On January 31st 2008, Mary Jo Foley posted an insightful blog about Microsoft’s Open Source Strategy. On the morning of February 1st 2008, Microsoft announced an unsolicited bid of $44.6B hostile for Yahoo!, and by the end of the day, Microsoft had lost $20B in market capitalization. Where does this leave Microsoft’s open source strategy and the analysis thereof?
Yahoo! was a pioneering “internet company”, one of the first to really create and capture value of a world newly web-enabled. And like many of these so-called internet companies (Google was another), Yahoo! built it infrastructure on open source technologies. Why? Better, faster, cheaper: Dave Filo and Jerry Yang were still poor college students back in the day, but smart. (As were Sergey Brin and Larry Page, but that’s another story.)
When the Internet became The Next Big Thing in 1995, Microsoft found its business strategy suddenly on the defensive. What seemed so smart for the thirteen years from 1982-1995 (selling a very high-margin product as a commodity to all market contenders, reaping the same high profits from any and all) suddenly seemed inadequate. After all, when these new market entries could create multi-billion dollar valuations with a few computers in a dorm room, what possible interest could remain in an OS that retailed for $399? Had Microsoft, who could earn 95% gross margins from some of the least profitable industries in the world missed a trick? I was there when opinion turned on Microsoft and Bill Gates challenged the analysts to “short Microsoft if you think we’re wrong.” (And to be fair to Gates, he was right that 1995 was too soon to do so.)
Not only did the new Internet companies create a huge amount of value on top of commodity hardware, they also had a tremendous appetite for open source software, as Microsoft learned when they bought Hotmail in 1997. This created a second dynamic for Microsoft: the first real challenge to their premise of selling a common product to all sides of the battle. During the California Gold Rush, the Levi Strauss Company made it big in San Francisco by selling denim jeans to all miners, regardless of the size of their mine or the value of their claim. Some miners got rich, most went broke, but Levi Strauss made good money on every transaction. Similarly, Microsoft did not need to care whether GE would best Honeywell or Dell would best Compaq, as long as everybody bought their product, they could laugh all the way to the bank.
The bid to buy Yahoo! demonstrates a radical shift in Microsoft’s thinking, far beyond anything they’ve yet done through even their media acquisitions. Rather than sell their goods uniformly to all operators, they have elected to become an operator themselves. And by that decision, they forego the luxury of selling a high-margin product (> 40% operating profit) that is insensitive to the margins of a given business and they are liable to operate at whatever the margin that operator was able to obtain (< 10% operating margin in Yahoo!’s case). It is for this reason I believe that the market has chosen to reevaluate Microsoft’s market capitalization.
Bringing this back to open source, what I see is that Mary Jo Foley’s analysis is quite correct and logical based on Microsoft’s past history and strategy. Microsoft should be thrilled to sell the Windows operating system as the base layer for stacks of open source software—Apache, MySQL, PHP, and the like. But their actions speak louder than words: Glasnost is the backup plan. Internet services is the go-forward plan. What a tough transition to make, now, thirteen years later.
In the mean time, I continue to see bright prospects for the companies who, since 1995, have aimed at building a high-margin business based on ubiquitous open source technologies. These companies need not pick winners but can sell to all comers. And I believe that open source is to internet technologies what Windows was to the PC, and thus has an incredibly long and wide future to build and enjoy. And the fact that these open source technologies also work just fine on the desktop…that’s just a bonus.