMs thought were great and users would love.

01:51:40 Speaker_03
They would do this user research, they would hear that people want them, and then the Salesforce would run back to them and say, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no, no,

01:51:48 Speaker_03
Do not include that. Are you kidding me?

01:51:50 Speaker_03
I'm gonna have all these objections in my sale If you make me take this new feature or take this ribbon or take this, you know Any big UI change everything has to be small and iterative and not add any training or confusion

01:52:06 Speaker_00
I joined the corporate workforce in 2007 when I graduated from college and I was an investment banking analyst on Wall Street at UBS. I started mid-summer 2007 and our corporate IT systems, my Windows laptop was so locked down.

01:52:25 Speaker_00
We were using XP, of course.

01:52:27 Speaker_03
In 2007, you were using XP.

01:52:29 Speaker_00
Yes, we were using Office 2003, of course. And like over everyone's dead bodies, would any of that change? Everything was firewalled. We could not access, we couldn't install anything. We couldn't access tons of websites.

01:52:44 Speaker_00
I remember when I first started, we could still access miniclip.com. And so the analysts were playing tons of games that like pretty quickly IT caught on and you know, that got the kibosh. So.

01:52:57 Speaker_00
Yeah, and I'm sure UBS as a customer loved every single bit of that.

01:53:02 Speaker_03
The other big thing that you are talking about, which you were hinting at with VBA macros, the key to enterprise is backward compatibility. Saying, look, we don't necessarily need to promise you anything too groundbreaking.

01:53:16 Speaker_03
We need to meet your needs today and be the most cost efficient, you know, total cost of ownership driven system that meets your needs and your employees are fine with. And from here on out, everything's going to stay compatible.

01:53:31 Speaker_03
Any modifications you make enterprise or software you use and rely on, we won't break no matter what.

01:53:39 Speaker_00
And we will continue to support those versions you are using.

01:53:41 Speaker_03
Yes. And enterprises love that.

01:53:45 Speaker_03
And we're going to put a pin in this right now and we're going to bring it back toward the end of this episode in a really illustrative way that it can deeply, deeply hold you back if you are Microsoft and you have built an entire brand and reputation around your backwards compatibility.

01:54:00 Speaker_00
Yep, one stat and then one point I wanna make to highlight all this.

01:54:06 Speaker_00
By 2007, analysts estimated that 40%, four zero, of all of Microsoft's revenue, which I think was about $51 billion that year, so 40% of $51 billion came from multi-year enterprise agreements.

01:54:25 Speaker_00
So these three-year agreements that you're talking about, Ben, And that covered Windows, that covered Office, that covered all the products that Microsoft offered, except like Xbox. 40% of all dollars were flowing from multi-year EAs.

01:54:38 Speaker_00
And then another 15% of all dollars that Microsoft was earning as revenue were flowing from single-year EAs.

01:54:48 Speaker_03
Wow. So more than half the company's revenue. Yes.

01:54:53 Speaker_00
more than half the company's revenue is all from this.

01:54:58 Speaker_03
By 2007. So I mean, it was really the first seven years of Steve's tenure as CEO. Yes. Already tipped the balance into majority.

01:55:07 Speaker_00
And the vast, vast majority of the rest of Microsoft revenues, you know, the other 45% of the company was the OEM Windows business. That was 30%. So if you look at Microsoft revenue in fiscal 2007, 55% is this new enterprise motion.

01:55:24 Speaker_00
30% is the old Windows business, you know, Dell and Lenovo and whoever, like, you know, selling laptops to consumers and paying Microsoft for the operating system.

01:55:35 Speaker_02
Yep.

01:55:36 Speaker_00
And only 15% of the company's revenue is anything else.

01:55:41 Speaker_03
Yeah, it's funny. I wasn't going to bring this up here, but since you brought up OEMs, the OEM business model is completely transformational for Microsoft. When they figured out, actually, we shouldn't be just selling software directly to consumers.

01:55:55 Speaker_03
Instead, we should be selling them to the PC maker, and the PC maker should do our distribution. So here's a couple stats. In the 90s, the box software that Microsoft would use to sell Windows Their gross margin on a copy of Windows was 29%.

01:56:10 Speaker_03
Oof, that's not good. They had to print the disk, which had actual real costs, especially on floppies. You had to put it in the box. You had to ship it to the retailer. You had to split profits with the retailer.

01:56:22 Speaker_03
You had to pay the sales and marketing costs. I mean, it's like real material. This is not a zero distribution cost, zero marginal cost business in the box software retail world.

01:56:33 Speaker_03
But when they're selling through an OEM channel, their gross margin was 75% because you just ship the bits to the OS once and then the PC manufacturer takes it from there. Not only is it amazing because you get that 75% versus 29% of gross margin,

01:56:49 Speaker_03
It's also an amazing way to scale because you do a deal with every OEM, you know, as you're going down the line, it's the Visa networks of networks thing. And I think we alluded to this last episode too.

01:57:01 Speaker_03
You just get each of them scaling on their own can accrue to you without you doing additional work to do the scaling yourself.

01:57:08 Speaker_03
And so David, it's interesting, you're talking about how 85% of the business by 2007 was either enterprise sales of the EA or OEM. I mean, they'd basically kicked the can to the curb on that crappy retail box software model.

01:57:22 Speaker_03
And they're just doing the whale hunting with their sales force and doing these enterprise agreements, which of course have great margin structures and the OEMs.

01:57:34 Speaker_00
And our annuities, annual annuities.

01:57:36 Speaker_03
Exactly. Way better business model in every way. They pivoted the whole business to the two best ways to sell software and completely eliminated the bad way to sell software.

01:57:46 Speaker_00
Yes. And one of which they figured out post-DOJ and it became, yeah, by 2007, over half of the revenue of the company, which is crazy.

01:57:54 Speaker_00
Now, Ben, when you said put a pin in a minute ago, and I know we're going to come back to this after all the consumer failures we're about to talk about. There is a downside to this.

01:58:03 Speaker_00
When IT becomes your customer, when you become an enterprise business, the quality of the software, especially the user-facing software, is no longer priority number one. And this wasn't a problem for the company until in 2007 with the iPhone.

01:58:25 Speaker_00
But let's rewind and talk about everything that happened in consumer software at Microsoft until then.

01:58:30 Speaker_03
Yeah. what was going on with Windows releases during that time. And I think through storytelling the Windows releases, we can then understand the state of the company. So, Windows XP. Why was Windows XP such a big deal?

01:58:44 Speaker_03
Well, it was a big deal technologically, it was a big deal for users, and it was a big deal because it's pretty wild that Microsoft, amidst all the antitrust stuff we were just talking about,

01:58:56 Speaker_03
During the 1998 to 1999, the rulings in 2000, the settlement proposal in 2001, they developed and released an operating system amidst all of that.

01:59:09 Speaker_00
And an awesome one.

01:59:10 Speaker_03
Yeah, so what was Windows XP technically? Well, for the previous better part of a decade, they had two parallel development efforts going on. There was Windows NT for the enterprise, and there was Windows 9X.

01:59:29 Speaker_03
you know, Windows 95, Windows 98 for consumers. And both of these had the same API that developers could write their applications for.

01:59:38 Speaker_03
But ultimately, the way they were implemented, the way interoperability worked, compatibility worked, user experience, everything about it was actually completely different, because it was a completely different implementation of those APIs.

01:59:51 Speaker_03
And so the knock against NT was always, well, you need really beefy enterprise grade PCs to run it, and it's not as nice and intuitive. And the knock against the Windows 9x, call it 95, was that, yeah, it looks pretty, but it's not powerful.

02:00:06 Speaker_03
I can't actually do anything. It was like a friendly interface, but not a powerful set of functionality that came with the operating system. And so XP

02:00:17 Speaker_03
did the impossible where they figured out how to take the ease of use of the 9x interface and make it run on top of NT.

02:00:29 Speaker_03
The whole thing is built on the NT kernel and it has the friendly approachable ease of use that you are used to in Windows 95 and 98.

02:00:39 Speaker_00
Amazing.

02:00:39 Speaker_03
Amazing. So the lineage of that nine X code base that came all the way from windows 3.0 or maybe even one or two, I don't know how long code lived, but interface manager, right? Exactly. Is now dead.

02:00:51 Speaker_03
And so you had the NT lineage of, I guess, maybe even you could say it started with OS two, but windows NT windows 2000 and then windows XP. So everybody's running XP. Now there's two additions. There's home and there's professional.

02:01:09 Speaker_00
Gotta get the professional. I always got the professional. Did you? Every time I built a new PC, I gotta go pro. I didn't even know what pro meant. I definitely didn't need pro because I was not a corporate office worker, but gotta go pro.

02:01:20 Speaker_03
It came with all kinds of great stuff. They've got this great slide. It's a fun announcement to watch. The emphasis on digital photography, digital music, digital video, home networking.

02:01:31 Speaker_03
It ushered us into this age of you probably have media that you're using on your computer. Apple famously owned this as a corporate identity with their digital hub strategy.

02:01:41 Speaker_03
But, you know, Windows XP, plenty of people were importing digital photos off their camera to Windows XP. That was a sort of big, exciting use case for it.

02:01:50 Speaker_00
A lot of Napster clients running on Windows XP machines.

02:01:54 Speaker_03
A lot of Napster clients. Yes. So, like I did for every Microsoft Windows release, I went and watched the keynote. The keynote is extremely strange.

02:02:09 Speaker_03
Think about what a Steve Jobs keynote was back in the day, or what a WWDC keynote is like today, or a Google I.O. This keynote opens with a gospel choir singing America the Beautiful.

02:02:24 Speaker_03
and is followed by Bill Gates and Rudy Giuliani walking out on stage together and talking about how bad terrorism is.

02:02:34 Speaker_00
And of course, the thing you need to know about this keynote is the date.

02:02:39 Speaker_03
Yes. So this happens one month after 9-11 in New York City. And it really underscores what a strange time it was in the US.

02:02:49 Speaker_03
If you had this once in three years product release, and it was going to be in New York October of 2001, you probably have this question, should we even do it? Should we make it all about the first responders?

02:03:04 Speaker_03
It grounds the whole thing in a very specific moment in history when you're watching it in a way that no other tech event really ever has been grounded in history before. So a few other things that jump out during the keynote.

02:03:18 Speaker_03
Bill Gates is not the CEO. Steve Ballmer is. And yet, Bill Gates is the one walking out with Rudy Giuliani to kick things off. And that's a strange and somewhat telling element of what Bill's role at the company was.

02:03:33 Speaker_03
Now you could argue he was the public facing figure, he was the founder of the company, it seems very natural. But also, at some point, why isn't the CEO the one doing the keynote? Another thing about Windows XP, there was a new release of Office

02:03:48 Speaker_03
right at the same time as XP. This is a classic Microsoft move. They are able to create great applications available on day one, which makes the OS more valuable.

02:03:59 Speaker_03
And so from the application's perspective, they're able to ensure that they get great market share since they're always adopting the latest and greatest Windows platform right away. So Windows success begets Office success.

02:04:11 Speaker_03
And it's important to remember that. That worked for many, many years. And if you remember back to the last episode, Lotus 1.2.3 and WordPerfect smoked Microsoft in Microsoft's own backyard.

02:04:24 Speaker_03
During the DOS era, Microsoft's productivity apps did not get real adoption in DOS, which is crazy. So when they were making Windows, they basically swore never again.

02:04:34 Speaker_03
They ensured that they were going to be very early with applications on those platforms. And so as Windows took off, Office also got huge market share. And it's smart to remember this lesson and carry it forward for years, maybe a decade.

02:04:47 Speaker_03
But again, they may have been on this strategy a few years too long. Forever, it kind of became gospel at Microsoft. So with Windows goes the company.

02:04:57 Speaker_03
And so you need to do things to make sure that Windows is going to continue to succeed because that is our company's platform and livelihood. It's almost like the old Disney adage. So with animation goes the company.

02:05:10 Speaker_03
And until 2014, Microsoft felt the same way.

02:05:15 Speaker_00
Yep. And yes, that is true for all the traditional reasons in the XP timeframe, the reason it was also true in part one of our Microsoft series.

02:05:26 Speaker_00
It's even more true as Microsoft becomes an enterprise company because Windows is at the heart of the enterprise agreement. The whole value prop of all of our server technologies is they work great with your Windows devices on your network. Right.

02:05:41 Speaker_03
And so there's strong incentives everywhere for Microsoft to ensure that Windows is the standardized platform that everyone wants to have on their PCs. because it kind of makes everything else work.

02:05:56 Speaker_03
And so, of course they're going to release a new version of Office that shows off the latest and greatest of Windows. And I think this XP timeframe is the showcase moment of when that was a great strategy, and we'll contrast that later.

02:06:08 Speaker_00
Yep.

02:06:10 Speaker_03
The other thing to know about this XP timeframe is last episode we talked about the incredible secular growth trend of the PC. That was this crazy tailwind for Microsoft. One of the greatest tailwinds you could ride in business history.

02:06:25 Speaker_03
PC shipments, I believe the stat, David, was that they grew 98% per year over the 11 years between the founding in 1975 and the IPO in 1986. The crazier thing is, even as late as 2001 with Windows XP, they were still riding this tailwind.

02:06:46 Speaker_03
The US household penetration of personal computers, again flashing back pre-IPO, was only 8%. So that whole doubling year over year over year By Microsoft's IPO, they still only got to around 10% of penetrating the US.

02:07:02 Speaker_03
By 1997, 13 years later, it grew to 37%. And after a couple of years of XP being in market, 2003, it had grown to 62%. So I think the craziest stat is actually that last one.

02:07:18 Speaker_03
2003 feels like a modern moment in history, but PCs were still only in 62% of US homes.

02:07:25 Speaker_00
Wow. That's crazy.

02:07:27 Speaker_03
The PC wave is just one of the greatest secular trends in history, particularly if you have a monopoly share of that market. Yup. And they, as defined by the U S government did. Ben define, define for me.

02:07:43 Speaker_03
I mean, there's just no question of as this market grows, are you going to be able to continue to participate in it? It's like, yeah, we basically are a tracker for that market. Like it grows, we grow with it.

02:07:53 Speaker_00
Yep. And now might be a good time. Certain Microsoft fans have probably been listening to this episode and gripping their phones with all their strength. Like, when are you going to talk about Xbox? We're going to talk about Xbox briefly right now.

02:08:07 Speaker_00
We will do a whole nother episode on Xbox someday.

02:08:10 Speaker_03
Maybe David, we'll make your case and then let's talk about it.

02:08:14 Speaker_00
My case is I love my Xbox.

02:08:17 Speaker_03
Well, it's important to know Microsoft didn't start in gaming with the Xbox. Windows 95, they shipped DirectX, that changed the world. They became a real gaming platform.

02:08:28 Speaker_03
Because of that is this unbelievably clever set of APIs that went entirely around Windows. Amazing piece of technology. You put Microsoft on the map and you have the whole rise in PC gaming for the next six years, even before the Xbox.

02:08:41 Speaker_00
yes totally it's funny microsoft is so huge that this is one of the things that kind of gets lost to history but you are absolutely right direct x was so important in that late 90s era for pc gaming you know quake counter-strike everything that happened half-life later that was

02:09:01 Speaker_00
enabled, you know, Doom came before and was really just like the genius of Carmack as a programmer to enable a first-person shooter to happen on a PC hardware without something like DirectX and hardware acceleration.

02:09:15 Speaker_00
But yes, everything that came after that, the birth of the first-person shooter genre, huge story to tell another day, but you're right, that leads into Xbox and Microsoft's entry into the home console. Crazy that happened in November 2001.

02:09:29 Speaker_00
So just like a couple of weeks after the XP launch, it was a big time for Microsoft.

02:09:35 Speaker_03
And how crazy is this? They thought they were getting broken up. Right.

02:09:39 Speaker_00
As they're launching a video game console.

02:09:41 Speaker_03
And this operating system that they've been working toward for like eight years.

02:09:45 Speaker_00
Yeah. This is also part of my argument of Microsoft was such a dominant consumer technology company before DOJ, because even though all this stuff comes out right after, it's the momentum still from before that's carrying Microsoft through to it.

02:10:00 Speaker_03
Yeah. Okay, while we're in Xbox land, should we finish our Xboxiness right now for this episode? Sure. Xbox has become an important part of our world, but not an important part of Microsoft's business. I agree.

02:10:16 Speaker_03
David and I sort of heard people utter things in our research like Xbox has kind of been a lifetime breakeven business or it's never meaningfully contributed to Microsoft. So I tried to figure out as much as I could from financial statements.

02:10:27 Speaker_03
And I got to thank Alex at the Science of Hitting. It's a great sub stack for helping me with this. If you look, there was a division called Entertainment and Devices that was part of their old reporting structure.

02:10:39 Speaker_03
And if you look at the E&D reporting over time, let's start back in 2006. they generated $4 billion in revenue, lost $1.4 billion operating loss. So this is five years after the Xbox has come out, loss-making.

02:10:58 Speaker_03
2008, they do $8 billion in revenue, $400 million in profit. So like even as it's becoming a real business at steady state.

02:11:09 Speaker_00
Yeah, as 360 is, yeah, coming into.

02:11:12 Speaker_03
Teeny margins.

02:11:14 Speaker_00
Yeah, totally.

02:11:15 Speaker_03
2009, $8 billion in revenue, $100 million in operating income. 2010, another $8 billion in revenue, $700 million. This is $700 million to Microsoft. In this time frame, they do call it $20 billion of profit. Yeah. What's 600, you know, 700 million?

02:11:34 Speaker_00
There's a great quote. I'll bring it up again later, but we got to talk to Steve again, to Bomber, as we were preparing for this episode. And he had this amazing quote to us about some of his acquisitions that didn't go well.

02:11:48 Speaker_00
He said, we only lost money. It's funny, but it's such an important point in the context of Microsoft. Money is not the scarce resource. The scarce resource is time and talent and focus.

02:12:00 Speaker_03
Yes, David, that is exactly the right point. Microsoft, since year two or three, has never been capital constrained.

02:12:06 Speaker_03
And Bill Gates says this in an interview, anytime we've thought about making an investment, it's just, do we have enough talented people to pull that off?

02:12:16 Speaker_03
On any given year, I can't deploy all of the dollars available as a CEO, as a capital allocator, because I'm constrained by the amount of smart people we have to pull it off. That is a much different position than most businesses are in. Yes.

02:12:32 Speaker_00
But is absolutely the case, not just for Microsoft, but for all the at scale tech companies these days, the top five market cap companies in the world.

02:12:40 Speaker_03
Yep.

02:12:41 Speaker_00
Money is not the issue.

02:12:43 Speaker_03
Right. In fact, you're making my point for me. If I had to make the case of why Xbox has been somewhat of a folly and perhaps not worthy of a full acquired episode, it would be there was a lot of Microsoft's best people worked on Xbox.

02:12:59 Speaker_03
This is a group of people that went and created Xbox Live that by 2012 had 40 million subscribers. So people who built a core competency of running a big online service.

02:13:11 Speaker_03
I mean, these are some of the best product people, the aesthetics of Xbox from a physical perspective, but also the software. I just think it was a sinkhole of some of Microsoft's best product people. and just hardest working people.

02:13:26 Speaker_03
The culture at Xbox was so hard driving to produce, at least in this point in history, up to the 2010 timeframe, very little in the way of contributing to Microsoft's business, but soaking up a huge amount of the talent.

02:13:41 Speaker_03
Imagine if that sort of product design sensibility was deployed across the rest of Microsoft.

02:13:48 Speaker_00
Yeah, totally. I think Xbox Live is debatable. We'll come back to this with Azure. Yes. Xbox Live was one of the original pioneering internet services, subscription services, across any category of software and technology.

02:14:08 Speaker_00
And the DNA and experience that Microsoft built from that served it extremely well.

02:14:13 Speaker_03
I mean, yes, I think there are two gigantic benefits. Look, the gaming market is massive and important. And if you could try to own one market in the world today, in the world of entertainment, it's gaming.

02:14:25 Speaker_03
I'm just saying Microsoft didn't up until that, at least this point in history. But it's the right market to go after. They were not successful in capturing value from it at this moment in history.

02:14:38 Speaker_03
But you're right, the two big things that they were able to do is build out a core competency of running a big online service, which totally led to Azure, which we'll talk about later.

02:14:49 Speaker_03
And two, it really did make Microsoft relevant with a whole new set of consumers when Microsoft was completely irrelevant in their lives.

02:14:57 Speaker_00
Should we talk about Vista?

02:14:58 Speaker_03
Yes.

02:15:00 Speaker_00
Oh boy.

02:15:01 Speaker_03
So there's a little tale off of XP that'll lead to Vista.

02:15:05 Speaker_00
We got to talk about the codenames too.

02:15:07 Speaker_03
Yes. So the Windows XP codename, David, was what?

02:15:11 Speaker_00
Whistler.

02:15:12 Speaker_03
Of course. Like the beautiful ski mountain real close to Vancouver. A lot of Seattleites go there. It's a favorite of many a Microsoft employee.

02:15:20 Speaker_00
and Blackcomb.

02:15:22 Speaker_03
The ski mountain right next to Whistler is, yes, Blackcomb, which became the name for the theoretical release that they wanted to do, like, just a year or two after Vista. We're gonna follow hot on the heels of that. Oh boy.

02:15:35 Speaker_03
But Blackcomb started becoming pretty technically hairy. So they decided to push the date out. Another reason they had to push the date out was Windows XP for all of its usability and reliability was very insecure.

02:15:49 Speaker_03
And so Microsoft had a whole thing where they thought they were going to spend like three months putting out a service pack.

02:15:54 Speaker_03
they spent the better part of two years iterating on Windows XP to come out with a release that really people at enterprises could trust as no viruses, you know, this is safe to deploy in your enterprise.

02:16:06 Speaker_00
This was Service Pack 2, I think was what ultimately. Yep.

02:16:10 Speaker_03
Windows XP SP2 is the stuff of legend. Like that's the good one. So that pushes Blackcomb's date out.

02:16:17 Speaker_03
And it also ties up a lot of the talent that Microsoft needs to start working on the next generation operating system, which again, they thought was going to be a fast follow.

02:16:26 Speaker_03
For anyone who skied up there, there's this great ski lodge restaurant right between the two mountains called the Longhorn Saloon.

02:16:35 Speaker_00
Yep. Longhorn, baby.

02:16:37 Speaker_03
That sounds like a great name for a modest release to follow XP before we get to the big hard changes that are going to come in Blackcomb.

02:16:47 Speaker_00
David, the look on your face.

02:16:49 Speaker_00
So I remember being like a teenager in high school at this point in time and reading all about Longhorn, Blackcomb, all the stuff on the internet, you know, on these new tech sites, these blogs, being like, this is gonna be amazing.

02:17:05 Speaker_00
I remember downloading like new shells for Windows XP to mimic the Longhorn UI with the sidebar and the clock of the side. Oh, man, what a disaster.

02:17:16 Speaker_03
Well, this was part of the belief behind Longhorn. They wanted to market all the cool stuff they were doing for it through these sort of like developer blogs and fan blogs, even though the product didn't have a ship date yet.

02:17:32 Speaker_03
And so everyone got really well versed in what was coming in Longhorn. And then everyone was kind of sitting on their hands like, where's Longhorn? They've been really telling us about Longhorn in a way that you would never see today.

02:17:46 Speaker_03
No one's dripping out the features of something that is potentially still years away from a release. And ultimately then, years go by. Five years go by.

02:17:58 Speaker_00
Could you imagine if Apple on their developer site, Apple, were just like, hey, here's, you know, iOS 23. Here's all the great new features we're building.

02:18:08 Speaker_03
I mean, the funny thing is they actually kind of did that this year with all the AI features.

02:18:12 Speaker_03
All of those are coming soon over the next year, dot, dot, dot, which I'm not saying that's a bad strategy in the current environment, but it is a different strategy for Apple. Anyway, Longhorn is teased for five years.

02:18:24 Speaker_03
All the David Rosenthal's out there are kind of like, What the heck, Microsoft? I've been excited for all this crazy stuff you're showing me. What's going on? Well, what happened behind the scenes?

02:18:34 Speaker_03
David, what was the initial technical spark that was supposed to be the cornerstone of Longhorn?

02:18:47 Speaker_00
Well, there were three pillars of, I think it was all originally supposed to be Blackcomb, and then they were like, no, no, we're gonna pare it down to Longhorn, but it all ended up getting added back into Longhorn.

02:18:59 Speaker_00
The first of which was called Avalon, and it was a new graphics engine that used direct hardware acceleration.

02:19:06 Speaker_00
So I think the vision for this was kind of like, hey, we're gonna take DirectX and bake it into the operating system and allow the operating system to use GPU hardware acceleration.

02:19:16 Speaker_03
Yeah, that's more or less it. All these code names ended up referring to multiple things because it was emblematic of the organizational disarray inside the Windows development team. But anyway, it sounds great, right?

02:19:29 Speaker_03
We can render all these really great graphics as a part of the operating system because it's GPU accelerated. Who doesn't want better graphics? Of course, right? The thing that ultimately happened is the OEMs were all trying to make netbooks.

02:19:42 Speaker_03
And so they're furious at Microsoft about saying the next new release of Windows, which is five years since Windows XP, they really, really are counting on a new version of Windows to drive PC sales.

02:19:54 Speaker_03
And the one that they're getting requires pretty good GPUs.

02:19:58 Speaker_00
Like a gaming PC.

02:20:00 Speaker_03
Yeah. So it was like a kind of a total miss with what their OEM partners were looking for.

02:20:06 Speaker_03
But if you did buy a nice PC and you did eventually end up with a copy of Windows Vista, this is why you got to see the new... What did they call the... Oh, the Aero interface. Aero, that's right.

02:20:18 Speaker_03
The blue, shiny sort of thing that was like kind of ripping off macOS's Aqua. I mean, call a spade a spade over here.

02:20:27 Speaker_00
We can tell where your true loyalty lies.

02:20:29 Speaker_03
Well, I'm just saying, like, if you run a company where you make all your own hardware and your own software, then it's much easier for you to hardware accelerate all the graphics in the operating system.

02:20:39 Speaker_03
But when you're counting on OEM partners, you need really good communication there.

02:20:43 Speaker_00
Yes. Yeah, that was one. The other one was a new web services framework called Indigo, which I don't know, I did a lot of research and I couldn't figure out what it was supposed to be.

02:20:53 Speaker_00
I think it was kind of a fever dream of like, let's stuff the internet fully into Windows.

02:21:00 Speaker_03
Ultimately, there was a very fundamental architecture shift that just did not pan out.

02:21:05 Speaker_03
If you remember from the last episode, we talked about Chicago, Windows 95, and Cairo, this theoretical thing that never shipped, that was going to be the next generation operating system.

02:21:15 Speaker_03
Well, they basically tried it again, did the same thing again.

02:21:18 Speaker_03
Yeah, I think Bill Gates was a big fan of this vision because it was really technically ambitious, where they had an object oriented file system where the file system could specify data types.

02:21:30 Speaker_03
and then every application would plug directly into the data types that the file system knew about. So there was these sort of standards like a calendar invites a calendar invite and the operating system has its own

02:21:46 Speaker_03
fields for date and time and notes. And that means you're not always traversing directory trees whenever you're trying to search through stuff.

02:21:55 Speaker_03
And also, it meant that the operating system could actually reach into the data within files that were being stored by applications. So it was sort of a standard way of storing files in an easy to search way.

02:22:07 Speaker_00
And what you're talking about here is the third pillar of Longhorn slash Blackcomb, which is WinFS, right?

02:22:12 Speaker_03
Yes. Ultimately, WinFS, they tried to build it many times.

02:22:19 Speaker_03
There was a lot of off-sites and architecture reviews and talking about how great it was, when in practice, there was never any pull from application developers that they wanted this in the first place.

02:22:34 Speaker_03
And this was a huge part of the wheel spinning of, well, we can't do all this other stuff in the operating system until we figure out the spec and the implementation for WinFS. And then once we have that, then we can start to do all this other stuff.

02:22:48 Speaker_03
Part of the other stuff was the .NET development team wanted to bake .NET directly into the bits of the operating system that shipped in the box and on your PCs. So .NET was everywhere.

02:23:00 Speaker_03
So ultimately what happened here is, and I heard this from a developer. There was many different groups who were all compiling their own subprojects and they could sort of run them.

02:23:10 Speaker_03
But when it came time to try to actually do a build of this operating system and say, Hey, we've had too many offsites and architecture reviews and restarts, and this is in, this is out.

02:23:20 Speaker_03
Let's just try to do like a build of the OS that we could deliver. They never built Longhorn.

02:23:26 Speaker_00
Like it did not compile.

02:23:28 Speaker_03
They could not integrate all the different projects into one.

02:23:32 Speaker_03
And they ended up re-forking from an old Windows server version or something and adding things in one by one piecemeal to try to figure out, you know, in year four, how can we get something shippable out to consumers so we can say, this is our next generation operating system.

02:23:51 Speaker_03
And what is the minimum acceptable set of stuff that we can put in such that it looks and feels new?

02:23:57 Speaker_00
Yep. So, okay. Longhorn Vista. This is truly a disaster for the company.

02:24:05 Speaker_03
Well, so, a hundred percent it is, but they were trying to talk about it like it wasn't. So I watched the launch announcement for this too. They kind of have to. can't really say, like, nobody should upgrade to this. So they come out.

02:24:18 Speaker_03
First of all, it's Bill Gates again in 2006, six years after Steve Ballmer has become CEO. My opinion on this is they clearly had no idea what to talk about in the keynote.

02:24:29 Speaker_03
Because the one feature that I can kind of really remember as a flagship feature is that alt tab switcher that was 3D that kept bringing the windows closer and closer and closer to you.

02:24:39 Speaker_03
You know, they've got the widgets, they've got the sidebar, it's arrow. They had one feature that people hated. There was a revolt called user access control, which the theory makes sense, protecting users from running malicious and blah, blah, blah.

02:24:53 Speaker_03
But in practice, it would just overwhelm you with dialogue boxes all the time. And everyone's just trying to figure out how do I turn off the dialogue boxes. So, they're standing up there at the keynote.

02:25:03 Speaker_03
The whole thing, the marketing message is, the wow starts now. Oh boy.

02:25:10 Speaker_00
Oh boy.

02:25:10 Speaker_03
It's a completely incohesive, incoherent set of things they're launching. Consumers didn't like it. Businesses tried not to upgrade even as late as 2009.

02:25:21 Speaker_03
So three and a half years after launch, something like that, three quarters of corporate PCs are still running XP and had never upgraded to Vista.

02:25:31 Speaker_00
Oh, it's even worse than that. You may have this in your notes, but Microsoft OEMs were so unhappy because consumers didn't want to buy Vista machines.

02:25:39 Speaker_00
Microsoft had to extend the ability for their OEM partners to keep selling XP machines to consumers for another two years after this.

02:25:49 Speaker_03
just brutal. This was kind of the Windows culture at its worst.

02:25:53 Speaker_03
I worked in Office, so I have a bias here when I was at Microsoft, but they weren't super ship date driven, whereas Office would set a ship date three years in advance and then they would hit it exactly. Office had all these really robust

02:26:05 Speaker_03
procedures for shipping, you know, a triage process, an escalation process, a zero bug bounce. Everything was run in this dev test PM triads.

02:26:16 Speaker_03
The excuse was this general guise that this is too hard to use your processes, like we're doing alchemy over here. And because we're doing systems level programming, none of your software development principles work on us. And so

02:26:32 Speaker_03
Ultimately, this was the failure mode of a process that really did work for a while, really did enable technical genius, really did enable solving hard computer science problems.

02:26:43 Speaker_03
And this is effectively the company smoking their own supply and just believing they were smarter than everyone else and what consumers wanted didn't matter.

02:26:50 Speaker_03
And if they could come up with some hallucinated, cool, technical thing, then that is what they should spend years doing and fighting about and then force into the market. And the market just didn't take it one bit.

02:27:03 Speaker_00
And a couple other things on this. One, so when Vista actually shipped, just sort of process-wise, it was, Ben, as you're saying, a complete reset.

02:27:14 Speaker_00
So Brian Valentine comes over from Exchange, you know, in Windows Server in the enterprise world to take over managing, getting something out the door and just cut all the features, cut all the pillars of the Windows Longhorn vision.

02:27:30 Speaker_00
It still takes two years in that process to get it out. And then immediately afterwards, Brian leaves the company. Lots of other great engineers leave the company too.

02:27:40 Speaker_00
They go down the street to Amazon and then Brian ends up leading the entire engineering platform team for amazon.com.

02:27:47 Speaker_03
Wow. Oh, I didn't know that's where Brian went. Interesting.

02:27:50 Speaker_00
Yep. Yep. He went to Amazon. He was like a named top senior level executive at Amazon for a long time.

02:27:56 Speaker_02
Wow.

02:27:57 Speaker_00
You know, and then the other thing about this whole process, that this is purely my own speculation.

02:28:04 Speaker_00
Like, nobody said this, but just as I've been thinking and reflecting on how seminal a moment the antitrust stuff was to Microsoft after the height of their consumer power right beforehand,

02:28:21 Speaker_00
I think this might be a case where Bill no longer being CEO and just being chief software architect really impacted this process. When you're a CEO, you have to engage with your OEM partners. You have to engage with enterprises.

02:28:34 Speaker_00
You have to engage with customers. And not that it's all Bill's fault by any means, but this Longhorn Blackcomb disaster, Ben, as you say, was a case of getting high on your own supply within the company.

02:28:47 Speaker_03
And if he's only spending his time on technical decisions, you need some introduction into that feedback loop, some governor on how deep to go in re-architecting Windows for re-architecting Windows' sake.

02:29:00 Speaker_00
And, you know, remembering back to part one too, it's not just that Bill was a great engineer. He was a great business person. One of the greatest of all time. He trained from birth. It's like, what company am I going to be CEO of, right?

02:29:14 Speaker_03
The issue with Microsoft is that there is only one Bill Gates. Bill was the best engineer. Bill was the best lawyer. Bill was the best deal negotiator to figure out what the right BD situations were. Bill was not the best enterprise relationship builder.

02:29:29 Speaker_03
I don't think Bill had a passion for empowering the enterprise and, you know, making sure that businesses succeeded the way that Steve was. But nobody should ever sell Bill Gates short and say he was just the technical genius. That would be wrong.

02:29:43 Speaker_00
Totally.

02:29:44 Speaker_03
Yeah.

02:29:45 Speaker_00
Anyway, this is really bad. At the same time as Vista actually is coming out in late 2006, this is when Apple starts running the Mac versus PC ads.

02:29:57 Speaker_03
Which is just brutal.

02:29:59 Speaker_00
And oh boy, if you're Microsoft, does that hurt. And like, Mac sales are irrelevant. Even today in 2024, Mac sales are 8% of the market.

02:30:09 Speaker_03
And what were they at this point in time, like two or 3%?

02:30:13 Speaker_00
Zero, I don't even know. Like, you know, it doesn't matter. But the point is not that Apple is taking massive amounts of market share from Windows.

02:30:22 Speaker_00
It's that they are hitting a nerve with consumers, with enterprises, and within Microsoft itself, most importantly. Shoot, we are way behind here.

02:30:32 Speaker_03
And the part that really hurt about all those Mac versus PC ads is so many were just straight up true. Oh, you know, I'm a PC and I crashed again. To be in the halls at Apple when they're firing at all cylinders, Steve Jobs is back.

02:30:48 Speaker_03
The iPod was a smash hit. You're developing the digital hub strategy. Macs are starting to sell because of that. Your iPod attach rate with Macs is actually working. People are buying Macs.

02:30:59 Speaker_03
Macs are becoming the option that students are starting to pick as they're picking their college computer, market share is rising, and Microsoft comes out with Vista? You just have to be besides yourself with this gift you've been given.

02:31:12 Speaker_03
Like, oh my God, look at this opening.

02:31:14 Speaker_00
Here's where it mattered, and the timing mattered so much too. This sets the stage for the iPhone. Because Apple now, in stark contrast to Vista and with these ads, is training consumers with the benefits and the joy of it just works.

02:31:31 Speaker_00
And what did the Mac do? It just worked. And what did the iPod do? It just works. And what did the iPhone do? It just worked.

02:31:38 Speaker_03
Right. Yeah. Because there was this pent up demand. I remember people in 2005 and six when the rumors started. There was this almost like glint in people's eyes. What if Apple made a phone? Wouldn't that be awesome? And it is remarkable.

02:31:50 Speaker_03
Like the iPhone delivered on all that promise. But there actually was. Wow. What if we had technology as good as the stuff that Apple makes? in the form of a phone, wouldn't that be great? Because phones are so crappy. So I think, yeah, you're right.

02:32:03 Speaker_03
There's something there. There was a training of associating the Apple brand with.

02:32:07 Speaker_00
Well, it was really a setting of the Apple brand promise at this moment in time.

02:32:11 Speaker_03
Yes. That's a great point.

02:32:14 Speaker_00
And I think we got to call it here, the death of Microsoft as a relevant consumer technology company. They never recovered from this as a leader.

02:32:23 Speaker_03
Well, yeah, I think that's correct. There's a lot to talk about in their consumer technology offerings. I also think this is the death of Microsoft as an interesting platform for developers. Who is writing Vista apps?

02:32:38 Speaker_03
The Win32 API as a potential target for my new, interesting, innovative application, it's just not a thing anymore. You have to write a Windows desktop app at this point in history because it's where a bunch of the users are.

02:32:53 Speaker_03
If you need a desktop app, for real, for real, but probably you're just writing a web app. you've lost developer hearts and minds, which is the path to losing relevance.

02:33:04 Speaker_00
I think with one exception, I think you were totally right. Nobody is writing Vista apps. But the only people left who are writing Windows apps, period, are enterprise developers writing custom software for enterprises.

02:33:14 Speaker_03
Yeah, that's a great point. That is the exception. And of course, anyone that had big legacy applications for Mac and Windows, so Adobe is a great example of they're going to keep that up forever.

02:33:25 Speaker_03
But where these new disruptive software players are coming from, they're just not going to have Windows apps.

02:33:31 Speaker_00
Facebook is not writing a Windows Vista app.

02:33:35 Speaker_03
Correct. So the biggest things to hurt Microsoft coming out of Vista are what we just talked about losing developers, what we just talked about losing users.

02:33:47 Speaker_03
I mean, consumers who are excited to buy a computer, they're just not excited to buy a Windows Vista PC. But the biggest thing is they lost years of their very best talent. I mean, Vista was a black hole.

02:34:01 Speaker_03
As it just kept growing and growing and growing, it would suck in more teams. And as it sucked in more teams, you would get the talent that it would suck in.

02:34:07 Speaker_03
But then it also would suck in executive and distinguished engineer talent from elsewhere to come fix it. And so Microsoft is about to be in a place where they need to compete and understand a changing landscape in social, in mobile, in search.

02:34:24 Speaker_03
They still have to fight the browser war. I mean, IE is peaking and about to start falling off a cliff and are completely consumed by Vista.

02:34:31 Speaker_03
So I think a lot of the consumer stuff can be answered by Steve Ballmer wasn't really a consumer-oriented technologist. That seems fair.

02:34:41 Speaker_00
I think that is true. Sure. True. But that's not the whole answer.

02:34:46 Speaker_03
Vista consumed a bunch of the smartest people, even if they had the right vision to be chasing. And the DOJ had just crippled the culture, among many other things. And they were still recovering from that.

02:34:58 Speaker_00
100% in that conversation that we had with Steve, where he made the comment about my acquisitions, my mistakes, we just lost money on the bad ones. The genesis of that conversation was about Vista.

02:35:10 Speaker_00
He was reflecting, he said, that probably was the worst moment, actually, in my tenure as CEO, because all of that best talent, everything you just said, Ben, It was off the field. It wasn't playing. It was out of commission.

02:35:23 Speaker_03
Right. Money's not a scarce resource. So bad acquisitions, whatever. Who cares? It's just money. But consuming a huge percentage of Microsoft's most talented engineers, that's company killing.

02:35:33 Speaker_00
Yep. I mean, hell, even taking Brian Valentine off of Exchange. Exchange was freaking killing it in the enterprise. And he goes and spends two years getting Vista out the door and then goes to Amazon. Oof, that sucks.

02:35:48 Speaker_03
Brutal. One other Microsoft exec put it to me, it hurt so bad that a bunch of our best systems people were leaving the company

02:35:59 Speaker_03
driving across the lake, going to work for an online bookseller, and then building that online bookseller into the market leading enterprise compute company. That is a black eye right there.

02:36:13 Speaker_00
Yeah. Oh, I can't wait to talk about that. Okay, Ben, I'm too excited for Azure. Let's do search, let's do mobile, Windows 8, Zune, let's get all that. Oh yeah. And then let's talk cloud, baby.

02:36:25 Speaker_03
And David, unexpectedly, there is a through line through all of them. There's a cohesive story that leads to Azure here.

02:36:31 Speaker_02
Oh yeah.

02:36:32 Speaker_03
But before we do that, this is the perfect time for another one of our favorite companies and longtime acquired partners, Pilot.com.

02:36:39 Speaker_03
For startups and growth companies of all kinds, Pilot handles all of your company's accounting, tax, and bookkeeping needs and is by far the largest startup-focused accounting firm in the entire U.S.

02:36:50 Speaker_00
Also, as on our first Microsoft episode, we have to give pilot CEO Wasim Daher a special shout out here because he is the only acquired sponsor CEO who is also a research source for us on the same episode.

02:37:04 Speaker_00
Back when Wasim was a student at MIT, he interviewed Bill Gates for the school paper and he dug it up and sent it to us. Bill talked about Microsoft's forthcoming 40 gigabyte portable media center. And it was a pretty fun time capsule.

02:37:19 Speaker_00
We will link to the PDF in the episode sources.

02:37:22 Speaker_03
Yep. So back to Pilot. And speaking of Bill, we talk all the time on Acquired about one of his Seattle neighbors, Jeff Bezos, and the AWS-inspired axiom that startups should focus on what makes your beer taste better.

02:37:34 Speaker_03
In other words, only spend your limited time and resources on what's actually going to move the needle for your company, for your product, for your customers, and outsource everything else that you need to do that doesn't fit that bill.

02:37:45 Speaker_03
And accounting is just example number one of this. Every company needs it. It needs to be done by a professional. You don't want to take any risk of something going wrong. But at the same time, it has zero impact on your product or customers.

02:37:56 Speaker_00
Yup. So enter Pilot. Pilot both sets up and operates your company's entire financial stack.

02:38:02 Speaker_00
So finance, accounting, tax, even higher level CFO surfaces like investor reporting, everything from your general ledger, all the way up to budgeting and the financial sections of your board decks.

02:38:13 Speaker_00
And they've been doing this for years across thousands of startups in Silicon Valley and elsewhere. There's nobody better who you can trust to both get your finance right and make it easy and painless for your company.

02:38:24 Speaker_03
And when you say thousands of startups, Pilot has done this for OpenAI, Airtable, Scale, as well as large e-commerce and other companies.

02:38:31 Speaker_03
So it's not just that they have experience across startups, they can also keep working with you as you scale to the growth phase and beyond.

02:38:39 Speaker_03
So if your company wants to start focusing on what makes your beer taste better, go to pilot.com slash acquired and tell them that Ben and David sent you. Thank you to Pilot. Okay.

02:38:49 Speaker_03
So search and the alternate title of this chapter could be an acquisition that wasn't, I think that's a lost to history moment is the acquisition that almost happened here for $47 billion. Ooh. Okay. So I'm just actually curious.

02:39:08 Speaker_03
Do you know the company I'm referring to? Do you know the deal?

02:39:11 Speaker_00
Well, it's funny, the way you phrase that, I'm thinking like, oh, did Microsoft try and buy Google and I don't know about it, but the number, of course, you're talking about Yahoo.

02:39:19 Speaker_03
Yes, yes. Okay, so let's set some context before we get to this 2008 Yahoo attempted acquisition. So there were two companies that had developed programmatic advertising technology to serve and target online ads, especially in search.

02:39:37 Speaker_03
There was DoubleClick, the market leader, and there was a quantive. Microsoft had lost the DoubleClick acquisition to Google. They bought a quantive, and that didn't go well.

02:39:48 Speaker_03
It was $7 billion, and they ended up declaring basically the whole thing a write-off.

02:39:52 Speaker_03
So Microsoft is desperate for search market share, and between their internal efforts with MSN Search and I believe it was called Windows Live Search, they were not making much progress there. And at the same time,

02:40:09 Speaker_03
Internet Explorer had totally languished. Microsoft had completely taken their eye off the ball of the browser wars from 10 years earlier. And IE was just widely regarded as a garbage browser.

02:40:22 Speaker_03
And web developers hated it because it made you write a bunch of weird custom stuff so randomly things wouldn't work in IE. Users hated it because basically nothing new was coming.

02:40:32 Speaker_03
Every time a new version of the operating system would ship, it just felt like it's the same old Internet Explorer over and over again.

02:40:38 Speaker_03
And you have Firefox coming on the scene starting around 2007, where it was really making a dent and Google was the default search from Firefox.

02:40:47 Speaker_00
Yep.

02:40:48 Speaker_03
Firefox was awesome. It had tabs. IE didn't have tabs at the time.

02:40:52 Speaker_00
That's right. Oh my God.

02:40:55 Speaker_03
You know, Safari, I don't think Safari had tabs either. Chrome wasn't a thing yet. And so I know I'm on the one hand talking about search, on the other hand talking about the browser, but it's the same pot of gold. But it's the same thing. Right.

02:41:06 Speaker_00
Yeah. It turned out search was the business for the browser.

02:41:10 Speaker_03
Yes. So the thing that you kind of have to realize is the browser is the front door to search. Search is heavily, heavily monetizable. And if you're Google and you can monetize it directly, that's great. But let's say you're not Google.

02:41:29 Speaker_03
Let's say you're Firefox or Microsoft or Apple and you don't have this incredible business model of people bidding on the keywords for search and all the R&D to go into making search good, but you actually do have the user attention, the front door.

02:41:45 Speaker_03
Well, you get to monetize it too. The rumors are that Apple makes something on the order of $20 billion a year today in 2024 from Google as being the front door to Google, sending all of the iPhone search traffic to Google.

02:41:59 Speaker_00
This is the traffic acquisition cost in Google's financial statements.

02:42:04 Speaker_03
Absolutely. And so if you can be in the business of operating a scale search engine, or you can be in the business of directing traffic to a scaled search engine who is willing to pay you for that traffic, it's going to be a great business.

02:42:17 Speaker_03
So David, as you just said, the way to monetize the browser is owning and operating or directing to a search engine. So, search isn't going well at Microsoft. At first, it was sort of because they just didn't take it seriously enough.

02:42:33 Speaker_03
When Google first started in 1998, I think there was a lot of skepticism that the auction-based advertising business would really work. And then there was skepticism that it would really scale.

02:42:46 Speaker_03
And then when it went public, people are sort of looking at it almost freaked out at how profitable it was. And then even after that, people didn't really realize that being the market leader at search was way better than being number two.

02:42:59 Speaker_03
There's these massive, massive returns to scale. And the reason for that is just pure marketplace liquidity.

02:43:05 Speaker_03
If you have the most searches, you can create the best data from the searches and you can return all the best results because you have the most data.

02:43:14 Speaker_03
And on the advertiser side, you have the most advertisers who are willing to come in and bid to the highest possible price. You just get to make the most money by a country mile versus other search engines.

02:43:27 Speaker_00
And then it locks in even further because you can spend more CapEx on the data centers and more on R&D and make the search better and more performant and faster and all that.

02:43:34 Speaker_03
Google's search, as monetized by a ad-based auction, is one of the world's true marvels. It's one of capitalism's greatest discoveries.

02:43:44 Speaker_00
We may or may not do an episode on Xbox someday. That's for Ben and I to discuss privately, for parents to discuss after the kids go to bed. But we're definitely going to do an episode on Google.

02:43:55 Speaker_03
Yeah, it's criminal that we haven't. So Microsoft is really nowhere to be seen in search. And part of it was just thinking, oh, well, search is just a feature of MSN. But there's all these other reasons to come to MSN.

02:44:09 Speaker_03
Or, hey, this is a product in the portfolio of Windows Live. And we can kind of do it with the talent that we have here.

02:44:16 Speaker_03
Ultimately, someone needed to grab leadership at Microsoft early, 2002, 2003, shake them, and say, nothing else matters in the next five years except you figuring out how to meaningfully participate in search revenue, because that is just the next big wave in technology, and it's a fantastic business.

02:44:39 Speaker_00
You needed the equivalent of the Jay Allard Windows the Next Killer application on the internet or the Sanofsky Cornell is Wired memo.

02:44:48 Speaker_03
So in 2008, Microsoft puts a deal on the table that gets bid all the way up to $47 billion to buy Yahoo. This was effectively their last Hail Mary to become relevant in search. They actually didn't launch Bing until 2009.

02:45:07 Speaker_03
Google was started in 1998 and went public in 2004, and Microsoft got serious about a branded search engine in 2009. But, clearly, before that, they're starting to realize, this is a big deal, we need to participate in it, you know, what do we do?

02:45:25 Speaker_03
So, they'd been negotiated by Yahoo! After a bunch of negotiating and flying back and forth, finally, both David Philo and Jerry Yang fly up to Seattle, and Steve Ballmer goes to Boeing Field, and they have a meeting at the airport.

02:45:40 Speaker_03
This is one of the great what-if scenarios.

02:45:43 Speaker_00
This feels like a episode of Entourage.

02:45:45 Speaker_03
Right? It's totally right. There's conflicting reports of what happened. From what I can tell, Bill and Steve kind of looked the Yahoo guys in the eye and decided... These guys are kind of jerking us around.

02:46:00 Speaker_03
They really don't actually want to be a part of Microsoft at all.

02:46:04 Speaker_03
And this has gotten so expensive that if we execute the transaction, or God forbid they even try to negotiate up even higher, it's just not going to go well because it's going to be an organ rejection here. So the deal completely falls apart.

02:46:20 Speaker_03
It's interesting to try to look at the deal and figure out, even at that high price of $47 billion, was it a good deal for Microsoft? So here's how to pull it apart.

02:46:30 Speaker_00
Oh, I'm laughing here. I was hoping I could surprise you and be at the end of it, like, have something to say here, but I think you're going to take my thunder.

02:46:37 Speaker_03
Let me know when I do and tell me if it rhymes with shmally baba. Yes.

02:46:42 Speaker_00
Yes. Yes. It's because I'm just loving, I'm smiling the whole time. I'm imagining, you know, all of you listening being like, $47 billion for Yahoo.

02:46:53 Speaker_03
What are they smoking? Keep going. So here's how to pull it apart. Yahoo had about 15% market share of search, which I think was number two. Google was way, way, way ahead.

02:47:04 Speaker_03
And so on the face of it, you're thinking, wait, $47 billion to buy 15% market share in search? But there's actually two other assets in here. There's Yahoo Japan. Yep. And there's a stake in Alibaba. Not just a stake.

02:47:21 Speaker_03
Which famously is one of the greatest investments of all time.

02:47:25 Speaker_00
40% stake. 4-0% of Alibaba.

02:47:31 Speaker_03
So collectively, those two assets together are worth over $30 billion. So if you back it out, it's really only like $15 billion to buy 15% of the search market.

02:47:42 Speaker_00
Yeah.

02:47:43 Speaker_03
David, what is Google's revenue today?

02:47:45 Speaker_00
Alphabet's annual revenue in 2023 was over $300 billion.

02:47:52 Speaker_03
So would you want to pay a billion dollars per percent of market share of that market? Yeah, sure. It's just money. Why not? I mean, it's the craziest thing.

02:48:04 Speaker_03
This would have been ludicrously profitable to spend only $15 to buy 15% of the search market, which is way bigger than $100 billion and still growing.

02:48:15 Speaker_00
This is the thing people just always continually underestimate and underappreciate about the search market, is it's just so large and so profitable.

02:48:24 Speaker_03
Yes. Now, because this is counterfactual, and we actually don't know what would have happened, Yahoo completely went away. They sold for $5 billion in their most recent transaction to be co-owned by Verizon and Apollo.

02:48:38 Speaker_03
So there's this real question of like, OK, if Microsoft bought all that traffic, would they actually have been able to harness it and build a Google-like business? Or would it have just gone the way that Yahoo was going to go anyway?

02:48:50 Speaker_03
But to make the bold case on that, Bing is a good business. It just has a small market share.

02:48:56 Speaker_03
Microsoft succeeded finally in 2009 at attracting all the right talent and taking it really seriously and building a super viable search engine that does, I don't know, something like a billion a year in profit.

02:49:11 Speaker_00
Well, you know, then they do go on and launch Bing, and they actually sign a commercial deal with Yahoo to provide the search on the back. So they're not getting the Yahoo traffic.

02:49:20 Speaker_00
Yahoo's still monetizing the traffic, but Bing is getting all the data from doing, performing the searches for Yahoo. And I know you know this, but most listeners will not remember.

02:49:31 Speaker_00
You know who the leader of Bing was for a brief period in its early days here? Satya Nadella. Satya Nadella, that's right.

02:49:39 Speaker_00
Other piece of Satya trivia that I very much suspect you do not know, Satya joined Microsoft first in 1992 from Sun Microsystems and he joined as an evangelist for Windows NT. He joined as an evangelist? An evangelist. Huh.

02:49:54 Speaker_00
And then he got his first product job. Do you know what product, it would never ship, but a product in development that job was? Ooh, no I don't. Tiger server the cable soft information superhighway Fever dream.

02:50:14 Speaker_03
Where did you find that? It's in his book. Oh my gosh and hit refresh What's he actually I always thought he was in the marketing side. Well, it's a little Microsoft product managers are marketers They don't live in the engineering org

02:50:27 Speaker_00
Yeah.

02:50:27 Speaker_03
Fascinating. There's so many things about his history that are not a part of the common narrative. Like he, I think, worked in Dynamics, their Salesforce competitor, their CRM for a while.

02:50:39 Speaker_00
Which they had acquired. And then he, I think, ran BizTalk server, which was another one of these enterprise server products. And then Bing.

02:50:47 Speaker_03
Wow. And then they plucked him out of Bing to go run Azure, right?

02:50:50 Speaker_00
and go around server and tools, which, oh, we will get to that in a minute.

02:50:54 Speaker_03
Pause, pause. OK, some of the other fun tidbits of this Yahoo deal. So Bing powers Yahoo Search. Microsoft does the ad sales for both sides.

02:51:07 Speaker_03
So while Microsoft doesn't get the user, they don't have the direct relationship with the users, they do get to build up their marketplace liquidity on the advertiser side.

02:51:17 Speaker_03
And as you mentioned, there's a huge data advantage of actually powering the search.

02:51:24 Speaker_03
While Yahoo gets 88% of the revenue in the deal for the first five years, arguably the value from this basically all accrued to Microsoft because they ended up building out not only a proper advertising business, which now is used on a number of different sites, I think even in partnership with Netflix for their ad supported tier, but also

02:51:47 Speaker_03
Bing, once it had all the Yahoo traffic, needed to be a scaled web service. Yes. Like a distributed computing system that operated at 24-7 uptime with super low latency, fast response time, and huge scale. God, that sure sounds like the cloud.

02:52:08 Speaker_03
It sure sounds like the cloud. So you've got Xbox Live, where they have 40 million users.

02:52:14 Speaker_03
You have a scale search engine, which is like the number one most difficult distributed computing problem, that if you get good at that, you can get good at lots of other stuff.

02:52:24 Speaker_03
The ingredients are really starting to come together for the right talent and DNA at the company to do well in building out the cloud.

02:52:31 Speaker_00
So funny. The other big piece of it, honestly, maybe even the biggest piece of it from talking to folks was Hotmail.

02:52:38 Speaker_03
Yes.

02:52:39 Speaker_00
Microsoft had acquired Hotmail back in 1997 and ran it the whole time. It eventually became Outlook.com, I think. But you know, it's running a consumer web service for decades at scale.

02:52:50 Speaker_03
Yep.

02:52:51 Speaker_00
But oh my God. It's so unfortunate that they didn't buy Yahoo just because of the Alibaba stake. Nothing else would have mattered. 40% of Alibaba at IPO in 2014, when Alibaba IPO debt stake was worth $92 billion.

02:53:07 Speaker_00
Obviously, Microsoft is not a hedge fund, but like... Right.

02:53:11 Speaker_03
These things are hard because how long would Microsoft have held that?

02:53:14 Speaker_00
Yeah, totally.

02:53:15 Speaker_03
But man, if they did, that'd be crazy.

02:53:18 Speaker_00
It's so funny. Yeah. One of the greatest venture investments of all time.

02:53:23 Speaker_03
Yep. OK, so at the end of all this, you might be wondering, why was search so important? How did Microsoft get so obsessed with the search engine? Why are they still running Bing today?

02:53:34 Speaker_03
Why has it been this sort of white whale for them, where they continue to try over and over and over again to do search deals or acquisitions or things like that? Well, search monetizes incredibly well.

02:53:47 Speaker_03
So Microsoft is sitting there realizing, OK, we're a technology company. Historically, what we've done is sell licenses of our software and people have paid us directly.

02:53:58 Speaker_03
But there's this new business model emerging that appears to just scale infinitely, where you can make three times or more off of each user, again, using software, but not selling the software to them. That's a much better business.

02:54:17 Speaker_03
If I could take 7 billion people in the world and sell them Windows, or I can take 7 billion people in the world and have them use my search engine for free and then make the money from the advertisers, I'm going to make 3 to 5x more money from the advertisers than I actually would selling them software.

02:54:34 Speaker_03
So suddenly this kind of becomes existential where the Windows revenue isn't going away, but actually the next generation of Economics generated from software is not selling the licenses. It is monetizing via advertising.

02:54:50 Speaker_00
It's funny, I never thought about it this way, but really what search did and what Google does is you go from selling software as a technology company to selling everything.

02:55:01 Speaker_03
Yep. And the offline economy is much bigger than the software economy. And so everyone has to acquire customers, whether you make software or tents or airline tickets. And there's only a small set of dollars that goes to software.

02:55:17 Speaker_03
So if I just pull up my credit card statement each month, How much software am I paying for versus how much everything else am I paying for? And even if you say, well, that's not really fair because it's advertising for everything else.

02:55:27 Speaker_03
It's not everything else directly. Even a small percentage of my everything else turns out to be way bigger than my software budget. So at the end of the day, Microsoft made a browser. They didn't monetize that browser.

02:55:40 Speaker_03
They monetized using it to defend an operating system. that they sold licenses to. Eventually, Google comes along and creates a browser.

02:55:50 Speaker_03
They also don't sell that browser, but they monetize all the traffic coming through that browser, and they do it way better than Microsoft does at monetizing selling licenses.

02:56:03 Speaker_03
Maybe put it more simply, Microsoft built a browser, had a bunch of share, and then kind of looked around and said, we don't really know what to do with it. I guess we'll use it for defense.

02:56:15 Speaker_03
And Google built a browser and said, we know exactly what to do with this. And they used it for offense.

02:56:21 Speaker_00
Yeah, such a good point. Well, while we're talking about using software to sell everything and not software, that sure makes me think a lot about social and Facebook. Microsoft has some history there during this period too, doesn't it?

02:56:37 Speaker_03
They do, David. Should we take a brief aside to talk about Microsoft's intertwined history with Facebook?

02:56:43 Speaker_00
Absolutely.

02:56:45 Speaker_03
So it's October of 2007. Microsoft is missing search. And they're realizing social seems to be a wave that's coming five, six years after search. Also a great online advertising business.

02:57:02 Speaker_03
We now deeply understand and regret not being a bigger player in that business. We can't let it happen again. So what do we do? We're not going to build one of these internally. We know better than to do Google plus.

02:57:17 Speaker_03
And so we are not capital constrained. And so we are very willing to try to do large acquisitions because we've got money lying around, but we don't have talent lying around and we don't have

02:57:29 Speaker_00
DNA and brand to be able to do this.

02:57:31 Speaker_03
Right. Exactly. So what do you do? You try to buy Facebook. Microsoft puts an offer on the table.

02:57:37 Speaker_03
It's a very complex deal structure, but effectively what it does is it lets Facebook shareholders cash out over a long period of time as the company's value grew. So you're not taking all your money off the table today.

02:57:52 Speaker_03
And so the important thing to take away, though, is a very big dollar valuation. News outlets reported it to be worth $24 billion. And again, this is way back in 2007, three years after the founding of Facebook.

02:58:06 Speaker_00
Right. We're not that long after the Yahoo $1 billion offer.

02:58:11 Speaker_03
Exactly. Facebook's not interested. I'm pretty sure Zuck doesn't even respond to the offer. Some of Zuck's lieutenants have been meeting with Microsoft people saying, if you get the number in this range, blah, blah, blah, blah, blah.

02:58:24 Speaker_00
They sent in an offer.

02:58:28 Speaker_03
We will. No dice. So instead, they work out an investment and a commercial deal. So the terms of the deal are in October 2007, Microsoft invests $240 million for 1.6% of Facebook.

02:58:36 Speaker_03
So for those trying to do the math at home, that is a $15 billion valuation on the deal. Microsoft will get the exclusive right to sell banner ads on Facebook internationally until 2011.

02:58:58 Speaker_03
So again, Microsoft cleverly is using this as a way to bootstrap the advertiser side of their marketplace now that they have all this inventory to sell.

02:59:06 Speaker_03
Now, it's interesting to think about, much, David, like your comment about Alibaba, if Microsoft sold all of it at IPO, which I don't think it did, that would be a 7x. Okay.

02:59:17 Speaker_00
That's a pretty good growth investment in, you know, a few years.

02:59:20 Speaker_03
Not bad. Right. From 2007 to Facebook's IPO in 2012. Yeah, five years, 7x.

02:59:26 Speaker_00
That's good for a growth investment.

02:59:28 Speaker_03
That's great. I'll take that. If they held for another two years and sold in 2014, that would have been a 14x. I actually don't know when they sold, but I feel like these are helpful guardrails to understand what this appreciation could have been.

02:59:42 Speaker_03
Either way, it's not really relevant to Microsoft.

02:59:46 Speaker_00
As I said earlier, they're not a hedge fund and money is the least important thing to them.

02:59:50 Speaker_03
Right. They're constrained by talent, execution ability, focus, DNA to pull it off, focus, but they're not constrained by cash. So who cares if you 10x your 240 million over five to seven years?

03:00:04 Speaker_03
So it seems like the actual interesting part of this deal is the fact that they had the right to sell Facebook's international ads for four years, and the companies kind of became friendly.

03:00:13 Speaker_03
So Facebook on the pages for businesses would use Bing Maps, and there was all this sort of reciprocal things that the company did together.

03:00:23 Speaker_00
And a lot of Microsoft people went to Facebook, like friend of the show, Vijay Raji, CEO at StatSig now, a lot of great early Facebook folks came from Microsoft.

03:00:34 Speaker_03
Yep. So right around this time, June of 2008, Bill Gates leaves the company full-time. It is an actual retirement. I'm no longer chief software architect. I am still chairman of the board, but I'm going to go be the... Full-time at the foundation?

03:00:49 Speaker_03
Exactly, at the Bill and Melinda Gates Foundation.

03:00:51 Speaker_00
Which, of course, is right at the time the iPhone, you know, of course, came out in 2007, but 2008 was when I think it was iOS 2.0, right, with the App Store opening up and the SDK comes out and the world completely transforms.

03:01:09 Speaker_00
There's a pretty rough quote in Time Magazine from Bill's retirement that was obviously written about Bill here, but I think it's just kind of more applicable to

03:01:21 Speaker_00
all of Microsoft DNA at this point in time, Gates is probably getting out of technology at the right time. Funnily enough, it's not really a business for nerds anymore.

03:01:32 Speaker_00
Gates was at the center of the personal computer revolution and the internet revolution. But now the big innovations are about exactly the things he's bad at, The iPod was an aesthetic revolution. MySpace was a social revolution.

03:01:46 Speaker_00
YouTube was an entertainment revolution. This is not what Gates does. Technology doesn't need him anymore. That's a stupid quote.

03:01:54 Speaker_03
That's just too reductionist.

03:01:56 Speaker_00
Yeah. It is totally too reductious and it's too personally about Bill and that's just completely not right.

03:02:02 Speaker_03
But that was sort of the view at the time. I mean, this really shows you how irrelevant people thought Microsoft was.

03:02:08 Speaker_00
Yes. That is why we included it.

03:02:12 Speaker_03
been saying this about Microsoft in the Windows 95 time frame, but after the obsession with enterprise, the complete failure in consumer markets, but importantly, the complete ignoring of what the exciting developer platforms were at the time, open source, the web.

03:02:30 Speaker_03
I mean, if you think about where all the development efforts were going, it was the LAMP stack, the Linux, Apache, MySQL, PHP, the stuff Facebook was written on. That's in a different universe from Microsoft's enterprise developer customers.

03:02:44 Speaker_03
So I just think you need developer excitement if you're going to have consumer excitement. I mean, or you need to develop every interesting app on your platform yourself, but that's just not how it goes.

03:02:52 Speaker_03
So that consumer and developer excitement goes hand in hand.

03:02:55 Speaker_00
Right. I said to put a pin in the iPhone and the downside of Microsoft becoming the enterprise juggernaut when we were telling that story.

03:03:04 Speaker_00
And all of the huge advantages in lock-in that Microsoft had built up, the iPhone changed that calculus because the iPhone kicked off shadow IT and bring your own device, and it kicked off the user revolt against IT.

03:03:22 Speaker_00
And this is what this quote encapsulates.

03:03:25 Speaker_03
Yeah, I think that's right. I think a set of technologies were breaking through. People were just going to use those devices and that software no matter what.

03:03:34 Speaker_03
The era today is one where users have way more choice in what they use at work than they did in that early 2000s era, and the iPhone sort of forced that door open.

03:03:44 Speaker_00
Yeah. Choice and expectations of what that software and hardware is going to be like. And Microsoft, for all of its great victory in the enterprise over this period, just fundamentally did not have any of that DNA in the company anymore.

03:04:01 Speaker_00
And that's what this quote from Time is pointing out.

03:04:03 Speaker_03
They were all over an Xbox.

03:04:06 Speaker_00
Okay, fair enough.

03:04:07 Speaker_03
Or they were developing cool new stuff that would then get killed because it's not a part of the Windows machine.

03:04:11 Speaker_03
I mean, you look at Courier, you look at Kin in mobile, you look at all these things that they would let them get so far, and then they'd be like, ah, you guys don't get it.

03:04:21 Speaker_03
Windows is the center of everything, and if it doesn't make Windows look great or it competes with Windows, that's not what we're doing. And I think that DNA was too strong to overcome disruptive innovations.

03:04:38 Speaker_00
Exactly. So let's talk about those things and what's happening in mobile.

03:04:43 Speaker_03
Okay. So let's rewind. What was Microsoft doing in mobile so far? A lot, actually. A lot actually is right. Microsoft was obsessed with all sorts of things, particularly Bill Gates, for decades before they became true.

03:05:01 Speaker_03
One of which was Bill Gates was always talking about mobile computing, so much so that in the key slide in the Windows XP presentation, one of the big bullet points is mobile computing. all the way back in 2001.

03:05:17 Speaker_03
And Gates thought natural user interfaces was gonna be a thing, multi-touch, tablet computing, pen computing. Yeah, from the early 2000s and sometimes even before that, these were Bill Gates's visions of the future that he thought were pretty close.

03:05:40 Speaker_03
And so in the world of, I suppose they were early smartphones, Microsoft had developed Windows Mobile. So what was this? Is it like iOS? Not really. No.

03:05:54 Speaker_03
What Windows Mobile was was an operating system for handset makers to adopt and put on their handsets. And, you know, these things kind of looked like BlackBerrys or mostly keys with a little screen. And when you looked at it, it looked like Windows.

03:06:11 Speaker_03
It had a little start menu and it was much like the rest of the enterprise strategy, David. designed around all working seamlessly together with your Windows PC and Exchange and your corporate network.

03:06:25 Speaker_03
Because surely people at home, consumers, were not using smartphones. These were for business people who, you know, these were issued by their enterprise. So it fits pretty squarely into the enterprise category.

03:06:38 Speaker_03
Now, how did Microsoft think about this product? They thought about it as an ingredient into the handset maker's product. Microsoft was somewhat at the whim of an OEM in the computer ecosystem.

03:06:57 Speaker_03
You know, Dell could install some more stuff on top of Windows and customize the installation, but it was still Windows XP. no matter who the PC was from, it was a pretty standard thing. That really wasn't the case with Windows Mobile phones.

03:07:12 Speaker_03
The handset makers could modify the code of Windows Mobile. So, when you bought a handset, first and foremost, you were trusting the product quality of the people at the handset maker.

03:07:25 Speaker_03
And they had several OSs that they could buy and effectively start from, one of which was Microsoft. We're handset makers, we make a phone, and we know how to interconnect and do all the carrier stuff with the carriers, because they're our partners.

03:07:41 Speaker_03
And we kind of needed to do a bunch of computer stuff too, like email and stuff. So can you guys do all that?

03:07:47 Speaker_03
And then we'll make sure when we get that from you that we'll start changing your code to make it work with our phone, and we'll do all the phony stuff. Not an iPhone. What was Microsoft's position in mobile?

03:07:59 Speaker_03
Yes, they had Windows Mobile, but no, it was nothing like what smartphones would become because of the way that the iPhone reset everything.

03:08:09 Speaker_00
Yeah. And at some point in this journey here, post-iPhone, but still in this sort of weird Windows mobile era, Microsoft buys Danger, the company that made the T-Mobile sidekick. You remember that?

03:08:24 Speaker_03
Which was awesome. You, like, pushed a button, and then it would, like, flip around, and suddenly you were on a sideways keyboard.

03:08:29 Speaker_00
Oh, yeah. It was in Entourage.

03:08:30 Speaker_03
I remember watching Entourage. Turtle had one, I think. That's right.

03:08:34 Speaker_00
And that was Andy Rubin before he started Android. Oh, you got me. I was hoping I could stump you. I was going to say, do you know who co-founder of Danger was? It was Andy Rubin. What do you think I do for a living? What do you think I do for a living?

03:08:47 Speaker_00
Amazing. Andy had already left Danger and started Android.

03:08:50 Speaker_03
Which would be the very thing that would sort of destroy their mobile business.

03:08:55 Speaker_00
Yes.

03:08:56 Speaker_03
But let's get there. So 2007, in January, the iPhone is announced. It won't come out until July. The iPhone comes out. It's the most spectacular technology demo since the mother of all demos, the old Doug Engelbart one way back in the day.

03:09:13 Speaker_03
Consumers are all in awe. The existing mobile industry people can't really believe it's real. The founder of BlackBerry basically said, I think his exact quote is, how did they do that? Then later says, we'll be fine.

03:09:28 Speaker_03
You have Palm, who was already saying things like, I believe the CEO, even before the announcement said, the PC guys are not just going to figure this out. They're not just going to walk in. Famously, David, I know you have it.

03:09:39 Speaker_03
Steve Ballmer has a quote after the announcement.

03:09:41 Speaker_00
Yes. And he says, you know, it's never going to work at $500, which is the full quote. Uh, you can totally see that. phones at this point in time, flagship phones were costing like $100 with carrier subsidies.

03:09:57 Speaker_00
And Steve's like, $500 that price, like who's going to buy that?

03:10:02 Speaker_03
Right. There is actually two quite interesting things about this quote. One, Steve is being the company salesperson.

03:10:08 Speaker_03
If a competitor drops this amazing bomb and you're interviewed and you have a whole bunch of enterprise customers who are sort of looking to you, what do you say? You say, Are things still great? There are things really expensive.

03:10:19 Speaker_03
Of course you say that. You are literally always selling all the time. And so I always take some issue with that. Two, Apple legitimately had a business model innovation there with the carrier subsidy.

03:10:29 Speaker_00
Yeah. When it wasn't the original, the original iPhone didn't have it. It was then later.

03:10:34 Speaker_03
I think the 3G... I mean, the mobile industry to this point had been, how do I make the cheapest possible phone? It's certainly not a scaled-down version of a Mac, which is what the iPhone was. So that was a completely different paradigm.

03:10:47 Speaker_03
This is a tiny computer, not a... kind of crappy embedded system that is optimizing for pennies. And Apple basically said, we don't care if it's really expensive. We just think this is the user experience bar and we will figure the business model out.

03:11:02 Speaker_03
And eventually, my God, did they figure the business model out and the carrier subsidies were that innovation. But Windows Mobile was that old paradigm.

03:11:11 Speaker_03
Embedded systems, cheap as possible hardware were a couple cents either way, determines whether your phone's gonna sell or not. And so it was pretty shocking. So iPhones start selling. They're selling well. It's 2008. Apps start coming out. It's 2009.

03:11:31 Speaker_03
Sales start really picking up. And finally, Microsoft decides, hey, what we're going to do is we have this old asset, Windows Mobile. We can repurpose some of that to make this new thing called Windows Phone.

03:11:46 Speaker_03
But unfortunately, everything we're optimizing for is different. The new ecosystem expectation is a super high quality user experience. Yeah.

03:11:57 Speaker_03
And so there's this way that we used to work with all of our hardware partners, which basically said, we will make the software work on whatever. You can come up with the crappiest hardware you can think of and we'll make it work.

03:12:10 Speaker_03
It's kind of like the Roku strategy, the way that they work with all the embedded TV makers.

03:12:15 Speaker_03
And the new strategy had to be, we will dictate really intense hardware requirements because now with Windows Phone, we are making a promise to users to compete with the iPhone where Microsoft is backing that up.

03:12:31 Speaker_03
The Microsoft brand is first, and we're defining a really breakthrough new user interface called Metro that actually came from the Zune, which is funny that that's its lineage. Now, how did it actually play out?

03:12:45 Speaker_03
Microsoft tried to use their existing business model. We will sell you an operating system. We will charge you a royalty.

03:12:52 Speaker_00
We will sell you, OEM manufacturer, an operating system.

03:12:56 Speaker_03
Correct. And you sell that phone. People want good phones now, so you can probably generate some nice margins on that good phone because the iPhone really set the bar. There's just one problem with trying to maintain your old business model.

03:13:11 Speaker_03
It's that you don't have the same competitive set that you used to. You now have Google. Google has acquired Android. Google has transformed Android from a BlackBerry clone into an iPhone clone. The software is open source.

03:13:27 Speaker_03
And so Google's value proposition is they go to all those same manufacturers that Microsoft used to work with. HTC, Motorola.

03:13:36 Speaker_00
And say, hey, how about a deal for zero dollars?

03:13:40 Speaker_03
Yep. Deal point number one, here you go. It's free. Deal point number two, you can even have the source code. Deal point number three, we aren't Microsoft. Look at what they did to the PC makers. Do not let them do that to you. You know those PC makers?

03:13:57 Speaker_03
They make no money. Zero the profit dollars in the value chain accrued to these PC makers. They all accrued to the software vendor. It's literally the same people who did that to the PC makers. Why would you let them do that to you?

03:14:08 Speaker_03
And remember, in this mobile world, every cent matters. And so Microsoft is trying to ask for, you know, whatever it is, some single digit number of dollars for a licensing fee to the US.

03:14:20 Speaker_03
I mean, I think I'm undershooting, but let's even say it's five bucks. That is a mountain of difference between $0 and $5.

03:14:28 Speaker_00
In a low margin business.

03:14:30 Speaker_03
In the total bill of materials of these things. Exactly.

03:14:33 Speaker_00
And Google also only really cares about their services that they monetize through advertising. So one of the deal points in there, I think this may be varied by geography, but is, oh yeah, you got to use Google services on there too.

03:14:49 Speaker_00
But by the way, they're best in class and they're free. You don't have to pay anything for that either.

03:14:53 Speaker_03
Yeah, I think at first it was you can have it open source, but you don't get any of our services or you can take the whole thing and you take all of our services, but our services are great. And guess what? The play store is one of our services.

03:15:07 Speaker_03
So if you want all the apps, then you have to take all the other Google services too.

03:15:10 Speaker_00
Right, right, right.

03:15:11 Speaker_03
Now, keep in mind, how does Google make money? They make money on search.

03:15:18 Speaker_03
So Google, from the moment they figured out, hey, we can run a, call it 2002, when Google's search business model was really hardened, and it was evident this will scale, it's ludicrously profitable, it's very high value per user, Google's going to be the number one at it.

03:15:39 Speaker_03
It's almost like if you really thought about it, you could have figured out that Microsoft wouldn't win in mobile.

03:15:47 Speaker_02
Hmm, yeah.

03:15:48 Speaker_03
It's a really circuitous path. But if step one is Google makes a ton of money on search, then step two is Google should try to get all the searches. So then step three is Google needs to have the front door to search.

03:16:05 Speaker_03
And so you have to count on Google being the actor that figures this all out. Step four is Google figures out what the next platform is and make sure that they are guaranteeing all the search volume comes to Google from them. So what do they do?

03:16:21 Speaker_03
They invent or buy a mobile operating system. What do they do after that? The next step, they give it away for free because again, all they care about is all the search volume.

03:16:30 Speaker_03
And so therefore, unless Microsoft adopts Google's business model, they're immediately screwed.

03:16:36 Speaker_00
This is such a good point. Microsoft's competitor was not Apple and the iPhone. It was Android.

03:16:46 Speaker_03
Yeah. It's a little bit butterfly flaps its wingsy, but there is a direct line over a 10 year period from Google finds its web-based search business model and Microsoft cannot employ its traditional business model and win in mobile.

03:17:03 Speaker_03
Like Microsoft will lose in mobile. And there's some pivots in there. I think the biggest moment when the door really shut is when Verizon freaked out after the Apple and AT&T deal and said, we need an answer. And they decided that answer was Droid.

03:17:19 Speaker_03
And they put like a gajillion dollars behind the Droid advertising campaign.

03:17:25 Speaker_00
The motor droid. Yep.

03:17:26 Speaker_03
Yeah. And so I think at that point it was sort of a two horse race. Microsoft probably could have figured out a way to get in before that, but it is all related to Google finding that orthogonal business model.

03:17:38 Speaker_00
Yep. And it's funny, you know, Microsoft did have Bing at this point in time, so they did have a business model that they could have used if they'd been willing to go free on Windows Phone.

03:17:47 Speaker_03
And it would have taken a big culture shift at Microsoft to say, we're an advertising company.

03:17:51 Speaker_00
Right.

03:17:52 Speaker_03
Microsoft is not a company that is, at least at this point in time, comfortable with their bread being buttered from advertising. I mean, they're the PC company. They want to sell software to people using PCs. They're the software company.

03:18:04 Speaker_00
Yeah. They sell software. Might be via enterprise agreements, but they sell software.

03:18:08 Speaker_03
Yep. So then if you really believe this step-by-step-by-step thing, then actually what Google should keep doing is finding things that Microsoft sells and figure out which ones are the cheapest per user to run and then give those away for free.

03:18:28 Speaker_03
And so Outlook, Exchange, geez, Gmail, hmm, Word, Excel, PowerPoint, oh, G Suite, Workspace. And all they're doing is they're just looking at Microsoft's core value propositions they charge money for.

03:18:42 Speaker_03
And Google says, would it really be that expensive if we just gave that away for free? And the more of those that they do, A, it's good for Google's business model because they just get more data, a closer relationship with you.

03:18:55 Speaker_03
You're doing either more queries or you're interacting on their platforms in ways where they have other ways to show you ads. Maybe while you're off platform, now they know a lot about you from data they've collected, blah, blah, blah.

03:19:07 Speaker_03
But even if it doesn't actually make more money for Google, they make so much money in their core business that if it hampers Microsoft, then it's a good thing to do.

03:19:17 Speaker_00
Yeah. Interesting. And that is totally true. I totally buy it in the consumer world and in the enterprise world. Microsoft lock-in is still as strong as it ever has been.

03:19:27 Speaker_03
Yes. And Google has really not figured out how to be an enterprise company.

03:19:34 Speaker_00
Excel is still the main way that spreadsheets are done around the world. I bet a lot of listeners use Google Sheets. We do too. We love it. Also use Excel, but if you do use Google Sheets, you are in the minority.

03:19:45 Speaker_03
Globally, you think? Yeah. I guess because most consumers don't actually use spreadsheets. Yeah, yeah.

03:19:50 Speaker_00
Enterprise spreadsheet work is done in Excel. Full stop.

03:19:54 Speaker_03
Yep.

03:19:55 Speaker_00
That brings us to Nokia. But I think let's save Nokia for the end here.

03:20:00 Speaker_03
Yeah, Nokia is our coda. What it does bring us to is a realization from the very top of Microsoft that the profit pools in mobile are changing. And this is a thing that I think Steve Ballmer also doesn't get credit for.

03:20:14 Speaker_03
Bill Gates was obsessed, correctly, with being the software company. It was a brilliant business strategy to be the software platform and then everything around you had to interoperate with you.

03:20:28 Speaker_03
And again, the profit pools in the PC world just accrued to software vendors. It was remarkable how the PC manufacturers over time had no profits and Microsoft had tremendous profits.

03:20:40 Speaker_03
Steve Ballmer realized pretty early, I think because of the Google Android thing, mobile was going to shake out differently. Future hardware platforms were not guaranteed to have the same profits in the value chain the way that the PC did.

03:20:55 Speaker_03
And so he was pretty aggressive about, actually, we need to be in the hardware business. And I know that seems really unattractive to us as a company because we've been in the software business.

03:21:06 Speaker_03
There's this great general rule that it's really hard for any business to enter a lower margin business than the one they are currently in.

03:21:14 Speaker_00
Yeah, Amazon can go from e-commerce to AWS.

03:21:16 Speaker_03
Right. Amazon can go anywhere. But for Microsoft, you know, you're selling software licenses. It's hard to even get into cloud because cloud is a lower margin business. You know, you have to operate those data centers than just selling licenses.

03:21:28 Speaker_03
So if you're Microsoft and you've been making software all these years and you've been enjoying those margins and suddenly you're realizing, oh, we have to be in the hardware business.

03:21:40 Speaker_03
or at least if we're not in the hardware business or the search business, we're not going to enjoy any of the profits in the mobile era. That's a difficult conundrum. But to Steve's credit, he acted. They released Surface, they tried to buy Nokia.

03:21:57 Speaker_00
Let's talk about it. Let's start with Surface and Windows 8, which we got to talk briefly about Windows 7 before that. Because Windows 7 was awesome. So Steven Sanofsky, he ends up running off his product management.

03:22:09 Speaker_00
After the Vista disaster, he gets drafted to come over and run Windows. And Ben, like you're saying, the office culture was known as, we ship, we ship product. That's what you were part of. That was the culture that Steven set.

03:22:22 Speaker_03
Mind-bending that three years in advance, a date is set and then 6,000 people ship on that date no matter what.

03:22:29 Speaker_00
So he comes in for Windows 7 and he does that for Windows. We were talking to him and he had this great analogy of Windows at this point in time didn't need technical vision. It was trying to be the Dodge Viper. That's what Longhorn was.

03:22:46 Speaker_00
It needed to be the Toyota Camry. And he comes in and he makes Windows 7 the Toyota Camry of PC operating systems. I love that analogy. That's exactly right. It's so good. It's exactly what it was, and it's exactly what everyone wanted.

03:23:00 Speaker_00
It's what the consumers who were still using Windows wanted. They wanted it to just work. And most importantly, it's what the enterprises wanted.

03:23:07 Speaker_03
Everyone's like, hey, it's like XP but modern, or it's like Vista without all that random stuff and all the regressions that Vista had.

03:23:14 Speaker_00
Yes, do not crash my devices or my network. Thank you.

03:23:18 Speaker_03
Nice easy start button in the lower corner. Normal predictable menu, fast search, fast file system. I honestly can't tell you a feature that launched in Windows 7.

03:23:31 Speaker_00
I have no idea, but I remember I had a Windows 7 laptop when I first joined Madrona and it was great.

03:23:38 Speaker_03
Yep, it ran everything the way you expected it to. And so the product that Sanofsky shipped there was just as much the new organization as it was the actual product that customers experienced. It was a much more slimmed down team. It was dev test PM.

03:23:54 Speaker_03
It was ability to hit a ship date. It was a proper planning and vision process. A lot of what the team was doing with Windows 7 was, yeah, yeah, yeah, we feel like we can do 7 with our arms tied behind our back.

03:24:05 Speaker_03
But let's start thinking about the future, about what we're really going to do now that we have all the infrastructure in place to really ship an interesting product.

03:24:13 Speaker_00
And then Apple comes out with the iPad in 2010.

03:24:18 Speaker_03
Yeah, so Windows 8 vision had kicked off. The planning process for what it's going to be had kicked off. And they're starting to play. Actually, Steven puts these videos on YouTube. They're awesome to watch.

03:24:30 Speaker_03
The original vision of what Windows 8 should be. And they're kind of out on a limb. They're saying the future is touch. The future is tablets. We think that's going to be a dominant computing paradigm.

03:24:43 Speaker_03
And on the one hand, Bill Gates has been saying this for years. So there's sort of like a cultural acceptance with the idea. On the other hand, it really hasn't manifested in the market. So it's a little bit dangerous to say.

03:24:57 Speaker_00
But the iPhone has now come out and multi-touch has shown this is the way to do it.

03:25:01 Speaker_03
So, but you're right. The iPad coming out really validates, whoa, big tablets. with multi-touch actually might be the computing paradigm for the future. And oh my god, we've been in planning, we've been in development for a year or two already.

03:25:17 Speaker_03
This thing hits the market. We're right. We are so right. We've been validated.

03:25:23 Speaker_00
It validates the product vision and it terrifies Bomber and Microsoft leadership because they just watched what happened, what Apple did to the phone market. The iPad sure as hell looks like it's going to try and come do that too.

03:25:40 Speaker_00
Microsoft's core PC market. I mean, the original Jobs keynote introducing the iPad lays out his vision, right, of like the PC is going to become the pickup truck and the iPad is going to become the car.

03:25:54 Speaker_00
And that would be a truly terrible thing for Microsoft, especially if that goes into the enterprise, as the iPhone is clearly going into the enterprise on the phone side.

03:26:04 Speaker_03
Now, there was a little bit of a folly in believing that the iPad was the PC of the future. Standing here today, we all can look at unit sales and realize, oh, the iPad was not the PC of the future.

03:26:16 Speaker_03
It had its place, but it did not in any way replace PCs. And it turns out that Apple scaling up the iPhone metaphor was good for tablets, but that never was going to take over most PC use cases today.

03:26:31 Speaker_03
In fact, the phone has far more replaced the PC than the tablet has.

03:26:36 Speaker_00
Yes. But back in 2010, that sure looked pretty terrifying as a prospect to Microsoft.

03:26:42 Speaker_03
The other thing that's happening around this time is, I've said this a number of times, but Windows, despite having great revenue, great profits, massive penetration in the enterprise, and momentum, almost just like staying power in consumers because people were just used to it, it was not relevant for the next frontier.

03:27:03 Speaker_00
Totally not.

03:27:04 Speaker_03
It did not have hearts and minds. It was not where the excitement was. It was not what people were building for. So there's sort of a two birds with one stone attempt with Windows 8. One, touch tablets. We are going to get out ahead of Apple.

03:27:20 Speaker_03
I mean, we're going to try to out Apple Apple here, and we're not going to let what happened in phone happen to us in our core market of PCs. Two, we need a new developer platform.

03:27:32 Speaker_00
Yeah, we need to bring developers back.

03:27:35 Speaker_03
Everyone's building for the web. Web is agnostic to what operating system it runs on. Can we create a platform that is so exciting for developers that they're going to use it? And we should lean into the technologies people are already using.

03:27:51 Speaker_03
So the Windows 8 touch mode Metro UI development environment was HTML5 because all these web developers are already writing their web apps. We want to support that too.

03:28:05 Speaker_03
And we're going to build a whole new tool chain so that their HTML5 Windows 8 apps run really well on ARM processors because these tablets are going to run on ARM processors.

03:28:18 Speaker_00
And we're going to make our own Surface RT.

03:28:20 Speaker_03
Yes. So that's the two-headed dragon of Windows 8 is new developer platform and touch first.

03:28:28 Speaker_00
And the way the touch first manifests in the operating system itself is the desktop is now just an app. And when you boot up Windows 8, you are presented with a tablet tiled start screen. And if you're looking for a desktop, you got to go find it.

03:28:48 Speaker_03
Now in practice, it's not hard to find the desktop. You learn it in like five seconds. You're like, okay, I see. The start screen is actually the start menu, but full screen. So if I click in the bottom left corner, I can collapse it.

03:28:59 Speaker_03
I can enter the desktop mode and then it's like, it doesn't even exist. I can run my win 32 apps, blah, blah, blah. But there is a learning curve.

03:29:05 Speaker_00
There's also just the shock value though, of I bought a Toyota Camry expecting it to be a Toyota Camry and. I don't even know what this is. It's like a scooter.

03:29:15 Speaker_03
Yeah. And it is a little confusing.

03:29:16 Speaker_03
I used it for a long time when I worked at Microsoft and figuring out how to app switch between things that are part of the Metro modern UI versus the legacy apps and what's sitting on my desktop and what's sitting in the

03:29:28 Speaker_03
tablet-optimized app switcher. It mixed two metaphors. Now, the question is, why did it mix two metaphors?

03:29:34 Speaker_03
And it took me a while to figure this out, but what ended up happening was the original vision for the Windows 8 Touch thing that we're all talking about, these live tiles, that was supposed to only ship for tablets, as it was originally dreamed up.

03:29:51 Speaker_03
And there was a version of Windows 8 that did not have that, that was gonna ship for desktop PCs.

03:29:56 Speaker_00
Hmm, that was going to look like Windows 7, probably.

03:30:00 Speaker_03
Word comes down from on high, Windows is Windows. We need to ship Windows across all devices. So what happens?

03:30:09 Speaker_03
All of this effort has gone into and momentum and political capital and betting your career has gone into this HTML5 developer community, the Metro UI. And so that is the desktop version that ships.

03:30:28 Speaker_00
I see. Yeah, there can only be one Windows. And so we got to put both of these babies in here.

03:30:35 Speaker_03
Yup. And what you have is not as bad as Vista, but man, the rollout was pretty bungled. It's confusing. The reception was poor.

03:30:47 Speaker_03
Interestingly, not by the tech pundits, like the tech pundits who actually spent some time and figured it out were trained up pretty quickly, but the cat was out of the bag even before they got to review it on people who were angry.

03:30:59 Speaker_03
What do the Microsoft people refer to them as? People that, uh.

03:31:02 Speaker_00
Oh, the basement.

03:31:03 Speaker_03
The basement. Yes, the 0.001% power users who are the loudest, of course, on the internet. And so that kind of taints the product. OEMs hate it because, frankly, OEMs weren't signed up to make these touch devices.

03:31:18 Speaker_03
But now Microsoft's putting all this energy behind touch-optimized operating system. So there's this mixed message to consumers. It's like, are there even good laptops available? Am I supposed to use touch on my desktop? They have to run ARM.

03:31:33 Speaker_00
They can't run x86, they gotta run ARM processors, they gotta run mobile processors, but you're asking these devices in 2012 to also be able to function as laptops and the technology just wasn't there.

03:31:48 Speaker_00
There's a reason why the iPad was a scaled up version of the iPhone, not a scaled down version of the Mac. Today, I think it might be a very different proposition and the public might be much more ready to accept something like this.

03:32:02 Speaker_00
I wish Apple would do this with the iPad. Oh, yeah. I don't want to have a MacBook and an iPad. I just want an awesome pane of glass that can do everything. And Apple Silicon totally can do everything.

03:32:11 Speaker_03
Yeah. My dream machine is, you know, those Lenovo yogas that can flip all the way around. Yes. Yeah, yeah, yeah.

03:32:19 Speaker_03
My complete dream machine is my 13 inch M3 MacBook Air that when I flip it all the way around, they do something like universal binary with the apps where all the same apps that I had installed on my Mac, they now run their iOS counterpart.

03:32:35 Speaker_03
They grab all the data that's stored in the same places. So all my apps, you know, it knows which Google sheet I'm looking for. It has the YouTube videos cached. It, you know, does whatever, but it just turns into an iPad with an iOS

03:32:47 Speaker_03
UI, that is the dream. I can't figure out if I'm like a super nerd for wanting that, and most people wouldn't actually want that, but I travel with an iPhone and an iPad and a MacBook, and I think I could just do two.

03:32:59 Speaker_03
I think a lot of people would want it. Yeah, so one takeaway may just be, hey, it was too early. The other takeaway might be, look, it turns out that tablets should have been a scaled up phone, not a scaled down PC. That was certainly true at the time.

03:33:14 Speaker_00
Yeah.

03:33:15 Speaker_03
Certainly at the time. So complete commercial failure, the ecosystem of windows eight apps did not really galvanize. And where we're left is the state of the windows app developer ecosystem. In the 2013, 14 time period is right back where we started.

03:33:34 Speaker_03
No one's terribly interested in targeting that as a developer platform. All the energy is actually just going to go into the web app.

03:33:40 Speaker_00
Yeah. And then all the energy is going to go into the mobile app.

03:33:43 Speaker_03
Yep.

03:33:44 Speaker_00
None of which is in the Microsoft ecosystem. Okay. Yeah. I mean, this is the death of Microsoft as a consumer company.

03:33:52 Speaker_03
No doubt. Undeniably. Zune failed being small market share windows phone lost to Android. Yep.

03:34:00 Speaker_00
Lost mobile windows eight, you know, this whole thing didn't work. The stock price has languished. Hasn't moved in 10 years stock stuck at 30 bucks.

03:34:11 Speaker_03
This is dark, this 2012, 13 time period, this is dark. And at the same time. Well, it's funny, it's dark and revenues and profits have grown tremendously. The enterprise motion of Microsoft has basically never had a down year.

03:34:28 Speaker_03
I mean, 2008 in the Great Recession, but other than that, like chug, chug, chug, chug, chug, even through the bad Windows releases.

03:34:36 Speaker_00
It's dark and yet the light is shining so bright on the financial statements of this company. And what is going on here? Obviously, it's the enterprise, but it's even more than that. It's Azure. It's the cloud. It's already humming. It's going.

03:34:51 Speaker_00
Microsoft did reinvent itself. Microsoft did position itself to be at the forefront of technology. It just did it all within the enterprise context of the company.

03:35:04 Speaker_00
And the Azure story is absolutely incredible, and I think nobody knows how it really happened.

03:35:09 Speaker_03
Yes. As the general public is concerned, Steve Ballmer was obsessed with Windows. He built the enterprise business. He left. Satya Nadella came in and launched Azure, and Azure has been great. Not exactly. That's not really what happened.

03:35:24 Speaker_00
So when Bill was planning to fully retire from the company, to retire from his chief software architect role, all the way back in 2004, 2005, He and Steve know that there needs to be a successor in this role.

03:35:42 Speaker_00
Even Steve would be the first person to tell you he is not a technologist. He can't do both roles. He needs a Bill. He needs a chief software architect.

03:35:51 Speaker_03
And realistically, you can't replace Bill Gates with one person. So we need two Bills.

03:35:57 Speaker_00
Yup. So they're casting about. Craig Mundy becomes one of those two Bills internally. And they also know who probably the perfect person is to take the other job. and that is Ray Ozzie.

03:36:09 Speaker_00
Ray, of course, being the author of Lotus Notes, Ray is a legendary developer, and he has great relationships within Microsoft because Ray built Lotus Notes, not at Lotus, but at his own software studio startup, and Lotus was just his publisher.

03:36:28 Speaker_00
So he's known all the Microsoft guys for years.

03:36:31 Speaker_03
This is so fascinating. I never put two and two together, but Lotus one, two, three, and Lotus notes were not like peers together. Lotus one, two, three was developed by Lotus. Lotus notes is actually Ray's company.

03:36:45 Speaker_03
It's almost like the way a game studio works. Ray and his company are building it. Their publisher is Lotus, but. Ray can have agreements with Microsoft where he's privy to information that Lotus is not.

03:36:58 Speaker_03
And so Ray is like really close in the fold with the Microsoft folks. I think he was even a contractor working on, maybe the project was Landman, but he was actively contributing to other Microsoft products.

03:37:12 Speaker_00
Right, because he had his own software company.

03:37:14 Speaker_03
Yeah, he was almost like Switzerland in the middle.

03:37:16 Speaker_00
Yeah. So by this era now, 2004-2005, Ray has a new startup called Groove Networks, and Microsoft just acquires the company. And they get Ray.

03:37:28 Speaker_00
So in June 2006, when Bill announces his coming retirement, Ray gets named as his successor in the official chief software architect role.

03:37:40 Speaker_03
And essentially what's going on is Bill and Steve kind of look at Ray and they say, you figure out the vision. We've got all these assets, we've got a killer business, got all this great talent.

03:37:50 Speaker_03
In the coming world, the next generation of technology, why don't you figure out how Microsoft fits in and what our play is?

03:37:59 Speaker_00
So Ray writes the Internet Services Disruption Memo in October 2005. And to quote from it, this is Ray writing, the environment has changed yet again, this time around services.

03:38:14 Speaker_00
Computing and communications technologies have dramatically and progressively improved to enable the viability of a services-based model.

03:38:21 Speaker_00
The ubiquity of broadband and wireless networking has changed how people interact, and they're increasingly drawn toward the simplicity of services and service-enabled software that just works.

03:38:33 Speaker_00
Businesses are increasingly considering what services-based economics of scale might do to help them reduce infrastructure costs or deploy solutions as needed and on a subscription basis. Wait, David, you're telling me

03:38:49 Speaker_03
that businesses may want to basically rent capacity from big data centers to just deploy their applications and not worry about the catbacks of buying the servers and racking them all and maintaining the data center and handling the privacy and blah, blah, blah.

03:39:05 Speaker_00
I'm telling you that and I'm telling you they might not even just want to buy the infrastructure. They might just want to buy the solution as a service hosted by us.

03:39:17 Speaker_03
All right, so this is Ray in 2005.

03:39:20 Speaker_00
And so in January 2006, Ray, with Steve Ballmer's full blessing, goes and starts recruiting for a secret project within Microsoft incubated outside any of the existing divisions. And this is super important.

03:39:35 Speaker_00
This should have come within Server and Tools. Like that whole big new business that we talked about that was like the key linchpin of Microsoft's Steve Ballmer era enterprise strategy. Of course, Azure should have come from within.

03:39:50 Speaker_03
Microsoft has a group that produces a product called Windows Server, and that is an operating system that runs on other people's servers. And that group is not the group that produced Azure, the cloud service that runs, at the time, Windows Server.

03:40:05 Speaker_00
Yes, the reason for that is that this is completely disruptive to the whole Windows Server and Server and Tools business model.

03:40:13 Speaker_00
Their go-to-market and their business model is we sell these solutions to be operated in your data centers, in your infrastructure, where Accenture and all the consulting firms and all the value-added resellers, they're all our partners.

03:40:29 Speaker_00
They're all our go-to-market. They're all gonna go implement that on-prem for you. And so if we were now to say like, wait a minute, all of a sudden we're going to do that as a service and we're going to sell it to you separately.

03:40:42 Speaker_00
That is a huge issue risking a lot of my go-to-market motion.

03:40:46 Speaker_03
Not to mention, these end enterprises in some ways are actually the OEM's customers. Yeah, these Dell servers are running Windows Server, but Dell sold a bunch of servers, probably through Accenture, to the end customer.

03:41:02 Speaker_03
There's that whole issue of upsetting the apple cart. There's also the internal rewards issue and KPI issue. Everyone in

03:41:12 Speaker_03
Windows and Enterprise land, ultimately their KPI is how many copies of Windows can we sell to end customers and generate the licensing revenue on Windows?

03:41:22 Speaker_03
And this new thing, if we actually pursue a cloud strategy, is how can we spend a whole ton of money building out a data center, buying other people's servers, generating zero licensing dollars, and hoping people use the servers so we can charge them later?

03:41:40 Speaker_00
Yeah, Windows is nowhere in this equation.

03:41:42 Speaker_03
Yeah, we're gonna build out a gigantic server farm and rent usage to people. That doesn't fit into anyone's current KPI or compensation.

03:41:52 Speaker_00
So, Ray's recruiting for this project, codenamed Red Dog, and he brings in the biggest of big guns. That's right, the legend himself, Dave Cutler.

03:42:05 Speaker_03
No one builds hardcore, enterprise-ready, close-to-the-metal code than Dave. Dave was the architect on Windows NT.

03:42:16 Speaker_00
We talked about him a lot on part one. Also another guy named Amitav Srivastava. Amitav had also come from DEC, which is where Dave came from. Total beast of an engineer. He had experience both in the enterprise server and tools products.

03:42:29 Speaker_00
And Amitav was also a big part of getting Vista out the door with Brian Valentine before Brian left for Amazon. And the two of them recruit a team and they build Azure. Cutler builds a new hypervisor.

03:42:45 Speaker_00
that Azure runs on from scratch without using open source, like himself. Hypervisor, of course, is the piece of software that virtualizes underlying hardware and allows, you know, multiple software tenants to run on a single piece of hardware.

03:43:02 Speaker_00
It's like VMware was a hypervisor company. It was a whole company building hypervisors. And Dave just was like, yeah, I got this. It's crazy. So great.

03:43:11 Speaker_00
And Steve Ballmer supported this whole thing, pushed it all through, despite heavy pressure and incentives from inside the company, from Windows, from partners, from the whole go-to-market motion that he built, you know, Microsoft's enterprise go-to-market motion.

03:43:28 Speaker_00
Steve, he didn't get it right away, but he started talking to enough customers and realizing that this was the future of enterprise computing, that he just flipped a switch and said, I'm all in, we're doing this, whatever resources we need.

03:43:43 Speaker_00
I mean, we're talking billions and billions of dollars of capital expenditure to build up these data centers. This is not just a like, Oh, some little incubation project, you know, sure. We'll see what happens.

03:43:53 Speaker_00
This is like, no, we kind of got to like bet the company on this.

03:43:57 Speaker_03
Well, it's funny. I disagree that it's a bet-the-company move because of two reasons. One, it's only money that they're spending. Cash is never a resource constraint. The bigger concern is Ray Ozzie and Dave Cutler are working on this.

03:44:14 Speaker_03
That is why it would be bet-the-company. Two, in its initial incarnation, Azure did not threaten the Windows-centric approach.

03:44:26 Speaker_03
If you remember, when Azure launched, it was Windows Azure, and it ran Windows Server, and it was Platform as a Service, and Microsoft in no way changed its tune on open source.

03:44:38 Speaker_03
I mean, to this point in history, Microsoft thought that open source was a complete cancer. And for good reason.

03:44:45 Speaker_03
I mean, at the end of the day, basically, Microsoft charged for things that open source was giving away for free, from operating systems to programming languages to development environments to servers and everything about it.

03:44:57 Speaker_03
It was like, oh, my God, is there a future where everyone just expects all of our value to be free? And they managed to combat that and build a great business despite that. But they never embraced open source. They never at all

03:45:12 Speaker_03
wanted to be a part of anything that open source developers were doing until a couple years into Azure. Not until 2014-15.

03:45:20 Speaker_00
And why I would say this is bet the company, you're right. They didn't go full infrastructure as a service and embrace open source and let people use Azure to run Linux in the lamp stack on top of it.

03:45:32 Speaker_00
That was not day one, but they knew they had to and they were going to. And it was just a, Hey, we're not going to do this right away because the company would Oregon reject this so hard, but we are moving in that direction. And. we will be AWS.

03:45:50 Speaker_00
We will offer everything they offer and more to our enterprises who trust Microsoft.

03:45:57 Speaker_03
Yep, that's a fair pushback. But Azure came in with an aggressive point of view. We are platform as a service, which was distinctly different than AWS, which was we are infrastructure as a service.

03:46:09 Speaker_00
Now, interestingly, Office and applications and software as a service actually came pretty quickly thereafter, too.

03:46:15 Speaker_00
Famously, they did a pilot program with Energizer, like the battery company, selling to sort of, I don't think it was like the office productivity suite, but it was like SharePoint and stuff, I think, as a service, as software as a service. Right.

03:46:30 Speaker_00
So in 2010, Ray Ozzie actually leaves the company, but as he's doing, he and Steve roll Red Dog, by this point in time renamed Azure, back into the server and tools business.

03:46:44 Speaker_00
And the two of them go to the University of Washington and Steve gives a speech at the University of Washington. We are all in and we are betting the company on cloud and on Azure.

03:46:55 Speaker_00
The intended audience, of course, was Microsoft internally of like, hey, we are sending a message to the server and tools team. This is the future.

03:47:04 Speaker_00
And after that, Steve replaces the division head of the whole server and tools division, who was Bob Muglia at the time. Bob would later go on to be the CEO of Snowflake before Frank Slootman came in. So he did fine. Bob was great.

03:47:21 Speaker_00
Bob was crushing it as head of server and tools. Revenue was growing, I don't know, 30, 40% a year. It's a $12 billion business, but.

03:47:31 Speaker_00
The reason that Steve made the change was he said, we need a new leader who's going to come in and change this organization and make it a cloud first organization.

03:47:41 Speaker_03
And not carry the baggage of all the success from the previous iteration.

03:47:46 Speaker_00
And the person that Steve taps to do that from Bing is none other than Satya Nadella.

03:47:55 Speaker_03
Yep.

03:47:56 Speaker_00
To come in and lead that transformation.

03:47:58 Speaker_03
And from what I can tell, it's just as motivated by Azure is the future and it needs a new leader as it is Satya is a really talented rising executive in this company and needs to be put on an important project.

03:48:11 Speaker_00
Absolutely.

03:48:12 Speaker_03
Almost like Bing's not enough for this guy. Where can we put him?

03:48:16 Speaker_00
Totally. It was, let's get this guy the right exposure to the right important things that he could be CEO of this company someday in the not very distant future.

03:48:27 Speaker_03
Yep.

03:48:28 Speaker_00
To say that this goes well is an understatement, obviously, but just to put some numbers on this, Microsoft has three reporting segments, productivity and business process, aka Office, and that includes Office 365 as part of that segment, the more personal computing segment, that's Windows and Surface and their hardware efforts, and then the intelligent cloud segment, and that's Azure, and I think LinkedIn is part of the Office segment.

03:48:58 Speaker_00
if I have that right. I think that's right. I don't think LinkedIn is in the cloud segment. Intelligent cloud today is by far the largest segment in the company by both revenue and profit and by very, very far the fastest growing within the company.

03:49:18 Speaker_00
Windows is declining.

03:49:19 Speaker_03
It's the largest business now and the fastest growing.

03:49:22 Speaker_00
Largest business, most profitable, fastest growing. In fiscal 2023, Intelligent Cloud did $88 billion in revenue.

03:49:32 Speaker_03
Wow. Crazy. It is worth not to pour cold water at all, because I think the high level point stands.

03:49:37 Speaker_00
I was going to say this too. I know where you're going.

03:49:39 Speaker_03
Intelligent cloud includes SQL Server and Windows Server. So these are big legacy businesses.

03:49:46 Speaker_00
Yes, I think that is both a, especially in the early days when Microsoft and Satya was hyping up how much cloud revenue the company was doing, being able to report the legacy server business as part of that revenue helped a lot.

03:50:01 Speaker_00
On the other hand, the counter argument to that is, this is actually Microsoft's competitive advantage versus AWS.

03:50:08 Speaker_03
Totally agree.

03:50:08 Speaker_00
Microsoft can go to enterprises and say, we are hybrid cloud, less so today, but in the earlier days of the Azure transition, saying like, hey, you need to be on cloud, we have a world-class public cloud for you, and it works great with our on-prem server offerings, and we can be hybrid for you.

03:50:27 Speaker_00
Yep, totally agree. We'll talk about this a little more in conclusion. We have one more chapter in Nokia and the end of Steve's tenure to talk about here, but it turned out actually that the cloud market was so big. that nothing else really mattered.

03:50:46 Speaker_00
All the missteps, all the losses, it makes sense, right? Cloud powers everything. Cloud powers tech. Cloud powers all the consumer services. They all run on the cloud.

03:50:58 Speaker_00
So every consumer service that is not owned by Microsoft or Meta or Google or Amazon runs on one of their clouds. And some portion of that revenue accrues to Microsoft.

03:51:10 Speaker_03
And increasingly, the offline economy is becoming some sort of cloud dependent service. I mean, it's crazy to just see cars rely on the cloud and restaurants rely on the cloud.

03:51:24 Speaker_03
Like anything that you interface with in the physical world, you expect to have some digital component. At the very least, take credit cards.

03:51:31 Speaker_03
And all of these things, point of sale systems, all of these things are routed through the cloud at some point. David, I think you're making the same point about the cloud today that I was about Microsoft in the PC era.

03:51:45 Speaker_03
Microsoft was lucky to own 90% market share, and in cloud they own, you know, meaningfully less than that. But it's still basically a tracker on the growth of an insane secular tailwind that is just an inevitability in the world.

03:52:00 Speaker_03
It's probably a 30, 40 year wave that they get to keep riding.

03:52:04 Speaker_00
And again, this is outside the scope of this episode, but it's sure looking like, to the extent AI is the next computing wave, that is also happening in the cloud in the data center. So like, that's just going to turbocharge everything.

03:52:19 Speaker_03
Yep. So to review how it came to be, interestingly, it was Ray Ozzie in an incubation group doing it outside the bounds of the business units. Beginning in 2006. Beginning in 2006.

03:52:32 Speaker_03
with Steve's buy-in and the air cover from Steve to make it happen organizationally. You look at where all the talent came from. Bing taught them how to do distributed systems.

03:52:45 Speaker_03
Xbox Live was a always-on cloud service, real-time, zero latency, with 40 million subscribers. MSN was a super high-traffic web property with 750 million registered users. Hotmail was a web application that hundreds of millions relied on.

03:53:02 Speaker_03
They had SharePoint and Exchange. There was knowledge of how to do server based application software for the enterprise.

03:53:09 Speaker_03
I mean, there was some conflict business model wise with Windows Server since Azure would be an orthogonal business model, but the technical chops were there. I mean, these are hardcore server OS people.

03:53:21 Speaker_03
Of course that group is going to be capable of doing things like hypervisors so. I just think the ingredients were remarkably there from all these other things that Microsoft had been doing over the years.

03:53:35 Speaker_03
They were kind of the only one who could pull this off at this scale with this set of enterprise relationships to migrate all these people to the cloud as they built out the product suite.

03:53:46 Speaker_00
I mean, really kind of like, we got, I don't know, halfway-ish through our research for this and this just hit me of, holy crap, this era for Microsoft that everybody thinks of is like the loser era. This is the era where they won, you know?

03:54:03 Speaker_00
Or they built the foundation to win.

03:54:05 Speaker_03
Yeah, there was seven years before Steve Ballmer handed the reins to Satya where Azure development was happening under him.

03:54:17 Speaker_00
Yes.

03:54:18 Speaker_03
That is nowhere near the public narrative.

03:54:21 Speaker_00
And Steve is the one who handpicked Satya to lead it and get all the credit and the narrative and the win and then become the CEO.

03:54:30 Speaker_03
Pretty wild.

03:54:31 Speaker_00
That is definitely not the public narrative out there.

03:54:33 Speaker_03
Yep. I could see if you were an Azure doubter and you were sitting there at the top of Microsoft enjoying the Windows monopoly, the tremendous business that is Windows and Office, and thinking, why would I do anything to jeopardize this?

03:54:50 Speaker_03
I mean, Windows has self-reinforcing network effects everywhere. Huge switching costs for the enterprise, super profitable, high margin, one of the greatest businesses of all time.

03:55:01 Speaker_03
And now there's this idea that you want me to spend the money to run servers. People can run their own software on my servers, even if it's open source, so it's not feeding into my Windows-centric ecosystem.

03:55:15 Speaker_03
There's a chance they're not paying for Windows licenses. Right.

03:55:18 Speaker_00
There's a chance they're not even paying for my enterprise software services like Exchange or like, you know, Windows Server or whatever. Like you're saying, Ben, they might be running Linux on there or my competitor's products.

03:55:30 Speaker_03
It's not even as good a business. It's not zero marginal costs. Running servers, running these big data centers has huge costs. And even if you say, oh, those are fixed costs to rack them, and you amortize them over a course of years.

03:55:41 Speaker_03
But energy has a real cost. It's kind of shocking that they eventually did embrace this very unproven new business that could potentially be way worse than their current business.

03:55:54 Speaker_00
Totally. And without taking anything away from Satya, because I think he does absolutely deserve a ton of credit for knocking it out of the park on execution.

03:56:04 Speaker_00
I kind of think all of the credit for the vision for it and the championing it for the initial seven years within Microsoft goes to Steve and to Ray.

03:56:14 Speaker_03
Yep. Now, I will say the company stayed the Windows-centric company for too long.

03:56:20 Speaker_00
Oh, for sure. Yeah, no doubt.

03:56:22 Speaker_03
I mean, Azure was being built, so it was successful enough that it sort of erases everything else. But a lot of listeners know this, but I worked at Microsoft from 2011 to 2014.

03:56:32 Speaker_03
My internship in 2011 was on the Word web app in the Office 365 suite, but before it was called 365. And then my real job was I worked on, when I came back, Office for iPad. which was super secret at the time.

03:56:47 Speaker_03
It was really counter-strategy because we were the Windows company. But at the same time, what users wanted in this world in 2012 was, I want to access my documents on any device that I'm on. We have moved to a world where I have multiple devices.

03:57:04 Speaker_03
I just want to be able to use your application on my device, please. And absolutely 100% something that happened is all 200 of us worked for multiple years to get these things ready. We had a ship date. Well, we had what we thought was a ship date.

03:57:22 Speaker_03
Actually, what happened was we were told that actually we're going to shelve it. And instead of a ship party, we had a shelf party because the product got canceled.

03:57:32 Speaker_00
Oh, that's brutal. Oh, I'm sorry. Canceled. What time frame is this? Okay.

03:57:38 Speaker_03
And basically it was, hey, we just released Windows 8, we just released the Surface, and we want the marketing message for those things to be that Office is first and best on Windows, and the only tablet in the world

03:57:54 Speaker_03
that can run real Office is the Surface. And I, of course, am too biased and too personal to really think through this, but I was like, oh, this company has its head in the sand. This is ridiculous.

03:58:09 Speaker_03
What users want is we have a good version of Word, Excel, PowerPoint that people can run on their iPads, and we've decided not to ship it to try and advantage Surface and other Windows 8 devices. Yes.

03:58:24 Speaker_03
The year later, we did ship it actually right after Satya became CEO. That was one of the first things he did. So ultimately that decision didn't happen that much later than it would have otherwise.

03:58:35 Speaker_03
And kind of an open question of whether it was a mistake. Like did Microsoft ever lose a dollar for deciding to hold office for iPad another year? Probably not.

03:58:43 Speaker_00
Yeah.

03:58:44 Speaker_03
At the time, I held this belief we have stayed the Windows company for far too long and need to embrace users where they are.

03:58:53 Speaker_03
Now, with all this hindsight, I understand why you wouldn't make the decision when you feel like the iPad could be the end of you.

03:59:01 Speaker_03
Why would we go all in on that now and put our finest products to advantage that thing when we don't know if that thing is going to kill us or not? So there's the big downside. There's not much upside to launching it.

03:59:17 Speaker_03
What, am I going to renew a few more enterprise agreements because of it? Probably not. Perhaps young Ben working at Microsoft at that period of time failed to understand how important it is to think like an incumbent when you are the incumbent.

03:59:32 Speaker_02
Hmm.

03:59:34 Speaker_03
And this was a low upside to doing it right away, plenty of downsides to doing it right away, really no risk on sitting on it.

03:59:41 Speaker_00
It was an easy win for Satya during his first year to say, culture has changed here, we are shipping Office on iPad.

03:59:48 Speaker_03
We have shifted from a devices and services company to a cloud-first, mobile-first company. I believe that was the message.

03:59:56 Speaker_00
Yes, that was the message. And that was a great supporting point, example of the message.

04:00:04 Speaker_00
Well, speaking of transitions and transitioning, I think it is time to wrap up our history of this period of Microsoft and mobile and everything and Steve's tenure and talk about Nokia as we end things here.

04:00:19 Speaker_03
Who bought Nokia?

04:00:21 Speaker_00
Oh, that's a good question. Okay. After Microsoft had released this Windows phone, which, like we said, was really kind of doomed to fail against Android, like you just couldn't compete with free.

04:00:38 Speaker_00
I think Bill Gurley had a blog post about Android back in the day about the less than free business model and why you can't compete with it.

04:00:45 Speaker_03
Yeah. In fact, as Heather, they were giving away for free. They were willing to pay people to take it. I mean, if you think about it, I'm sure there was money that they spent on the Droid marketing campaign.

04:00:55 Speaker_03
I'm sure there was money that they paid to the carriers to pay to their salespeople to incentivize people to buy it versus the iPhone in stores. That was a common practice in the mobile industry.

04:01:06 Speaker_03
So I think less than free is actually the correct way to frame Android.

04:01:11 Speaker_00
Totally. So there was one phone OEM that was willing to play ball with Microsoft and Windows Phone, and that was Nokia.

04:01:23 Speaker_03
Well, sort of. I mean, Nokia basically had Symbian as its OS. They tried to start another OS because Symbian was sort of reaching the end of its life. That wasn't going well. And so they were kind of left without a platform.

04:01:40 Speaker_03
And so they either needed to pick Windows Phone or Android as their platform of the future, despite being what used to be the dominant phone maker for all cell phones.

04:01:52 Speaker_00
And? The then CEO of Nokia was a guy named Stephen Elop. Folks will almost surely remember that name. He was a former Microsoft guy, and he had come over to run Nokia. So there were deep relationships there.

04:02:07 Speaker_00
In February 2011, Nokia agrees to adopt the Windows Phone operating system as its primary smartphone OS for its devices. Like you said, Ben, it didn't have a lot of options and it wasn't willing yet to go Android.

04:02:24 Speaker_00
Pretty quickly though, as we get into 2012, 2013, it's clear Windows Phone ain't really working and Android is the future. So as we get into 2013, Nokia comes to Microsoft and says, We gotta talk.

04:02:47 Speaker_00
We're gonna go Android, unless you make it worth our while or something happens here and changes. And as Steve put it to us, it was only money.

04:02:57 Speaker_03
That is actually the right way to think about it. We've been joking about it's only money, but honestly, what was Microsoft's market cap at this time?

04:03:04 Speaker_00
Call it 300 billion.

04:03:05 Speaker_03
And what was the forthcoming acquisition offer for Nokia?

04:03:10 Speaker_00
Seven.

04:03:11 Speaker_03
So that is 2.3% of the company. You're willing to give up 2.3% of your company for some particular bet.

04:03:21 Speaker_03
I actually think that's a very reasonable way to think about this, Aquanive, Skype, which we didn't talk about, which actually was a pretty good deal, especially because of the tax treatment, you know, Yahoo, Facebook.

04:03:33 Speaker_03
You should think of these things as a percentage of market cap. And sometimes things could go really, really right

04:03:40 Speaker_00
It's even less consequential than that. It's not even a percentage of market cap at all. Microsoft's operating income in 2013 was $27 billion.

04:03:50 Speaker_00
So it's $7 billion out of $27 billion in just cash that they don't know what to do with and that they aren't getting credit for.

04:03:57 Speaker_03
But your cash is valued as a part of your market cap.

04:04:01 Speaker_00
I mean, sure, but Microsoft stock is in the dumps here. The cash flow geyser is not appreciating the stock price here. Wall Street does not appreciate what's going on.

04:04:09 Speaker_03
It's funny. I delivered you a technically correct answer and you delivered me back a very pragmatic one. Yes, right, right. Which is that's not accruing to your market cap anyway, so you may as well spend it.

04:04:19 Speaker_00
And I think it was probably in Steve's mind here of like, I'm not getting any credit for this, all this cash I'm generating, like F it.

04:04:26 Speaker_03
When it doesn't cost you focus or your best people or whatever the scarce resources are and it only costs you cash, then you should totally think about it as, am I willing to bet 2.3% of my company or whatever percent of the cash that I'm not getting any credit for if something could go really right?

04:04:44 Speaker_03
It's a venture capital bet, you know?

04:04:45 Speaker_00
Yup. Well, and Nokia is basically holding a gun to my head.

04:04:49 Speaker_03
Right. There's actual downside to it also.

04:04:51 Speaker_00
There's actual downside here. Right. So that's how the deal comes together. It was super controversial within the company and on the board.

04:05:02 Speaker_00
Obviously, at one point, Satya talks about in the book, there's a straw poll taken of all the division heads, all the top leaders in the company, whether they're for or against the acquisition. The majority are against the acquisition.

04:05:17 Speaker_00
Satya is against the acquisition. The board basically says to Steve, like, clearly there's not support for this.

04:05:25 Speaker_03
And so my understanding of the timeline is there's a seven and a half billion dollar offer on the table. Steve mulls it over, plays with it, is for it, proposes it to the board. And exactly.

04:05:35 Speaker_03
The board comes back and says, hey, there's not support for this.

04:05:38 Speaker_00
Okay. After that happens. A series of discussions start and culminate. We're in kind of late summer, early fall 2013 when all this goes down.

04:05:51 Speaker_00
And on August 23rd, 2013, Microsoft and Steve Ballmer announced that he is retiring within the next 12 months and that the board and the company have started the search for a successor as CEO. That was August 23rd, 2013. Yep.

04:06:10 Speaker_00
On September 3rd, so 10 days later, Microsoft agrees to buy Nokia's mobile unit for $7 billion. We heard a bunch of different stories. How it went down, we don't know exactly, but the fact pattern is Steve announced that he was leaving.

04:06:28 Speaker_00
10 days later, Microsoft agreed to buy Nokia. The question kind of remains, who bought Nokia? We don't really know in any event.

04:06:40 Speaker_00
Here's what happens next February 4th 2014 Satya Nadella is introduced as the next CEO of Microsoft Steve Ballmer steps down on that same day bill also steps down as chairman of the board and John Thompson becomes chairman of the board, so it's a

04:06:58 Speaker_00
Wholesale changing of the guard within Microsoft. Bill, Steve, the original folks were retiring. We're done. It is a new day. And that needed to happen. The Office for iPad discussion we had a minute ago You know, I think it was emblematic.

04:07:15 Speaker_00
Like, there is truth to what Satya wrote in his book that we said at the very beginning of the episode of, hey, this company culture needed a reset.

04:07:23 Speaker_00
You know, it's kind of like a bigger version of Brad Smith's presentation to the board of it's time to make peace. Like, it's time to make peace internally. And there just needed to be a reset.

04:07:33 Speaker_03
Yeah, there was a lot of baggage. I mean, it's just, what, 40 years of baggage. Bill, Steve, old wars, antitrust, bad releases of windows. Like, you just gotta get it out to move on. And it was Bill and Steve leaving in one fell swoop to clear the path.

04:07:54 Speaker_00
And at the same time, everybody knew, hey, there is a huge win that we are sitting on right here, like a huge, huge, huge win in Azure. And it is going to be really good for everybody's personal net worth, if nothing else.

04:08:10 Speaker_00
If we can just let that be appreciated and let a new day dawn here, So, on February 4th, 2014, on that day, Microsoft's stock price was $30.50. And as we said a minute ago, the market cap was, I don't know, call it $300 billion, slightly below.

04:08:28 Speaker_00
Today, 10 years later- Whoa, whoa, whoa.

04:08:31 Speaker_03
This is volume three, David. Don't- Yeah, yeah, yeah. Well, you know, just to- Foreshadow.

04:08:35 Speaker_00
Show that this was the right decision. Ten years later, stock is at $465. Market cap is three and a half trillion dollars.

04:08:47 Speaker_00
Probably like, I don't know, I haven't done a sum of the parts analysis, but I think you can say probably at least half is Azure propping up that market cap.

04:08:57 Speaker_03
They are currently the most valuable company in the world.

04:09:00 Speaker_00
The once and future king, Microsoft. That's our story for part two. We still have a lot to talk about in analysis.

04:09:10 Speaker_03
I'm sure someone's looking down at their podcast player right now, like, wait, why are they acting like they're done? There's so much time after this. Are they just going to like play some music or?

04:09:17 Speaker_00
Lots to talk about.

04:09:18 Speaker_03
Okay. I have got some start and finish stats on Steve's tenure as CEO. Ooh, great.

04:09:26 Speaker_03
This episode, we started a little bit before Steve took over because we wanted to put the internet chapter in and the antitrust chapter in, but I think everyone kind of feels it by this point.

04:09:35 Speaker_03
The question really is like, what happened when Steve was running the company? And so here are the numbers. And this is the time frame from 2000 when he was announced as CEO until 2014 when Satya was announced. So a 14-year period.

04:09:51 Speaker_03
Revenue went from $23 billion to $84 billion. That's a 3.5x over 14 years. Operating income went from $12 billion to $30 billion, so almost a 3x. Important to pay attention to is the price-to-earnings ratio when Steve was announced as CEO was a 75x.

04:10:15 Speaker_03
That's high. It was real close to an all-time high, which was in the month prior at an 80x. So it is worth pointing out, it still has not been that high to this day. Even today, with all the excitement around Microsoft, AI, everything going on, 40x.

04:10:32 Speaker_00
Right, so Steve comes in at an all-time high multiple, and right before the DOJ verdict and the breakup of the company.

04:10:41 Speaker_03
And the dot-com bubble is exploding. Yes. And you're taking over from Bill Gates.

04:10:47 Speaker_00
All the things.

04:10:49 Speaker_03
Essentially, if you're doing an analysis of what happened in Steve's tenure and you're trying to grade that, you are implicitly saying, did Steve make a good investment?

04:10:59 Speaker_03
To be honest, I think Steve took one for the team in taking over as CEO in that moment. He was handed a bit of a impossible situation, garbage sandwich, inheriting something when it is valued that highly.

04:11:13 Speaker_00
Not to mention, as we talked about during that period, all the frankly shit going on at the company.

04:11:19 Speaker_03
completely. So I worked at Microsoft during this period. I was a big open source guy. I was a big Apple guy. I was all these things. And I hated Steve's Windows strategy. And frankly, I didn't like using any Windows products.

04:11:34 Speaker_03
I felt like they were all crap. And it is still true that it's totally insane to evaluate how did someone do with an asset that they were sort of forced into buying at 75x earnings. Yep. So at the end of his term, it was 14x. The P.E.

04:11:54 Speaker_03
multiple went from 75x to 14x. The market cap when he was announced went from $600 billion to when he left at $330 billion. A lot of that is basically the price-to-earnings multiple rationalizing in that first year.

04:12:11 Speaker_03
And then after it did that, the stock price was basically flat. for his entire tenure, no matter how much the revenue or the profits grew. And so one crazy stat on this is you could have bought Microsoft in 2009 for 2.1 X annual revenue.

04:12:27 Speaker_00
Oh my God. I mean, everything was on sale back then, but like, wow, listeners are slight of hand here.

04:12:33 Speaker_03
We switched from earnings to revenue, but David, I thought that too. I was like 2009, come on in 2013, you could have bought Microsoft stock for three X revenue.

04:12:44 Speaker_00
Oof.

04:12:45 Speaker_03
Wow. And so the question is, why? Why did investors give Steve zero credit for any of this growth? Cut off that first year when the multiple was coming down.

04:12:59 Speaker_03
Why is it that effectively what happened from 2001 to 2014 is for any gains that they got in revenue or profits, it was offset by multiple compression coming down and saying the asset's still worth the same thing.

04:13:13 Speaker_03
One is, very legitimately, the investors had little belief in Microsoft's long-term relevance. Not the place for user excitement, not the place for developers. They doubted that there was real vision from leadership.

04:13:26 Speaker_03
I mean, you went from Gates, this guy who created it all, to someone that everyone was chalking up to be the sales and marketing guy, and there's the product strategies all over the place, and Windows isn't getting any more relevant, or trying all these new things that are failing, search passes you by, social passes you by, blah, blah, blah.

04:13:42 Speaker_03
But the interesting thing is, investors basically didn't think Windows and Office businesses were sticky, and they were only valuing the newer bets. Which was super wrong.

04:13:53 Speaker_03
Windows and Office have proven to be these ridiculously durable franchises, generating more revenue today than ever.

04:14:01 Speaker_03
So, I mean, it is ultimately on the CEO to help shareholders understand where the value is, but shareholders obviously did not price in the retention and growth within the existing Windows and Office customers through a new era of technology.

04:14:14 Speaker_03
I think people were just betting that Microsoft would lose it, and they didn't. They held on to these durable franchises.

04:14:21 Speaker_00
You know, it's funny, when you asked this question a minute ago, I hadn't prepared for it ahead of time because as listeners know, we don't share notes.

04:14:30 Speaker_00
The first thing that popped into my mind about why Wall Street did not appreciate the revenue and profit growth during this time was just simply like Microsoft did not do a good job telling its story. And I think you're saying the same version here.

04:14:46 Speaker_00
Like, it's so funny. I mean, it's part of why I love doing Acquired, part of why I think the show resonates with people. Telling stories is the most important thing.

04:14:58 Speaker_00
If you cannot tell your story right and in a compelling fashion, this is what's going to happen to your stock price, even if you triple revenues and profits and build Azure and all these things.

04:15:09 Speaker_03
Yeah. I mean, consumers had no idea what Microsoft's strategy was and neither did developers, so neither did investors.

04:15:16 Speaker_00
Yep. CIOs probably did.

04:15:18 Speaker_03
Sort of, but they were probably like, what's going on in search and what's going on?

04:15:22 Speaker_00
Yeah.

04:15:23 Speaker_03
Sorry. What's Zune? Is it winning against iPod? Oh, it's losing. Oh, mobile, it's losing too, huh?

04:15:28 Speaker_00
And it's for another episode, but it really was brilliant what Satya did and the company did when he came in of, they got the story right.

04:15:37 Speaker_03
The messaging reset.

04:15:38 Speaker_00
This is a mobile first, cloud first company.

04:15:41 Speaker_03
Yep.

04:15:41 Speaker_00
That was it. That was the key. Just saying those words over and over and over again.

04:15:46 Speaker_03
Yeah, anyone who's listening who's a leader at a company right now knows that the right amount of repeating yourself to do is about 10 times more than you think it is. You need to keep delivering the same message over and over and over again.

04:15:58 Speaker_03
And that wins. The other way to sort of look at Steve Ballmer's tenure is comparing against what else was going on in technology from 2000 to 2014.

04:16:11 Speaker_03
So on the one hand, like we've been talking about, you have the rise of Google and search and you have social networking with Facebook. And yes, you absolutely can compare a CEO to these category defining startups that are in adjacent fields.

04:16:25 Speaker_03
But that's a little bit of an odd way to evaluate a CEO. Like how did you do against, they aren't even really competitors of yours in your exact market.

04:16:34 Speaker_03
And by the way, they created the best businesses in history that were also the fastest growing and capital efficient. How did you do versus those two particular sort of related outliers?

04:16:45 Speaker_03
I think this is sort of a funny measure, even though this is the measure we kind of all use. But if you actually just look at the peer set, what other big companies were there in 2000 in tech? You had Yahoo, AOL,

04:16:58 Speaker_03
The whole cable and media sector, you had HP, Nortel. I mean, so many of the great companies of the previous era completely fell apart.

04:17:09 Speaker_03
The three who actually survived and potentially thrived were Microsoft, Dell, and only Apple after Microsoft bailed them out and Steve Jobs came back personally.

04:17:21 Speaker_00
Yeah. I would throw Oracle in there too, but yeah.

04:17:23 Speaker_03
Yeah. Oracle. But I mean, surviving puts you in the top 5% against the peer set of that era.

04:17:31 Speaker_03
So even if you overlook all the revenue and profit growth, and you just look at pure enterprise value and relevance, there is actually a success in that the core asset was preserved.

04:17:42 Speaker_03
This whole notion you have, David, that Satya came in and we were great, and then we sucked for a while, and then we were great again.

04:17:48 Speaker_03
Even just setting up, we preserved the talent asset and that we had continuity in our businesses for another 15 years on what is already a 30 year old business. I don't know. That's way better than anybody else does.

04:18:02 Speaker_00
Yup. Totally.

04:18:04 Speaker_03
So anyway, this is all kind of analyzing the tenure from a business perspective. I am very amenable to the idea that products completely languished.

04:18:13 Speaker_03
Like I had no interest in using any Microsoft products during this period, despite being an employee of the company. Yeah, I'm very amenable to arguments of like, yeah, but they didn't make anything good.

04:18:23 Speaker_00
Yep. And that is, I think, particularly resonant to me, at least in my history, because they used to. They totally used to. They used to be the consumer technology leader.

04:18:33 Speaker_00
Windows 95, Windows XP, everything we talked about at the beginning of the episode, Internet Explorer, the browser wars, they were the leaders.

04:18:40 Speaker_03
And they did make some good, you know, Xboxes good. I actually thought Windows Phone, particularly Windows Phone 8, was a beautiful new crack at what does a phone look like.

04:18:49 Speaker_03
I thought it worked well, but I guess what I'm saying is the products that ended up being their big profit drivers were never their good products.

04:18:59 Speaker_00
Right. Well, they were their good products, just the enterprise products. They weren't the good consumer products.

04:19:04 Speaker_03
Right. They weren't good for me as a user. They met the needs of customers.

04:19:08 Speaker_00
Yes.

04:19:09 Speaker_03
All right. Moving to analysis.

04:19:10 Speaker_00
Great. Let's do it.

04:19:12 Speaker_03
Seven powers. So listeners, this is the part of the show analysis broadly, where we analyze the business sort of after we've completed the story. And the first one is a section called seven powers, which is named after Hamilton Helmer's book.

04:19:26 Speaker_03
And the question that he sort of poses is, what is it that enables the business to achieve persistent differential returns, or put it another way, to be more profitable than their closest competitor and do so sustainably?

04:19:41 Speaker_03
And there are seven different powers, sort of categories that it can fall into. There's counter positioning, scale economies, switching costs, network economies, process power, branding, and cornered resource.

04:19:56 Speaker_00
And I think on part one, we said Microsoft in that era had all of these, right?

04:20:02 Speaker_03
I feel like there were one or two that I was shaky on, but most, yeah.

04:20:06 Speaker_00
Well, in this era, they definitely don't have counter positioning. That's for sure.

04:20:10 Speaker_03
Right. That's the interesting thing. Once you're an incumbent, you can almost never have counter positioning.

04:20:15 Speaker_00
Yep. Actually, I would say they had some of it in the development of Azure because they could say to Fortune 500s, we will do hybrid cloud with you and we can be your trusted partner in a way that AWS couldn't.

04:20:30 Speaker_03
Counterposition against AWS. Yeah.

04:20:33 Speaker_00
Yeah. But broadly as a company, like no way.

04:20:37 Speaker_03
Yeah. They were getting counter-positioned in mobile. I mean, Google was saying, we'll give it to you free.

04:20:42 Speaker_00
Yeah. Less than free. Yep.

04:20:43 Speaker_03
Yeah. All right. Perhaps the single greatest asset they have is scale economies with the number of users and customers they have. Any investment that they make gets amortized over such a massive user base that it's worth it.

04:20:59 Speaker_03
If they can charge a dollar more on EAs, they should do almost any amount of incremental R and D or acquisitions.

04:21:07 Speaker_00
And that translates directly into the cloud era too.

04:21:11 Speaker_03
Yeah, the cloud era even more. I think there's crazy returns to scale on cloud economics.

04:21:17 Speaker_00
Yep. I think process power, I would argue they actually lost during this era. I mean, the Blackcomb Longhorn Vista thing illustrates that.

04:21:29 Speaker_03
Yeah, they went from knowing how to ship the most beloved operating system of all time with Windows 95, managing to pretty much do it again, even during the antitrust thing with Windows XP, with, I think, zero blunders in between.

04:21:41 Speaker_03
I mean, they had ME, but that wasn't a blunder as much as like a, I don't know, fresh coat of paint that wasn't really real.

04:21:48 Speaker_03
And then, yeah, with Longhorn and Windows 8, separate problems, but completely forgot why those franchises have economic value.

04:21:57 Speaker_00
Yeah. I think they also definitely lost branding power in the consumer world.

04:22:03 Speaker_03
Yeah. The question is, did they become more trusted by the enterprise where if you're offered the exact same service from Microsoft and AWS, are you more willing to pay Microsoft for it?

04:22:14 Speaker_00
Definitely. So yes, they gained it in the enterprise world.

04:22:17 Speaker_03
Yeah. Microsoft has unbelievable switching costs. The EA, you just can't switch now. You have to switch sometime in the future.

04:22:25 Speaker_03
And when that time comes, you're probably not going to switch then either because the next EA is going to offer even more value.

04:22:31 Speaker_00
It's funny to the extent that the DOJ and governments were concerned about Microsoft being a monopoly when it came to product tying on the consumer side.

04:22:42 Speaker_00
They really should have been concerned about product tying on the enterprise side where you pay us a dollar amount per device on your network and you get all of our software.

04:22:51 Speaker_00
For sure, there would be way better point solution software for any one of the hundreds of things that Microsoft is providing for you, but there's no way you're going to switch.

04:23:00 Speaker_03
Yep, you're so right. It's so funny you reflected it back to the DOJ. It's been so long now since we covered that. Hours ago, I kind of forgot about it. In that era, there were literal switching costs to getting a different browser.

04:23:13 Speaker_03
The one that came with your computer was the one you were going to use because a different browser was going to take like five to 24 hours to download over your internet connection in the dial-up days.

04:23:22 Speaker_03
It was good for consumers to receive a browser with their computer because getting another one was almost prohibitively difficult.

04:23:29 Speaker_00
Yep.

04:23:30 Speaker_03
Network economies. It's actually a little thin.

04:23:33 Speaker_00
Yeah, I mean, they had the great network economies with Windows that we talked about last time, but that starts to erode here.

04:23:40 Speaker_03
As interoperability becomes a thing as file format standardized and I can open the same documents on Macs and PCs. It's like, okay, file formats stop being a network economy that accrues only to the operating system.

04:23:53 Speaker_00
Yeah.

04:23:54 Speaker_03
I'm trying to think, are there any other, like if you were an enterprise and become a Microsoft customer and I am an enterprise and I become a Microsoft customer, do we really benefit from each other being. I don't think so. Yeah, I don't either.

04:24:05 Speaker_03
That just leaves cornered resource. Yeah. No, I don't think they have that meaningfully. No, I don't think so. I guess this power, I mean, the fact that we came up with, they don't really counter position. They have great scale economies.

04:24:17 Speaker_03
They have a lot of switching costs. And that's kind of it. That's pretty illustrative of why you kind of feel like this is the lost era of Microsoft.

04:24:26 Speaker_00
And I think it also illustrates that sounds like an enterprise company to me.

04:24:30 Speaker_03
Yep. Okay. Playbook.

04:24:32 Speaker_00
Playbook.

04:24:33 Speaker_03
Well, the first one that talks to mind that I want to address a little bit more specifically is this idea of a cultural shift. Cause we've mentioned it many times on the episode. Oh, at the DOJ, there was a cultural shift.

04:24:43 Speaker_03
Oh, with the new leadership, there was a culture shift. But what does it actually mean and how do you go about quantifying that?

04:24:50 Speaker_03
The thing that I kept hearing in all the research interviews we were doing was that when the stock price was flat, and flat for a long time, people became convinced it's just going to stay flat.

04:25:04 Speaker_03
So basically, whatever the cause of that was, it created a zero-sum environment. Nothing I do is going to make the company more valuable

04:25:15 Speaker_03
So therefore my value, the only way to grow value accruing to me, is to win at the expense of someone else at this company. I'm going to get promoted over them. My product's going to eat their product. My team's going to eat their team.

04:25:31 Speaker_03
I get kudos and at the expense of them looking like an idiot. That's the kind of incentive.

04:25:38 Speaker_00
This is the cartoon org chart of all divisions of Microsoft pointing guns at one another.

04:25:43 Speaker_03
Right. And of course it's amplified by stack ranking, which I don't have a problem with stack ranking generally, but famously at the company, everybody was ranked one to five. Every manager was only allowed so many ones and so many twos.

04:25:57 Speaker_03
Ultimately, it was an environment where everyone, every 6 or 12 months, sometimes there were mid-year check-ins, was kind of being baked off against your immediate peers in your group.

04:26:09 Speaker_03
And because the company wasn't growing in value, you had to out-compete your friends to win.

04:26:15 Speaker_00
Right. The pie was not growing.

04:26:16 Speaker_03
Right. So why was the pie not growing? We talked a lot about that. There's a lot of reasons you could argue why it wasn't, but the culture is an effect of that.

04:26:27 Speaker_03
There's a big one I've been thinking on, which is how to go about placing your bets for the future as a company. And I think in the 2000s, Microsoft was viciously trying to fight against the tide.

04:26:40 Speaker_03
There was open source, there was the web, there's all these things people wanted to do. Ultimately, over time, you cannot fight what people want to do as a company. You can put up all these barriers, you can steer them back into your ecosystem.

04:26:54 Speaker_03
But ironically, the playbook that Satya is now running is a return to a classic Microsoft One embrace and extend. Yes. Rather than fight what users are doing, I want to use open source software or whatever. I want to make web apps.

04:27:09 Speaker_03
I want to host a web app. You just figure out what people want, you embrace it, and then you figure out what product you can build with a business model that extends that existing user behavior.

04:27:21 Speaker_03
But it does require you to be clever and outcompete a lot of other people to invent that new business model that, you know, is created on top of new user behavior.

04:27:31 Speaker_00
I just want to double underline and highlight this one because I think also this same dynamic played out in the building and evolution of Microsoft's enterprise business.

04:27:44 Speaker_00
Really, IT just wanted to control the network and prevent users from messing it up.

04:27:49 Speaker_03
Right.

04:27:49 Speaker_00
Eventually, when the iPhone came out, that damn broke. And IT could no longer hold back users within their company from doing what they want and having what they wanted.

04:28:00 Speaker_00
And this is where the shift to the cloud was another reason it was so strategically important.

04:28:06 Speaker_00
Shifting to the cloud is what enabled IT to say, okay, and become a partner to their users in a way that they, you know, paid lip service to before, but they were really antagonistic to their users.

04:28:19 Speaker_03
Yep.

04:28:19 Speaker_00
And it works exactly with what you're saying for Microsoft as a company and its products too. Like, you want to use an iPhone? Great. You want to use open source? Great. We can still serve you.

04:28:28 Speaker_03
Yep.

04:28:29 Speaker_03
And the trick is figuring out how to make money when you lean into what people want, because ultimately, like if you just reduce it all to economics, what people want is free value, but you can't actually build a business on giving away free value.

04:28:42 Speaker_03
Yes. You know, I can give you a dollar for 90 cents, but ultimately I'm just going to go out of business. And so I need to figure out some way that you're happy from value creation and willing to pay me more than it costs me to anyway.

04:28:53 Speaker_00
The trick is getting the business model, right?

04:28:55 Speaker_03
Yes. There's this other one of what was going on given that the ideas were good. And this is going to sound harsh, but timing, implementation, and taste at Microsoft from call it Windows 98 on were just terrible.

04:29:13 Speaker_03
Or maybe put another way, they had the right ideas, but late timing and bad execution. Strategically correct, but tactically misguided. I mean, Bill was super right that touch computing was going to be a thing.

04:29:26 Speaker_03
He referred to this idea of a natural user interface very often. Bill was super right that interactive TV was going to be a thing. I mean, think about how I watch Netflix. I will watch Netflix tonight after we record on my Apple TV upstairs.

04:29:38 Speaker_03
Bill was right on mobile that that was going to be a huge part of the computing landscape. And yet, all of these started at Microsoft 5 to 20 years before the tech was actually ready, and they would often bet on the wrong standard or paradigm.

04:29:52 Speaker_03
I mean, touch computing ended up being capacitive, not resistive with a stylus. Tablets have proven to be a cousin of phones scaled up, not PCs scaled down.

04:30:01 Speaker_03
Interactive TV came after the internet, not before, and only once there was a tremendous amount of bandwidth.

04:30:08 Speaker_03
I mean, think about how much more bandwidth it consumes for all of us to ad hoc start Netflix streams versus there's one broadcast happening and we all just tune in when we tune in and we just catch whatever part of the broadcast is over anyway.

04:30:21 Speaker_00
Not to mention interactive TV looked like YouTube and Netflix and not like, you know, a layer on top of Comcast.

04:30:28 Speaker_03
Totally. Mobile was five years early and it was more akin to embedded devices than it was to scale down PCOS. So something was off in Microsoft's ability to leverage their future predicting into creating the right products. Right.

04:30:48 Speaker_03
Which is weird because historically they have been good at it.

04:30:51 Speaker_00
Yeah.

04:30:52 Speaker_03
Well, they at least employed the one Microsoft employee referred to it as bracketing. You basically develop two products concurrently, one aimed below what the current technical capabilities are and one aimed above.

04:31:06 Speaker_03
And as you get closer to shipping or as you get closer to like letting the market play out, you kind of pick whether you're going to make the low end one better or you're going to sort of start reducing functionality of the high end one.

04:31:18 Speaker_03
And so in the IBM days, you know, you had Windows and OS2.

04:31:22 Speaker_03
And in the internet era, you had like the web browser versus all the interactive TV stuff, or Longhorn, which was supposed to be little or an iterative versus Blackcomb, which was so ambitious, it actually got canceled.

04:31:34 Speaker_00
Yeah, the problem was during this era, that sort of optionality and multiple bets. kind of collapsed down to like, no, we're going to make one bet in each of these.

04:31:43 Speaker_03
Yeah. Or like the bets somehow couldn't continue to flourish internally. I don't really know why, but it seems like for some reason, bracketing worked well for a while.

04:31:54 Speaker_03
And then eventually their ability to take a good idea and implement it at the right time, the right way fell apart.

04:32:02 Speaker_00
Yep.

04:32:03 Speaker_03
My next one is the idea of positive sum leadership. This one's a little bit more personal than our playbook themes typically are, but I think it's an important takeaway.

04:32:14 Speaker_03
Bill Gates plus Steve Ballmer, in the right roles, with the right level of respect for each other and who made which decisions, when that was all humming, that was way more valuable than Bill alone or Steve alone. It was like one plus one equals five.

04:32:31 Speaker_00
Yes. They were so great together.

04:32:34 Speaker_03
This is actually pretty common among teams. The most high-performing teams are so much better together than they could possibly be apart.

04:32:45 Speaker_00
Yeah.

04:32:46 Speaker_03
Well, hell, look at you and me, right? I totally agree. I was going to make that analogy, but it's too much.

04:32:51 Speaker_00
There is no way we could do this on our end. Yes. Too much navel gazing, but yes.

04:32:57 Speaker_03
Bill alone, at least in this era, was totally at risk of getting too excited about theoretical technologies like WinFS. That's the perfect illustration of this. And, you know, Steve needs a great technology partner and

04:33:11 Speaker_03
one who kind of has the extreme loyalty of the thousands of brilliant engineers at the company, so they'll sort of align and follow the vision. And Steve also needed someone willing to change their mind in the face of new data. Bill was

04:33:27 Speaker_03
constantly processing new information, and as new things came in, he would say, I don't care how in motion things are, if you're right, which is rare, usually Bill's right, but if you're right and you're arguing something to me, like, screw it, we gotta change everything.

04:33:41 Speaker_03
New data, new thing. The internet tidal wave. And Steve was much more like, we have to align an entire aircraft carrier in the company and then all the aircraft carriers outside the company.

04:33:54 Speaker_03
So we are going to make a decision and then we are going to implement and execute. And I think together there was some magic where there was just the right amount of stick-to-itiveness versus adaptability.

04:34:06 Speaker_00
Yep.

04:34:07 Speaker_03
My next one is being extremely partner-focused is a gift and a curse. Microsoft is an extremely partner-oriented company.

04:34:15 Speaker_03
There are far more profits who have accrued to Microsoft's independent software vendors, resellers, retail partners, than just to Microsoft itself. But it basically makes it impossible to reset.

04:34:27 Speaker_03
I mean, Apple, when jobs came back, hit a full reset, all new developer tools, all new products, all new software, all new platforms.

04:34:36 Speaker_03
But when you have all these externalities depending on you, you actually can't really hit a reset button to adapt for a new era. you have a whole ecosystem to preserve.

04:34:46 Speaker_03
And I think this is the more nuanced view of the idea that, well, if you miss one wave, then you're actually well-suited for the next wave.

04:34:55 Speaker_03
People often say the only reason Apple was able to win in mobile is because they totally lost in desktop or whatever. And I think really what the answer is, is the more externalities you have depending on you, the more difficult it is to reset.

04:35:08 Speaker_03
And usually a next generation.

04:35:10 Speaker_00
The more switching costs you have.

04:35:12 Speaker_03
Right. A next generation technology requires you to hit a big reset button. That's all I had for my playbook. Great.

04:35:22 Speaker_00
I have just one big one, but I'm going to save it for takeaway and landing the plane.

04:35:26 Speaker_03
Let's do that now. Listeners, we've been trying out this new way of ending episodes. How do we land the plane?

04:35:33 Speaker_03
What is the one takeaway that is really sitting with me after having done all this research, talked through it with David, hardened our thinking by bouncing ideas off of each other? What is the thing that you can't get out of your mind?

04:35:47 Speaker_00
So for me, this only came to me just a few minutes ago, but I think is the right and most complete version of what I've been feeling about this part of the Microsoft story for a long time since we've been doing the research.

04:36:03 Speaker_00
And the feeling started with As we were talking to people and digging in, we were just like, this story is not understood right. And this narrative about these were the losing years of Microsoft.

04:36:22 Speaker_00
Yes, there were a lot of L's during this time, but that's not complete by any stretch of the imagination. And as we were preparing, I really felt a lot of weight on this one of like, Man, we really have a responsibility to try and get this right here.

04:36:40 Speaker_00
And I think what I realized a few minutes ago as we were talking is this was the biggest failure of the company during this period. They did not tell their story, right?

04:36:53 Speaker_00
And so much of what we think of as the losses from this timeframe and certainly everything baked into the stock price not moving was because of that. Yes.

04:37:05 Speaker_00
Steve came to the CEO role at an all-time high multiple, and it was the tech bubble, and all that stuff. Sure, that's a big thing. But why did the stock price stay in the 30s for his whole tenure? they just couldn't tell the story right.

04:37:20 Speaker_00
And there are all sorts of reasons for that. But the story does not have to be so negative because there is so much positive that happened during this time. And yet the narrative became this self-reinforcing Microsoft sucks narrative.

04:37:38 Speaker_03
Yeah, irrelevant, failing, can't do consumer. The counterfactual is Amazon. If they had a consistent message that they went forward with, such as, we're a company who invents and wanders. Amazon has failed at so many things. So many things.

04:37:55 Speaker_03
Publicly, huge bets that have totally failed, and yet... Huge consumer failures.

04:38:01 Speaker_00
The phone.

04:38:02 Speaker_03
People are like, what a beautiful thing that Jeff Bezos has imbued into this company. This idea that we invent and wander, we make these bold bets, we embrace failure. I mean, Kindle Fire, or I guess Kindle Fire kind of counts. Certainly the phone.

04:38:19 Speaker_00
I mean, at this point, I feel like standing here today, we can say Alexa.

04:38:23 Speaker_03
Maybe if LLMs hadn't become a thing, I'd be with you. It turns out it might be good distribution for a good LLM if they actually.

04:38:29 Speaker_00
Yeah, sure. But the thing itself, anyway.

04:38:30 Speaker_03
It's an option on LLMs.

04:38:32 Speaker_00
There's so many. There's too many to count.

04:38:34 Speaker_03
There's grocery, Amazon Go, local. I mean, all the restaurant stuff. It's a narrative problem.

04:38:40 Speaker_00
And yet the narrative about Amazon is, ah, what a beautiful thing Jeff imbued in the company. Yes. And the narrative about Microsoft was they can't get anything right. Yep.

04:38:51 Speaker_03
You're right. I think yours is better than mine. Now that's my new land the plane. Do you want to hear what mine was before? Yeah, tell me what was on your mind. All right. Ultimately, Bill Gates is right.

04:39:04 Speaker_03
Technology companies are always extremely at risk of disruption. Even if you won the battle today, even if you're the most dominant company today, it is so easy for you to lose and become irrelevant tomorrow.

04:39:21 Speaker_03
You may keep a great business because these things are sticky. As we know, IBM made a lot of money for a long time, but even without the whole DOJ thing, Microsoft probably would have visited themselves.

04:39:33 Speaker_03
Microsoft almost certainly would have missed mobile because there's no chance they would have realized that the business model that Google had meant that they were going to win in mobile when they came in from the side and gave away the software for less than free.

04:39:48 Speaker_03
Microsoft was going to have these huge downstream misses because technology moves so fast and is such a dynamic landscape. Yep.

04:39:58 Speaker_00
And I think this is why I feel so adamant that Microsoft during this era and Steve deserve so much more credit than they get because Microsoft is not IBM today. It is not large but irrelevant. It is very relevant.

04:40:16 Speaker_00
And what they have done with Azure and in cloud and now with AI is, I mean, hell, they're the most valuable company in the world.

04:40:23 Speaker_03
If all this era did was give them a free option to play in the cloud and AI era, or even just say the AI era, that would have been great. But also what they did was they tripled revenue and profits.

04:40:36 Speaker_00
Right. Yeah. They did that while building this whole new great business.

04:40:41 Speaker_03
Yep. It's a great takeaway. Carve-outs.

04:40:44 Speaker_00
Let's do it. Okay. I have two hardware technology products. One is a re-carve-out from you, past carve-out, the Ray-Ban Metas. Oh yeah. Finally got a pair. They're great. They're awesome.

04:40:56 Speaker_00
The use case of the audio, ambient audio in my ears without earbuds is great, particularly for a baby monitor.

04:41:06 Speaker_00
When I am talking to my wife or other family members or friends or whatnot, and I want to be able to hear what is going on in the baby crib and not wear earphones in my ears.

04:41:21 Speaker_03
Great.

04:41:21 Speaker_00
That is great. They're also just a great product in general. Another related hardware carve-out is a startup called Oslo and the Oslo Sleepbuds.

04:41:31 Speaker_00
In the last couple of years, I have slowly and then pretty much every night gotten into using some form of audio to help fall asleep or if I wake up in the middle of the night, get back to sleep.

04:41:44 Speaker_00
And I used AirPods for years and years and they're great. But, you know, if you sleep on your side or do anything real like, you know, you got the AirPod jamming into your ears. These are little sleep buds that are made for sleeping.

04:41:59 Speaker_00
And if you lie on your side on your ear, they don't stick out. And so you can lie.

04:42:02 Speaker_03
Text me a link. I'm buying this immediately.

04:42:04 Speaker_00
Yeah, they're great. So this is the team that was at Bose that made the Bose. I don't even know what the product was called, but Bose had this product. They killed it. The team left, started a startup. And so it's all like Bose engineering.

04:42:19 Speaker_00
Anyway, it's great. I love them.

04:42:20 Speaker_03
I'm buying this as soon as we get off.

04:42:22 Speaker_00
Yeah. They're fantastic.

04:42:24 Speaker_03
Awesome. I have two and they're like the most absolutely basic products of all time. And I'm okay with that. The first I mentioned earlier. M three MacBook air.

04:42:34 Speaker_03
It's the finest computer I've ever owned, which I say every time I get a new Mac, if only you could turn it around and touch the screen. I know.

04:42:42 Speaker_03
I'm rocking the M1 MacBook Pro at home and it's a 16 inch and gosh, that thing is just a beast to fly with.

04:42:50 Speaker_03
And so for all the travel we've been doing recently, David, it has been awesome to have this incredibly lightweight, incredibly fast, just beautiful machine for flights and all sorts of travel stuff. Nice. So it's my on-the-go.

04:43:05 Speaker_03
And then, sticking with this theme of staying incredibly basic and predictable, the Tesla Model Y is an awesome car.

04:43:13 Speaker_00
Oh, yes, that's right. You are finally joining the club.

04:43:17 Speaker_03
Yeah. We just took a weekend and drove up to Orcas Island, and it was so sweet.

04:43:22 Speaker_03
I never once charged it, you know, drove multiple hours, took a ferry, were on an island that's sparsely populated, hung out for the weekend, drove all over the island, did the whole thing back, got back with 18% battery.

04:43:34 Speaker_00
And had you needed to charge it, there'd be a supercharger network.

04:43:37 Speaker_03
Yeah. And it's unbelievably fast and fun to drive. And I finally get the, it's an iPhone with wheels. Like it just feels whenever I drive my other car, it feels kind of icky and this one feels clean. It's perfect. Yeah. It's amazing. I get it. I get it.

04:43:52 Speaker_03
Tesla people.

04:43:54 Speaker_00
All right, we got a lot of thank yous here.

04:43:55 Speaker_03
Yeah, we have a huge set of thank yous. First, of course, is our sponsors, JP Morgan Payments, ServiceNow, and Pilot. You can click the link in the show notes to learn more and tell them that Ben and David sent you when you get in touch.

04:44:07 Speaker_03
I was trying to count, David. It's definitely over 20 people that we talked with this time. So on my end, thanks so much to Brad Silverberg. Brad led Windows for a while, notably the development of the Windows 95 product and that team.

04:44:22 Speaker_03
Thomas Reardon, who was one of the original team members on Internet Explorer, and actually went on years later to start Control Labs, which sold to Meta and is a part of Meta's effort now to do the neural interface.

04:44:36 Speaker_03
You can sort of twitch your hands and I don't know. We haven't actually seen a product yet, so we'll have to see what that looks like. But that was Thomas Reardon in his next act.

04:44:44 Speaker_03
Stephen Sanofsky, who led Windows in Windows 7 and 8 and led Office before that. And David, you read quite a bit of Stephen's words to prepare for this.

04:44:57 Speaker_00
Yeah. His blog, Hardcore Software, he published in book form. It's a thousand page book. It's like a textbook sitting on my desk. It's awesome. We talked to Stephen for a few hours. He's great. He's a board partner in Andreessen Horowitz now.

04:45:10 Speaker_00
That was super fun.

04:45:11 Speaker_03
Yep. Julie Larson-Green was also great. She worked closely with Stephen in Office and also on Windows.

04:45:19 Speaker_03
My old co-worker Anand Rajaswaran, who worked with me on Office for iPad, helped refresh my memory on what the blow-by-blow was like in those days where we almost shipped the product, then didn't, then got a new CEO, then did.

04:45:33 Speaker_03
Huge thank you to Fritz Landman, who worked in some strategy and corp dev roles at Microsoft. Just an awesome guy. Actually, now he is the CEO of the combined company ClassPass and MindBody.

04:45:49 Speaker_03
And talking about a person with multiple lives and careers, he was great. Someone that he worked closely with at Microsoft, Charlie Songhurst. Charlie's one of the smartest people I've ever met. I mean, that could go for a lot of people on this list,

04:46:00 Speaker_00
Didn't Charlie do a great invest like the best interview with Patrick a couple of years ago?

04:46:04 Speaker_03
Did he? I got to go listen.

04:46:05 Speaker_00
I think he did. Yeah.

04:46:06 Speaker_03
Absolutely brilliant mind expanding person. John Rubenstein who led engineering at Apple and actually went on to lead Palm.

04:46:14 Speaker_03
It was fun talking with him about what was it like from the Apple side from the competitive perspective competing against Microsoft all these years. Huge thank you to Ray Ozzie who David and I both spoke with.

04:46:25 Speaker_00
Yeah.

04:46:26 Speaker_03
Ray is so damn delightful.

04:46:29 Speaker_00
He's such a legend. Delightful. The right way to put it. Ray is now running another startup, a new one called blues wireless. And I was just so generous to give us a couple hours.

04:46:39 Speaker_00
He had some amazing, you know, things that belong in a museum in his office that he showed us over zoom, like old computers and hardware from the seventies, the eighties, the nineties. It was super cool.

04:46:53 Speaker_03
Yeah. More on my side to Rob Glazer, who worked at Microsoft in the nineties and founded and ran real networks to Joe Belfiore, who played a large role in windows and windows phone.

04:47:06 Speaker_03
And actually he demoed windows XP in the way back when 2001 and the launch announcement to Regis Fieldman. That's like how the second half of the keynote works is Joe is demoing features to Regis.

04:47:17 Speaker_00
It was Jay Leno for Windows 95 and Regis for Windows XP.

04:47:21 Speaker_03
Yes. So Joe's got this beautiful long history at Microsoft and was just really great. To Vivek Varma, who was at Microsoft deeply involved in sort of the comms and legal stuff during the antitrust era.

04:47:37 Speaker_03
Of course, to Steve Ballmer being very generous with his time and helpful in helping us sharpen some of our thinking.

04:47:44 Speaker_00
And especially being generous with his time as we were entering free agency here. He's got a busy day job these days at the Cliffs.

04:47:53 Speaker_03
That's right. Our good friend who runs the Science of Hitting, it's a great sub stack that does investment analysis and just was very generous sharing a large spreadsheet of historical data from Microsoft.

04:48:04 Speaker_03
It's very easy to parse and look things up live while we're doing the episode. And finally, last one from me to Todd Bishop at GeekWire.

04:48:11 Speaker_03
Todd has these unreleased recordings from when he was covering Microsoft at the Seattle PI way back in the early 2000s. And he sent me the raw recordings, you know, when he was standing there with Bill and Steve, just being a reporter.

04:48:28 Speaker_03
And it's very fun to hear their voices in ways that I don't think were ever released or publicly heard.

04:48:34 Speaker_00
Yeah. Super cool. Yeah, a few more on my end. Terry Meyerson, the CEO of Truvetta in Seattle. Terry ran Windows and Windows Phone at Microsoft for a long time.

04:48:45 Speaker_00
To Soma Soma Sagar, who is a managing director at Madrona, but is a legend in the server and tools business at Microsoft. Soma, we talked about him on part one, but he's wonderful. To Mary Jo Foley. It was so fun to talk to Mary Jo.

04:49:02 Speaker_00
Mary Jo dedicated her career, probably the last, 20 plus years to solely covering Microsoft. And she is the best in the business today. She's the editor in chief at Directions on Microsoft.

04:49:14 Speaker_00
It's a research firm like Gartner, except it only covers Microsoft. She was super kind and generous. And then the last one, Dave Marquardt. It was so fun to talk to Dave. Dave was a 33 year board member at Microsoft.

04:49:33 Speaker_03
The only outside capital.

04:49:34 Speaker_00
The only outside capital into the company before IPO from TVI. And then Dave went on to co-found August Capital where he's a partner emeritus these days. I think Dave was the longest serving Microsoft board member besides Bill Gates. Three decades plus.

04:49:50 Speaker_03
Wow. Oh, and I have one more. Thanks to good friend Arvind at Worldly Partners for some of the research that he provided as well. So thanks Arvind. Well, with that, you should check out our previous episode, Microsoft Volume 1.

04:50:05 Speaker_03
If you've already heard that, check out our AWS episode. We also recommend our NVIDIA series. Part 1 intersects nicely with this era of Microsoft, and we tell some of the PC gaming story from the NVIDIA angle.

04:50:18 Speaker_03
Lastly, of course, if you are sitting around right now and you're thinking, oh no, what should I do next? The answer is acquired.fm slash sf. We cannot wait to see you at the Chase Center. Mark freaking Zuckerberg is going to be there.

04:50:33 Speaker_03
It's going to be the event of the century in the acquired world. So

04:50:37 Speaker_03
If you've always thought like, ah, I've always wanted to go to something like Omaha, you know, for the Berkshire Hathaway annual meeting, or I've just wanted to celebrate with other business and technology nerds who also like Acquired, this is going to be the greatest way you could ever imagine to do that.

04:50:52 Speaker_03
Yes.

04:50:52 Speaker_00
If you are wondering what you should be doing on September 10th, 2024, there is only one acceptable answer, and that is to be in San Francisco at the Chase Center celebrating with us. It's going to be awesome.

04:51:06 Speaker_03
Yep. And with that, listeners, we'll see you next time.

04:51:09 Speaker_00
We'll see you next time.