How Did Microsoft Become Microsoft?

First, a little quiz.

Which company invented these cornerstones of the personal computer revolution:

  • First personal computer
  • First high-speed computer network
  • First laser printer
  • First graphical user interface (mouse, pull-down menus, etc.)?

(The answer is three paragraphs down.)

A few days ago, I taught a new case, Apple Inc. in 2010, in a graduate student orientation session at MIT. In preparation, I reread one of the most interesting and informative books on strategy that I know.

The book is Accidental Empires: How the Boys of Silicon Valley Make Their Millions, Battle Foreign Competition, and Still Can’t Get a Date, by Robert X. Cringely. Cringely was a columnist for InfoWorld, a PC trade magazine, and his book chronicles the early days of PCs and software. Written in 1993, it is still a wonderful read.

By the way, the answer to the quiz is Xerox. These were all invented at Xerox’s PARC (Palo Alto Research Center). The company failed to commercialize them because they didn’t seem to fit its strategy closely enough. Think about it.

Some of the most informative stories in the book concern the early history of Microsoft. The company’s story starts in 1975, when Bill Gates was a sophomore at Harvard. Cringely writes,

Like the Buddha, Gates’s enlightenment came in a flash. Walking across Harvard Yard while Paul Allen waved in his face the January 1975 issue of Popular Electronics announcing the Altair 8800 microcomputer from MITS, they both saw instantly that there would really be a personal computer industry, and that the industry would need programming languages. Although there were no microcomputer software companies yet, 19-year-old Bill’s first concern was that they were already too late. “We realized that the revolution might happen without us,” Gates said. “After we saw the article, there was no question of where our life would focus.”

In a recent Harvard Commencement address, Bill Gates told of how he went to his dorm room and called the responsible executive at Altair, offering to provide software for the new PC,

One of my biggest memories of Harvard came in January 1975, when I made a call from Currier House to a company in Albuquerque that had begun making the world’s first personal computers. I offered to sell them software.

I worried that they would realize I was just a student in a dorm and hang up on me. Instead they said: “We’re not quite ready, come see us in a month,” which was a good thing, because we hadn’t written the software yet.

When Gates received the nod, he dropped out of Harvard, Allen left his programming job, and they moved to New Mexico to finish the software. That was how Microsoft began.

Cringely notes, “Gates and Allen started Microsoft with the stated mission of putting ‘a computer on every desk and in every home, running Microsoft software.’” Before long, Microsoft was the dominant provider of software to the early PC business.

Unlike the other PC and software pioneers, however, Bill Gates was first and foremost a businessman. He saw clearly the need to get an inside track on the revolutionary growth by using his products to create a dominant strategy.

The second major cornerstone of Microsoft’s early success came about five years later. IBM had developed its PC, and Gates had agreed to provide BASIC for the new computer. He also offered to provide an operating system.

At that time, Microsoft was the dominant provider of software, but Digital Research’s CP/M was the dominant operating system. IBM sent a team of managers to Digital Research and Microsoft to find out more about the companies.

First they went to Digital Research. Cringely writes, “When the IBMers arrived… to talk with Gary Kildall at Digital Research, he wasn’t there. Despite his appointment with IBM, Gary had gone flying in his small plane. Not a good first impression.”

Needless to say, when the IBM team arrived at Microsoft, they were greeted by Bill Gates. Gates proposed providing an operating system, and IBM was interested. The only problem was that Gates didn’t have an appropriate system.

When he heard that IBM was interested, Gates contacted Seattle Computer Products, a small local company that had an early operating system called QDOS (“quick and dirty operating system” – later to become a more respectable-sounding MS-DOS). Microsoft bought the system for $50,000 even though it didn’t work well. They rewrote it, and entered into their historic agreement with IBM in which DOS would be provided on every IBM PC, while Microsoft was free to sell DOS to every other PC maker as well.

And that’s how Microsoft become Microsoft. The rest is history. Bill Gates was 25 years old at the time.

This story is remarkable. What’s even more amazing is that at every point, someone else had a better product. But Microsoft always had a much better strategy. Remember Xerox’s PARC?

There’s an old rule of thumb in checkers that if you’re not sure what to do, move toward the middle. Bill Gates relentlessly moved toward the middle, and won by constantly positioning Microsoft at the center of the entire PC industry.

The moral of the story: a great strategy always beats a great product.

Or, as my father used to say about sailboat racing, a good sailor in a bad boat will always beat a bad sailor in a good boat.

Profit from Managing Returns. Yes, Returns.

What do a typical hospital and a typical retailer have in common? They both have a problem managing returns. Let me explain.

About a year ago, I spent a day with the President’s Cabinet of a major medical center. This is one of the most prominent institutions in the country, with a very talented and dedicated management team. During the day, we reviewed and discussed a number of important topics, ranging from prospective healthcare legislation to growth plans.

One comment in particular caught my attention. A senior physician noted that the hospital didn’t systematically monitor readmissions – patients who are discharged and soon return to the hospital for additional care.

I thought about a friend who had started a company to oversee the care of patients who had a particularly difficult chronic illness. He had done studies of patient care, and he found that a surprisingly large portion of hospital readmissions occurred because of simple logistical errors. For example, when many patients were discharged, the oxygen or other medical supplies were not delivered to their homes in time. This resulted in very costly readmissions.

A few years ago, I did a number of studies of product returns in retail and distribution companies. I found that virtually all companies viewed returns as a logistical hassle to be managed primarily to minimize the handling cost and residual product value.

My studies showed something very interesting, however. When I compared retailers in the same industry, their rate of product returns varied significantly. Not only that, but even within the same retailer different associates had very different returns rates – even for the same product.

The conclusion: the returns rate was really a measure of the quality of the sales process. The retailers and associates who had low returns rates were very good at diagnosing a customer’s real needs, and had a good understanding of what supplemental instructions a customer typically needed. The others did not.

The traditional way of managing returns turned out to be to not manage them at all – just to handle them efficiently. The right way to manage returns is very different: to view them as a quality feedback loop that enables a manager to pinpoint the places where the sales process breaks down, and to formulate sharply targeted measures to improve the process.

In a sense, the hospital readmissions rate is very much like the retail returns rate. Some patients legitimately need additional care, but many simply come back because they experience avoidable errors – most of which are not the hospital’s fault. And in most institutions, this critical measure is not systematically analyzed.

Both the hospital and the retailer had the potential to monitor their “returns” not just for handling efficiency, but more importantly to improve the quality and drive down the cost of their core organizational processes.

The big profit leverage that comes from managing returns – not just handling them efficiently – is that the returns rate offers a very important window into how well the institution or business provides service to its customers.

In both business and not-for-profit management, there are a number of “hidden” quality measures like the returns rate. The insightful manager will seek out these measures, and use them to maximize the overall performance and profitability of his or her organization.

Managing in a Deflationary Economy–A View From Malaysia

Today’s economic news features descriptions of our stalled economy, punctuated by concerns that we may slip into deflation. Most U.S. managers have not had direct experience with managing in a deflationary economy. This economic environment creates extraordinary challenges and requires a completely different way of managing.

In my last post, I related the experiences of Tenglum Low, a top Malaysian executive (and former executive student), in managing mergers and reorganizations in Malaysia. Tenglum also has successfully guided his company through a series of severe deflationary episodes that accompanied the Southeast Asian economic crises that took place over the decade of the 1990s.

In 1999, Tenglum wrote a letter to me about managing in an economic crisis that I read to my class every year. I reproduce the letter below (with some minor editing). Tenglum wrote:

It has been a long time since we last met and corresponded. The Asian crisis has been going on for almost two years. The initial stage was a lot of arguments between IMF medicine (i.e., International Monetary Fund mandated belt-tightening) and Keynesian theory.

Under the IMF package, we see the recovery of Korea. Until the restructuring of our bankruptcy law, we have yet to see a major shakeout. Indonesia is still going through chaos, because the tightening affects the poor more. One school of thought is that unless there is military power, peace would be a long way off because of the breakdown in law and order. Malaysia is already near the bottom, and has not shown signs of further decline. Meanwhile, the banking sector is undergoing major restructuring, and major M&A is just beginning. However, we think foreign direct investment will still be slow until investors see stability in long term government policy.

Meanwhile, we are beginning to feel a breakdown in the international trade system due to more protectionism everywhere – like don’t export your problem away.

As for me, this is the second recession I have gone through in Malaysia during the past ten years. The last one was milder because it did not hit all Asia. This round is much tougher because it is a combination of financial and economic crises. Further, I was made responsible for what used to be a US$200 million company, which has plummeted to US$80 million.

Probably, I have learned my lesson well. There are many things we needed to do which can now be summarized into newly conventional wisdom (which seemed to be lacking at the beginning of the crisis, or perhaps we could not swallow our pride and face reality or overcome denial).

  1. The first step is to clear all inventories, because selling prices will drop very fast, and demand will shrink even faster. Two months stock will turn into nine months stock.
  1. Next, go on just-in-time to reduce financial risk, and focus on making only the manufacturing margin (variable cost), otherwise you will be too rigid to sell at all.
  1. When you are in a difficult time, still allocate time and money for new products.
  1. Strengthen your strategic alliances with your best customers, and be prepared to drop your fringe customers because you cannot count on everyone to be able to make it.
  1. Further, it helps to see clearly beyond the current distortions to determine whether you can be an ultimate world player with sound competitive advantages.
  1. The weak foreign exchange rate will help you to export, but the bigger question is whether you can create productivity improvements over the next few years that will enable you to sustain business growth when economic order returns.

Tenglum’s letter closes with these six points of essential management advice. It is clear that a deflationary economic crisis removes all the safety nets and margin for error that prosperity provides.

The essential question for managers is to what extent these six principles should guide our actions today.

A Malaysian Perspective on Managing Mergers

One of the great pleasures of writing this blog is the opportunity to stay in touch with friends and former students. I received a nice note from Tenglum Low, who is a top executive in Malaysia. Tenglum took my course when he was in an executive program at Harvard.

Tenglum wrote that over the last 25 years, a significant amount of his time was spent in reorganizing two publicly listed Malaysian companies, serving as COO and CFO.

The first was a steel company which he helped grow from 200 to 2,000 employees over 15 years. He started his career in this company when it had 200 employees, and he had a key role in selecting and developing the employees during its growth period. He noted that once the company’s vision and values were aligned, it grew quickly. While the company did not have the financial resources to hire experienced people, the commitment of the employees and the strength of the culture permitted them to succeed.

However, as they expanded through acquisitions, they were not able to integrate the cultures of the newly-acquired companies with that of the “original mothership.” The management team was reluctant to divert management resources to the newly-acquired subsidiaries because they were so important to the strategic and financial performance of the main business. Tenglum noted, “The acquired subsidiaries continued to be a sore thumb in terms of financial performance.”

The second company Tenglum managed was a mature brewing company, formed through the merger of two breweries. These entities had a similar history and heritage, but were competing in the marketplace prior to the merger. After the merger, the shareholders of the respective companies, through their representative directors, were acting more as brand owners than as owners of the whole enterprise. They were suspicious of each other, and this caused further problems. The company did not reduce the workforce and wound up with two separate organizational cultures, which were continually fighting with each other.

When Tenglum joined this company as a top manager, he initiated the following changes:

  1. Elevated the responsibilities of the independent directors over those of the representatives of the two former companies in order to align the board members around a common vision for the whole enterprise;
  2. Aligned the management team with this new integrated vision, and formed a culture around it;
  3. Reduced the layers of senior staff who were not contributing directly to the company’s operations;
  4. Raised management expectations in order to identify those managers who were both committed to the new vision and capable of achieving it;
  5. Allowed about 1/3 of the management team, who were committed but less talented, to retire over time with dignity – and replaced them with committed, capable younger managers.

Tenglum noted that this is a painful exercise, “but the results were great, a continuous 9 years of growth to become the market leader.” He also noted, as a bottom line, that without a massive reorganization, it is very difficult to merge companies, and quickly improve their management skills and allegiance to a viable new strategic vision.

I have had the privilege of staying close to Tenglum Low for over ten years. He is a manager who combines great capability with deep compassion. He was able to learn from his experience at Malaysian Steel, and to apply those lessons to successfully turning around a major brewery and guiding it to industry leadership.

Three Missing Steps in Supply Chain Optimization

I just finished an interview with a journalist who is writing on the importance of supply chain optimization. This writer is addressing a set of distributors of products that have relatively low value for their weight and volume. This makes supply chain costs really critical to their profitability.

As I thought about the topic, it struck me that there are two very different ways to approach the problem. The traditional way is to assess the software and automation possibilities that could be deployed, and then to think about ways to get the operating personnel to “buy into” the solution. I could visualize the usual checklists of software packages and capabilities.

Certainly, a number of terrific software packages and warehouse automation systems have been developed, tested, and put into widespread use. But the real question is what to do with them.

In this slow economy, customers are minimizing their inventory, and increasingly depending on distributors for fast service. This enables strong distributors to increase business, but it also places a big cost burden on them. In the particular industry the journalist was writing about, this cost dynamic was having an extremely strong impact on profitability.

When I considered the deeper question of how to optimize this supply chain, three steps seemed especially important – steps that are all too often left out of the process.

First. Divide the business (logically) into core and non-core customers, and core and non-core products. Usually, your core customers and products are characterized by high-volume. If you think of this as a 2×2 matrix, each quadrant has very different characteristics, and each requires a different supply chain.

For example, core products for core customers should flow like a river from suppliers through distributors to customers, with minimal inventory (relative to sales) and minimized handling. Think about how radically this differs from core products sold to occasional customers, or from non-core (sporadically-ordered) products even sold to core customers.

The most important initial step in optimizing a supply chain is to understand that the right supply chain solution (decision rules, inventory levels, physical process) for each quadrant can and should be very different.

Second. Work with your customers – especially your core customers. Many customers do not have a sophisticated knowledge of how to set inventory levels and reorder patterns. You can make a big difference in both your profitability and your customers’ profitability by helping them. This is especially critical in these difficult times.

I recall working with a major distributor a number of years ago to reduce supply chain costs. After a little investigation, we figured out that there were only three or four inventory/replenishment systems that the customers used, and that most customers did not know how to keep them set correctly. We created a small team that worked with the core customers to readjust their systems. After a month or two, the cost savings were surprisingly large.

Third. Get the sales reps involved. In most distribution businesses, the sales reps are the primary link to the customers. In my experience, sales reps in many companies have an overwhelming number of objectives, ranging from revenues to promotional programs to brand introductions to point-of-purchase displays. While some companies include gross margin in sales objectives, net profitability, per se, is almost never an objective.

In many distribution businesses, supply chain costs are a critical determinant of profitability. These costs can vary considerably from customer to customer and product to product. They are deductions from gross margin in profitability calculations, so a simple focus on gross margin eliminates a major source of profit improvement.

It is very important for the sales force to understand the profit impact of customer orders and other supply chain costs, and to be given a fairly simple program to selectively improve customer profitability. Here, creating a simple “red-yellow-green” color-coding designation can provide terrific results.

For a sales force to be productive, the reps must have at most 3–4 clearly understood objectives. Profitability maximization must be one of them.

All too often, managers instinctively reach first for technology solutions, focusing primarily on the selection and implementation processes. But the real profit impact comes from changing the business.