Fortune May 26, 1997 p. 58




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He Wants All Your Business- And He's Starting to Get It
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Forget the Internet. Forget MSNBC. Windows NT, Bill Gates's new software for corporate networks, is the real future of Microsoft.


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by David Kirkpatrick
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In the movie Volcano, an eruption. threatens to destroy Los Angeles. Inexorably, with shocking speed, the lava engulfs the city, forever changing the landscape. The coast, as the slogan has it, is toast.

This is a story about another eruption, one that's altering the landscape of computing. Win- dows NT, Microsoft's new operating system for your desktop PC and the corporate network it runs on, is beginning to take over. NT has been bubbling since its introduction in 1993-but only now is there evidence that the software is likely to help Microsoft seize large chunks of the corporate computing market and dominate them as thoroughly as it does the market for desktop PCs. Last year, sales of NT software for network servers exploded 86%, vs. 12% growth for other software that runs corporate networks. This year, according to Montgomery Securities, Microsoft will license NT software to another 7.4 million corporate users. Sales of NT and BackOffice, the suite of applications that runs on NT, will exceed $1.8 billion, up from $591 million in 1996.
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Behind this eruption is a Vulcan named Bill Gates, who is stoking it for one reason only-to ensure that Microsoft keeps growing explosively. Forget Internet browsers; forget MSNBC; forget multimedia, Slate, and the Microsoft Network. "NT," says Gates, "is the centerpiece of what we are doing." The PC business, after all, represents just over half of the $550 billion worldwide mar- ket for computing software, hardware, and ser- vices, according to McKinsey & Co. Gates's strategy is to extend Microsoft's hegemony from the desktop into the windowless rooms housing the servers, minicomputers, and mainframes that are still central to business data processing. If he succeeds, Microsoft could dominate information technology well into the next decade.
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The easiest way to understand NT is to compare it with Windows 95, the operating system that runs virtually every PC sold in the past two years. Windows works in the background to keep your PC performing smoothly; it makes sure software applications get appropriate attention from the microprocessor, keeps track of all your files, and knows the difference between your CD-ROM drive, your modem, and your printer. NT provides similar housekeeping services for a network of computers-it keeps track of the devices on the network, helps assure smooth delivery of data and applications from servers to desktops, and controls who gets access to which files. NT and Windows 95 are closely aligned-if your company switches to NT, you'll have new software installed on your PC, but what you see displayed on the screen won't change much at all.
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Comparing NT with Windows 95 is also the easiest way to understand why the newer product seems unstoppable. As it has done before, Microsoft is combining product innovation with marketing power and financial muscle to take over a market. It has thrown billions of dollars of R&D into improving NT, which in its earliest version was a typically unreliable, bug-ridden Microsoft mess. Now, however, many corporate information managers think NT is becoming the technological equal of Unix, the server operating system that for years has been the backbone of many corporate networks. To get NT into all the right businesses,
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Microsoft is working closely with PC makers that sell heavily to corporations- Compaq, Hewlett-Packard, and Digital Equipment-and with Intel, of course. Like earlier versions of Windows, NT is a wedge that will enable Microsoft to sell profitable applications software, in this case the BackOffice suite. Says Gates: "We are a very predictable company. What we did with Windows on the desktop, we're doing with Windows NT on the server. What we did with Office on the desktop, we're doing with BackOffice on the server." When combined with BackOffice, NT is far more profitable, per user, than anything Microsoft has done with Windows.
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The eruption of NT is good news for Microsoft's closest allies. For others, NT may well stand for Nasty Trouble. (For stock winners and losers, see "Riding the NT Wave" in Personal Fortune.) Companies using NT may no longer need Novell's flagship product NetWare, which was until recently the de facto standard for connecting computers on an office network. Preferring to get the bulk of their key network software from one vendor, some corporations may snub IBM's Lotus Notes and choose Microsoft's competitor, Exchange, which is part of BackOffice. And Sun Microsystems' servers and workstations are threatened by lower-priced PCs running NT and powered by Intel's Pentium Pro.
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No one is saying that these companies or their products are toast. NT is a relatively young technology, and financiers, engineers, and others who need high-powered networked computing at their finger-tips may stick with their present suppliers. If Windows crashes your PC, you just reboot; if an NT server crashes, your whole network goes down. A trading house could potentially lose millions. And unlike Sun, Novell, or IBM, Microsoft has little experience supporting corporate customers' most essential computing operations.
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But Microsoft does have $9 billion in cash, lots and lots of patience - and Bill Gates.
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The Road to NT

Few successful computer companies have seen their products vilified as much as Microsoft. For 15 years, as the company has racked up one victory after another, jealous observers and rival executives have carped that Microsoft is nothing more than an overbearing marketer popularizing work bought or appropriated from others.
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With NT, Gates finally has a chance to mute the naysayers. Built by Microsoft programmers virtually from scratch, NT is perhaps the most important step toward a goal long envisioned by Gates, co-founder Paul Allen, and other forward thinkers: shunting the world's biggest computing tasks from mainframes to cheaper, smaller machines. The shift started in the 1970s as minicomputers took on some of the work of mainframes. The 1980s brought so-called client-server networks that used Unix, an operating system invented at AT&T's Bell Labs. Unix networks took over services like database access, order entry, and accounting for small companies and departments of large ones.
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Gates has long wanted the next phase of this evolution to bear the Microsoft stamp. Around 1982 he and Allen approached Bell Labs with a proposal to jointly develop, standardize, and promote Unix (there are currently 36 major versions of Unix, and getting applications to work on several is a chore for developers). But after serious negotiations, says Allen, Microsoft was "stifled": AT&T, which then owned Bell Labs, decided it could do without the help of puny Microsoft.
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The seeds of NT were planted soon after, when Microsoft teamed with IBM in an ill-fated effort to develop the OS/2 operating system. By 1990 the partnership had fallen apart, and Gates shifted scores of programmers to building Microsoft's own Unix killer: NT, which stood for New Technology Gates has developed it with Microsoft's hallmark intensity, throwing money, marketing expertise, and gallons of Jolt cola at the project.
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With Windows gaining almost universal acceptance among PC users, and knowing that corporate buyers want as uniform a system as possible, Gates and his team made a critical decision: NT would look like Windows and run existing Windows applications.

This year Microsoft will spend about $1 billion on operating-systems R&D. Most of that is related to NT, which Gates wants to endow with something called scalability, a geeky buzzword for the ability to tackle really big corporate computing jobs. So far, Microsoft has shown that NT is muscular enough to handle workaday tasks like departmental database management and accounting. That's a vast market in itself. But the company aims to prove that NT can also run complex applications - hotel reservations systems, say, or realtime stock trading systems - on the same scale as Unix networks hosting hundreds or thousands of users. Jim Allchin, who oversees all NT and BackOffice work at Microsoft, says he will meet the challenge: "It's just a matter of time before no customer would even consider buying a proprietary Unix system. To be clear, though, my sights aren't just set on Unix, but on the mainframe."
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Allchin has a long way to go. For instance, Sun's top Unix machines run 64 processors simultaneously-enough com- puting power to handle many large-scale corporate tasks. NT currently can't efficiently manage a server with more than eight processors. Closing the gap will likely take years and is a top Microsoft priority, according to Gates.

All the same, there's enough of a market at the lower end of server processing that NT is already outselling the Unix competition. According to Dan Kusnetsky at International Data Corp., the market watcher in Framingham, Massachusetts, Microsoft sold 732,000 server copies of NT in 1996, while all versions of Unix combined sold only 600,000. This fiscal year Microsoft will likely sell 1.2 million copies of NT server software at a cutthroat $625 each. Microsoft is also expected to sell 6.2 million copies of NT's desktop edition, for about $85 a pop-up from $35 a seat for Windows 95.
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The Combination Punch

One reason Gates can offer NT at such low prices is that the operating system is but the lead of a two-punch strategy for capturing the corporate network market. The knockout punch is BackOffice: a fearsome assemblage of built, bought, and borrowed computer code that will bring Microsoft into direct competition with almost every major software company on the planet. Its parts include Exchange, a groupware program aimed at Lotus Notes, which brought IBM $2 billion in software and services revenues last year (according to Merrill Lynch); SQL Server, a database aimed at Oracle's estimated $2-billion- a-year flagship product, as well as at products from Informix, Sybase, and IBM; systems management and transaction- processing software; modules to connect NT servers to mainframes; and more.
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Gates is using the NT and BackOffice combination to assault IBM, Novell, and Oracle in much the same way he used Windows and Microsoft Office to kayo Word- Perfect and Lotus 1-2-3 on the desktop. NT customers get to buy the whole Back- Office bundle as one superdiscounted package. Oracle has typically charged far more for a copy of its database software alone. Recently, in response to the NT threat, Oracle has lowered its prices.
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Analyst David Readerman of Montgomery Securities has compared the cost of a 100-user client-server network running NT and BackOffice with that of a Unix network using software from Sun, Netscape, Oracle, and Lotus. The cost of purchasing the software for the NT network: $372 per person. The cost of the multivendor network: $728 per person.
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The threat to Oracle and other companies that create enterprise software for Unix is hard to overstate. With its billions of dollars in cash, Microsoft can afford a bloody price war. But the rise of NT poses another, potentially greater threat-that Microsoft may lure away key software and consulting allies on whom all Unix software makers depend.
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As they reengineer their businesses, many corporations have turned to customized, enterprise wide applications created by developers like SAP, Baan, and PeopleSoft. Their software automates manufacturing, finance, logistics, and hu- man resources. The stuff is costly, complex, and so crucial to the businesses that use it that installing the software properly can require armies of consultants and months or oven yeers
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To serve customers in the fragmented world of Unix, SAP must offer 34 versions of its manufacturing-automation software. One, for example, is painstakingly tailored to Oracle's database on Sun's version of Unix. Another iteration for Oracle's data- base runs on IBM's version of Unix. No wonder the Microsoft solution, by contrast, seems attractive-SAP and other software firms need only adapt their software once to serve most NT customers. Even though NT has existed for only four years, 27% of SAP's 10,000 corporate customers now use it.
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As NT spreads into more companies, some of the hottest applications developers are forgoing Unix and building products that work exclusively on NT: Fast-growing Siebel Systems of San Mateo, California, for example, sells NT-based systems that automate sales forces, and doesn't offer a Unix alternative. Says Deborah Willingham, who heads Microsoft's Enterprise Customer Unit: "The more customers on the platform, the more business logic there is for applications companies to develop for it. It's the same success loop that happened years ago on the desktop with Windows."
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Gates explains the shift to NT in simple terms. "It's all volume," he says. "What NT represents is that the PC model has won out. It's just a superior economic model."

The Adoring Suitors
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Unsurprisingly, Microsoft's key partner in perpetuating this volume strategy is Intel. Just as NT is cheaper than Unix software, the computers that run NT tend to be servers and PCs that are cheaper than the heavy-duty Unix boxes made by companies like Sun Microsystems and Silicon Graphics. Even though they are lower priced, the NT-based computers incorpo- rate powerful microprocessors. Windows 95 does much of its work in 16-bit-long chunks of data; NT processes information in chunks of 32 bits at a time.
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Enter Intel, whose new Pentium Pro chips are 32-bit microprocessors. Says Pat Gelsinger of Intel's desktop product group: "About a year and a half ago we made a pretty fundamental decision to make NT the centerpiece of our business computer positioning. When we introduced Pentium Pro, we said it was the best processor for NT. Period."

With Wintel backing them up, the leading PC makers are salivating over the pros- pect of delivering the hot rods that will drive corporate computing in the future. The opportunities are huge. According to IDC, computer makers sold $3.8 billion of NT-based servers in 1996; but the world-wide market for large-system hardware totaled $53.6 billion.
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Bill Gets Testy
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In a sit-down with FORTUNE's David Kirkpatrick, Gates laid out his plan for NT-and let loose when asked about his foes.

You recently announced a deal with Hewlett-Packard that should help push Windows NT into the corporate marketplace. Could you ever do such a deal with IBM?

Lotus makes it tough. If it wasn't for Notes, our relationship would be quite different today. Let me give you a side note on Notes. Take 20 seconds and do a back-of-the-envelope calculation and compare the revenue IBM gets from Notes with the cost of the [Notes] sales force. Then throw in R&D and marketing. I don't know what your imputed interest rate on the $3.5 billion [they paid for Lotus in 1995] is, but throw that in too. The notion that somehow this was a good business deal for IBM is the silliest thing I've ever heard.
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Does your alliance with HP put Compaq at a disadvantage?

Not at all. HP delivers NT support, but people can buy services from one com- pany and hardware from another. Compaq chose to compete on hardware.

Compaq would love to compete on services too. They just don't have the bodies. That's like saying they want to compete in the soft drink business.
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Let's talk about Netscape. Is its move into corporate software designed to slow NT?

It's more a response to the fact that we've gained share in the browser busi- ness. [He stands up and pantomimes running.] There's a difference between what you're running from and what you're running toward. Netscape is running from what we did in the browser. They're running toward what we're doing with BackOffice and what IBM is doing in the same space. That doesn't mean Netscape won't be successful, but they're not in virgin territory.
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How are you fighting the network computer (NC) and the Sun-Oracle axis around it?

You're welcome to put into your story a little graph of NC sales vs. PC sales. [Look at that and] you'd have to ask, "What?"

Sun has always hated PCs. They've always predicted the demise of PCs; they say they're an evil thing. What gets [Sun CEO] Scott [McNealy] excited is high margins, and he has this spiel about how, if you do NT, you can't make outra- geous margins, so why should Sun go near it? The answer is that you have to do more than what some margin model drives you to do. Take HP in printers, and PCs, and now NT servers. You go after the volume and add value there.
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You can pooh-pooh the NC, but aren't you and Sun responding to the same issues?

No. Sun's responding to the opportunity to tell people to give up their PCs. I don't see the customer demand for that, but apparently Sun does. What we see is customer demand to make it easier to update software and manage their net- works. That's what Zero Administration Windows is all about.

So the NC debate isn't part of what pushed you to develop Zero Administration Windows? You're the only person Inflow who thinks that.
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I'm confused. How many NCs have been sold? Help me out again ...

Okay not many have been sold But surely the NC buzz has created a response from you. I think you're trying to have a philosophical discussion that I can't relate to. We are doing this work, okay? Maybe it's because of a meteorite that fell a thousand years ago. We are doing this work.

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Saying that the PC manufacturers want to ally with Microsoft doesn't begin to express the intensity of their courtship. These companies are behaving like a giddy bunch of college football players infatuated with a gorgeous but petulant debutante all the jocks want to bring to the dance. Some of the boys find that occasionally Miss Microsoft flings a drink into their face, but they quickly head back to the bar for her refill. Every one of the biggest PC makers-with the notable exception of IBM- insists that Microsoft likes it the best.
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"This powerful combination will make HP the leader in Windows NT ... enter- prise solutions," said Hewlett-Packard CEO Lew Platt at a recent joint press con- ference with Gates, where the companies announced a strategic partnership. John Rose, Compaq's senior vice president for enterprise computing, points out that of those 2,700 SAP installations using NT, fully 1,200 employ Compaq hardware. "I don't see any advantage HP has as far as partnering with Microsoft," he insists. But don't leave out Digital, please: "Microsoft people tell me the HP deal is not very broad and not very deep," says Robert Bis- mush, Digital's vice president for strategic alliances. "We have a branded trademark for our Digital/Microsoft Alliance." Like a smitten and tattooed lover, Bismuth shows up at an interview for this story wearing a denim shirt with DIGITAL/MICROSOFT ALLIANCE stitched into the chest.
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Digital CEO Robert Palmer created his joint "brand" back in August 1995. At the time, it seemed to the world (and to Digital executives) that Microsoft had chosen Digital as its hardware partner for its heavy assault on corporate computing.

Why would Gates want an ally so saddled with troubles as Digital? Microsoft lacks what is perhaps the most important asset in today's corporate computing mar- ket-a service organization. Complex global corporations require extensive handholding, consulting, and support services for their computer operations. When a company like Sun, HP, or IBM installs a large-scale network for a customer, it often leaves employees on-site to ensure that the system runs smoothly. Microsoft has but a small services operation, mostly dedicated to answering phone calls from PC users who can't figure out how to do things like transfer their Excel spreadsheet into a Word document.
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There were only four computer companies with the global service infrastructure Microsoft needed to deliver NT to corporate customers-IBM, HP, Digital, and Sun Microsystems. Sun was clearly out of the question as an ally because it had no NT-related business. IBM and HP both had big Unix businesses that NT might cannibalize.

That left Digital, the weakest of the bunch, but a company with a 22,000- person service and support force with old ties to many of the world's biggest corporations. Microsoft so desired access to that manpower that it included in the deal a payment of more than $100 million to help defray Digital's costs of training engineers and software developers. So far, the alliance has been a success, especially for Digital. According to Bismuth, well over one-third of Digital's $14.5 billion in 1996 revenues came from hardware, software, and services related to NT.
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How nice. But Miss Microsoft has a wandering eye. Sure, Digital carried the ball for a few early scores, but the cham- pionship is looming. Suddenly a beefier boyfriend, a running back by the name of Hewlett-Packard, looked appealing.

When Gates spoke to press and analysts in March, he called the HP alliance "the most comprehensive set of initiatives we've ever undertaken." And he showed how little he worried about Digital's sensibilities when he referred to that company as "DEC,"a moniker from the past that makes current management wince.
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The Microsoft linkup represents a sharp swerve for HP. It has a $6.5-billion -a-year business selling Unix servers. Never-the-less, CEO Platt phoned Gates after the Digital alliance was announced and asked what HP could do to have a similar relationship. Gates replied: Show more enthusiasm for NT. But the HP executive in charge of Unix, Wim Roelandts, would not go along. In January 1996 Roelandts was replaced by Richard Watts, who until then had run the company's PC division. This year HP will sell $1. 1 billion in NT servers, ten times what it sold last year, estimates Montgomery Securities.
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Richard Belluzzo, who directs all of HP's computer businesses, deflects any talk of a wholesale shift from Unix to NT. "We think we can have more than one horse in the stable," he says. "We are not cutting our Unrx investment." But when asked if Unix will eventually give way to NT, Belluzzo hesitates. "If Unix falls prey to NT ..." he replies. "If it happens, it happens."

The computer maker wariest of a close relationship with Microsoft is IBM. True, its PC division does foresee a bright future selling personal computers and servers that use NT. IBM has even stationed 185 engineers just down the road from Microsoft headquarters, solely to ensure that NT works well on IBM PCs.
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Big Blue's dilemma is that in addition to PCs, it sells loads of mainframes and Unix servers. Even more important, it competes against Microsoft in software. IBM is the only company squared off against Microsoft with a BackOffice-like suite of NT applications: It sells Notes (E-mail and groupware), DB2 (a data- base), and software for systems management, transactions, security, and more.

The product that most impedes cooperation between IBM and Microsoft is Notes, the prize IBM acquired when it paid $3.5 billion for Lotus in 1995. Says Gates: "Inside Microsoft I always said that as soon as IBM realizes OS/2 has failed, we're going to have a great across-the-board relationship. Now what prevents IBM from approaching us at all on a deal like the one we've done with HP is their ownership of Notes."
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Microsoft would love NT to have IBM's wholehearted support. After all, no com- pany can match IBM's access to and influ- ence over corporate customers. But a far- reaching alliance is unlikely anytime soon. As Aaron Goldberg of the Computer Intelligence research firm in La Jolla, California, points out, IBM isn't happy when another company's product has a key place in a customer's infrastructure. "IBM's all about account control," he says, "and NT is an opportunity for somebody else to exert influence on the account."
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In fact, NT is just the kind of threat that irritates IBMers. Steve Mills, who runs Big Blue's software products group, is not a particularly excitable fellow. Yet at the end of a long interview about NT, he lets fly some pointed criticism: "Microsoft will work its tail off to promote the idea that NT is sweeping the landscape. That is hyperbole. It's not a one-size-fits-all world."

It's Not a One-Size-Fits- All World (Yet)
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If there's a Tommy Lee Jones character in this saga, it's Scott McNealy, the CEO of Sun. When he surveys the computer industry around him, he sees a bunch wimps rolling over as the NT conflagration approaches. He dismisses HP, for in- stance: "Either you're a car manufacturer or you're a dealer. And HP's becoming a dealer. They'll resell Intel, Oracle, Unix, Netscape, Microsoft-anything anybody will give them. They're out of the computer business."

McNealy wants the computing land- scape to include a diversity of products that don't absolutely depend on Microsoft. "There will never be one of anything. There's always more than one cola, ketchup, car, whatever," he says. "Besides, there's a very interesting bunch of people out there who are scared to death of Microsoft. If NT were to become the only answer, SQL Server becomes the only answer and Exchange becomes the only answer. So where can companies like Oracle, Sybase, Informix, and even IBM consolidate? What are they going to do, rally around the Mac OS?"
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Obviously not. McNealy's answer is that they will rally around products and software created by Sun. On the high end, he thinks Oracle and other developers can profit for many years by continuing to write software for high-octane Unix servers. He says that customers who demand top performance, who can't afford to gamble on a relatively young piece of software like NT, will stick to Unix. Novell CEO Eric Schmidt says there's an even more basic reason to stay with Unix: "There's a simple test. I can crash NT in a few minutes, and I can't crash my Unix machine. NT will lack the fundamental stability and scalability of Unix for at least three years, maybe longer."
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For simple, low-end tasks, McNealy is pushing network computers, his primary defense against NT. These are stripped- down devices that will run applications created in the Java programming lan- guage, which Sun invented. There are hardly any NCs on the market yet, and the Java applications available so far are mostly peewee programs that perform menial tasks. Still, led by McNealy and Oracle CEO Larry Ellison, executives at many companies threatened by NT prom- ise that simple Java-based devices will of- fer the kind of computing corporations want-as opposed to what Emperor Bill tells them they need.
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One reason customers may be willing to consider buying NCs is that PCs have become costly to support. According to the Gartner Group in Stamford, Connec- ticut, it costs a typical company $7,000 per year to own and maintain a PC on a net- work. While the average business PC sells for around $3,000, Ellison promises that NCs will cost considerably less than $1,000. That's just the beginning, say NC evangelists. They argue that the machines will radically reduce the administrative costs of corporate networks.
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If they're right, the NC could pose a serious threat to Microsoft. Today, software developers mostly concentrate on writing applications for Windows. But because Java is designed to run on any operating system, it could open an even broader market. Explains Glenn Ricart, chief tech- nology officer of Novell: "A developer can write for NT, which is the fastest-growing server operating system, or for Unix, which has the biggest installed base, or for OS/2 because it's popular in Europe-or he can write in Java and automatically cover all three."
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In the past few months, Gates has been busy trying to dampen NC euphoria. He has focused primarily on explaining how Microsoft too will lower its customers' cost of ownership. He has trumpeted the fact that over 100 companies have signed on to build something he calls the NetPC, a stripped-down Windows computer. And he has announced an initiative called Zero Administration Windows, essentially a laundry list of changes that could make an NT-based network of computers cheaper to maintain.
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Zero Administration Windows will almost certainly never live up to its name. And to date, no NetPCs have actually been manufactured. Yet it would be a mistake to dismiss the initiatives as classic Microsoft "vaporware." They send a clear signal that Gates means to address what is most compelling about the NC argument-the promise of lower cost of ownership.
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Gates, of course, refuses to admit to feeling any threat from the NC. He insists he's only responding to customers' needs. "Do I think customers are dying to re-write all their applications?" he asks. "I haven't noticed that. Do I think customers are dying to give up the flexibility of the PC? I haven't noticed end users saying, 'No, I don't want the empowerment that I've been given. Take that back from me.' " But surely some of this is a response to Ellison and the NC debate, right? "We are doing this work, okay?" he retorts. "Maybe it's because of a meteorite that fell a thousand years ago. We are doing this work."
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Gates believes there's little chance Microsoft can be thwarted by network computing, improvements in Unix, or NT's technological shortcomings. Remember what happened on the desktop, he says. "Customers wanted somebody who inte- grated the user interface and made all the software work together. That is just more attractive than having piece parts that peo- ple buy separately."

He acknowledges that there are "tough technical problems" Microsoft must over- come before big customers will move lock, stock, and barrel over to NT and Back- Of lice. He also admits that this will take a "long period of time," so much so that in a recent interview he drew out the word "long" over several seconds. Then he smiled. And added: "But we are very pa- tient people." ~