Software Business Entrepreneurship Lessons from Bill Gates and Microsoft SWP 4046 Michael A. Cusumano MIT Sloan School of Management Fuji Conference, January, 1998 Revised Draft: December 10, 1998 Introduction Established in 1975, Microsoft is now the largest company in the world specializing in computer software, with some 27,000 employees and annual revenues of exceeding $11 billion in 1997 (Table 1). Microsoft has grown by skillfully moving from one software mass market to another. The company started by selling programming languages for a new PC kit, and then built an operating system (MS-DOS) for IBM and then other computer equipment manufacturers. It gradually entered a variety of applications markets and sold products directly to retail stores. Today, Microsoft dominates various PC software markets throughout the world. It has a market share of around 90 percent in operating systems (Windows and Windows NT), and this has provided the company with an enormous revenue stream for many years. But Microsoft has also learned how to develop applications programs, and builds more than 200 software products. In addition, the company has an Internet portal business and is rapidly increasing its presence in the Internet software (browser and server) markets, where it entered late but now has a market share of approximately 60 percent in browsers (Cusumano and Yoffie, 1998). In fact, Microsoft continues to grow at an astounding pace for a large firm (see Table 1). The company has also created incredible wealth: Microsoft's market valuation in 1998 reached approximately $300 billion. Bill Gates is frequently listed as the richest individual in the world, with a net worth (mostly Microsoft stock) of more than $50 billion. Several thousand of Microsoft's employees are also millionaires due to their generous stock options, and Gates' generosity here has helped him retain the best employees. Clearly, there should be much that high-tech entrepreneurs can learn from Bill Gates's management style and Microsoft as an example of American-style entrepreneurship in the personal computer (PC) software business. Accordingly, this paper focuses on three different themes that characterize the success of Bill Gates and Microsoft as an entrepreneurial company. The first theme -- understanding both the technology and the business -- emphasizes the point that the software business is highly technical. Therefore, it is extremely difficult and usually unwise to separate technology decisions from business or strategic decisions. Microsoft has never had to struggle with this problem because Bill Gates grew up with computers, has been one of the pioneers of PC programming technology, and has displayed a remarkable ability to understand strategic thinking and make money off his technical skills. The second theme -- building an organization of "smart people" -- emphasizes the point that developing products for the software industry is a highly creative and intellectual activity, and therefore successful computer software companies must be built around "smart" people. Not only does computer programming combines elements of art, science, and engineering, but the technology has been evolving so rapidly that managers and engineers must be able to make decisions very quickly and on their own. This also requires smart people. Gates has always understand this issue and has been extremely selective in recruiting people for his company. In addition, following the example of Bill Gates, the word "smart" has come to have a special meaning in Microsoft: the ability to learn and solve problems quickly, as well as the ability to understand software technology and how to make money with this knowledge. The third theme -- balancing structure and flexibility -- emphasizes the point that a successful software entrepreneur and entrepreneurial company needs to have enough flexibility to allow creative software developers to create and invent products and new technologies as necessary. At the same time, however, a successful software company also has to have enough 2 structures and processes in place to coordinate and focus the work of these creative people. This requires a delicate balancing act in management, which Bill Gates and Microsoft have also done extremely well. Table 1: MICROSOFT COMPANY DATA, 1975-1997 Year Revenues Growth Rate Employees Operating Profit R&D/Revenues ($1,000) (%) (people) (%) (%) 1975 16 3 na na 1976 22 275 7 na na 1977 382 1636 9 na na 1978 1,356 255 13 na na 1979 2,390 76 28 na na 1980 8,000 235 38 na na 1981 16,000 100 130 na na 1982 24,486 53 220 na na 1983 50,065 104 476 na na 1984 97,479 95 778 na na 1985 140,417 44 1,001 na na 1986 197,514 41 1,442 31 11 1987 345,890 75 2,258 37 11 1988 590,827 71 2,793 32 12 1989 803,530 36 4,037 30 14 1990 1,183,000 47 5,635 33 15 1991 1,843,000 56 8,226 35 13 1992 2,759,000 50 11,542 36 13 1993 3,753,000 36 14,430 35 13 1994 4,649,000 24 15,257 37 13 1995 5,937,000 28 17,000 34 14 1996 8,671,000 46 20,000 35 17 1997 11,358,000 31 27,000 45 17 Note: "na" refers to "not available." Microsoft began publishing data on operating profits after going public in 1986. Sources: The major sources for this table are Microsoft annual reports from 1986 to 1997, and, for prior years, Philip M. Rosenzweig, "Bill Gates and the Management of Microsoft" (Boston:, Harvard Business School, Case #9- 392-019, 10/9/92). 3 Understanding the Technology and the Business Computer software has special characteristics as a technology and as a business. Understanding these characteristics is essential for an entrepreneur to succeed in the software business. Bill Gates has this understanding. He became familiar with computers and programming in junior high school. In fact, he was one of the pioneers of PC software technology and the first person to establish a dedicated PC software company. Gates also showed an early interest in making money, and had a software company in high school with partner Paul Allen, co-founder of Microsoft. We also know that Gates has been an avid reader of business history and biographies of great leaders in world history, and he continues to apply what he has learned in managing Microsoft. As a result, Gates has positioned himself to understand deeply both the technology and the business of computer software. He has also played several roles simultaneously in Microsoft. Gates has been both an entrepreneur (the company founder) and key technologist. He has also been the chief strategist as well as an effective leader and manager. Software as a Technology and a Business: We can observe several unique characteristics of computer software as a technology and as a business. First, the technology consists of computer code -- instructions written in one of many programming languages -- running on computer hardware and over networks. There is no bending of metal or molding of plastic to create software products. But products can be large and extremely complex in terms of the number of components and their potential interactions. (Microsoft's Windows 95 operating system, for example, totaled about 11 million lines of code and took a team of about 400 developers and testers nearly 3 years to create.) This is truly a "knowledge" industry, where products consist of ideas and the key assets of a company are well-trained people -- often very young people. Product distribution is also increasingly "electronic" and "instantaneous" over telephone and cable-TV networks. The people who write computer code are also unique. The popular press refers to them as "nerds" or "hackers" -- unkempt technical wizards who can make computer hardware do almost any task imaginable. Part of the fascination with software developers is that programming is more an "art" than a "science," though some companies try to manage software development like crude "engineering," using rules of thumb and historical data (Brooks, 1975; DeMarco and Lister, 1987). Entrepreneurs and managers in the software business need to understand the mentality and motivations of software programmers, as well as the peculiarities of the technology they create. Another characteristic of software relates to what I call the mythical man-month syndrome. Managing software projects is notoriously difficult (there is something like a 10 or 20 to 1 difference in productivity between the best and worst programmers on a typical team). How long it will take to build a product is extremely difficult to predict because of the variance in individual performance as well as the uncertainty of the technology (programmers often have to "invent" functions as they go along). And people and months are not interchangeable; companies usually cannot speed up late projects by just adding more people, because the new people take time to learn what has been done and existing team member must stop and teach them what to do. Larger teams also create communications and coordination problems. Then testing software products -- finding and removing bugs -- is also incredibly difficult due to the huge number of 4 combinations of software and hardware products and user scenarios. Yet shipping at least "good enough" products in a timely fashion can be critical to success. Not surprisingly, software programmers have created a special culture: The companies they prefer to establish and work in are notoriously non-bureaucratic, informal, and laid-back, but very hard-working. Work any 80 hours a week that you like, and the drinks are free, too! A hobby that is big business! Then there is the rapidpace of change. Since the beginning of the software industry in the 1950s, the hardware technology and software programs have evolved with astounding speed.