01/19/98 ONLINE ORIGINAL: WHY STARTUPS CAN'T AVOID 'THE DREADED 'M' QUESTION'

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WHY STARTUPS CAN'T AVOID 'THE DREADED 'M' QUESTION'

At first blush, the PalmPilot looks like one of those classic Silicon Valley success stories. A small band of entrepreneurs with a great idea (a simple electronic,0 pen-based, pocket organizer) turns it into a megahit -- selling over 1 million copies in 18 months. And, hey, it doesn't run Microsoft's Windows operating system. So there's no answering to that Big Daddy to the north.
The full story is a little more complicated -- and not nearly so auspicious for entrepreneurs. The founders of Palm Computing couldn't get venture-capital funding two years ago. As a result, they had to sell out to a larger company -- 3Com Corp. -- to bring PalmPilot to market. On top of that, they went out of their way to design the device so it could link up easily with Microsoft's software on personal computers. As Donna Dubinsky, general manager of 3Com Corp.'s Palm Computing Div. readily admits: "Connecting to Windows was fundamental to our success."
So much for escaping the long arm of Microsoft. And the PalmPilot experience is anything but unique. Most electronics-industry startups today have their own "Microsoft strategy." Will they compete head-to-head with the software giant? Do they become a partner? Or do they pick a market where Microsoft won't ever play? Venture capitalists demand an answer. "You have to ask the dreaded 'M' question," says Geoffrey Y. Yang of Institutional Venture Partners. "How will this work with Microsoft's view of the world? To the extent it's complementary, you say that's great. To the extent it's competitive, we think long and hard before we do it."
Does Microsoft make sure of that? It does seem that way. In each of the past two years, it dispatched a contingent of executives to Silicon Valley to meet with venture capitalists. Microsoft denies it's an attempt to intimidate. "We give the VCs insights into how we see our platform unfolding and into possible opportunities for others," says Paul Maritz, a Microsoft senior vice-president. But the parallax view is quite different. "They do it in a very nice way, but it has the desired effect," says Scott D. Sandell of New Enterprise Associates. "They probably stop a few potential competitors before they start."
But not everybody. In fact, according to research firm VentureOne, startups these days are less likely to define themselves vis-a-vis Windows. In 1992, 23% of the software and service startups that received venture capital mentioned Windows in descriptions of their business. During the first three quarters of last year, however, only 9% cited Windows. Instead, many are focused on the Internet and communications.
Still, Microsoft is a potential hurdle -- or a help -- for nearly every software startup, and plenty of hardware companies, too. Consider the fate of Diba Inc., which earlier this year was sold for a measly $25 million to Sun Microsystems Inc. Founder Farzad Dibachi says things went well for the company, at first. Diba persuaded Samsung and Zenith to make "digital appliances" based on its designs. But when Microsoft announced its competitive Windows CE operating system for small devices in late 1996, Diba's deals slowed to a trickle.
That's why many startups position themselves from the get-go as Microsoft allies -- like pilot fish to a shark. For Dan Bricklin, chief technology officer at Trellix Inc., seller of document-publishing software, there was no question that Windows -- not Sun's Java -- was the platform to choose. "We wanted to ship a real product that people use in their everyday life," he says. "Quite simply, Windows is what most people use on their desktop."
But partnering with Microsoft has risks of its own. Citrix Systems Inc. had a close relationship with Microsoft -- selling a terminal version of Windows NT for two years. Then last winter, Citrix Chairman Edward E. Iacobucci learned that Microsoft planned on developing its own version. Iacobucci fought back and finally persuaded Microsoft to license his technology rather than compete with him. "We pretty much held our ground," says Iacobucci.
Now the PalmPilot folks have to hold theirs. They captured 66% of the market for standard handheld devices in the first half of last year, according to Dataquest Inc. But devices based on Windows CE quickly got a 20% share. And new ones are popping up every day: Launches for handheld and automobile-based devices were announced on Jan. 7. PalmPilot can still thrive. But analysts don't advise others to follow in its footsteps. "When people call and want advice, I ask them who they're competing with," says Andrew Seybold, a well-known consultant in the handheld arena. "If they say they're going head-to-head with Bill Gates, I say 'I can't help you.'" As long as that's true, having a sound Microsoft strategy will be essential in any startup's business plan.
By Steve Hamm, with Linda Himelstein, in San Mateo, Calif.

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