For Apple, the big break came from Jobs’s association with Atari. Jobs approached the head of Atari and was put in contact with a prominent provider of capital in California, who in turn referred Jobs to Mark Markkula. Markkula had retired from Intel in his thirties, after its success turned his stock options into financial self-sufficiency. He had worked with both Fairchild and Intel, and with his background in engineering was fully conversant with the properties and potential of the microprocessor. More important was his commercial background in marketing at Intel. After meeting Jobs and Wozniak, Markula decided to devote part of his time and financial resources to backing the new concern. At that time, the capital of the embryonic Apple Computer Company was almost non-existent. Markkula injected nearly $100,000 ($290,000) for a third of the company’s equity, and promised to inject a further amount to bring his capital commitment up to $250,000 ($730,000). Markkula quickly recognised the need to bring in professional management to shepherd the idiosyncratic Wozniak and the evangelist Jobs.
Unlike many of its competitors, Apple was not only to survive, but to make the list of the 500 biggest companies in America. Fundamental to this success was the development of the Apple II. This computer was a wholly different proposition from its predecessor, which had little to distinguish it from the other rudimentary, often self-assembled kits, whose purchasers needed to possess the interest of a hobbyist to put up with the effort required to put it together and to be satisfied with the limited tasks it could complete. Unlike the calculator – an easier, more efficient replacement for the slide-rule – the early personal computers did not replace anything. They only began to do so when they became easy to operate and had freely available software capable of performing the applications to which they were suited.
The key requirement for the successful personal computer was ease of use. This meant it had to be sold pre-assembled and contain all the fundamental elements from keyboard to screen. There also had to be software available which would expand its audience beyond those who viewed the PC as a challenge to include those who might see it as a practical tool. These two ingredients were augmented by an intensive marketing campaign, which preceded and accompanied the launch of the new computer and was designed to have both technical and aesthetic appeal.
The Apple II was completed and launched at the West Coast Computer Faire in 1977. As the product gained public recognition, sales began to increase, but serious problems still faced the nascent company. Firstly, since it had a different operating system from CP/M, which had effectively become the industry standard, existing software would not run on it. Secondly, it suffered from the input problems of its counterparts. Just as Ed Roberts had seen the need to move to a disk-based storage system, so did Markkula at Apple. Unlike MITS, though, the necessary software was written in-house by Wozniak rather than contracted out to a third party. As a consequence, Apple had its disk storage capability much more quickly.
So far as software was concerned, this was to come to Apple’s aid simply by chance. The chance in question was that the individuals who were to write the software liked the capabilities of the Apple computer and as a consequence wrote their software to work on the Apple operating system. The software was developed by two alumni of the Harvard Business School, who perceived the need for financial forecasting software. The two individuals, Daniel Fylstra and Dan Bricklin, were not the first to see this need. They were, though, the first to build such software for a personal computer and to do so in a manner that closely replicated how calculations were actually performed. The concept of a calculator that incorporated the characteristics of a mouse and a screen became the vision of Dan Bricklin as he worked on a series of painstaking calculations. His challenge was to translate the concept into a practical working example.
Bricklin borrowed an Apple computer from Dan Fylstra, proprietor of the Personal Software company. Eventually the concept was translated into a rudimentary working example by Bricklin and his friend Bob Frankston. With this achieved, a deal was struck with Fylstra. The authors, who formed a company called Software Arts, would receive roughly one third of the gross wholesale revenue with Personal Software as publisher retaining the balance to cover expenses and profits. The software was to be given the abbreviated name of visible calculations, or ‘VisiCalc’ for short. The software was demonstrated to Markkula, who gave it a decidedly unenthusiastic reception. Despite his vision for Apple, Markkula completely underestimated the importance of software for Apple sales. Undeterred, VisiCalc was launched through Fylstra’s company, Personal Software, in 1979. The first advertisement appeared in Byte magazine in May that year. In addition to his interests in Personal Software, Fylstra was also one of the founding editors of Byte. At the same time, VisiCalc made its first public appearance before the industry press at the West Coast Computer Faire. The following month, it was demonstrated in New York City. The response to the initial presentation was muted; as the makers later recalled, the audience consisted of roughly 20 people, of whom 90% were either friends or family. Of the remaining 10%, they (both) left early on discovering the topic was not what they had expected.
Still, the response was not wholly disappointing. The business community showed sufficient interest to give the group hope. Moreover, at least one member of the financial community sensed the product’s importance. Ben Rosen, then an analyst at Morgan Stanley, waxed lyrical about VisiCalc. He pointed out the product’s capabilities and its ease of use, finishing with the quote: “So who knows, VisiCalc could some day become the software tail that wags (and sells) the personal computer dog.”⁹¹ He was proven absolutely correct. In many ways, VisiCalc was the application the market had been waiting for – an application that would transform the personal computer into a useful tool for the whole business and non-specialist community.
In December 1980 Apple became a listed company as some of the founding shareholders, including Xerox and a number of venture capitalists, reduced their holdings. A total of 4.6 million shares were sold at $22, a price which some commentators believed excessive. Indeed, the IPO was banned in some US states because it exceeded the guidelines for IPO pricing. The stock closed on the first day at $28.75. History records the gains made thereafter.
It has been estimated that up to 20% of the sales of the Apple II were effectively derived demand for the VisiCalc program. The spreadsheet program was soon augmented by the plotting and graphics capability produced by Mitch Kapor and sold under royalty by Fylstra’s company, Personal Software. Eventually Kapor sold the rights to the software to Personal Software for $1.7m and struck out on his own to develop a full-scale competitor product. At that time the prevailing opinion was that software could not be patented and hence the leading business product was protected by licensing and copyright rather than by patent. This meant that there were no barriers to competitor products in terms of intellectual concept. Kapor was free to pursue development of an improved version of VisiCalc.
9.7 (a) and (b) – Don’t touch it: how some US states barred investors from buying Apple shares
Source: New York Times, 7 November and 12 November 1980.
The environment was one where despite sporadic skirmishes, full-scale war had not yet commenced. Existing companies, most notably Apple and Commodore, had demonstrated the viability of the personal computer as a business product. This demonstration was not lost on the big battalions, however, and the biggest battalion of them all had taken notice.
IBM lumbers in
In 1980, IBM decided to enter the personal computer market. Moreover, recognising the dynamic nature of the business, it had decided on taking what (for it) was a radical step. IBM sought to avoid the normal bureaucratic channels endemic within its organisation, instead effectively behaving as if it were itself a new entrant – albeit a new entrant with the deepest pockets in the world. IBM was willing to outsource both components and software in an effort to bring to the market a product that would genuinely compete with the Apple.
This step –
by one of the world’s most powerful companies – had a number of implications. Firstly, it legitimised the personal computer market, providing reassurance that it was here to stay. Secondly, it ensured that subcontractors would share in the success of the IBM product. Thirdly, it threatened to set an industry standard with potential benefits to anyone who could quickly produce compatible products. Finally, though this was not foreseen at the time, IBM set the trend towards ‘cloning’ in personal computing. The company was putting its brand name on product assembled from components produced by others. This legitimised these components, effectively leading to the whole ‘cloning’ paradigm.
Apple Computer
Many histories of Apple have been written, mostly lamenting management inadequacy and missed opportunities. These histories have largely been written by insiders and make fascinating reading on the internal decision-making and politics of the company. Aside from discussion of the colourful personalities involved, two recurrent themes are the technological arrogance of the company and its inability to grasp the strategic shift in direction occurring in the personal computer market. Apple felt it had little to learn from its competitors in a technological sense, the so-called ‘invented here’ syndrome. Its desire to protect its margins in the upper end of the market and consequent refusal to release its technological secrets to others meant it missed the opportunity to become the industry standard.
Whether these accounts have been compiled only with the benefit of hindsight, or whether such failings were understood at the time, is open to question. The share price of the company does not suggest that investors understood or reacted to the problems being stored up. But while it might not have been possible for investors to appreciate what was happening at the time, it was not long before telltale signs emerged.
The decline in profitability in the mid-1980s associated with the Lisa and the slow start of the Apple Mac can be seen from the steady decline in return on equity. Equally, the subsequent success of the new line is reflected in the pick-up in numbers from then until the 1990s. From 1990 onwards, the financial figures increasingly reflected the strategic errors which had occurred earlier. Not only did return on assets fall, but debt levels began to rise, reflecting deteriorating cash flow. For investors, this should have been the signal to sell.
The deterioration continued year on year through the 1990s, with margins declining until eventually the company fell into loss. The share price reaction did not occur until after the debt had begun to build in earnest, and paradoxically when the losses were actually recorded, this marked the bottom in the share price, as Apple’s fortunes recovered and the tech boom began in earnest. Yet the recovery in fortunes was only relative. Returns did not go back to the levels of the 1980s, nor was the debt position meaningfully reduced.
9.8 – Apple: always up against it
Source: Apple annual reports. CRSP, Center for Research in Security Prices, Graduate School of Business, University of Chicago, 2000. (Used with permission. All rights reserved. www.crsp.uchicago.edu.)
So far as Mitch Kapor was concerned, the imminent arrival of the IBM personal computer represented an opportunity for him to invade the spreadsheet market. He needed to ensure his product was at a stage where it could be quickly adapted to run on IBM machines; hence the product was redefined to work on the IBM PC. Initially his product was intended to combine spreadsheet, graphics and word processor, but the last of these required resources beyond what Kapor’s new company, Lotus, could provide. Instead of a word processor a database was incorporated and the new product was named Lotus 1-2-3 to reflect its three capabilities.
Kapor initially sought to follow the same route as he had with VisiTrend/Plot but found that Personal Software, then one of the world’s largest software companies on the back of VisiCalc, had no interest in purchasing his competing product. However, Ben Rosen – who, while at Merrill Lynch, had immediately spotted the potential of VisiCalc – also saw the market potential for Lotus 1-2-3. Rosen both committed personal funds and raised funds from other investors. In a short time, more than $5m was raised and the nascent software industry witnessed its first large-scale marketing campaign. The campaign and the product were an overwhelming success. When Lotus 1-2-3 began sales in 1983 it immediately became the top-selling piece of software, grossing over $53m in that year. The effect on VisiCalc was predictable, given that it had been supplanted by a new and better product.
Lotus Corporation
The financial returns for Lotus illustrate the pitfalls for investors in a company the success of which is largely based upon a single product. Lotus had usurped the market developed by VisiCalc by producing a superior integrated product. The superiority of the Lotus 1-2-3 product brought rapid revenue growth and growing market share, but in an increasingly competitive marketplace. As a consequence, margins began to fall sharply, meaning that profits growth was much more muted than the advances in topline revenues. Return on assets and equity remained reasonable through most of the 1980s, but by the end of the decade Microsoft was beginning its relentless advance.
The problem for Lotus was that it had created no barrier to entry in its market segment, something that typically only becomes evident when it is too late and the product is superseded, just as had happened to VisiCalc earlier. Users increasingly had other alternatives, and as Microsoft Windows began to evolve into a genuinely usable interface, Lotus found itself with no protection from the gathering attack. The main attack took the form of the Microsoft Office suite of programs which offered integrated spreadsheet and word processing functions in a Windows environment. As a consequence of this attack, margins and returns continued their decline, such that Lotus moved from being one of the world’s foremost software companies to relative decline.
9.9 – Lotus: 1-2-3
Source: Lotus annual reports. CRSP, Center for Research in Security Prices, Graduate School of Business, University of Chicago, 2000. (Used with permission. All rights reserved. www.crsp.uchicago.edu.)
Against a backdrop of declining earnings, the company was eventually acquired by IBM. It was not that Lotus deliberately sat with all its eggs in one basket – quite the contrary. It was simply that the profitable niche which had been exploited with 1–2–3 was difficult to identify and replicate in other areas. Whether this difficulty stemmed from poor strategic direction, or issues of managerial or technical implementation, Lotus proved unable to build sufficient alternative income streams. For IBM, Lotus had some attractions, as information-sharing products such as Lotus Notes could be better exploited under the IBM umbrella. Such exploitation depended upon their continuing viability under a new information-sharing structure that would come with the arrival of the Internet and the World Wide Web.
For investors, the lessons from the Lotus experience were not new. Software companies require two things to survive as long-term profitable players. They require constant improvements to their product to fight off competition, and they require somehow to place their product in a position where it can either be allied with or replace the industry standard graphical user interface (GUI). When the effective owner of the GUI decides to produce a competitor product, as Microsoft did with Excel, retaining competitiveness becomes well nigh impossible.
Few companies with a foundation based on a single product manage to translate this into a long-term sustainable business. For those that fail, the share price reaction is typically savage, given the growth expectations that normally underpin valuations of companies with a high-growth history. There is often, of course, a safety net, in that larger competitors will purchase software companies whose fortunes have slipped – in the mistaken belief that this can be altered by virtue of new ownership.
While Lotus Corporation was an indirect beneficiary of IBM’s entry to the PC market, there were two companies that were much more directly affected. The first was Intel. IBM selected the Intel 8088 chip as the microprocessor, thus giving the machine a faster speed than any other on the market, but also underwriting
Intel’s future. The second company affected was the one chosen to write the operating system. Initially IBM contacted the leading figure in the field, Gary Kildall, who had developed CP/M. Kildall offered IBM a licensing arrangement for CP/M, as an alternative to IBM’s offer of $250,000 for outright purchase.
9.10 – The entrenched against the newcomer: operating system CP/M versus MS-DOS
Source: Financial Times, 5 November 1982.
IBM considered the proposition, but eventually awarded the contract for development of an operating system to Bill Gates of Microsoft. Gates had argued that, as the new Intel processor was more powerful than its predecessor, the capabilities of CP/M would have to be enhanced anyway, meaning that there was no reason why an alternative could not be considered. Gates’s view eventually held sway and the contract was awarded to Microsoft in November 1980. Microsoft was placed under intense time pressure. IBM was intent on bringing the product to market within the shortest possible time frame, and Microsoft had less than six months to produce the desired result. Microsoft’s solution was to adapt an existing operating system, one produced for the 8086 chip by Seattle Computing Products and named SCP-DOS. Eventually, under the most intense pressure, Microsoft produced the adapted operating system known as MS-DOS.
Engines That Move Markets (2nd Ed) Page 47