Microsoft 1994-2000: How Bill Gates Turned a Browser War Into an Antitrust Disaster

[00:00:09] Morning folks and welcome to today's episode. It's called Microsoft 1994-2000. How Bill Gates Turned a Browser War Into an Antitrust Disaster. And this is without doubt, I've said this a few times, but this is without doubt one of my favourite stories ever. And look, I'll be doing a good few episodes on Gates and Microsoft, but why I decided to start off with this one is because it's a fantastic standalone story.

[00:00:39] You have Bill Gates and Microsoft in the mid-90s at the very height of their powers. Then along comes Mark Anderson and Netscape, who develop a browser that really launches the World Wide Web. And the launch of Netscape is an existential threat to Microsoft. So they try to bully Netscape into a deal. But Netscape fight back. And this sets in motion the antitrust case that brings out Gates's arrogance, his

[00:01:09] petulance and his fear. And it leads to a judgement where Microsoft is ordered to split in two. It is a cracking story. Enjoy. So while this story starts in 1993, I want to first just give a little context as to where Microsoft was at this point. So the company had made its fortune after creating an operating system for IBM's first PC in 1981. But Gates very cleverly inserted a clock on the clock.

[00:01:39] And then also made its own laws into the laws into the contract, allowing IBM to use the software for a flat fee, while Microsoft held on to full ownership and it could sell it to anyone. Because IBM mistakenly believed that the real money was in the hardware, not in the operating system. So then, when other manufacturers began to use the same way. So then, when other manufacturers began producing clones of the IBM PC, they all turned to Microsoft for the MS-DOS, their operating system.

[00:02:04] And as I discussed in the same way. And as I discussed in the same way. And as I discussed in the Steve Ballmer episode, Microsoft then tied manufacturers into this per-processor licensing agreement. And this is where they paid Microsoft for every PC they built, whether it ran MS-DOS or not. And so, the net effect of this was that almost every manufacturer simply pre-installed Microsoft on every machine.

[00:02:30] So, by 1993, Microsoft was running on around 90% of the world's PCs. Within two years of that, Bill Gates would become the richest man on the planet with a fortune of $12.9 billion. And Microsoft would become the world's most valuable company. However, Microsoft's strategy of packaging more and more features into Windows, while it appeared to benefit the customers,

[00:02:56] it was also a way of abusing its monopoly power by stifling competition and innovation. So, for example, imagine you're a software company with a brilliant new application. But because Windows dominated the market, your software had to work with Microsoft's operating system. Which meant you first had to open up discussions with Microsoft. But that put you into a very vulnerable position.

[00:03:21] Because more often than not, if Microsoft liked your product, it would either invest in your company and eventually absorb it. Or it would simply build its own competing version and bundle it into Windows. So, Microsoft back then, it kind of reminds me of the Borg in Star Trek. Resistance is futile. Because if you tried to resist Microsoft, if you wanted to go it alone and approach the PC manufacturers directly

[00:03:49] and ask them to preload your software. Because remember, this was pre-internet. Software had to be distributed physically. Or ideally, it would be preloaded by the PC manufacturers. Then Microsoft would play hardball and either threaten the PC manufacturers with less favorable conditions or even threaten to pull their Windows license from the PC manufacturers.

[00:04:11] And Microsoft's power, it was so complete that apparently, once a year, senior figures from Microsoft gave a presentation to the top venture capitalists in Silicon Valley where they laid out their plans and projects for the upcoming year. And some of these projects might not even materialize. But the VCs then knew to avoid funding any startups that had products or applications that would clash with Microsoft. That's a lot of power.

[00:04:40] So, that's just setting the story, setting the scene as to how powerful Microsoft were in the software business back then. And the origins of this story now, they start in 1993 at the National Center for Supercomputing Applications at the University of Illinois. So, Mark Andreessen, who I have covered in a separate episode about a year ago, he was an undergraduates and together with a small crew of fellow students and developers, they built the first user-friendly free web browser called Mosaic.

[00:05:10] Now, an early adopter of Mosaic was Silicon Valley figure James Clark. He was the founder of Silicon Graphics. He'd recently quit his company, sold his shares for tens of millions, and he was looking for his next venture. He got talking to Andresen, and he agreed to invest $5 million to transform Mosaic into an even, I suppose, more user-friendly commercial product, which they named Netscape. And they launched it in 1994.

[00:05:37] And it was an instant hit because it was sleek, it was fast, it was reliable, and it quickly became the browser of choice. And it really kick-started the whole dot-com boom. In 1995, Netscape went public. Demand was so high that trading had to be delayed for two hours. It was the hottest IPO in history up to then. The company was valued at $3 billion. And Clark's $5 million investment was now worth over $600 million.

[00:06:07] Now, while all this was going on, Microsoft was pretty late to the whole internet party. At a conference in 1994, Gates is quoted as saying, I see little commercial potential for the internet for the next 10 years. However, within a year, he changed his mind. Because after one of his now famous Think Week retreats, this is where he goes into a small cabin by himself to read and reflect. I mean, what a privilege to be able to do that.

[00:06:37] So after one of these Think Weeks, Gates produced what is now the famous Internet Tidal Wave Memo. And this is where he wrote that the internet is crucial to every part of our business. And of course, the browser was the gateway to the internet. So Gates had two very, very good reasons for wanting to control the browser market. First of all, Microsoft believed that whoever controlled the browser

[00:07:04] could take a cut from all of the online commerce that would go through that browser. Of course, that's not how the internet ultimately evolved. But back in the mid-90s, nobody knew what the winning model would be. As Microsoft's CTO put it, the company's goal was to get a VIG. Those are his words exactly. In other words, a cut or a fee from every internet transaction that used Microsoft's browser. I mean a VIG.

[00:07:33] Talk about a nerd trying to sound all gangster. Anyway, the second reason Gates wanted complete control of the browser market was even more important. He believed that if developers began writing software that ran inside a browser rather than directly on Windows, then the browser, not Windows, would become the platform. And if that happened, Microsoft's operating system monopoly would become irrelevant. Now, Microsoft had begun developing its own browser.

[00:08:03] It was called Internet Explorer in 1994. But by mid-1995, with Netscape already controlling more than 80% of the browser market, Microsoft's own browser was nowhere near competitive. And so, in June 1995, two months before Netscape's IPO, the two companies met for what would become the pivotal meeting that ignited the browser war and the antitrust case that followed.

[00:08:31] This is a huge moment. Now, according to the Netscape team, Microsoft proposed a, and I'm putting them in parentheses, a special relationship. It would buy a 15-20% stake in Netscape. In return, Netscape would agree not to compete with Microsoft on Windows 95. So, like, that would have been 90% of the PC market. And the message Netscape got from that meeting was clear.

[00:09:00] And pretty similar to every deal that Microsoft offered competitors. Agree to our terms, or face Microsoft's full competitive force. But Netscape rejected Microsoft's offer. First, for business reasons. As Jim Clark said, I can't think of one company that collaborated with Microsoft and became a significant company. But they also rejected it for ethical or, I suppose, legal reasons.

[00:09:28] Because as Jim Barksdale, Netscape's CEO said, it was such an explicit proposal to divide the markets that he had never encountered in his years in business. Because, you see, competitors aren't allowed to carve up markets between themselves. That's a textbook antitrust violation. But, not only did Netscape reject Microsoft, after their IPO two months later, Mark Andreessen had become the new poster boy for the tech sector.

[00:09:57] He was appearing on the covers of all the major business and tech publications. And he used this platform to taunt Microsoft, predicting the end of their dominance. And goading Microsoft publicly, it probably wasn't one of Andreessen's smartest moves. Because it only made Gates and Microsoft even more determined to crush Netscape.

[00:10:22] So, Microsoft now poured huge resources into improving Internet Explorer and made one crucial strategic decision. Instead of selling it as a separate product, which they had initially done, they would now bundle Internet Explorer and put it in free with Windows. And this is important because, only months earlier, Microsoft had signed a decree with the US government designed to stop it from using its Windows monopoly

[00:10:52] to crush competitors by tying other Microsoft products to its operating system. And next, Microsoft upped their bully-boy tactics even more by threatening to revoke the Windows license from PC manufacturers if they put Netscape on their computers. And, you see, because 90% of consumers and businesses used Windows, most people, they wouldn't buy a PC unless it came with Windows. So, the threat to revoke the Windows license

[00:11:22] from the PC manufacturers, that was a very significant threat. Now, I know, some of you might be thinking, well, that's just good business, you know, you use every advantage you have. And fair enough, I'm all on board with leveraging whatever you have to win, as long as it's ethical and legal. But companies with monopolies are treated differently and for good reason. Now, a monopoly itself isn't illegal. The issue is how you use

[00:11:51] or abuse it. And Microsoft was abusing it, first of all, by proposing to carve up the browser market with Netscape. That's a classic example of attempted market allocation. and then, by threatening to withhold Windows from PC manufacturers unless they dropped Netscape. This is a clear abuse of their monopoly power. And on top of that, as mentioned, by bundling Internet Explorer into Windows, Microsoft was totally disregarding

[00:12:21] the decree they had only just recently signed with the government to commit to not doing this. And so, Netscape fought back. They put together a 220-page document that outlined why they believed Microsoft was abusing its position and they gave it to the Department of Justice. Now, the Department of Justice didn't immediately act on this document. One reason was due to its failed 13-year antitrust case against IBM.

[00:12:50] It ended in 1982 without a victory and it left the Department of Justice very wary of taking on another technology joint. The other challenge that made the government slow to take on the case was that in traditional antitrust cases, when a company has a monopoly, it more often than not abuses it by raising prices and harming the end consumer. So, that's a very easy case to prove. But Microsoft was giving

[00:13:19] Internet Explorer away for free. The harm wasn't in higher prices. It was the stifling of competition and innovation. And proving innovation that never happened is way more difficult than proving consumers paid too much. However, after increased pressure from Netscape, as well as the fact that individual states were lining up to take cases against Microsoft themselves, in June 1996, the Department of Justice sent what are called Civil Investigative

[00:13:49] Demands or CIDs to Microsoft and these are requests for documents and they were looking for documents related to the Netscape charges. But Microsoft's response to this application was pretty extraordinary and it basically blew everything up. Because, for context, the usual practice when a company gets a CID from the government is that the lawyers for the company would carefully filter what was handed over and they'd hand over only the documents

[00:14:18] linked to the specific case. In this case, linked to Netscape. But, Microsoft sent the government a treasure trove of internal emails and documents that went far beyond the dispute with Netscape and that painted a much broader picture of how Microsoft was abusing its power in all areas of its business. And to quote one of the government lawyers, you can't be a lawyer and not know these

[00:14:48] documents are lethal. So, with all of these emails and documents, the government realised they had a much bigger case and this opened the gates to the huge antitrust case that almost brought Microsoft down and that we're going to get into. But, before we do, like the big question here is why did Microsoft just hand over all of these internal documents and emails without double checking? And this is the nub of the story. This is the bit that I love because

[00:15:17] this allows us to dig into Gates' mindset back then and also the power and control he had and the fact that he was so centrally involved in this case when he really shouldn't have been. And there's a lot of answers and reasons as to why they handed over all these documents but the first thing we do need to understand is that Bill Gates was the one calling the shots here not the lawyers. Because, see, Gates had always been very, very deeply involved in

[00:15:47] Microsoft's legal strategy. It was his contract negotiations with IBM in 1980 that secured Microsoft's right to sell MS-DOS or their operating system to other manufacturers which laid the foundation for the company's fortune. He was also credited internally with helping win Microsoft's huge copyright battle against Apple. I don't have the time to get into that here but a lawyer for Microsoft involved in that case is quoted as saying Gates practically wrote our briefs himself.

[00:16:17] And even during the 1995 consent decree that we already mentioned, Gates was personally rewriting the legal language for that late into the night. And in relation to the antitrust case that we're just talking about now, a member of Microsoft's legal team is quoted as follows, the lawyers are not in charge, all the shots are being called by Gates. So, given Gates' central role in all things legal, why then did he give the go-ahead for

[00:16:46] all of these emails and documents to be sent over without any due diligence or filter? Well, arrogance played a role. Microsoft or Gates didn't believe the government had the expertise or understanding of the software market to pose any threat. Here's a quote from Gates in relation to the Department of Justice. These people have no idea who they're dealing with. Another reason why Gates gave them all of these internal docs and emails, he believed Microsoft wasn't

[00:17:16] doing anything wrong because unbelievably he rejected the idea that Microsoft had a monopoly. When asked why he didn't believe Microsoft was a monopoly, Gates replied, a monopoly is where you don't have competition. The notion that this is a market without competition is the most ludicrous thing I have ever heard in my life. You see, Gates was talking about the software industry as a whole, but the government was focusing on the operating system sector, where Windows controlled

[00:17:46] around 90% of the market. And Gates could argue all he wanted that Microsoft competed in the software industry, but the fact of the matter is that defendants don't get to define the markets in an antitrust case. The government does. I mean, it's just nuts that Gates was trying to frame it this way. Another possible reason why Gates handed over the email so freely was that people back in 1996 didn't really appreciate just how damaging internal emails could be in court. They were seen as

[00:18:16] informal conversations between colleagues, not legal documents. But the final, and I think probably most pertinent reason as to why Gates allowed the release of all these emails and documents was as a result of the IBM antitrust case that I mentioned briefly earlier. It ran from 1969 to 1982 and as mentioned, the Department of Justice eventually dropped the case, but it had a major negative impact on IBM. And Bill Gates had a

[00:18:46] front row seat because Microsoft did a lot of business with IBM during this time. And Gates recalled being in meetings with IBM where lawyers always had to be present because they had to have an input into almost every decision. And Gates was determined that Microsoft wouldn't go down that road. As Gates is quoted as saying, the minute we start worrying too much about antitrust, we become IBM. So Gates' view was, this investigation shouldn't change

[00:19:15] how Microsoft did business. Rather than tying up senior executives in endless document reviews, he chose to hand over the material and keep the company focused on what it did, building software. But that was a huge miscalculation on his part. So now the government started to build its case over the next 18 months. And while this was going on though, the browser war was effectively over because between 1996 and 1998 Microsoft continued to

[00:19:45] launch much improved versions of Internet Explorer, bundled it into Windows for free, so by 1998 Internet Explorer had captured almost 80% of the market. And then in October 1998 Netscape was sold to AOL for $4.2 billion. The first browser war was over, Microsoft had won, but now they were facing a much tougher and far more formidable opponent because the government not only now had a mountain of evidence

[00:20:14] and huge resources, they also now had probably the best litigator in the USA at that time on their team. Enter Stage Right David Boyes. Now, David Boyes is a more controversial figure today than he was back then, largely because of his later work with Harvey Weinstein and Theranos, but back in the 1990s and early 2000s, he was widely regarded as America's top trial lawyer. He had

[00:20:44] a legendary work ethic combined with a near photographic memory and this allowed him to acquire expertise very quickly and this was crucial for the Microsoft case because Boyes brushed up on his tech research and by the time the trial came around he was more than capable of sparring with Microsoft's senior executives and in particular with Gates when it came to the intricacies of software. Now, as always happens before a case goes to

[00:21:14] trial, both sides tried to negotiate a settlement. Steve Barmer, Microsoft's number two and as I mentioned in the episode on Barmer, he believed the company should settle but Gates was in charge and Gates didn't think Microsoft should settle. In the negotiations he'd passionately argue that the software industry was fundamentally different from every other industry and that traditional antitrust laws didn't apply and what struck Boyes and the government lawyers was just how

[00:21:43] personally Gates was taking the case. Like on more than one occasion Gates suggested the government wasn't simply trying to break up Microsoft it was trying to destroy him personally. Like Gates was taking this all too personally and looking back it's easy to see why. Back then Gates and Microsoft they were inseparable. Like Microsoft's greatest strengths its strategic brilliance its ambition its relentless drive

[00:22:12] they were all a reflection of Gates himself but so too were its weaknesses arrogance stubbornness and above all fear because according to people who knew him well back then Gates lived with a constant fear that windows could one day be displaced. In one email that he sent to senior executives at three o'clock in the morning he wrote the internet is taking away our power every day

[00:22:41] but given all the evidence the government had Barmer was right like the sensible business decision was to settle but Gates had become so successful so powerful and so revered with Microsoft that very few people were prepared to tell him that he was wrong and that he needed to take a step back so settlement talks eventually broke down and David Boyes warned Gates and his team and this is a quote from him once the United States government files suit against you

[00:23:11] everything changes people you thought were your allies turn out to be your enemies everyone is more willing to question you to resist you the whole world changes and as we shall see these were very prophetic words so the trial begins October 19th 1998 and as expected the government used the unfiltered emails and documents that Microsoft gave them to continually undermine Microsoft's case for example Microsoft insisted

[00:23:40] that Internet Explorer had always been part of their operating system since 1994 now they maintained this so that they could be compliant with the decree they had signed in 1995 which prohibited them from bundling products into Windows but the government produced several internal emails showing Microsoft's initial intention was to sell Internet Explorer as a separate and generate revenue from it there was an email sent by Hewlett Packard to Microsoft after Microsoft had instructed them

[00:24:10] to remove Netscape and I quote we are very disappointed from a consumer perspective it is hurting our industry if we had another choice of another supplier based on your this this your lucky day I mean this is so damning and exactly as boys had predicted

[00:24:40] the government also managed to get key Silicon Valley insiders like Bill Campbell CEO of Intuit Scott McGeady a senior executive with Intel to testify against Microsoft and they got depositions from computer manufacturers like this one from Compaq we had a relationship with Netscape and we had been shipping their product for a while when Microsoft found out about it they sent a letter to us telling us they would terminate our agreement for doing so but without doubt the greatest asses

[00:25:10] in the government's case turned out to be Bill Gates himself because as part of the proceedings the judge allowed the Department of Justice led by Boyes to take a video deposition of Bill Gates before the trial began now there are 20 hours of video in this deposition they're all available

[00:25:43] it is riveting and totally car crash stuff like in these videos you just see how Gates is so petulant childish stubbornly debating the meaning of the most simple words for example claiming not to understand the phrase market share now his competitors joked that it was the word share that threw him Gates failed to understand that in a deposition it's the litigator in this case Boyes who holds all the

[00:26:13] cards and for once Gates he wasn't in charge and this unsettled him and it was also obvious that he just hadn't prepared himself for this type of questioning again there was an arrogance there that he would get the better of Boyes and crucially Gates underestimated Boyes was and he Boyes had acquired a very good understanding of the software industry most importantly a lot of what Gates said in the video deposition

[00:26:42] was then contradicted by emails between him and his that Microsoft proposed that they illegally divide the market and when Microsoft also offered to take a stake in Netscape Gates reply in the deposition was my only knowledge is the Wall Street Journal

[00:27:12] article it surprised me I was not involved then Boyes showed an email that Gates had written just a few weeks before that meeting where he wrote I mean you know that is so damning and Boyes continued to use the video deposition throughout the trial significantly undermining Gates and Microsoft credibility

[00:27:42] it was massively damaging and there by using their own emails and documents so it was no surprise that the court came down so hard on Microsoft in April 2000 the judge ordered the company to be split in two one business for Windows and another for its software and internet operations and also he imposed a series of

[00:28:12] restrictions on its conduct now that breakup judgment was overturned on appeal in 2001 but the appeals court they did uphold central findings Microsoft had abused its monopoly power and engaged in anti-competitive behavior later that year Microsoft settled with the US government agreeing to end restrictive licensing practices with PC manufacturers and to share key Windows technical information with software developers and although Microsoft avoided being broken up

[00:28:42] the case it fundamentally changed the company it became far more cautious operating under the constant scrutiny of regulators the very thing that happened to IBM and the very thing that Gates had feared and as a result of the case and also due to the internet boom that was going on during this time many talented executives left Microsoft and historians also debate whether the antitrust probably gave emerging companies like Google and

[00:29:12] Facebook the breathing room they needed to grow and flourish now my own take on this especially having sat through the hours of video depositions is that Gates and I mentioned this earlier he took all of this way too personally and that's probably the main reason why he made such big mistakes such bad judgment calls but this was also combined with the fact that he was

[00:29:41] willing or strong enough to point out how wrong he was but more crucially even if they did he wouldn't have listened and maybe after the initial verdict was handed down and on one of his weekly retreats where he goes off to think it hit him maybe he realized he was too invested in Microsoft that there was more to life than fighting the government and everyone else and so on this

[00:30:11] is just supposition on my part but the whole experience did mark a turning point because in January 2000 Gates stepped down as CEO to become Chief Software Architect and later that year he and Melinda launched the Gates Foundation and look I will definitely be doing loads more episodes on Bill Gates and Microsoft but I think this story reveals just so much about Gates and Microsoft when they were at the absolute height of their power too

[00:30:44] involved that you really can see the wood from the trees to the extent that it almost destroyed Gates and Microsoft and I think that's why it's such a great business story anyway that brings us to listeners emails and this one comes from Christopher who would love to hear an episode on Alan Sugar the businessman who has been the face of the UK version of The Apprentice for the last 20 years now a fantastic suggestion Christopher and I actually didn't have sugar on my list so thanks for that and for

[00:31:14] listening and remember if you have any comments any corrections or any story you'd like me to cover email me at info at gbspod dot com all the best folks