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Microsoft's Future


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MICROSOFT'S FUTURE

A band of powerful foes is determined to slow the Gates juggernaut, but Microsoft's reach already extends further than you may think

In December, Samuel Goodhope stood hunched over an Austin conference-room table eyeing a dismembered personal computer. As a special assistant in the Texas Attorney General's office and point man in its antitrust investigation into Microsoft Corp., he needed a keen understanding of a PC's innards. So a technician painstakingly explained how each of the components is supplied by a different company, but they must all work with the critical Windows operating system made by a single corporation, Microsoft. That's when it hit him: Microsoft owns a key monopoly in the Digital Age, and the software maker is a lot like the Borg. These fictional Star Trek characters--part flesh, part machine--prowl the universe conquering other races. "Resistance is futile," says Goodhope in a mechanical, Borg-like voice. "You will be assimilated."

Microsoft and its hypercompetitive chairman, William H. Gates III, are no science-fiction fantasy. And the Texas Attorney General's office fully intends to resist. Indeed, Goodhope predicts that two dozen states will soon join his effort--amassing some 100 attorneys for a Big Tobacco-style courtroom battle that he says could reshape the computing landscape. "We're talking about what the high-tech world is going to look like in five years," says Goodhope. "Will the Information Superhighway become the Bill Gates toll road?"

Microphobia, a national pastime in recent years, is reaching a new frenzy. Since October, the most influential company in the $700 billion U.S. computer industry has been under siege from all quarters. Texas and eight other states have launched investigations into whether the software giant is using anticompetitive tactics. Consumer advocate Ralph Nader is calling for a breakup of the company. The European Commission is mulling a probe of its own. And Microsoft is embroiled in a knock-down, drag-out fight with the Justice Dept. over whether it is violating a 1995 consent decree by requiring PC makers to ship its Internet browser with Windows 95. "This kind of product-forcing is an abuse of monopoly power--and we will seek to put an end to it," vows Joel I. Klein, Assistant Attorney General for the Antitrust Div.

For his part, Gates denies violating any laws and says the earlier consent decree with Justice allows Microsoft to enhance Windows. Browsing, he says, is a natural addition to an operating system. "What we're doing is quite straightforward and quite pro-customer," Gates says. "In no way are we eliminating choice." He also bristles at the notion that Microsoft wants to turn the Internet into its personal toll road. "We'll get our revenue from selling great software."

Microsoft's dispute with the Justice Dept. is no mere joust over the mechanics of linking a Web browser to the ubiquitous Windows 95. The passions aroused in the government and industry alike reflect the realization that this is a bruising fight over which companies will dominate the Internet and move into new markets from there. The prize is huge. The Net not only opens the possibility of a vast new marketplace for everything from banking to buying cars, but it is also the electronic gateway into homes and--perhaps more important--into corporations. Owning the browser and Internet server software could well become as key to the new age of Net computing as Windows is to PCs.

If Gates extends his PC hegemony to these new realms, the little software company he co-founded in 1975 could come to dominate the nexus of computing and communications well into the 21st century. "The question is, are we looking forward to the Information Age, or will it be the Microsoft Age?" asks Lawrence J. Ellison, chairman of database maker Oracle Corp. "It's kind of like Microsoft vs. mankind--and mankind is the underdog."

A BROADER CASE? Hyperbole aside, Microsoft wants to move into every business where software matters--from the chilled rooms of mainframe computing to the household appliances that are being computerized. Gates wants to expand into the corporate-enterprise market--from databases to E-mail. And he wants to play in consumer electronics--from TV set-top boxes to car navigation systems.

Rivals and critics hope the Justice Dept. can slow down Microsoft's pace. The current dispute, which centers on Windows 95, is likely to have little effect on Microsoft. But if Justic broadens its suit to cover the upcoming Windows 98--something it has hinted it might do--or attacks Windows NT as well, Microsoft would suffer a devastating blow. "Unless we're allowed to enhance Windows, I don't know how to do my job," says Gates. It would also set an ominous precedent that cuts to the heart of the software maker's strategy of melding Internet capabilities into all of its products--from PC software to new consumer-electronics offerings to corporate enterprise programs.

It could get worse for Gates. No matter how the current dispute is resolved, Klein and his team could bring a broader antitrust case. Caswell O. Hobbs, a Washington (D.C.) antitrust attorney with Morgan, Lewis & Bockius, says the current consent violation case is just "an opening salvo. I'm sure it's not the last of the proceedings."

In its thinking on Microsoft, Justice is relying on a novel theory in antitrust law. It's not only about monopoly pricing power, as in the days of the Robber Barons. Information technology, after all, is an industry in which prices fall. Rather, Justice is concerned that Microsoft's operating system is so dominant that it is the de facto standard, the very springboard for all sorts of new applications software. By controlling the standard, Justice fears, Microsoft stifles innovation. That means competing technologies, even if they're better, stand little chance, making it tough for startups to bring whizzy new inventions to market. "They're hell-bent on dominating the entire information infrastructure of the world," says attorney Gary Reback, who represents rival Netscape Communications Corp., "and it scares the daylights out of me."

Such talk rankles Gates. He says his rivals should spend less time obsessing about Microsoft and more time on their own businesses. What's more, he argues, there's no assurance Microsoft will succeed in any new markets, much less dominate them. The emergence of Netscape's popular Navigator browser and Sun Microsystems Inc.'s Java programming language--threats to Windows, as he sees it--shows that the industry is highly competitive. "No one has a guaranteed position," says Gates.

Point taken. But if ever there was a company that has the best seat in the house, it's Microsoft. It practically owns the PC software market. Its Windows operating system claims some 86% of that segment, and its Office suite of productivity programs, including a spreadsheet and word processor, has an 87% lock. Game won--and the victor has emerged enormously wealthy. Microsoft is expected to reel in more than $4 billion in profits this fiscal year, which ends in June, on $14 billion in revenues, up 23% over a year ago. It looks even richer when compared with the rest of the software industry: In calendar year 1996, its $8.7 billion in revenues accounted for 10% of all sales for the 613 publicly traded software and information-services companies, says Standard & Poor's Compustat. More significantly, its $3.1 billion in operating profits was a remarkable 30% of all such profits.

With the company's pockets lined with riches from Windows and related software, it can spend a staggering $2.5 billion a year on new-product development--more than the annual profits of the next 10 largest software companies combined. And what it can't develop fast enough, the company can buy. In the past two years, Microsoft has invested in or acquired 37 companies. On Dec. 31, it added Hotmail, an Internet E-mail startup founded by Sabeer Bhatia and Jack Smith, for an estimated $350 million in stock (page 37). It has snapped up technologies for surfing the Web via TV, for viewing video over the Net, for authoring Web pages, and for computers to understand voice commands. And still its cash hoard keeps climbing--from $6.9 billion in mid-1996 to $10 billion today.

That has helped Microsoft extend its reach to brand-new terrain. In the past year, Microsoft has gotten a jump in online travel services, car sales, investment advice, and gaming. And Gates isn't shy about his ambitions. "We will not stop enhancing Windows," he says. "We will not succumb to the rhetoric of our competitors. We won't stop listening to customers and being aggressive about meeting their needs."

Indeed, 1998 may be the year Gates makes his biggest push yet beyond the PC. Starting this month, planned new products will move Windows into car dashboards, cell phones, point-of-sale devices, and on up the food chain into powerful server computers that can do the job of a mainframe. In short, the world ain't seen nothin' yet. Here's where Microsoft is headed.

CONSUMER ELECTRONICS

On Jan. 10, the next chapter unfolds. That's when Gates will head to the Consumer Electronics Show in Las Vegas to demonstrate new $300-to-$500 palm-size devices that use a pint-size version of Windows called CE, for consumer electronics. These gizmos go a long way toward fulfilling Gates's dream of a "wallet PC"--a tiny device for keeping phone numbers, schedules, and zapping E-mail, all of which can be synchronized with Windows PCs. A half-dozen manufacturers are ready to ship the new palmtops, including Philips Electronics and Samsung Co.

The real buzz at the electronics show could come from the debut of Microsoft's "Auto PC" operating system. This version of Windows CE is built into a car's sound system. It can handle cell-phone calls, fetch E-mail, and dispense travel information--much like a "Java car" unveiled by rivals Sun, Netscape, and IBM in November. Nissan Motor Co. will be the first to show Auto PC in an Infinity I-30 concept car. So far only a handful of carmakers, including Volkswagen and Hyundai, have signed up. Microsoft is betting that aftermarket car-component companies will make Auto PC a hit. "Windows CE gives us an opportunity to sell more software to more people," says Kathryn Hinsch, senior director of marketing for Windows CE. "This could be the next billion-dollar business for Microsoft."

Windows CE is a classic example of how Microsoft stubbornly pushes its way into new fields, even if it takes years. CE is the software giant's third attempt to crack the handheld market--after its At Work and Winpad operating systems that never caught on. Microsoft didn't give up. Over the past seven years, it has continued to invest several hundred million dollars to improve the basic software. CE was launched in fall, 1996, and nine months later claimed 20% of the handheld market, according to market researcher Dataquest Inc.

Today, CE is licensed by more than a dozen handheld manufacturers, and it's finding its way into all manner of machines. Atlanta-based Radiant Systems Inc., for example, plans to sell Windows CE point-of-sale devices to fast-food restaurants this winter. Customers press buttons on a screen to select the food and drinks they want--and orders are instantly whisked to the kitchen. Such devices could help boost Windows CE to 60% of the U.S. handheld market this year, says International Data Corp.

What happens when even the try, try again approach fails? Consider Microsoft's attempts to corral the TV set-top box market--the fulcrum for software, entertainment, and Net cruising. In 1994, it debuted a scheme for digital set-top boxes, but it fizzled along with the market for interactive TVs.

So Microsoft tried a different method: acquiring the leading business. Last winter, Microsoft spent $425 million to buy Silicon Valley startup WebTV, which had pioneering technology for surfing the Net via TV. Since then, Microsoft has improved WebTV with a faster setup and, during the holiday shopping season, an added carrot--a $100 rebate to anyone who bought a $279 WebTV device and signed up for six months of the $19.95-a-month service. The result: WebTV has racked up 250,000 subscribers, up from 50,000 a year ago, say WebTV executives.

Still, the world of TV is proving tricky for Microsoft. Last spring, the software maker once again began stumping to sell its designs to the nation's cable-TV operators for their next-generation interactive systems. The pitch: Microsoft would provide software for set-top boxes, networks, and servers that pump info across the cable network. When Microsoft paid $1 billion in June for a piece of cable operator Comcast, it looked as though it might buy its way into becoming a top supplier of software for interactive-cable systems. But no such luck--at least, not yet. In October, the cable industry announced it would require all suppliers to comply with a set of industry-standard specifications--not necessarily those of Microsoft.

Gates regrouped. Microsoft revised its pitch to cable operators--agreeing to comply with the specs and to sell pieces of its software a la carte. It's unclear how Microsoft will fare, but one thing is certain: Cable execs have seen how successful Microsoft is in PCs and are determined not to let it control a key piece of cable-network technology. "We don't want to be Bill Gates's download," says Tele-Communications Inc. President Leo J. Hinderly Jr. Still, rumors are swirling that TCI is about to accept financing from Microsoft--which could turn it into an ally overnight.

CORPORATE COMPUTING

Microsoft's high-stakes bid for the $30 billion corporate market has never looked so good. Four years ago, it was nearly a no-show in so-called "enterprise" software, which spans databases to E-mail to powerful servers. After a dogged three years and $1 billion spent beefing up its industrial-strength Windows NT, Microsoft is gaining ground. Today, NT accounts for nearly 40% of server operating systems, up from 24.5% a year ago, says IDC.

That share could take off even more when Microsoft ships its fifth and most powerful version of NT late this year. With some 27 million lines of code, it is the most ambitious program Microsoft has ever tackled--and it could prove to be its trump card. NT 5.0 is designed to handle the largest computing tasks, giving Microsoft a sorely needed piece to push beyond midsize networks and small server jobs. Says James E. Allchin, Microsoft senior vice-president of Personal & Business Systems: "Microsoft is betting the company on this."

Chances are it's a safe bet. While Microsoft concedes that Windows NT servers won't replace the world's supply of mainframe computers anytime soon, Jeffrey S. Raikes, Microsoft's group vice-president for sales and marketing, predicts that in the next few years, NT could unseat IBM's stalwart AS/400 minicomputer--a $3.4 billion annual business. By selling NT, Office 97, and a suite of networking software called BackOffice, Raikes' goal is to increase Microsoft's average annual revenues per corporate computer user from less than $150 today to more than $200 in the next two years.

Analysts like what they see. They predict the software maker will sell $5 billion worth of NT and BackOffice by 2000, double what's expected this fiscal year. "Today, we see Microsoft software at the heart of almost every desktop," says analyst Neil Herman of Salomon Smith Barney. "In 10 years, we'll see Microsoft software at the heart of 90% of the servers out there, too."

One company already feeling the heat is Netscape. On Jan. 5, the Silicon Valley highflier announced that its quarterly sales would be $125 million to $130 million--well below the $165 million analysts had expected. Worse, it will report its first loss in nine quarters. The reason: Netscape's server and browser sales are down because of stiff competition from Microsoft and IBM (page 69). "Microsoft is the primary cause of Netscape's problems," says analyst Bruce D. Smith of Merrill Lynch & Co.

That doesn't mean Microsoft will own enterprise. The operating system accounts for just 20% of the installed base of computer servers. And for the rest of that business Microsoft faces a revitalized IBM that is well entrenched in Corporate America and becoming a formidable competitor on the Net. After stumbling in the early '90s, IBM has made a remarkable comeback by using PC technology to sell mainframe computers costing less than one-tenth what customers paid in the late 1980s. That has kept many major customers true blue.

Database giant Oracle also has an incredibly loyal following. It has 39% of that sector, vs. less than 4% for Microsoft's SQL Server. Microsoft's database software is still seen as not powerful enough to handle the really big jobs at giant corporations. "Microsoft has given their database away, but it hasn't helped--because their database isn't any good," says Oracle's Ellison.

And then there's Java. Sun Microsystems' much hyped programming language offers the prospect of an alternative to Windows, since applications written in it can run on any operating system. So far, Microsoft has convinced hundreds of corporate customers that they can save money by running even their biggest jobs on NT. But many companies still have millions invested in mainframes, and moving everything to Windows could take years. Java offers an alternative. This software--used to write other programs--runs on a variety of computer architectures. That helps it to act as a digital glue for creating programs that allow companies to use existing software, such as mainframe programs, while still tapping into new Internet businesses.

Early this year, Java will get better yet. Improved security and performance could make it more appealing to use on a slew of devices. "Between Java cards and Java rings and Java phones and Java set-top boxes and Java everything else, we're going to destroy them on unit volume," predicts Sun CEO Scott G. McNealy. For all this, analysts don't see Java replacing Windows anytime soon. The 700,000 software developers using Java pales next to the 4.5 million that Windows claims. Even John F. Andrews, chief information officer for transportation giant CSX Corp. and a huge Java fan, says: "Java's a punch, but it's not a knockout."

That's because Microsoft is well protected. Many corporations have already standardized on Windows and its desktop applications. So now, they're interested in buying software from Microsoft that can help tie their computer systems together more simply and run their large databases, accounting systems, and manufacturing operations. "The plan ultimately is to run everything on one platform. That's the carrot out there," says Dean Halley, an information-systems executive at Credit Suisse First Boston Corp.

THE INTERNET

When it comes to new markets, none is as vast and potentially lucrative as the Internet. Analysts predict that Net revenues from software and commerce will reach dizzying heights--as much as $100 billion by 2000. And no single company is investing so much or so broadly--or holds as many of the pieces--as Microsoft. In the two years since it vowed to become a leader in cyberspace, Microsoft has been true to its word.

The most visible proof is Internet Explorer. Since releasing the first version of IE a little more than two years ago, Microsoft has jetted from zero to 40% of the market. Moreover, if the software maker's plans to weave the browser into Windows 98 go unhampered by the Justice Dept., analysts expect IE to shoot past market leader Netscape to become No.1 this year.

Microsoft's browser has one huge draw: It's free. Cash-rich Microsoft can afford such tactics, while scrappy rivals such as Netscape have to charge a few dollars. And that can make a difference. Internet service provider Concentric Network Corp., for example, switched from Netscape's browser to IE over price. "We're operating on slim margins, so it matters," says Vice-President James Isaacs.

That has sent Netscape looking for more lucrative server business. "If I had to depend on the browser for profits, I'd be flat-ass broke," says Netscape CEO James L. Barksdale. In the face of a loss for the quarter, Netscape may be forced to match Microsoft's giveaway strategy.

Internet Explorer is just the tip of the iceberg. Across the board, Microsoft is making the Net its No.1 priority. "It's hard to think of much that we're doing that isn't influenced by the Internet," says Gates. "All of our software is very tied up in helping people use the Internet in a better way."

That includes deep-pocketed corporate customers. As they refashion their businesses around the Internet, Microsoft is out to make sure that Windows NT will be the software of choice. In the past few months, Microsoft has updated all of its corporate software to boost the latest Internet features. BackOffice, for example, now includes Commerce Server, specialized software that companies such as Barnes & Noble Inc. and Dell Computer Corp. use to run their online sales operations.

As it does in the browser market, Microsoft gives away much of its basic Internet server software. It packages Internet programs, such as Site Server for managing Web sites, with BackOffice at no additional cost. And each copy of NT includes Internet Information Server, a basic Web-server program. That has helped catapult Microsoft's share of Web and corporate intranet servers to 55%, with all rival Unix makers combined at No.2, with a 36% share.

The Net initiatives that draw the most attention, though, are Microsoft's attempts at building new Web-style businesses. It has set up 16 Web sites for everything from online investing to travel reservations to home buying.

Some of these Web sites are already leaders in their categories. Microsoft's Expedia is in a dead heat with Preview Travel and Travelocity for the top spot in online travel, with more than $2 million in bookings a week. CarPoint has quickly become a popular spot for car buyers. This year, CarPoint is expected to begin offering insurance and financing services that will make it a one-stop shop for auto needs. Forrester Research Inc. predicts that CarPoint will rack up sales of $10 million a month within a couple of years. MSNBC, Microsoft's news venture with NBC, ranks third--after Softbank's news site ZDNet, and Walt Disney's site--in the most recent PC Meter Survey of Web-site viewership in the news, information, and entertainment category.

Microsoft plans to launch a couple of new sites this year. One, code-named Boardwalk, will let home buyers shop for real estate and mortgages. The other is an online bill-paying service that will be operated as a joint venture with First Data Corp. "There will be three or four major networks on the Internet, and we expect to be one of them," says Jeff Sanderson, general manager for Microsoft Network, the software giant's online service. By some measures, Microsoft is already there. PC Meter rates Microsoft's 16 Web sites combined as No.4 in its monthly survey--behind only America Online, Yahoo!, and Netscape.

LOCAL UPRISING. The prospect of Microsoft entering everything from travel to car sales has put competitors on alert. Indeed, even a rumor of Microsoft's imminent arrival can jolt formerly complacent industries into action. Take newspaper publishers. Last year, when Microsoft announced it would launch Sidewalk, a series of Web sites offering local-entertainment listings, newspaper publishers geared up to protect their $24 billion in annual local advertising. Some 136 newspapers signed up with Zip2 Corp., a Mountain View (Calif.) supplier of online publishing technology that helps publishers create electronic versions of their newspapers. "Microsoft tries to scare people into giving up, but it's just not working," says Zip2 CEO Rich Sorkin, who claims that his combined newspaper sites are racking up 8 million viewers a month--nearly triple the traffic Microsoft's 10 Sidewalk sites are drawing.

So are critics' fears founded? Gates claims Microsoft has no grand plan to control the Net. What's more, not all of his Web ventures have been hits. Microsoft Network, the company's online service, has failed to live up to its early hype.

LONG-TERM VIEW. While some of these new business are starting to pay off, Microsoft views the estimated $250 million a year it spends on Web sites as an investment in the future. "Anybody involved in this is projecting out 5 to 10 years and asking what can they start to build now that can become more valuable as the Internet becomes more mainstream," says Gates.

For that reason, Microsoft's biggest Web opportunity may lie in doing what it does best--creating software for others to use and build upon. It has begun selling its online travel software to airlines, including Northwest Airlines Corp. and Continental Airlines Inc. And American Express Co. is selling travel services to corporations based on Microsoft software called Microsoft Travel Technologies. "They paid us quite a bit for that," says Gates. The potential looks huge: American Express Interactive is being rolled out in 20 large corporations, including Monsanto and Chrysler. An additional 180 companies will be using it by the end of 1998. All told, these companies represent more than $5 billion in yearly travel purchases, according to Microsoft's Richard Barton, general manager of Expedia.

Still, it is unlikely that Microsoft will dominate the Web the way it has PC software. For one, it must compete against the giants in their fields, be they bankers, stock brokerages, real estate empires, auto makers, or travel agents. And the Web is still a work in progress, with new sites and opportunities popping up every day. Even with Windows as a starting point for most computer users, "everything else is just a click away," says Bill Bass, a new-media analyst for Forrester Research.

For his part, Gates doesn't show any willingness to let up to placate his critics or government investigators. And there's no sign in Redmond of complacency. In fact, Gates sees threats all around--even from operating systems that few people have ever heard of and Web sites that haven't been created yet. The key for Microsoft, he says, is satisfying customers, innovating, and keeping prices low. "If we don't do all of these things," says its 43-year-old chairman, "Microsoft will be replaced."

It's that sort of paranoia that has enabled Mircosoft to survive and thrive. It's possible, of course, that competitors will blunt his new attack in at least some areas. But unless the government succeeds in a full-scale antitrust assault, Bill Gates and Microsoft are destined to become a still more potent force in the world's most important industry.By Steve Hamm in Redmond, Wash., with Amy Cortese in New York and Susan B. Garland in Washington, D.C.Return to top


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