One Day, Junior Got Too Big

By Andrew Pollack
The New York Times

Redmond, Wash. -- August 4, 1991 -- TEN years ago this month, the International Business Machines Corporation introduced its first personal computer, changing the computer industry forever. Almost overlooked at the time was the company chosen to provide key software for the machine, headed by a nerdy programmer young enough to be the son of many of the I.B.M. executives.

No one is overlooking the results of that decision today. Seizing on that initial opportunity to provide the MS-DOS operating system for I.B.M. personal computers and the clones that followed, the Microsoft Corporation has grown into the world's largest software company, with revenues of $1.8 billion for the fiscal year ending in June. Its reach expands into nearly every nook and cranny of the software business.

With a market capitalization of $12.8 billion, Microsoft is also one of the 50 most valuable companies in the nation, according to a Business Week ranking, ahead of all computer companies except I.B.M. and Hewlett-Packard and in the company of Ford Motor, Dow Chemical and other industrial giants with many times its revenues. The nerdy programmer, William H. Gates, now 35, owns enough of Microsoft to make him worth $4 billion, more than the gross national product of Nicaragua.

But it is getting lonely at the top. On the way to its current dominance, Microsoft and the intensely competitive Mr. Gates have angered many rivals and even some former partners, including I.B.M. Now, almost everyone in the industry is hatching plans to try to compete with Microsoft for control over the industry's direction. And the resulting massive realignment of forces that is reshaping the industry could pose a severe challenge to Microsoft's hegemony.

"Our belief is that Microsoft has peaked," said George Colony, president of Forrester Research, a market research firm in Cambridge, Mass. "They have enough hubris now to believe they don't need I.B.M., that they don't need anybody. I think Microsoft will be a big, struggling company in two years."

Microsoft's relationship with its former mentor, I.B.M., indeed is in a shambles. After a falling out over the joint development of a successor to MS-DOS, I.B.M. is now competing head to head with the software company in what promises to be one of the nastiest personal-computer industry battles of the 1990's. Each company is already trashing the other's product in public. Under the old rubric that "My enemy's enemy is my friend," I.B.M. has even joined forces with its former rival, Apple Computer Inc., to develop software that will compete with Microsoft's offerings. I.B.M. has also formed smaller alliances with other software companies, including the Lotus Development Corporation and Borland International Inc.

Others Are Joining Forces

Novell Inc., which so far has bested Microsoft in software for controlling networks of personal computers, recently strengthened its hand by buying Digital Research Inc., which makes a program that competes with MS-DOS (Page 4).

And the Federal Trade Commission is investigating Microsoft's practices, spurred in part by complaints from competitors that Microsoft's dominance in operating systems gives it unfair advantages in other categories.

The key threat to Microsoft, however, is not other companies but a big technology change. With MS-DOS and its newer product called Windows, Microsoft dominates the market for software that controls personal computers. But personal computers are increasingly being linked in networks and with larger machines called servers to handle computing tasks now handled by centralized mainframe computers.

Not only has Microsoft had little experience with networked systems, but such an interconnected computing world is likely to require cooperation among companies. Some say Microsoft will have a tough time going it alone, especially against I.B.M., which wields considerable influence with corporate data processing departments.

"No one really likes to do business with Microsoft," said Philippe Kahn, the founder and president of Borland, who predicts that the falling out with I.B.M. will hurt the software company. "He didn't need to declare war on I.B.M.," Mr. Kahn said, referring to Mr. Gates. "That will turn out five years from now to look like his biggest mistake. That's ego."

To be sure, there is an element of wishful thinking and jealousy in predictions of Microsoft's downfall. For all their moaning that Microsoft was lucky to be anointed by I.B.M., or that it abuses its control over the key operating software, rivals also acknowledge that Microsoft is a superb competitor and has executed its strategy with precision.

Moreover, most of the threats to Microsoft from new alliances might take two or more years to materialize. In the meantime, Microsoft will likely continue its rapid growth merely by selling Windows to as many as possible of the 70 million users of MS-DOS PC's. "Until anyone sees evidence of a broadside hit, it's just a war of words in my opinion," said David Readerman, a software analyst at Shearson Lehman Brothers. "The product momentum is very much on Microsoft's side."

10 New Workers a Day

And what momentum it is. Net income has been growing at an average of 64 percent a year over the last five years and revenues at 56 percent. With 8,200 employees, Microsoft has been hiring 10 new people a day, and its campus here, outside Seattle, is in a perennial state of construction.

Mr. Gates is not unaware of the challenges. "I think I need to work extremely hard if we are to do anywhere near as well as we've done," he said. But he also added that challenges are not unusual. "Name a year and I'll name the people out to get us," he said.

Mr. Gates also dismissed talk that his behavior has angered his partners and that he, or his competitors, were driven by emotion and ego instead of business sense. "This is business. This is not Divorce Court or Psychology Today," he said. In forming their alliance, he said, I.B.M. and Apple are acting out of perceived needs.

"I won't take any credit for that wildness," he said, explaining that he thinks the partnership makes little sense, particularly for Apple, which will sacrifice its uniqueness by sharing software development with I.B.M. "Why do they need help? What are they missing?" Mr. Gates said. "It's certainly a huge step backward to have to smoosh it together" with I.B.M.'s effort, he said.

I.B.M.'s need for Apple and other partners stems in large part from the void left by Microsoft. I.B.M. and Microsoft initially worked together on OS/2, which was supposed to be a successor to MS-DOS, with more sophisticated features. But now Microsoft is backing its own program, Windows, which it began developing long before it started work on OS/2.

For I.B.M., OS/2 is crucial to tying personal computers to its larger machines. It also needs its own operating system to help differentiate its personal computers from the legions of cheaper clones that have severely cut its market share.

But clearly, emotions are playing a role as well. Industry executives say I.B.M. feels betrayed, like a father whose son has turned against him. Mr. Gates and I.B.M. executives have not spoken for months. For his part, Mr. Gates said he is angry about a demonstration by I.B.M. a few months ago in which it showed how easy it was to make Windows "crash" or stall. Microsoft responded last month by showing securities analysts how easy it was to crash OS/2 as well.

Mr. Gates said Microsoft tried to accommodate I.B.M. in every way but at some point, I.B.M. had asked too much. For instance, he said, I.B.M. asked that Microsoft stop work on future versions of Windows, a request Microsoft rejected.

A Swollen Budget

Mr. Gates said he was also worried when the number of I.B.M. people working on OS/2 began to mushroom and costs to escalate and when I.B.M. began pressuring Microsoft to "fund the bloat." Mr. Gates argued that the software could never be profitable if so much was spent developing it.

Indeed, a March 1990 audit by a leading expert from I.B.M. and one from Microsoft compared the companies' contributions to OS/2. The software written by Microsoft was characterized as "O.K." and in some cases as "slick" or "great," while the portions by I.B.M. were usually characterized as "fat," "slow," "disorganized" and "inappropriate." An I.B.M. spokeswoman this week acknowledged problems existed but said the company has long since taken corrective steps.

To that extent, not having to work with I.B.M. could be a relief for Microsoft. But Mr. Gates said that he is not relieved and that I.B.M.'s attempt to steer corporate data processing managers away from Windows is Microsoft's single biggest threat.

With relations with I.B.M. broken off, however, Microsoft is fully committed to Windows. It has sold more than 4 million copies since a revamped version appeared a little more than a year ago, dwarfing the 600,000 copies of OS/2 sold since 1987. Windows works on top of MS-DOS, making it an easier transition than OS/2, a replacement for DOS.

But being tied to the older technology of MS-DOS could also be a drawback for Windows. So Microsoft is developing a new operating system, known as Windows NT, which it says will be ready next year. The project, which could be the key to Microsoft's future, is being headed by Dave Cutler, formerly a key designer at the Digital Equipment Corporation, a balding, grizzled veteran who stands in sharp contrast to the youthful programmers he commands.

Versions of Windows

NT -- which stands for new technology -- will run on powerful personal computers using different kinds of microprocessors and will be better geared for use in networks. Indeed, Microsoft plans a whole series of versions of Windows for different machines, ranging from pocket-sized personal information organizers to supercomputers. The company is also looking at using Windows to help control computerized facsimile machines, voice-mail systems and high-definition television sets.

Windows, however, is more than just an operating system. Microsoft is using it to increase sales of applications products like Microsoft Word, its word-processing program, and its Excel spreadsheet by tailoring these programs to run with Windows.

Competitors are following suit, after having initially ignored Windows in favor of OS/2. Some, in fact, say Microsoft misled them into supporting OS/2, a charge Microsoft denies.

In any case, Microsoft has had the market for applications that work with Windows nearly to itself. "It's almost like taking candy from a baby," said Scott Oki, senior vice president of sales, marketing and services for Microsoft.

Microsoft said that in the last year its share of the United States markets for spreadsheets and word processing for I.B.M. and compatible personal computers have both doubled to about 30 percent, as measured by revenues. Mike Maples, the senior vice president of applications software for Microsoft, predicts Microsoft will surpass Lotus in spreadsheets in 12 months. Wordperfect, he said, is a little tougher: "We're not that far, but it's a very steep hill."

Hogwash, replied Frank King, senior vice president of Lotus, who called Microsoft's market-share claims exaggerated. In units sold, he said, Microsoft is still "solidly in third place" behind Lotus 1-2-3 and Borland's Quattro Pro.

Moreover, Microsoft's honeymoon is about over. Lotus has said it will have a version of 1-2-3 for Windows out by September and Wordperfect is not far behind. If there is any consolation for Microsoft, it is that the debut of all these new products will help increase sales of Windows.

Mr. Gates seems determined to enter every major area in the personal computer software business. To develop new software concepts, the company has started a lab, headed by Nathan P. Myhrvold, a physicist who worked with the noted British astrophysicist Stephen Hawking before being bitten by the software bug.

Rivals have long complained that the rest of the industry has served as Microsoft's R.& D. lab. Windows was clearly inspired by Apple's work with the Macintosh, so much so that Apple is suing Microsoft for copyright infringement. While the Go Corporation has pioneered development of new software to control pen-based computers, Microsoft is adding extensions to Windows to handle pen input. Even MS-DOS, the program that put Microsoft on the map, was acquired from another company.

"You will have a hard time finding anything that Microsoft pioneered," said Mr. Kahn of Borland. "Guys like Steve Jobs have contributed tons more to the industry than Bill," he added, referring to the founder of Apple and of Next Computer Inc.

That might be somewhat unfair. Microsoft has been early in some technologies like combining video with computing, and has kept up its investment for years even though a big market has yet to materialize. As the Japanese have proved, what matters most is not the basic invention but the ability to commercialize it. Mr. Gates has proved to be a master at quickly positioning Microsoft to take advantage of new developments.

Mr. Gates is, by all accounts, a demanding boss. Employees who enter meetings not fully prepared can leave carrying their head in their hands. "At least three times in a meeting he'll say 'That's the stupidest thing I've ever heard,' " said Paul Maritz, vice president for advanced operating systems.

But Mr. Gates also inspires loyalty. Microsoft has had very little turnover in its top management.

Mr. Gates works at the same relentless pace as in 1975, when he dropped out of Harvard at age 19 to start Microsoft, staying up late to reply to some of the more than 100 electronic mail messages he gets each day. "You see mail from Bill at 2 in the morning," said Mr. Oki, the senior vice president. It is somewhat disconcerting to Mr. Gates, then, that some of his thirtysomething lieutenants are starting to marry and have kids, and sometimes can't reply to his messages until the morning. A couple of executives have retired to enjoy the wealth they've earned from Microsoft.

An Underground House

Mr. Gates has not had much time to enjoy his fortune, with the exception of a penchant for fancy cars and of a new house he is building, most of it underground, with a garage the size of an airplane hangar and space to seat 250 people for dinner. High-definition television screens will display artworks that can be changed to suit the tastes of guests. The house will also have four children's bedrooms, perhaps a sign that Mr. Gates will someday settle down and marry.

But most of Mr. Gates's efforts will be occupied with making Windows a broad-based success and extending Microsoft's reach throughout the software business, which could be among the most important industries of the coming decade.

Said Paul Grayson, chairman of Micrografx, a Dallas software company that was an early supporter of Windows but is now working with I.B.M. on OS/2: "If Bill succeeds in his strategy, in my opinion he'll become the wealthiest, most powerful person in the history of mankind."

Microsoft's Diversity Strategy

In an industry in which many companies focus on one type of product, Microsoft has long been known for diversity, from its Flight Simulator game to its Basic programming language. While it is best known for its systems software, Microsoft is also the largest supplier of personal computer applications software like word-processing programs and spreadsheets. It trails companies like Lotus and Wordperfect in individual categories, but has the largest overall revenues, $935 million in the last fiscal year.

Microsoft continues to expand into new categories. This fall, it is expected to introduce software aimed at homes and small businesses. Microsoft Publisher will be a low-end desktop publishing program to print fliers, say, or menus. Microsoft Money will be for personal finance management. Later on will come programs for checkbook balancing.

The company is also making a big push for programs, exchanging and commenting on documents and routing forms from place to place.

Microsoft does not have a data-base program, an important category controlled by Borland International and Ashton-Tate, which are merging. Mike Maples, senior vice president for applications software, said that about 18 months ago, Microsoft realized it was working on the wrong approach to such a product, scrapped its efforts and started over.

The product it will introduce, next year at the earliest, will allow computer users to retrieve and analyze data without knowing how to program. He said the program might be similar to one by Metaphor Computer Systems that brand managers at companies like Proctor & Gamble use to analyze competitive data.

Avoiding Big Mergers

Will Microsoft jump into the computer industry mergers and alliances frenzy? William H. Gates, its chairman, does not completely count it out. Among computer companies, "Every combination of A with B has not only been thought about, there's been at least one meeting on it," he said.

Microsoft has made a few small acquisitions but has stayed away from large ones, in part because of the difficulty of merging technology companies. Antitrust concerns could also prevent such mergers.

Would Microsoft be interested in buying Novell, which is beating Microsoft in the crucial area of networking software? "It'd be interesting," Mr. Gates replied. "It would be new for us to do a big acquisition."

Industry curiosity was piqued recently when Mr. Gates met with Scott McNealy, president of Sun Microsystems. Sun champions the Unix operating system, a direct competitor to Windows NT. Mr. Gates denied rumors that Sun and Microsoft would join to counter I.B.M. and Apple, or that Microsoft would make a version of its new Windows NT operating system for Sun's Sparc microprocessor. "There's nothing going to happen between us and Sun," he said.

Microsoft does hope to work more closely with the Digital Equipment Corporation, an I.B.M. rival. But Mr. Gates said there would be no formal alliance. Microsoft and Digital, along with Compaq Computer, are in a consortium trying to set standards for a new generation of desktop computers.

CORRECTION-DATE: August 11, 1991, Sunday

CORRECTION:
A chart last Sunday with an article about the Microsoft Corporation, depicting the capitalization of six major computer companies and their ratio of capitalization to revenues, carried an incorrect legend for shading that denoted the types of company. The three major software producers were represented by black bars, hardware producers by white ones.

GRAPHIC: Photo: William H. Gates, Microsoft's chairman: Going it alone. (Doug Wilson for The New York Times) (pg. 6)

Graphs: "Despite Microsoft's Size ... Investors Will Pay a Premium," shows current market capitalization, in billions of dollars, for a sampling of computer software and hardware companies and the ratio of market capitalization to revenues for the year ended June 30. (Sources: Shearson Lehman Brothers, company reports) (pg. 6)

Copyright 1991 The New York Times Company