From: acquiredfm
Microsoft, founded in 1975, played a pivotal role in creating and defining the software business model, eventually becoming the world’s most valuable company with a market capitalization over $3 trillion [01:44:00]. This early period was characterized by sharp strategic decisions, fierce competition, and a unique understanding of the nascent personal computing market.
Early Influences and the Genesis of an Idea
Born in 1955, Bill Gates grew up in a unique household, frequently hosting CEOs, senators, and governors for dinner, absorbing business conversations from a young age [07:33:00]. His father, Bill Gates Senior, was a prominent attorney, co-founding Preston Gates and Ellis (now K&L Gates) [06:38:00] and galvanizing Seattle’s entrepreneurial community as an angel investor [07:07:00]. His mother, Mary Maxwell, was a powerful business figure in the Pacific Northwest, serving on numerous corporate and non-profit boards, including First Interstate Bank and the National United Way [04:56:00].
Gates’ intense competitiveness was evident from childhood; he approached everything from sports to academics with a desire to win [08:35:00]. At age 13, at Lakeside School, Gates and his best friend, Paul Allen, gained access to a DEC PDP-10 mainframe, a rare privilege for a secondary school in 1968 [10:22:00]. This early exposure was a stroke of immense luck, as the computing landscape was vastly different, dominated by room-sized machines, and the concept of a “personal computer” was unheard of [11:17:00].
In this era, IBM held nearly 100% market share in computing, selling bundled hardware, software, and services [13:51:00]. However, antitrust scrutiny led IBM to proactively unbundle its offerings in 1968, inadvertently “cracking the door” for companies like Microsoft [15:10:00]. Concurrently, Digital Equipment Corporation (DEC) pioneered the “mini-computer” – closet-sized machines that were smaller, less powerful, and significantly cheaper than mainframes, opening new markets through a classic low-end disruption playbook [16:42:00]. DEC became Gates’ hero, inspiring his own approach to market entry [19:26:00].
Gates, Allen, and other students formed “The Lakeside Programmers Group,” recognizing the value of their rare programming skills. They gained experience debugging systems and writing software for companies, earning royalties that far surpassed average household incomes at the time [21:43:00]. This led to Traff-O-Data, a venture to build a machine using Intel’s new microprocessor (the 8080) to analyze traffic data [26:23:00]. Though not a massive commercial success, it provided crucial experience with microprocessors.
A pivotal moment came when Paul Allen articulated the exponential improvement in semiconductors, later known as Moore’s Law. Gates, initially skeptical, quickly grasped its profound implications: if computing became “free,” it would enable a “computer on every desk in every home” [30:42:00]. This vision, initially dismissed as “whackadoo stuff” by others, became the guiding star for Microsoft [32:56:00].
Founding Microsoft and the Altair BASIC Deal
In December 1974, Paul Allen saw the Altair 8800, the world’s first commercially available microcomputer, on the cover of Popular Electronics. Recognizing it as the dawn of the personal computer era, he immediately alerted Gates [37:40:00]. Gates and Allen, then college students, bluffed MITS (the Altair’s manufacturer) by claiming to have a BASIC interpreter ready, despite not having written a single line of code [41:47:00]. They then worked frantically to write the BASIC interpreter on an emulator, with Allen even hand-coding the bootloader on the plane to Albuquerque for the demonstration [44:26:00]. The successful demonstration led to a contract, marking the birth of “Micro-soft” as a two-person partnership on April 4, 1975 [52:17:00]. Gates initially held 60% ownership, later increasing to 64% [53:58:00].
The deal with MITS granted MITS an exclusive license to Microsoft BASIC for the Altair, with Microsoft earning 180,000 [56:06:00]. This arrangement created a misalignment of incentives, as MITS prioritized hardware sales over maximizing BASIC distribution. Furthermore, widespread software piracy plagued early sales; in 1976, despite MITS selling thousands of Altairs monthly, only a few hundred copies of BASIC were sold [58:27:00]. This exposed the nascent legal framework for software: it wasn’t until 1980 that U.S. Congress formally codified computer programs as copyrightable works [01:00:36].
Recognizing the flaw in their deal, Gates and Allen leveraged a clause in their contract requiring MITS to use “best efforts” to commercialize BASIC broadly. In 1977, after MITS was acquired by Pertec, Microsoft won an arbitration case, freeing them to license BASIC directly to other companies [01:06:40].
The Strategy of Ubiquity and the IBM PC
Microsoft’s strategy was to offer low-cost, fixed-fee licenses to establish BASIC as the industry standard, rather than maximizing per-unit revenue. This allowed them to “set the standard” for programming environments, ensuring compatibility and attracting developers [01:09:00]. By making it a “no-brainer” for hardware manufacturers to include Microsoft BASIC, they initiated a “positive spiral” where success reinforced success in a growing market [01:12:03].
Microsoft’s early international expansion was also a key differentiator. In 1978, they partnered with Kay Nishi to establish an exclusive distribution presence in Japan, and by 1979, half of Microsoft’s revenue came from Japan [01:16:45]. This global mindset ensured their software was designed for localization from the outset, providing a significant competitive advantage [03:48:31].
In 1979, Microsoft moved its operations from Albuquerque back to Seattle, primarily to aid in recruiting top talent from the University of Washington, which would become a pipeline for Microsoft employees for decades [01:18:15].
The most transformative event for Microsoft was the Microsoft’s partnership and eventual competition with IBM. In 1980, IBM, then the world’s most valuable company [01:30:24], decided to enter the microcomputer market to avoid missing the next wave of computing, as they had with mini-computers [01:30:05]. They established a secret “Project Chess” in Boca Raton, Florida, with a mandate to develop the IBM PC within one year using off-the-shelf components [01:32:07].
IBM approached Microsoft, the “only game in town” for programming language interpreters [01:34:01]. Gates, in good faith, initially directed IBM to Digital Research for an operating system. However, a series of misunderstandings and failed negotiations with Gary Kildall of Digital Research (who was reportedly flying his plane or had licensing demands for high royalties) led IBM back to Microsoft [01:39:51].
Seizing the opportunity, Microsoft purchased a 16-bit operating system called “QDOS” (Quick and Dirty Operating System) for 75,000 for full rights [01:45:17]. This became MS-DOS. In November 1980, Microsoft signed a deal to provide IBM with DOS and other programming languages for the IBM PC. IBM paid a fixed sum of $430,000, with no ongoing royalties [01:48:50]. Crucially, Microsoft retained the rights to own and license DOS and its languages to anyone else, on any terms [01:50:04].
This agreement is often cited as the “greatest deal in at least computer industry history” [01:54:08]. IBM, perhaps underestimating the value of software platforms and assuming its dominance would render the retention clause irrelevant, created a commodity hardware market while making Microsoft the “lynchpin” of the entire ecosystem. Microsoft leveraged IBM’s market-building power to establish DOS as the standard, then captured massive value by licensing it to the burgeoning IBM PC “clones” (like Compaq), who emerged to offer cheaper hardware compatible with IBM [01:56:56]. Unlike IBM’s fixed fee, Microsoft charged royalties per machine sold to the clone manufacturers [02:01:15].
This strategy led to exponential growth: Microsoft’s revenue jumped from 98 million by fiscal year 1984, driven by the high-margin software business [02:02:10].
Applications, IPO, and Windows’ Rise
In 1980, Microsoft converted from a partnership to a C corporation. Steve Ballmer, Gates’ college friend from Harvard, joined as employee number 30 in June 1980, receiving an 8.5% equity stake [01:35:18]. In 1981, venture firm Technology Venture Investors (TVI) invested 20 million post-money [02:04:11]. This was the only external dilution Microsoft ever took, allowing Gates to retain 49% ownership at the time of Microsoft’s IPO in 1986 [03:32:27]. This capital efficiency and high founder ownership allowed Microsoft to control its destiny and execute long-term strategies.
In 1980, Microsoft established a “consumer products division” to develop application software, hiring Charles Simonyi from Xerox PARC [02:14:40]. Simonyi brought knowledge of graphical user interfaces (GUI), object-oriented programming, and the mouse, all inventions from Xerox PARC (which Apple also famously “borrowed”) [02:16:35]. Simonyi led the development of Microsoft Word and Multiplan (Microsoft’s spreadsheet) [02:19:20]. While Word shipped with a mouse even for DOS in 1983, Multiplan struggled against Lotus 1-2-3, which became the most successful software of its time by focusing exclusively on the IBM PC [02:22:15]. Microsoft learned a crucial lesson: “never leave yourself open to the next generation of technology,” always targeting the future platform [02:21:57].
This led to Microsoft’s focus on the GUI. The first version of Microsoft Excel was developed for the Apple Macintosh, which launched in 1984 [02:30:52]. Excel was the world’s first graphical spreadsheet, a significant advantage over character-mode applications like Lotus 1-2-3 [02:29:10]. Apple and Microsoft collaborated closely on applications for the Mac, with Apple even matching Microsoft’s marketing spend for Excel [02:29:57]. In 1985, Microsoft released its first bundled suite, “The Business Pack for Microsoft,” on the Mac, marking the beginning of Microsoft Office [02:32:50].
Simultaneously, Microsoft pursued its own GUI operating environment. Announced in November 1983 (before the Mac shipped, much to Apple’s displeasure), Windows 1.0 launched in November 1985 [02:44:45]. It was not a full operating system but a “graphical operating environment” that ran on top of MS-DOS [02:39:59]. Windows 1.0 and 2.0 had limited adoption (5% of the DOS installed base) [02:49:09]. Development was “super freaking Rocky,” with Steve Ballmer even stepping in to manage the final push for Windows 1.0 [02:36:38]. Apple licensed its GUI intellectual property (originally from Xerox) to Microsoft, including for “all future versions of Windows,” a decision that would later haunt Apple [02:39:01].
Microsoft’s relationship with IBM remained complex. While Windows was a “hedge,” IBM was pushing “OS/2,” a new operating system designed to be proprietary to IBM hardware and regain control of the PC ecosystem [02:42:05]. Bill Gates and Ballmer publicly committed to OS/2, viewing it as “riding the bear” – staying with IBM because it was the most important player [02:43:40]. However, IBM’s decision to use the less powerful Intel 286 chip (deemed “brain dead” by Gates) for its PC AT, aiming to discourage PCs from encroaching on mainframe territory, created an opening [02:45:17]. Microsoft secretly encouraged clone manufacturers like Compaq to adopt the more powerful 386 chip, while also developing Windows for it [02:46:32].
Market Dominance and the Windows 95 Phenomenon
The “divorce” between IBM and Microsoft became official by the end of 1990, as OS/2 proved unpopular [03:07:01]. This freed Microsoft to fully commit to Windows. Windows 3.0, released in 1990, “got it right,” doubling its penetration of the DOS installed base within six months and demonstrating the power of a true multitasking graphical interface [02:48:45]. PC Computing magazine declared May 22, 1990, the “first day of the second era of IBM compatible PCs” thanks to Windows 3.0 [02:49:21].
Internally, this was the moment Microsoft decided to “bet on Windows,” transforming it from Plan B to Plan A [02:51:50]. The Windows team, previously a “ragtag group” of 65 people, became the focus of the company’s strategic opportunity [02:52:04]. Microsoft’s revenue soared, hitting 1 billion) [03:14:16] and $2.8 billion by fiscal 1992 [03:15:06]. In 1992, Gates became the wealthiest person in America at age 31 [03:15:20], and by January 1993, Microsoft surpassed IBM in market capitalization, inheriting its throne in computing [03:15:43].
As Microsoft matured, it shifted focus to nurturing its platform. A “developer relations group” was established to support application developers, and an OEM push ensured that manufacturers pre-installed Windows [02:57:21]. From 1988 to 1994, Microsoft often employed a “per processor licensing fee” model, where OEMs paid a fee for every microprocessor-based machine shipped, regardless of whether it ran DOS/Windows. While this practice later drew antitrust scrutiny and was stopped in 1994, it strongly incentivized OEMs to standardize on Microsoft’s operating systems [02:58:49].
Microsoft also recognized the burgeoning consumer PC market, spurred by developments in multimedia and gaming [03:15:33]. The company had 75 million Windows users even before Windows 95 shipped [03:16:03].
On August 24, 1995, Microsoft launched Windows 95 (code-named “Chicago”) with an unprecedented global marketing spectacle. The event, co-hosted by Jay Leno, featured tents across Microsoft’s campus, a Rolling Stones theme song (“Start Me Up”), and worldwide simultaneous launches [03:18:05]. It was an “unabashed celebration of software,” selling a million copies in the first week and 7 million in the first month [03:26:43]. Coca-Cola even sought advice from Microsoft on its marketing prowess [03:21:06].
Windows 95 represented a significant technical leap, becoming a true 32-bit operating system rather than just an environment on DOS [03:28:10]. Its user-friendly interface, notably the “Start” menu, made computing accessible to a mass audience, cementing Windows as Microsoft’s “franchise product” for the next two decades [03:22:00]. By fiscal 1997, Microsoft’s revenue hit 10 billion in revenue [03:27:02].
This period also saw the origins of Microsoft’s Enterprise Transformation. Steve Ballmer spearheaded the effort to sell to businesses, building direct and indirect sales forces, and fostering an ecosystem of partners and independent software vendors [03:11:00]. This was driven by the “product-led growth” of Microsoft Office: employees were already using Excel and Word in offices, and Microsoft capitalized on this bottom-up adoption to establish central business relationships [03:07:32]. Concurrently, Microsoft embarked on Windows NT, a powerful, enterprise-ready operating system (led by former DEC engineer Dave Cutler), which would later become the foundation for Windows Server and, eventually, Azure [03:10:04].
Business Playbook and Power
Microsoft’s early success demonstrates several key business principles:
- Capital Efficiency: Through high founder ownership and minimal external dilution, Microsoft maintained control of its destiny, bootstrapping its way to becoming the world’s most valuable company [03:31:03]. The low fixed cost of software development in the early industry allowed this.
- Tailwinds and Market Dislocations: Microsoft benefited immensely from the 98% compound annual growth rate of the PC market from 1975 to 1986 [03:39:12]. They capitalized on the disruptive shift enabled by microprocessors, challenging IBM’s mainframe dominance [03:42:31].
- Strategic Hedging: Despite strong internal convictions, Microsoft was willing to hedge its bets across different platforms (e.g., Mac, Windows, OS/2) and product types (operating systems, applications) [03:40:39]. This flexibility allowed them to adapt quickly when market dynamics shifted.
- OEM Scaling: By distributing its software through numerous hardware OEMs, Microsoft achieved immense scale and market penetration that Apple’s integrated model could not match [03:46:00].
- Early Internationalization: Forcing global readiness from the outset allowed Microsoft to amortize development costs over a massive user base and quickly establish its software as a worldwide standard [03:48:00].
- “Software is Never Done”: Unlike competitors who viewed software as a finished product, Microsoft embraced continuous iteration, learning from customer feedback and consistently shipping improved versions [03:53:47].
- Not First to Market: Microsoft was often not the first to market with its applications but focused on learning from competitors, incorporating best features, and leveraging platform shifts to deliver superior experiences [03:51:17].
In terms of Hamilton Helmer’s Seven Powers, Microsoft demonstrated:
- Counter-Positioning: By embracing the microcomputer revolution and a software-only business model without hardware baggage, Microsoft disrupted IBM’s bundled mainframe business [03:56:11].
- Scale Economies: Fixed development costs amortized across a massive global user base led to incredible profitability and a compounding advantage [03:57:46].
- Switching Costs: Once users and organizations adopted Microsoft software (like Office or Windows), the cost of switching to an alternative became prohibitive due to training, file formats, and application compatibility [03:58:29].
- Network Economies: More Windows users incentivized more developers to create applications for Windows, which in turn attracted more users, creating a powerful positive feedback loop. Document formats (e.g., Word, Excel) also created strong inter-organizational network effects [03:58:50].
- Branding: Microsoft became synonymous with the PC and software, building a strong, trusted brand (though Jobs famously criticized its “taste”) [03:51:28].
- Cornered Resource: At various points, Microsoft possessed a cornered resource of unique talent (e.g., Paul Allen’s emulator skills, Dave Cutler’s OS expertise) and strategic partnerships (e.g., the IBM deal) [03:34:31].
- Process Power: While less defined early on, Microsoft’s culture fostered aggressive product development, rapid iteration, and a relentless focus on customer feedback, leading to world-class software by third versions [03:45:59].
By 1995, Microsoft was no longer a startup but a global titan, having effectively dethroned IBM as the undisputed leader in computing, a position it inherited and would continue to dominate for decades.