In January 1979, Microsoft moved from Albuquerque to a suburb of Seattle, Washington. Paul and I came home, bringing almost all of our dozen employees with us. We concentrated on writing programming languages for the profusion of new machines that appeared as the personal-computer industry took off. People were coming to us with all kinds of interesting projects that had the potential to turn into something big. Demand for Microsoft’s services exceeded what we could supply.
I needed help running the business and turned to my old Economics 2010 pal from Harvard, Steve Ballmer. After graduating, Steve worked as an associate product manager for Procter & Gamble in Cincinnati, where his work included a stint paying calls on small grocery stores in New Jersey. After a few years he decided to go to the Stanford Business School. When he got my call he had finished only one year and wanted to complete his degree, but when I offered him part ownership of Microsoft, he became another student on indefinite leave. Shared ownership through the stock options Microsoft offered most of its employees has been more significant and successful than anyone would have predicted. Literally billions of dollars of value have accrued to them. The practice of granting employee stock options, which has been widely and enthusiastically accepted, is one advantage the United States has that will allow it to support a disproportionate number of start-up successes, building on opportunities the forthcoming era will bring.
Within three weeks of Steve’s arrival at Microsoft, we had the first of our very few arguments. Microsoft employed about thirty people by this time, and Steve had concluded we needed to add fifty more immediately.
“No way,” I said. Many of our early customers had gone bankrupt, and my natural fear of going bust in a boom time had made me extremely conservative financially. I wanted Microsoft to be lean and hungry. But Steve wouldn’t relent, so I did. “Just keep hiring smart people as fast as you can,” I said, “and I will tell you when you get ahead of what we can afford.” I never had to because our income grew as fast as Steve could find great people.
My chief fear in the early years was that some other company would swoop in and win the market from us. There were several small companies making either microprocessor chips or software that had me particularly worried, but luckily for me none of them saw the software market quite the way we did.
There was also always the threat that one of the major computer manufacturers would take the software for their larger machines and scale it down to run on small microprocessor-based computers. IBM and DEC had libraries of powerful software. Again, fortunately for Microsoft the major players never focused on bringing their computer architecture and software to the personal-computer industry. The only close call came in 1979, when DEC offered PDP-11 mini-computer architecture in a personal-computer kit marketed by HeathKit. DEC didn’t completely believe in personal computers, though, and wasn’t really pushing the product.
Microsoft’s goal was to write and supply software for most personal computers without getting directly involved in making or selling computer hardware. Microsoft licensed the software at extremely low prices. It was our belief that money could be made betting on volume. We adapted our programming languages, such as our version of BASIC, to each machine. We were very responsive to all the hardware manufacturers’ requests. We didn’t want to give anyone a reason to look elsewhere. We wanted choosing Microsoft software to be a no-brainer.
Our strategy worked. Virtually every personal-computer manufacturer licensed a programming language from us. Even though the hardware of two companies’ computers was different, the fact that both ran Microsoft BASIC meant they were somewhat compatible. That compatibility became an important part of what people purchased with their computers. Manufacturers frequently advertised that Microsoft programming languages, including BASIC, were available for their computers.
Along the way, Microsoft BASIC became an industry software standard.
Some technologies do not depend upon widespread acceptance for their value. A wonderful nonstick frying pan is useful even if you’re the only person who ever buys one. But for communications and other products that involve collaboration, much of the product’s value comes from its widespread deployment. Given a choice between a beautiful, handcrafted mailbox with an opening that would accommodate only one size envelope, and an old carton that everyone routinely dropped all mail and messages for you into, you’d choose the one with broader access. You would choose compatibility.
Sometimes governments or committees set standards intended to promote compatibility. These are called “de jure” standards and have the force of law. Many of the most successful standards, however, are “de facto": ones the market discovers. Most analog timepieces operate clockwise. English-language typewriter and computer keyboards use a layout in which the keys across the top letter row, left to right, spell QWERTY. No law says they must. They work, and most customers will stick with those standards unless something dramatically better comes along.
But because de facto standards are supported by the marketplace rather than by law, they are chosen for the right reasons and replaced when something truly better shows up—the way the compact disc has almost replaced the vinyl record.
De facto standards often evolve in the marketplace through an economic mechanism very similar to the concept of the positive spiral that drives successful businesses, in which success reinforces success. This concept, called positive feedback, explains why de facto standards often emerge as people search for compatibility.
A positive-feedback cycle begins when, in a growing market, one way of doing something gets a slight advantage over its competitors. It is most likely to happen with high-technology products that can be made in great volume for very little increase in cost and derive some of their value from compatibility. A home video-game system is one example. It is a special-purpose computer, equipped with a special-purpose operating system that forms a platform for the game’s software. Compatibility is important because the more applications—in this case, games—that are available, the more valuable the machine becomes to a consumer. At the same time, the more machines consumers buy, the more applications software developers create for it. A positive-feedback cycle sets in once a machine reaches a high level of popularity and sales grow further.
Perhaps the most famous industry demonstration of the power of positive feedback was the videocassette-recorder format battle of the late 1970s and early 1980s. The persistent myth has been that positive feedback alone caused the VHS format to win out over Beta, even though Beta was technically better. Actually, early Beta tapes only recorded for an hour—compared to three hours for VHS—not enough for a whole movie or football game. Customers care more about a tape’s capacity than some engineer’s specs. The VHS format got off to a small lead over the Beta format used by Sony in its Betamax player. JVC, which developed the VHS standard, allowed other VCR manufacturers to use the VHS standard for a very low royalty. As VHS-compatible players proliferated, video-rental stores tended to stock more VHS than Beta tapes. This made the owner of a VHS player more likely than a Beta owner to find the movie she wanted at the video store, which made VHS fundamentally more useful to its owners and caused even more people to buy VHS players. This, in turn, further motivated video stores to stock VHS. Beta lost out as people chose VHS in the belief that it represented a durable standard. VHS was the beneficiary of a positive-feedback cycle. Success bred success. But not at the expense of quality.
While the duel between the Betamax and VHS formats was going on, sales of prerecorded videocassettes to U.S. tape-rental dealers were almost flat, just a few million copies a year. Once VHS emerged as the apparent standard, in about 1983, an acceptance threshold was crossed and the use of the machines, as measured by tape sales, turned abruptly upward. That year, over 9.5 million tapes were sold, a more than 50 percent increase over the year before. In 1984, tapes sales reached 22 million. Then, in successive years: 52 million, 84 million, and 110 million units in 1987, by which time renting movies had became one of the most popular forms of home entertainment, and the VHS machine had become ubiquitous.