IBM and Microsoft: They're Still Talking, But...

Information Processing

They've each agreed to stick to one operating system -- but not the same one

Richard Brandt in San Francisco and Evan I. Schwartz in New York, with Deidre A. Depke in New York and bureau reports
Business Week

October 1, 1990

From the beginning, IBM and Microsoft Corp. seemed like an odd couple. Microsoft's rumpled chairman, William H. Gates III, used words such as ''cool'' and ''superneat'' to describe his software. The pin-striped executives who ran the personal-computer business for IBM Chairman John F. Akers used terms such as ''strategic'' and ''market-driven'' to describe theirs. Funny thing was, they were usually talking about the same products. For most of the decade during which the two companies have collaborated, they've been able to smooth over their differences. But in recent months, the relationship degenerated into ''a rift, verging on open warfare,'' says Robert H. Dickerson, a former Microsoft manager, now a vice-president at Borland International. That rift threatened to paralyze demand, as customers tried to decipher conflicting messages from the two companies. IBM, attempting to secure a dominant position in the new market for networked computers, was making an all-out push to convert customers to OS/2, a basic program for controlling personal computers that had been developed jointly by IBM and Microsoft and that gave PC users the same sort of ''graphical-user interface'' popularized by Apple Computer Inc.'s Macintosh. And with OS/2 on their PCs, IBM told customers, they would be ready for Systems Application Architecture (SAA), IBM's grand scheme to tie all sizes of computers into giant networks controlled by mainframes. Microsoft, however, was telling a different story. It was pushing a hot new product called Windows 3 that also gave ordinary PCs the ''user-friendly'' graphics of the Macintosh -- and made the expensive switch to OS/2 unnecessary for most people.

With computer buyers and trade publications buzzing about turmoil in the IBM-Microsoft partnership, the two companies recast their relationship on Sept. 17. Gates and James A. Cannavino, general manager of IBM's Personal Systems, announced that IBM will now take charge of developing most versions of OS/2. Microsoft, meanwhile, will be free to push Windows 3 and continue updating MS-DOS, the operating system that it wrote for the original IBM PC and that OS/2 was intended to replace. Bottom line: The two have agreed to compete openly and have agreed to disagree on when OS/2 will become a major force in the computer industry. IBM will push OS/2 now. Microsoft will wait -- perhaps several years -- until it completes an advanced version of OS/2 that will work on many brands of computers.

LAST SHOT

At a minimum, the new pact scraps the unworkable 1989 compromise that was the source of the most recent tension (table). Dissatisfied with the slow sales of OS/2, last November IBM got Microsoft to agree to restrict development of Windows after June, 1990, and to make development of applications programs for OS/2 a top priority. Microsoft got one last shot to make Windows a hit. In return, IBM agreed to postpone its own graphics program that would have competed with Windows.

IBM and Microsoft had figured on a rapid switch to OS/2. Back in 1985, they had seen that businesses would need a better operating system than MS-DOS if PCs were to take on more complex tasks. MS-DOS placed severe limitations on the size of programs and was capable of doing only one thing at a time. PCs linked in networks, IBM figured, would need to do several things simultaneously -- compiling a spreadsheet, receiving electronic mail, and asking for information from a data base, for example.

So IBM and Microsoft set out to make OS/2 a powerful ''multitasking'' operating system. They also agreed that it needed an easy-to-use graphical interface. Microsoft's Gates lobbied IBM to simply adopt Windows, which had been introduced in 1983. But IBM balked, and OS/2 was announced in April, 1987, with Presentation Manager, a graphics ''environment'' derived from Windows but including technology developed at IBM's laboratories in Hursley, England.

SHIFTING GEARS

In 1988, shortly after initial shipments of the program, IBM and Microsoft officials predicted that OS/2 sales would overtake those of MS-DOS by 1990. But because OS/2 runs only on powerful PCs costing at least $ 4,000, and because few exciting programs have been written for it, sales have remained sluggish. Worse, the big businesses that were the best prospects for OS/2 seem to have lost interest. A recent Datamation/Cowen & Co. survey found that only 4% of corporate computer buyers plan to switch to OS/2 within the coming year. That's down from 8% in 1989 and 10% in 1988. In three years, only 300,000 copies of OS/2 have been sold -- while tens of millions more copies of MS-DOS were sold. ''It is fair to say that OS/2 hasn't lived up to our speculations,'' says Microsoft Senior Vice-President Steven A. Ballmer. ''That fact, more than anything else, has changed our relationship with IBM.''

Indeed. When OS/2 flagged, Microsoft was able to shift gears and concentrate on beefing up MS-DOS, from which it still derives 19% of its annual $ 1.2 billion in revenues. Windows was key. So, by 1989, Microsoft had diverted programming talent to Windows 3, further slowing OS/2's advancement. Boosted by a high profile promotional campaign that had Gates appearing on Good Morning America and other TV programs, the move paid off: In just four months on the market, Microsoft says it has sold a million copies of Windows 3. ''Microsoft sees the opportunity to have 40 million PCs running Windows,'' says Eric Benhamou, president of network-software maker 3Com Corp.

But IBM had bet big on OS/2. By including OS/2 in its SAA scheme, Big Blue had made it part of its basic marketing strategy for networking personal computers with mainframes. Forging those links was seen by IBM strategists as the best way to keep mainframes -- which deliver 50% of the company's revenues and 60% of its operating profits -- at the center of corporate-information systems.

To hedge its bets, IBM had also sought out alternatives to programs that Microsoft was developing. IBM licensed graphics and programming software from Steve Jobs's startup, Next Inc., and typeface software from Adobe Systems Inc. Early in September, Big Blue formed a joint venture with Metaphor Computer Systems, of Mountain View, Calif. Called Patriot Partners, the venture plans to create a layer of software that will allow a program such as a desktop-publishing package to run on a variety of operating systems. Thus, programmers would work with Metaphor's technology instead of Microsoft's when creating new software. Says Stewart Alsop, of PC Letter : ''The Metaphor deal is the opening salvo in a five- to-seven-year IBM plan to regain control'' from Microsoft.

IN THE MIDDLE

Those deals -- and the conflicting marketing campaigns by IBM and Microsoft -- also left customers in a muddle. Dan Willis, a computer manager at 3M Co., was so confused that he helped form a group of Minneapolis-area PC buyers to discuss their mutual problems. Like Willis, many wanted to make their office workers more productive by upgrading their IBM PCs and clones with easy-to-use graphics software. They didn't know whether to stick with MS-DOS and add Windows or to switch to OS/2. ''We were in the middle of it all saying, 'What do I buy?' '' says Willis.

While the new agreement makes it clear that IBM and Microsoft will be free to pursue separate goals, customers could still be confused. ''It's not all cut and dried,'' says IBM's Cannavino. ''You can't say that MS-DOS goes on this type of computer, Windows on this type, and OS/2 on another.'' For instance, IBM agreed to license Windows and plans to release OS/2 Lite, a version that will compete directly with Windows. And the IBM-Microsoft relationship is not cut and dried, either. Both say their disagreements have been blown out of proportion, but concede that there have been strains. ''You may not understand our marriage,'' says Microsoft's Ballmer, ''but we're not getting divorced.''

GRAPHIC: Photograph, Akers, IBM will keep custody of the OS/2 standard and will use a streamlined Lite version against Windows PHOTOGRAPH BY PSIHOYOS/MATRIX; Graph, A PC BUYER'S VIEW OF THE IBM-MICROSOFT RELATIONSHIP Data: Company Reports, BWE GRAPHIC BY LAUREL DAUNIS/BW; Photograph, Gates, Microsoft will keep beefing up the older but more popular MS-DOS, as well as new versions of Windows PHOTOGRAPHS BY JOHN MARTINI; Photograph, IBM'S CANNAVINO, WILL USERS STILL BE CONFUSED? Photograph by LOUIS BENCZE