Consider Microsoft’s huge cash flow: The former monopolist throws off nearly $78 billion in revenue and earns almost $27 billion in profit each year. Its three main product lines — Office, Server Tools and (now slipping into third place) Windows — account for three-quarters of its revenue and nearly all of its profit. It is not a coincidence that these business lines were the direct beneficiaries of the Microsoft monopoly. Indeed, none of Microsoft’s other businesses has achieved the success of its monopoly properties. Online service loses money each year. Despite enormous investments, its entertainment and devices division still earn less than $1 billion annually.
Gates’s true genius was not as a tech visionary. It was his business acumen in leveraging a monopoly position in operating systems to become the dominant U.S. tech company. IBM gave the world its first PC in 1980. The mainframe giant looked down on the idea of a personal computer for home or even business use. It thought the PC insignificant — it could never replace the big iron it made. In 1981, it happily outsourced the operating system to Gates’s squad of geeks, who themselves outsourced the OS code writing. By 1982, MS-DOS was released.
Embedded within that original IBM deal was the seed of Microsoft’s vast fortunes. Microsoft’s true genius was in its license agreements of MS-DOS (and, eventually, Windows) with PC manufacturers. They offered a variety of licenses, but the version that charged the least per copy included a clever kicker: Microsoft had to be paid for every machine sold — regardless of whether MS-DOS was the operating system. This brilliant, if evil, agreement with computer makers effectively blocked all OS competition. Microsoft became the standard adopted by corporate America.
Microsoft had its deal with the devil: Its lightning in a bottle was not some awesome technology or brilliant breakthrough – it was a clause in a contract that led to an enormously profitable monopoly. It then pre-installed Office in new PCs, creating a second monopoly and billions more in profits. By then, Office had become the dominant productivity software suite. Eventually, Microsoft’s server and tools division — which includes Windows Server and Microsoft SQL Database — also became a de facto standard.
Google’s motto, “Don’t Be Evil,” was a not-so-subtle swipe at how Microsoft had achieved its dominance.
Most monopolies, aside from baseball, eventually get broken. Microsoft was no exception. Once the Justice Department and the European Commission found the company in violation of antitrust laws, it was forced to compete fairly. It is no coincidence that as the company lost its vice grip on the desktop, its dominance faded. Revealed as a dinosaur, it was unable to compete with the smaller, more-nimble mammals.
And therein lay its current problems. In a fair and level playing field, the once-feared software giant has been revealed as a middling software writer and a mediocre competitor.
Ballmer oversaw a decade of missed opportunities, and he very well may have hastened Microsoft’s decline. But it might have been inevitable. The truth is that for all its claims of innovation, Microsoft never generated much in the way of profits by innovating. This then is a tale of the long, slow death of an enormous cash cow.
To quote London-based analyst Benedict Evans, “Just as overnight success can take a lifetime, so overnight collapse can also take a long time.”
Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. Follow him on Twitter: @Ritholtz.