*DC: Do a search for double parens — there are some questions in the text, esp. at the end

MORPHING MICROSOFT
Wired
June 1996

Is the future of media at Microsoft today?

By Denise Caruso

Just after the spring solstice in March 1994, the staff of the Broadband Media Applications group at the Microsoft Corporation clustered around a conference table in the board room of Building 8, headquarters of Microsoft’s executive staff. They were in the process of their first business strategy presentation to chairman Bill Gates.

At the time, Microsoft — still oblivious to the growing significance of the Internet and its publishing medium, the World Wide Web — was focused on a consensual hallucination of magnificent proportions called interactive television. In part to support Microsoft’s interactive TV efforts, the tiny broadband media group, only three months old with just over a dozen full-time staff, was chartered with building the “primal apps” for the company’s video-on-demand system. They were developing key components, such as user interfaces and interactive program guides, as well as prototypes of a new breed of TV programming and services-one such was an interactive version of “Bill Nye the Science Guy” — to be produced by Microsoft and piped to consumers over high-speed networks and delivered through a new breed of set-top boxes.

And so the group’s executives, many of them fresh recruits from various computer and entertainment companies, spent more than three hours answering Gates’ probing questions. Their hope: that they sounded smart enough to get the $20-plus million they needed to launch the company’s most radically un-Microsoft initiative ever. To their dismay, halfway through one of the presentations, an attendee recalled that Gates stood up and said: “Wait a minute — you’re talking about TV! Why would I do TV?’”

Who You Callin’ A Media Company?

Gates eventually gave the broadband group only half the budget they asked for. But less than two years later, he is “doing TV” in a big way, to the tune of $440 million worth of joint ventures with the National Broadcasting Company. A string of similar investments both inside and outside the company has led some of Microsoft’s top executives to freely acknowledge a notion so antithetical to the company’s culture that it boggles the mind: Microsoft — the $6 billion hive-mind which literally controls more than 85 percent of the personal computers on the planet,((ck)) the quintessential nerd palace where stock price and market share are the best revenge — is morphing into a 21st century media company.

Or is it?

Though it continues to assert that software for personal computers is its primary business, Microsoft has methodically begun covering all possible bets in today’s media crap shoot, placing money, staff and corporate resources in the hope that at least one of them will hit big.

During a live-broadcast, satellite press conference in December 1995, Microsoft announced that it would invest $440 million in two joint ventures with NBC, which claims to be to be the world’s largest provider of news and information. Each company would sink a staggering $220 million over five years to build MSNBC Cable, a 24-hour TV news service to compete head-to-head with Ted Turner’s (or perhaps by now, Time Warner’s) Cable News Network. Each will also invest $200 million into MSNBC Online, repackaging NBC’s news and information for the Microsoft Network (MSN), Microsoft’s proprietary online service and mainline software distribution channel that’s soon to be redeployed on the World Wide Web.

Microsoft has also inked high profile alliances with, or investments in, a broad range of media, including the ultra-high profile entertainment studio Dreamworks SKG, R/Greenberg Associates and Paramount Pictures, as well as with media distributors including Tele-Communications Inc. (TCI), the Internet service provider UUNet, DirecTV, and many others (see sidebar). Add to that significant internal investments, including an entire new campus for the 2,000 people who staff the Interactive Media Group, and you start getting into some real moneyŃfor example, two state-of-the-art studios for the new campus, the Digital Backlot and the Blender, cost about $8 million each “and growing,” according to Microsoft’s new group vice president of applications and content, Nathan Myhrvold, whose previous job at Microsoft was running the Advanced Technology Division.

In addition, over the past few years, Microsoft has been gradually creating or acquiring crucial pieces of media technology, which alone or in combination with others have potential to spawn powerful new types of media. SoftImage high-end imaging tools, for example, which Microsoft acquired in XX, in combination with its internally developed virtual-chat system, could be a compelling entrŽ to the future of online entertainment. An Internet browser married to a “social interface” like Microsoft Bob, which is designed to make using computers easy for novices, could become a compelling way for future consumers to navigate the Net. And the company is also primed to provide a broadband distribution alternative to cable as well, via its well-regarded Media Server system, which uses racks of off-the-shelf Pentium-based PCs to deliver digital video into the home.

Depending on how you tote it up, the total commitment in these projects, in one year alone ((careful–NBC investment is over 5 years)), could be anywhere from $800 million to $1.5 billion. That’s a lot of money, even by Time Warner or Viacom standards.

If you think this sounds like Microsoft is on its way to becoming a player in the media business, you’d be in agreement with Myhrvold and other top Microsoft executives who are in the process of making it so and who bluntly assert the point. “In some categories, yes, we are becoming a media company” says Myhrvold. “We’re more firmly on the path now than we’ve ever been,” says Patty Stonesifer, the senior vice president who runs the Interactive Media Group ((-cq)).

But the irascable Gates, who signs off on all but the smallest of Microsoft’s deals, is aggressively dismissive of this notion. He says the media business is too competitive and too fragmented for Microsoft to want to be a player, and scoffs at the notion that Microsoft’s media investments or revenues will match its $4 billion applications business “in my lifetime.” He says his company’s commitments to date are “experiments,” nothing more, and that the size of its investments isn’t noteworthy because, “Well, we’ve never been capital constrained.”

What Does Microsoft Want?

What’s the disconnect? Why is Gates apparently putting his money where his mouth is not? If taken at his word, then what does the company hope to gain from dipping its big toe into the media pool?

For starters, the media business is far riskier than being the world’s largest provider of computer software: though the upside is huge, the vast majority of media projects — whether movies, magazines or CD-ROMs — fails miserably. Despite the logic behind Microsoft’s turn toward media, Gates clearly doesn’t want to spook his shareholders into thinking that Microsoft is moving away from its core business any time soon. This poses a bit of a Catch-22 for Gates because, depending on how you view its core business, Microsoft may have no choice but to eventually move into media.

The total software industry, in which Microsoft is already the largest player, only pulls in some $20 billion in annual revenues at best((ck#)), while the media business-including film, television, music, video games and print publishing-is some $X trillion. In addition, despite its fairly steady 20 to 25 percent profit margins, the software industry is relatively finite; once PC owners have purchased their suite of application software (i.e., word processors, spreadsheets, databases), they generally don’t spend much more except to buy upgraded versions of what they already use.

Though today there is certainly plenty of growth left in the PC business, it has slowed, and will doubtless slow again. Always anticipating a cooling of today’s hot software market, Microsoft is looking for a way to both keep the company growing and keep its valuation high enough to satisfy its profit-hungry shareholders. One answer is to diversify and hook into the low-margin, but high-revenue media business.

Media, after all, is a renewable resource for which consumers steadily spend money every month. And over the past decade, as computers have become an increasingly inextricable part of the creative process for most mainstream media, including print, music, TV and film, new media emerged that use the computer itself as both distribution mechanism and delivery vehicle. This convergence of technology and media has yielded an intriguing, though risky opportunity: a new kind of product that looks like media, but acts like software. And while it’s arguable whether Microsoft knows from media, Microsoft certainly knows from software.

A 21st century media company

Positioning Microsoft as a 21st century media company begs the question: What’s a media company? It’s a definition that itself is morphing every day, both because of technology and because of mergers in the media and telecommunications industries. Clearly companies like Time Warner, Inc. and the Walt Disney Co., two of the largest owners of both intellectual property and distribution (via their TV holdings) in the world, are betting that a successful media company must both own boatloads of media assets and the means to distribute them globally.

But ownership and control of more and more intellectual property is the old-school, analog model for media companies. In a digital world, media assets spawned by this interspecies marriage between technology and content-call it digital media, multimedia, interactive media, new media, mediaware-are much cheaper to make. Almost anyone with (or without) talent can do it, then gain distribution via the global Internet. Owning old media assets or even wires isn’t a bad thing, but so far it hasn’t bought much in the way of success in the interactive media world.

In fairness, being an old-line technology company hasn’t yet bought much either. But a lesson for both sides is unfolding. In the new media world, media and technology are inseparable; one flows from the other. The Internet, for example, is not simply a distribution channel. It is a medium unto itself, and mastering it requires mastery of its underlying technologies. Media companies are catching on to thisŃthey are racing to hire smart technology people, and are making strategic technology investments in companies like Netscape, for example. In this area, Microsoft clearly has home-court advantage.

But media companies also have a larger problem: most of them are trying to use interactive technology to capitalize on their existing assets, and as a result are trapped between moving wholeheartedly into a new medium and cannibalizing the market for their existing, money-making products. The challenge is to find the right mix between technology and media to make a compelling hybrid.

Norman Pearlstine-cq, the former executive editor of the Wall Street Journal who is now editor-in-chief of Time Warner, says that “successful new media will come when you have at least one of three elements-timeliness, specificity or personalization, and a transaction-and if you have all three, so much the better.

“Information and money at some point become fungible,” Pearlstine adds. “It is an interesting question whether financial institutions, say, don’t more easily add information to what they do than information companies can add transaction capabilities. I can imagine a Citicorp having an automatic teller that prints out headlines and coupons every time I use it. Given how long it takes technology to become useful, how dumb is it to invest in things that may finally make some sense around the year 2010?”

Microsoft’s answer would be “Not dumb at all.” This is clearly a point of view that Microsoft hopes to capitalize upon, based on the sheer breadth of the media investments that it’s making today. In combination with Gates’ long-stated goal of “a PC on every desk and in every home,” Microsoft’s media investments are even less foreign to its core business of software and operating systems as they might appear.

First, the company claims its interest and focus in the media business is solely on interactive media, a PC-based market that Microsoft has steadfastly championed since the mid-1980s and that for now, at least, is a playing in a tiny niche compared to media giants like Disney, Time Warner and Viacom. Myhrvold says the company is “explicitly not” going to become a player in the movie business, and “certainly not” in the TV production business. And he thinks magazines and most print publishing, with the exception of news, have sufficiently flat growth that they don’t start Microsoft’s digestive juices flowing.

What does get those juices flowing is the idea of selling software into every nook and cranny where it can reside. Microsoft is legend for its single-minded focus and ability to leverage-with a crowbar if necessary-its dominance of the PC desktop market, starting with the office and now in the home. The key to Microsoft’s success in the software business is that it has linked its operating system, Windows, to its productivity applications and tools and network servers in a tight, interdependent chain. When the operating system is dominant, anyone in the chain-from applications developers to hardware manufacturers, and increasingly, networked back-office systems-must continue to tie their product development plans to Microsoft’s in order to remain relevant in the market.

Because it controls so much of the software market, Microsoft has the luxury of measuring its growth and success by what Gates and his lieutenants call “dollars spent per PC.” Having commandeered the market for PC software applications — it already owns about ((XX)) percent of the business — Microsoft’s next move, logically, is into the media world. Today’s consumers go to the theater, rent movies, buy music, watch cable TV, subscribe to magazines and newspapers. They also play video games, and some of them even buy CD-ROMs. And an increasing number of them are paying $10 to $200 a month or more, depending on their addiction level, to hang out onlineŃmost of them using their Windows PCs.

The Content Club

The online trend fits nicely into Microsoft’s “dollars per PC” formula, and clearly was the genesis for Microsoft to build the Microsoft Network. Though no one at Microsoft comes right out and says it, MSN was, and still is, the fulcrum of Microsoft’s media strategy.

MSN was to be a no-brainer for Microsoft. Owning the Windows franchise — some 19 million copies of Windows95 have been sold since the August 1995 launch, with 100 million Windows 3.1 users fence-sitting — means Microsoft has a mind-boggling potential customer base for just about anything it wants to ship with its Windows software. So it built MSN, a proprietary online service and, creating serious agita for competitors like America Online, CompuServe and Prodigy, announced that it would put its registration icon on the Windows95 desktop.

These competing services were beside themselves about the unfair advantage they believed the desktop registration icon for MSN represented, even going so far as to unsuccessfully petition the (Federal Trade Commission?) for a restraining order to stop the release of Windows95. (In March, ironically, AOL signed an agreement to allow Microsoft to distribute its Internet Explorer browser on AOL’s service.) But Gates says Microsoft’s surveys showed that “most users didn’t even know the icon was there.” So how did they sign up a million people in less than a year? “Through the [Windows] installation procedure,” says Gates, with a sly smile.

If only five percent of its Windows95 customers signed up for MSN, Microsoft knew it could quickly achieve a critical mass of subscribers and leave AOL, the market leader, eating its bits. Microsoft thought this critical mass would be a magnet to content companies looking for a better deal from an online service. (Most such companies pay exorbitant percentages of their online revenues to AOL — usually 85 percent. In its first iteration, MSN was going to collect only about 30 percent of content revenues.) But for whatever reason, not much in the way of compelling content flocked to MSN. And 10 months after launch, even with a million subscribers, MSN was not the AOL-killer that the company had hoped for.

Then came the Internet. The high-profile success of the Internet and the Web last year, which were genetically coded to be agnostic about operating systems, threatened not only the relevance of proprietary online services like AOL and MSN, but Microsoft’s entire model of market dominance as well. If Microsoft could not find a way to surgically insert the Internet into its operating-system/value chain model, its enormous business might be slowly bled away by competitors who considered the Internet, not Windows, to be the platform for which they created and distributed their software.

This realization spawned Microsoft’s Internet strategy, a complete corporate about-face announced in December 1995. “Here’s a company less than 20 years old that decided to reinvent itself last year,” says Dreamworks co-founder Jeffrey Katzenberg, who had been working with Microsoft for nearly a year before the Internet strategy was announced. “I’ve never seen or heard of it before, anywhere in corporate America, where a company at the pinnacle of its success decided to completely, overnight, cause a revolution in their strategic future.”

This strategic revolution meant building Internet access into Microsoft’s entire existing suite of products, from applications to tools to servers. If the strategy is widely adopted throughout the industry, Microsoft’s browser, Internet Explorer, may disappear from view entirely, sucked into the existing interdependent chain of operating system, applications, and servers. Outlined in detail at Microsoft’s first Internet Developers Conference in March, Microsoft’s plans are so comprehensive that one developer who attended said, amazed, “They really are going to own the world.”

But even if you own the world, how do you build the global Internet into a proprietary online service like MSN? Gateways to the Internet already installed by existing online services (like AOL) make the Web clunky and slow. So in a move clearly born of necessity, Microsoft decided to blow the doors off MSN; it announced early this year that it would shut down the proprietary version of MSN at some point in the future and transition it directly to the Web’s non-proprietary HTML standards.

How long Microsoft will remain committed to “non-proprietary,” however, is a matter of conjecture. Just as Netscape allows its developers to use non-standard HTML extensions today, which makes certain Web sites jump through hoops only for users with Netscape’s browser, it’s quite likely that at some point, Microsoft’s most advanced server and browser features will be available only through Microsoft’s Internet Explorer. If successful, this strategy will effectively force interactive media developers to choose one camp or the other, Netscape or Microsoft — a concept that would make media developers create two separate products and defeating the purpose behind defining the Web as a truly open publishing standard.

Such a strategy is not unprecedented in Microsoft’s history: over the past few years, as Windows gained market dominance, Microsoft and other developers began releasing Windows versions of their applications and CD-ROMs months before Macintosh versions came to market. Of course, Gates denies this will happen in the Internet world. When asked how long Microsoft and Netscape will continue to match each other’s software functions, he shrugs. “We’ll clone them and they’ll clone us,” he says. “That’s the name of the game.”

Will Microsoft’s new Net strategy work? Who knows? It’s easy to predict how the Internet affects Microsoft’s office strategy-Microsoft will almost certainly dominate-but the business case for anything that has to do with consumer interactive media, especially on Web, remains a complete mystery. As Stonesifer says, “We don’t kid ourselves that we know what’s going to happen. If someone told me they did know, I’d say sign ‘em up.”

But if it does work, Microsoft will have created a new business model with its Web-based MSN service-essentially, a distribution vehicle for “mediaware” that it calls “the content club.” Laura Jennings((-cq)), an eight-year Microsoft veteran engineer with an MBA-now director of content for MSN-says the content club is a kind of hybrid record club/cable service. In the same way that they can now choose a selection of TV programming from their cable service, MSN members will be able to select their own mix of Web programming.

Jennings says the company hasn’t set pricing yet, but that bare bones MSN is likely to be free, and like network TV, will be wholly subsidized by advertising. There’s likely to be a monthly subscription charge for premium-tier service. “And with some products, like the new Michael Kinsley magazine and other Microsoft products, “we’ll feel that we need to put a lot of marketing money behind them so we’ll offer them a la carte,” said Jennings.

This model is a counter-culture move for Microsoft, which is now being forced to do something it has never had to do before: act like a broadcaster and program its “channel” with interactive media that it hand-picks, based on what it believes will drive consumers to the MSN channel. (The “channel” strategy, by the way, will come in quite handy if interactive television becomes a reality.)

“They’re being forced to program the net,” says Mark Benerofe-cq, a former CNN producer and former Microsoft employee who participated in the early planning phases of the company’s media strategy. “This is a new skill set for them-doing programming means they’ll have to learn how to manage creatives, set up an advertising sales force and do retention marketing,” to hold onto customers once they’ve signed up for the service.

But because the Web is at present an open publishing platform and not a proprietary online service, Microsoft must be more than its elephantine self to attract quality content to MSN. As a result, deals for content providers have changed dramatically, with Microsoft acting as the bank for most of the online content development deals it is pursuing.

David Witus-cq, director of business development for MSN, says Microsoft has abandoned the boilerplate “take it or leave it” contracts of the proprietary MSN days. Today, the former Hollywood entertainment attorney says, Microsoft’s business involvement with its MSN content partners might range from fully funding a project in exchange for equity participation rather than ownership, to paying an advance against royalties or advertising revenue. The most gossamer business connection is the $1,500-per-month link that content providers will pay to link their site from the Web-at-large to MSN.

Advertising and other kinds of program sponsorship will provide most of MSN’s cash flow and underwrite the basic service. Witus believes MSN will create value for advertisers in much the same way that a TV channel does: by packaging programming — in this case, Web sites — within the MSN brand and selling its demographics. “We don’t want 50 content providers in 50 areas talking to 50 advertisers,” he says. “It’s better if the broadcaster owns the model.” Yes, indeed.

The Strategy Morphs, Too

The date hasn’t yet been announced for when Microsoft will flip the switch from today’s proprietary MSN to Web-MSN, though it’s expected toward the end of 1996. But with a business model that’s in flux and a variety of ways to fan a revenue spark if ever one catches on the Web, Microsoft is covering its bets in virtually all forms of interactive media, and reconfiguring its strategy as it goes along.

For example, Stonesifer says that Microsoft’s CD-ROM product line is in the process of dramatic change. At the moment, there are almost 50 CD-ROM media products available in the Microsoft Home portfolio, from “Julia Childs: Home Cooking With Master Chefs” to “Microsoft Dogs” and “The Ultimate Frank Lloyd Wright.”

But don’t expect to have Julia or the dogs to kick around much longer, nor a number of other high-profile special-interest publishers such as Readers Digest, the Voyager Company, WGBH and Dorling Kindersley. Though they were courted and signed up to produce interactive media titles for Microsoft early on, none of these partnerships are currently active and products of such narrow interest will no longer be found in Microsoft’s product line.

Though Stonesifer claims “quite a few” of the titles are profitable, she says it’s a question of “opportunity cost” — in other words, they’re too much work for too small a return. “We have big engines that need to be fueled here. If you do everything right and the stars align, on a gardening title you can make $5-10 million,” says Stonesifer, sounding a refrain familiar to any major media company executive. “But $5 million is a very small number per home PC. Just the sheer dollars per title caused us to say, ‘Let’s do fewer and go further with them.’”

Virtually all the projects in Stonesifer’s division (see sidebar, p. x) reflect this new philosophy, as well as how traditional media is morphing into “mediaware,” a combination of software, technology and media.

Encarta, Microsoft’s multimedia encyclopedia and the company’s most profitable title, will be regularly updated via MSN and has become the fulcrum for ancillary products like live events and special versions for teachers. The Cinemania movie guide and Music Central, a music guide, both include online updates as part of the purchase price.

In addition, Microsoft now owns the technology to build a line of simulation products, beyond its popular Flight Simulator title, and has hired a cartography team to map the entire globe electronically. Its online products also appeal to a more universal audience, including a decision guide for buying cars, a health information database, and a 3D service called Vchat where chatters are represented by avatars. MSN’s Jennings is commissioning outside producers for entertainment products with broad appeal, including “cybersoaps,” and is building a team to deliver entertainment listings on a city-by-city basis, a step toward creating regional editions of MSN.

But joint ventures with large, traditional media companies who have businesses that match Microsoft’s sense of scale are even more critical to the company’s success, according to Neupert, a member of Stonesifer’s division who’s negotiated virtually all of Microsoft’s media deals. Strong brands, he says, can pull new users into MSN; big-name partners also bring assets and expertise to Microsoft that it does not have, and vice versa.

For this reason, MSNBC Online may be particularly interesting to watch, since NBC News is bringing to the venture a formidable set of video assets for the next generation of online services. “Any partnerships we’re establishing now, we’re looking at video assets,” says Jennings, who warns against writing off interactive TV permanently. “For a bunch of reasons, 1997 is when we’ll start to deploy video in any common way in online services,” she adds. “It’ll be pervasive by 1998 or ‘99.”

Of course, such partnerships are risky in many ways. Ask Neupert, who, as the former head of Microsoft’s OS/2 applications development team, witnessed the breakup of what was the computer industry’s all-time most powerful partnership, Microsoft and IBM. The split came not long after Microsoft decided to abandon its development efforts for IBM’s OS/2 graphical operating environment and concentrate instead on building Windows applications.

But a more serious risk, and one that is all too evident in the new media market today, is that joint ventures are fertile breeding grounds to create products of staggering mediocrity. The vast percentage of what’s considered new media today is actually repackaged old media — magazines, newspapers, film and music clips, coffee table books — that’s been digitized and slapped onto a Web site or a CD-ROM. The vast majority are big time money-losers that inevitably end up in discount bins at the local Wal-Mart or bundled in 12-packs with cheap PC clones.

With the changes that electronic delivery has already wreaked upon the world’s newsrooms, NBC was compelled to move ahead despite that risk. “Everyone’s trying to define or redefine how you get at the editorial process, at the production of content online,” says Andrew Lack, president of NBC News. “You could go it alone, but the reason we wanted to get together with Microsoft is we have some appreciation of each other’s talents. I don’t believe anyone’s actually created programming for television with an understanding of how it might be applied in the online world. I have huge changes to make in my culture here, in this organization, to make this happen.”

And what happens if one company decides it wants to be in the other’s business? Especially when the companies are competing in virtually the same market, as are Dreamworks Interactive and Microsoft, making PC-based CD-ROM and game titles for kids and adults?

“It’s not possible for us consider them a competitor and not a partner,” says Katzenberg. “We are a great testbed for a lot of the things that they are developing today, and a great showcase. Based on everything I’ve seen in the last year, I suspect their first instinct would be figure out how we could do something together, should their ambitions get bigger in the world of media creation.”

Although this doesn’t exactly play to form for the market-hungry Microsoft, collective wisdom is that the media business is making Microsoft a kinder, gentler partner. “They’re just so much nicer now” is a familiar refrain. And in any case, the sheer weight of Dreamworks’ collective talent will certainly make Katzenberg’s statement true for the foreseeable future. But even if Microsoft’s partnerships eventually fail or implode or in some other way cannibalize themselves, some people think these types of ventures are the only way for companies to cover their bets until the real new media industry emerges.

“Joint ventures are the places where new cultures will be born,” says Steve Arnold, who was head of Microsoft’s broadband media group before joining a venture capital firm last year. “It’s a complex transition — to figure out how you combine technology and media so that the product is best of both worlds, rather than something that’s smushed in-between.”

Cutting into the cultural safety zone

Anyone plunging into interactive media today is putting a happy face on the risks involved — except for Gates, of course, who continues to sound the dour note — but clearly the the kind of transition that Arnold describes has all the big information, entertainment and technology companies thinking big thoughts about their future. “Anybody who has built a business of scale needs to do anything he can to protect it,” says Time Warner’s Pearlstine of Microsoft’s eyeballing the media business. “I think the hard thing for Gates is that he doesn’t understand content much more than any of the content people understand the technology.”

But, he adds, Gates seems “more willing than most” to figure out what customers want and give it to them, “even if it means cutting into the safe margins he’s built.”

If true, proving that willingness over the long haul may be the toughest challenge that Microsoft has faced. Its media strategy must cut into its safety zone not just economically, but culturally. Media-even the news-is about imagination and emotion, and often it is about singular vision. Writing good code does not always rule.

One videogame developer remembers being wooed by Microsoft some time back as a potential acquisition. “They kept wanting to look at the [software] code,” he recalls. “I kept saying, ‘Forget the code! The code is meaningless! Look at the creative process, that’s what’s important!’” This is, in fact, one of the most important lessons for Microsoft to learn: great media is often created in a collaborative environment, but it cannot be done by committee-a painful fact Gates learned first-hand after seeing his book, “The Road Ahead,” almost universally panned for having been put through the corporate “blander” and not sounding Gates’ own querulous, authoritative voice.

A corporate commitment to change on such a fundamental level may be more difficult than anyone at Microsoft can imagine today. The Microsoft executives most closely aligned with its media strategy believe that the interactive media business is not only unproven but untapped, but other top executives at Microsoft may already be balking at spending so much on what is clearly a far riskier proposition than defending their stronghold in PC software.

Above all, Microsoft is a company that makes its way in the world based on financial strengthŃso much so that every employee has real-time access to Microsoft’s stock price over the corporate network. Anything that might push down the company’s stock price or valuation is considered anathema. Though Microsoft is definitely a long-term player when it comes to technology investments, most of the company doesn’t know squat about media, except that it is a very risky business financially.

As a result, some Microsoft employees believe that the company’s recent reorganization, which pulled all of the company’s media products and projects into a single unit, Stonesifer’s Interactive Media Group, was the first step in what they fear is an effort to separate the weak calf from the herd.

Before the reorganization, what was then called the Consumer Division was financed primarily by one of Microsoft’s most lucrative products, the small but mighty Microsoft Mouse. After the reorganization, the mouse became part of the Consumer Input Device Group. In addition, the MSN group has been split in two, with Jennings’ MSN content group now working for Stonesifer and the technology group now in Microsoft’s Platforms group. “The Mouse business kept us afloat,” said one employee of the division who works at the elaborate new Red West campus. “Now they’ve put all the money-losing things in one place. We’re hearing that they want the business to make 20 percent margins before infrastructure costs. The waterfall alone [on the new campus] would eat that up.”

Even if the group hits the 20 percent mark, compared to the X billion in revenues brought in by the desktop applications and operating systems groups, interactive media will remain a small business for Microsoft for the short term. But at some point, the company will have to decide if media is to be a long-term business. If the answer is yes, Gates will have to bring a real media person into BOOP-Bill’s Office Of the President — so that the tenets of the new business can start to pervade the company as thoroughly as the hive-mind, programmers culture which has reigned for more than a decade.

Gates himself is not one of the customers he hopes to attract — a busy guy, he has been heard to say his regular media consumption includes CNN and the Economist, and not much more. Instead, Microsoft’s budding media culture is championed within BOOP by Myhrvold, a physicist by training who’s also been busy over the past decade building Microsoft’s technical prowess. Stonesifer, who has held a variety of senior positions at Microsoft, including a stint as the general manager of Microsoft Canada, was a senior executive at a technical publishing company before coming to Redmond almost a decade ago. And despite the high esteem in which he’s held by the publishing and entertainment communities in New York and Hollywood, Neupert’s experience is mostly in business strategy and project management.

Though clearly everyone from Myhrvold on down the org chart are reaching deep into the creative community for both staff and deals, things may reach the point where their best efforts aren’t enough to move the business forward. “The thing that never changes at Microsoft is the upper levels,” says one former employee about the long-time Microsoft veterans who run the media group. “All the real media people are outside of those inner membranes.”

Inserting at the highest possible level a seasoned, lives-and-breathes-media executive will become increasingly important for a couple of reasons: first, such a person will be critical if Microsoft wants to attract and hold onto creative talent. In March, when this story was written, Michael Kinsley had not yet met either Gates or Myhrvold-a situation that would be considered a grave faux pas in a real media company. And second, when the big joint ventures get down the road apiece and are still hemorrhaging red ink (as they almost certainly will be), someone with sufficient knowledge and authority will need to be around to remind Gates and his fellow executives that media is the polar opposite of the shrink-wrap-and-ship software business. It is an annuity, driven by hits and subscription renewals, that builds value over time.

What will success look like?

Microsoft executives generally brandish garlic and crucifixes when asked to visualize what their future will look like five or 10 years down the road. Asked about the media business, besides the the occasional, dyspeptic “Do the math!” comment, Gates will only say, “No guarantees. Microsoft is the company that will never make any forecasts. We don’t promote our future. We may fail!”

Stonesifer, who leads the interactive media group, won’t say much more. “We certainly think interactive media is a good business, and if we attract consumers, this could be a very big business-and for Microsoft, that is a very big number. The economies will become more clear over the next 18 months. Of course there are projections,” she adds, “but they’re ‘what ifs,’ and of course I’m not going to tell you what they are.”

Eighteen months sounds about right: another one or two Christmas seasons will make or break most of the CD-ROM companies who are struggling mightily today, and many of today’s big Internet investments, experiments and public offerings — like @Home, Yahoo, Pathfinder, and the viability of advertising on the Web — will by then manifest signs one way or the other, boom or bust.

But the future success of Microsoft’s media business has as much to do with what happens inside the company over the next 18 months as what unfolds in the market at large. Analysts are already predicting that Microsoft’s new Internet strategy will pump up its core applications business to new heights and encourage some of the 100 million slacker Win3.1 users to upgrade to Windows95. So there’s no reason to believe the company’s overall steady growth will slow in the short term, and since Microsoft has gone on the record repeatedly as a long-haul player, it’s unlikely that cash will cease flowing to Red West any time soon.

But given Microsoft’s internal growth pains, in conjunction with the unstable state of the interactive media business, what Microsoft’s media business will look like in five years is anyone’s guess. Aside from questions of Microsoft’s internal commitment to building the business, what remains unanswered is the same for Microsoft as for anyone else. Most critical, of course, is whether any of the business models constructed today for its CD-ROM titles or MSN will hit pay dirt. And always a frightening spectre is the question of what new technology will roll out of some 27-year old’s garage and onto the net, obsoleting whatever has come before. As Katzenberg says, even trying to guess where the industry is headed “would be like calling a baseball game in the fourth inning.”

But as long as it doesn’t pull the plug on its own efforts, Microsoft certainly has a better chance than anyone else in the business to figure it out.

For one thing, Microsoft has more disposable income to play with than anyone else dabbling in new media. Unlike media companies, most of whom are in debt way past their eyebrows, it has a sea of money to play with and has made good use of it. It has placed bets in every possible category — from high-profile partnerships with existing media companies to extensive development of internal media properties — to see which will hit pay dirt. Microsoft also doesn’t have to worry about new media cannibalizing its existing business–a tough nut to crack for media companies trying to add interactive properties to their mix without losing existing readers or advertisers. In fact, with the PC as delivery vehicle, anything Microsoft can do successfully in this world actually improves its existing businesses.

And in addition to its stronghold as the dominant supplier of PC software, Microsoft has virtually all technology bases covered, from CD-ROM, which it helped pioneer, to the Internet, which it is absorbing into its corporate culture at a rate that is most alarming to its competitors, to more futuristic stuff such as 3D graphics which will surely be built into both PCs, system software and new consumer products as soon as feasible and marketable. It is primed and ready to deliver high-bandwidth interactive mediaŃcall it interactive TV, if you’d likeŃand has developed the technology to deliver it using anything from cable wires to satellites.

And while many are concerned that the Microsoft may be incapable of embracing media culture, others working with the media group have a bit more faith, especially in light of Microsoft’s impressive historical willingness to make incremental improvements on the fly in its products and strategies. “Microsoft is a learning company,” says Linda Stone, who runs the Vchat group. “The culture here is already changing. I have no doubt that they will learn whatever they need to be successful.”

So whether by design or by coincidence, Microsoft is holding the pieces to a puzzle that could snap together into a new breed of media company, a “technomedia” company that not only creates media, but also controls the entire value chain of delivering it — PC software, Internet access, servers and creative tools. And it has the market clout to keep trying until something clicks.

Despite the fact that no one seems to be making money on it yet, and the rampant mediocrity of the products in the market today, the good news for Microsoft and other players is that there does seem to be something compelling overall about interactive media. Kinsley, Microsoft’s one bonafide media star, wasn’t exactly a technophile when he moved to Redmond earlier this year((ck)). The telephone, not email, was his primary mode of electronic communication, and he had seen his first Web site less than a year before left CNN to work for Gates.

Attracted first by the offer to run his own magazine and by the economies of publishing on the Web, Kinsley recalls that “the glitzy stuff, links and all that” were the lowest on his list of priorities. “But I will say this-having gotten here, you get excited about the whiz-bang stuff in spite of yourself,” Kinsley says. “The original idea of just publishing a magazine only never printing it-well, that’s ancient history.” If Microsoft can learn to nurture and capitalize upon more creative impulses like these, success will be much closer at hand.

((*DC, fact: here’s how I got the numbers, which I would love to run by Rex for a reality check:

2000 people at average of $60K/year
(including overhead and taxes): $120M year
MSNBC commitment: $440M
Building the studios: $16M
Building the campus (ballpark): $100M
Cost of work (average of 100Kper employee, which is cheap for a media co.) $200M
JV with dreamworks $30M
Other JVs (ballpark): $50M

total: 956M If you add Tiger and SoftImage et al, you are easily to 1.5 billion**)) How much did they pay for SoftImage?

refer at end; For more on Microsoft’s media plans, watch for Charle’s Platt’s report on etc. etc. in the next issue….i need to ask the lead editor for a refer blurb.

Pqs:

This convergence of technology and media has yielded an intriguing, though risky opportunity: a new kind of product that looks like media, but acts like software. And while it’s arguable if Microsoft knows from media, Microsoft certainly knows from software.

Though no one at Microsoft comes right out and says it, MSN was, and still is, the fulcrum of Microsoft’s media strategy.

Depending on how you tote it up, the total investment in these projects could be anywhere from $X to $X billion. That’s big money, even by Viacom or Time Warner standards.

I don’t believe anyone’s actually created programming for television with an understanding of how it might be applied in the online world. I have huge changes to make in my culture here, in this organization, to make this happen.
MS/Wired Pg