How Microsoft won the PC era: from BASIC interpreter to Windows 95

Executive overview

Bill Gates and Paul Allen founded Microsoft in 1975 to sell software for microcomputers — a category that barely existed. They bet that computing power would follow an exponential curve and that software, not hardware, would capture the resulting value.

The pivot point was the IBM PC deal in 1980: Microsoft licensed DOS to IBM for a flat fee but retained the right to sell it to anyone else. IBM built the market; Microsoft owned the choke point. Every clone manufacturer that followed had to license from Microsoft.

Retaining the right to license DOS to third parties while IBM funded mass adoption of the PC is the greatest deal in technology history.

Early years: BASIC interpreters and the microcomputer market (1968–1977)

• Gates and Allen met at Lakeside School in 1968, where access to a shared DEC PDP-10 gave them years of programming experience ahead of their peers
• They founded Microsoft on April 4, 1975, as a two-person partnership: 64% Gates, 36% Allen
• Their first product was a BASIC interpreter for the Altair 8800 — written in weeks against an emulator, before they had access to the real hardware
• An exclusive licensing deal with Altair's maker MITS capped Microsoft's total revenue at $180,000 and blocked third-party deals — a misaligned incentive Gates quickly recognized
• After winning arbitration against MITS in 1977, Microsoft immediately licensed BASIC to Apple, RadioShack, Commodore, and major OEMs at deliberately low prices to set the standard
• Bill's strategy: remove every reason for a hardware maker not to use Microsoft's BASIC, compound the installed base, and let the standard become self-fulfilling
• Revenue: $16K in 1975, $22K in 1976, $381K in 1977 (after the MITS dispute resolved)

The IBM deal and the birth of DOS (1980–1982)

• IBM launched Project Chess in Boca Raton in 1980 — a secret skunk works tasked with shipping a personal computer in one year using only off-the-shelf components
• They needed an operating system; Microsoft referred them to Gary Kildall at Digital Research, whose CP/M was the only off-the-shelf option — the meeting broke down, the deal collapsed
• Microsoft acquired a quick-and-dirty 16-bit OS called QDOS from Seattle Computer Products for $75,000 total, adapted it into DOS, and delivered it to IBM
• The deal terms: IBM paid Microsoft a flat fee (~$430,000) with no per-copy royalties — but Microsoft retained ownership of DOS and the right to license it to anyone
• IBM assumed it would dominate the PC market; it did not account for clones
• Compaq reverse-engineered IBM's proprietary BIOS using a clean-room process and launched in 1982, doing $111M in its first year
• Microsoft licensed DOS to every clone maker on a per-machine basis — no piracy problem, pure margin at scale
• Revenue: $25M in calendar 1982; fiscal 1984 hit $98M — almost all from clone licensing

Applications and the graphical interface (1981–1990)

• Charles Simonyi was recruited from Xerox PARC in 1980, bringing firsthand knowledge of the Alto's GUI, object-oriented programming, and desktop paradigm
• Microsoft Word launched in 1983 for DOS, shipped with a mouse — an early bet on graphical interaction
• Lotus 1-2-3 dominated spreadsheets by focusing only on the IBM PC; Microsoft's multi-platform multi-plan was left behind
• The lesson Microsoft drew: never compete on the current platform — always target the next one
• Excel launched in 1985 as the world's first graphical spreadsheet, exclusively for the Macintosh; Apple matched Microsoft's marketing spend to promote it
• Microsoft and Apple had a licensing agreement granting Microsoft rights to use Mac UI paradigms in Windows "and all future versions" — a clause Apple later regretted
• Office as a bundle emerged from 1985 onward; early versions were a pricing and packaging concept, not integrated software

Windows, the IBM divorce, and taking the enterprise (1983–1993)

• Windows 1.0 launched November 1985 — tiled, non-overlapping windows, widely considered a half-step toward a real GUI
• OS/2, Microsoft's joint project with IBM for a next-generation proprietary OS, consumed enormous internal resources through the late 1980s while Windows remained a small, low-prestige project
• Windows 3.0 launched May 1990 and exceeded all expectations; within months, Microsoft's leadership made Windows the official Plan A and abandoned OS/2
• Steve Ballmer led the push into the enterprise from this point: building a direct sales force, channel partnerships, executive briefing programs, and solutions for IT buyers
• The enterprise sales wedge was product-led: millions of workers were already using Excel and Word; Microsoft simply had to convert that grassroots adoption into enterprise agreements
• Microsoft passed IBM in market cap in January 1993; revenue passed $1B in fiscal 1990, $2.8B in fiscal 1992
• The IBM board reportedly approached Gates to become IBM's next CEO; he declined

Windows NT and Windows 95 (1988–1995)

• Dave Cutler was hired from DEC in 1988 to build Windows NT — an enterprise-grade OS to displace mainframe and mini-computer workloads; NT seeded what would become Windows Server and Azure
• Windows NT and Windows 95 were developed concurrently as "one architecture, two implementations," targeting the same Win32 API
• The Windows 95 development team (code name Chicago) had 360 people; the launch on August 24, 1995 was treated like a film premiere — Jay Leno co-hosted, the Rolling Stones licensed "Start Me Up," and the CN Tower and Tower of London were lit up
• Windows 95 was a true 32-bit OS for the first time, with plug-and-play hardware, the Start menu, and full multimedia support; it sold 7 million copies in its first month
• Revenue: $5.9B in fiscal 1995; $8.7B in fiscal 1996; $12B in fiscal 1997 — first software company to pass $10B

Business model and capital structure

• Microsoft was entirely bootstrapped in practice: TVI's $1M for 5% in 1981 was the only outside investment, and the $45M IPO proceeds in 1986 were never needed
• At IPO, Gates held 49%, Allen 28%, Ballmer 7.5% — an ownership structure impossible in venture-backed companies of any comparable scale
• Going international in year three (1979 deal with Kei Nishi in Japan) was decisive: roughly half of Microsoft's revenue came from Japan within a year, and international remained close to half permanently
• The OEM model required roughly 20 people to distribute Windows to hundreds of millions of machines; Apple's integrated model could never achieve that velocity
• PC unit shipments grew at a 98% CAGR from 1975 to 1986 — from 4,000 units to 9 million annually; being the OS linchpin in that curve compounded into the most valuable company in the world

Powers

• Counter-positioning: no legacy hardware business to protect; Microsoft could embrace clones that IBM could not encourage
• Scale economies: fixed R&D costs amortized over an expanding global install base; adding a feature to Excel cost the same whether 1 million or 100 million users benefited
• Switching costs and network economies: developers targeted Windows; file formats locked users and organizations into interoperability with each other
• Cornered resource: once IBM shipped DOS, the OS became the standard; licensing rights retained by Microsoft made every subsequent clone a revenue event
• Branding: Windows 95 created the first mainstream consumer brand for an operating system