How Microsoft Works

Bill Gates and Paul Allen founded Microsoft in 1975 as the classic "garage start-up." They were part of the first leap towards personal computing with a difference. While Apple founders Steve Jobs and Steve Wozniak built both a machine and software (the computer code that gives the computer the ability to do the things it does) in it, Microsoft only developed software.

Another key difference between Microsoft and other "garage start-up" computer companies was that neither Gates nor Allen held illusions about the business world. Many of their peers were hobbyists and acolytes of the "Home Brew Computer Club," which resembled a 1960s era "rap session" instead of a business association. Gates and Allen (along with Steve Balmer) were running a commercial enterprise in a competitive market. If there was a competing product, then they had two choices: buy it or destroy it. Their first conquest was also their biggest: DOS (Disk Operating System).

To make a long and dramatic story short, IBM was building its first personal computer and needed an operating system to run it. The company approached Microsoft, thinking that it had one available. But Microsoft didn't make operating systems -- they just wrote computer languages. Bill Gates directed them to the makers of CPM, which was the reigning OS (Operating System) at the time. The culture clash between the IBM suits and the groovy style of the CPM manufacturers threatened to send the IBM PC into the dustbin of history...until Microsoft came to the rescue.

In what would become a typical move for the company, Gates and Balmer bought an OS for $50,000, which they in turn licensed to IBM for $80,000. Even in the early 1980s, $80,000 wasn't very much money. So what was Gates thinking? It turns out that he was thinking far ahead. He said as much when interviewed for the PBS series "Triumph of the Nerds": "the key to our...deal was that IBM had no control over...our licensing to other people."

Microsoft realized that the IBM PC was going to create a mass market for personal computers. Gates gambled that the business cycle would follow the mainframe model and spawn clones. Out of necessity, these clones would be obliged to pay Microsoft any price to use DOS, which meant that the company was the gatekeeper that PC makers had to pay to compete in the personal computing world.

It worked.

From that moment on, Microsoft would out-fox, bully, best and co-opt all comers. It was simply a matter of finding new ways to reproduce the business model and the revenue it generated. Microsoft's shift from DOS to the Graphical User Interface (GUI)-based Windows operating system completed the cycle.

Next, we'll discuss how Windows came about and why Microsoft broke with IBM.

Apple's world-changing Macintosh hit the market in 1984 and was the first commercially successful PC to use a graphical user interface (GUI), making it user friendly. We use GUIs to interact with computers and networks today.

Bill Gates immediately saw the Mac as both a danger and an opportunity. The GUI could popularize computing on a level beyond the mass market created by the IBM PC and its clones, making it a threat to Microsoft's franchise. It also presented an opportunity to help Microsoft finish off its current opponent, IBM, and ensure its supremacy for years to come.

IBM and Microsoft had been embroiled in a battle over the PC's next operating system. IBM was collaborating with Microsoft on O/S2, a successor to DOS. IBM needed something other hardware makers couldn't clone. Microsoft played along until it became clear that the companies were at cross-purposes: Microsoft was trying to exploit IBM's market position and IBM was trying to put the DOS-genie back in the bottle. This precipitated a break, and Microsoft was on its own.

If Microsoft could create its own GUI to work on top of DOS, then Bill Gates was killing two birds with one OS. The impact of Windows from a business perspective was as strong as the Mac's impact from a user's perspective. Almost overnight, a boring, obsolete PC could become Mac-like at a tenth of the cost of buying a Mac.

Bill Gates had again adapted to re-define the computer market, and just in time. Just before Windows 95 launched, a company called Netscape went public. Microsoft also had to deal with another oncoming threat: the Internet. How would Microsoft deal with an open global network, seemingly powered by altruistic creators bent on giving their products away?

Easy, Microsoft said -- we'll give our stuff away too. The "browser wars" didn't last long and were particularly one-sided, with Internet Explorer ultimately triumphing over Netscape.

In the next section, we'll look at what gives Microsoft the decisive advantage in nearly every commerce endeavor that it undertakes.

In their 2005 annual report, Microsoft lists its financial highlights. The "Cash & Short Term Investments" entry for 2005 really stands out. It's amazing that such a large company has nearly $38 billion in the bank. That cash allows Microsoft to be adaptable. While most dominating companies retrench defensively to preserve the valuable territory that they control, Microsoft does the opposite. It can change its focus in an instant. Like some kind of mutant super-company, Microsoft can out-maneuver giants like IBM and apply its endless cash resources to overwhelm smaller rivals like Netscape.

Part of this incredible ability is the nature of producing software: It doesn't have the logistical struggle of building an airplane or a skyscraper. People make software by writing computer programs. You can produce software as long as you have the skills and the idea.

Microsoft was also there before anyone else. Not only have they "been there and done that," but they also have the market position and the cash on hand to exploit the market to their advantage.

Organization may be the most important key to Microsoft's success. Bill Gates never really consolidated the company after its start-up phase. Instead, he sought to replicate the most productive aspects of Microsoft's first team. Microsoft designs its teams to be overworked. Project managers calculate the number of staff members needed to accomplish a task, then reduce it. This results in a team that has to scramble immediately or be overwhelmed.

Microsoft also takes great care to choose the "right" people. The take-away is that Microsoft has very specific criteria their workers must fulfill, and they have developed an innovative means of assessing candidates: They ask them riddles. A company built on dominating via improvisation and high-energy needs high-energy problem solvers who don't mind working 72 hours straight. Although this type of employee seems difficult to find, somehow Microsoft keeps finding them.

All empires fall at some point, and organizations atrophy like muscles in old age. Usually, the charismatic leader isn't there to see it, because he probably wouldn't let things get to that point. Bill Gates is not likely to buck that trend, so you can count on Microsoft's reign to extend for years to come.

In the meantime, let's look at what Microsoft has in store for us.

In their annual report, Microsoft boils itself down into "Business Units," or "Product Segments," which represent its main product line: Client, Server & Tools, Information Worker, Microsoft Business Solutions, MSN, Mobile & Embedded Devices, and Home & Entertainment.

Here's how Microsoft describes these segments to its investors [source: 2005 Microsoft Annual Report, Business Description, Page 2: Product Segments]:

Microsoft is a long way from DOS -- and Windows (part of the MS Business Solutions segment) is still their biggest seller. In fact, Windows gives Microsoft the edge in nearly all of the other segments, with one key exception: Xbox. Video games appear to have a mind of their own, even on the corporate level.

Because Windows is on the majority of PCs in one form or another, Microsoft has an advantage when it seeks to market new products. Whether it's part of an update or advertised on the homepage of your Internet Explorer, Microsoft's new product will probably find its way to you before you hear about its competitor.