As Michael Fowlkes notes in his post this morning, Bill Gates topped Forbes' rich list yet again, with a net worth of $53 billion. I trace the reason why Gates is the world's richest person back to a decision he made at the dawn of the PC age to exploit International Business Machines Corp.'s (NYSE: IBM) confirmation bias.
What is confirmation bias and what does it have to do with Bill Gates? Confirmation bias is a decision-maker's tendency to lap up information that reinforces the decision-makers' beliefs about the world and to ignore information at odds with them.
So what exactly was IBM's confirmation bias? Based on decades of dominance of every business computing technology wave -- including desk calculators, mainframes, and data storage -- IBM believed that its entry into the PC market would confer instant legitimacy on the market. Moreover, IBM believed that its track record of marketing excellence would lead it to prevail over any competitors who might seek to challenge it.
In 1980, when IBM decided to enter the PC business, it wanted in fast. So instead of building a closed system for which IBM would supply all the hardware, software, and peripherals; IBM decided to build an open one which would encourage many other companies to develop software, displays, printers, and other parts.
IBM's search for suppliers took it to Seattle in search of an operating system for its PC. There IBM met with Bill Gates, founder of Microsoft Corporation (NASDAQ: MSFT), which had developed BASIC programming software for a small computer called the Altair. Unfortunately, Gates had no operating system available off the shelf for IBM.
But Gates perceived a huge opportunity from the IBM PC. So he searched around and discovered an operating system, called Quick and Dirty Operating System (QDOS) from Seattle Computer Products -- which he licensed for $50,000. (In so doing, Gates neglected to mention the IBM licensing deal to Seattle Computer Products.)
Gates sold IBM the rights to the OS for use on IBM PCs for a pittance. IBM, assuming that no PC-clone market would emerge, granted Gates the license for the OS on clones -- e.g., computers built by companies other than IBM that used the IBM PC standard. IBM had convinced itself that Gates was naïve about the emergence of PC clones. If Gates was right, IBM reasoned, then IBM was no longer the marketing powerhouse it believed itself to be.
History shows that IBM was initially correct about its decision. Between 1981 when it introduced its first PC and 1983, IBM's market share climbed to 42%. But by setting the standard in this rapidly growing market, IBM attracted competitors like Compaq -- whose low-priced portable clones enabled it in 1982 to reach $100 million in sales during its first year, making it the fastest growing company in US history.
Dell Inc. (NASDAQ: DELL) entered the market in 1984 and Hewlett Packard Company (NASDAQ: HPQ) shifted from a proprietary architecture to IBM's standard. By 1985, IBM's share had fallen to 37% and four years later IBM controlled a mere 16.9% of the PC market. Finally in 2005 IBM sold its money losing PC business to Lenovo Group Ltd (OTC: LNVGY).
How exactly did Gates exploit IBM's confirmation bias? Decision makers drop market signals into one of three mental buckets:
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Opportunity -- a new source of growth to be exploited;
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Threat -- a competitive initiative aimed at reducing a company's revenues and profits; or
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Noise -- any other event which decision-makers do not consider when allocating resources.
While Gates and IBM agreed that the PC OS represented a big opportunity, they categorized the clone OS differently. IBM thought the clone OS market was noise -- and therefore not worth its decision-makers' attention -- while Gates saw it as a bigger opportunity than the PC OS. To admit that the clone OS market was valuable would be at odds with IBM's perception of itself as the ever-dominant company in the computing market.
This led IBM to cede a very valuable asset to Microsoft -- giving Gates a lead which Microsoft preserved for decades -- and that keeps him at the top of the Forbes rich list a quarter century after his brilliant exploitation of IBM's confirmation bias.
Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm, and a Professor of Management at Babson College. He has no financial interest in the securities of Dell, IBM, Hewlett Packard, Lenovo, or Microsoft.
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Reader Comments (Page 1 of 1)
9-23-2006 @ 10:16AM
Robb Harrison said...
I say go get 'em Bill! First things first... the govt wants you to develope something greater than ever before then they sue you when it turns out to be so good everybody wants it. I have heard that B.G. was basically in the right places at the right times and that he was not the visionary we are led to believe he is, but whatever the case may be, he is the one who was positioned to capitalize. While he may or may not be a pirate of sorts he is the Multimedia king of the generation. I believe someone should create a better(term used loosely) OS. Then the torch can be passed.
PS. if reading this makes you angry, think about how much less angry you would be if you were on the Gates' Christmas list?!
9-23-2006 @ 7:32PM
Debbie said...
It also didnt hurt that Bill Gates' Mommy was on the board of directors of United Way with the Chairman of the board of IBM and close friends.
Gates was simply a rich mans son with a nerdy hobby. He was coddled enough to be able to drop out of Harvard and run off to New Mexico, on lawyer Daddy's dime, to pursue this enthusiast passion. All of the claims about his brilliance and keen instincts are a bit misrepresented. Mommy and Daddy Gates were more instrumental to the success of Microsoft than Bill and Paul Allen ever were.
9-24-2006 @ 3:45PM
Rich said...
Your comments smack of jealousy Debbie. Wouldn't your parents pave the way to introduce you to one of their friends that you could do business with? Assuming you are correct that he was a rich man's son with a nerdy hobby does that make his ability to identify a niche and compete in it any less remarkable? Perhaps he should use his money and influence like other young wealthy people(Paris Hilton). You know what if he chose to do that that would be fine too.
If my son had a great idea that came from a hobby or a skill I would do anything he needed to give him the opportunity to develop it.
Along the way they made millionaires out of many of their employees and became the richest men in the world.
9-24-2006 @ 9:48PM
Debbie said...
The writer is simply giving too much credit and too much supposition to Gates success and ommiting some very pivotal points. IBM didnt just meet with teenaged unkempt college dropouts and sign open-ended licensing agreements back then or now.
There was no brilliant innovation, great vision or prophetic talent in Gates' taking someone elses software and showing it to his parents friend aka chairman of IBM. Nor is there any criticism or "jealousy" as you put it. But facts are facts.
The preface of Cohan's post was to try to outline the "confirmation bias" not to just be impressed with someone because they are wealthy, which is clearly all that seems to matter to you.
Reading a book or two on the subject would probably help. The story is very interesting. Gates parents bought him an $800,000 beachhouse in his early 20s. His father's family was from one of the most wealthy and respected law firms in the Seattle area.
Bill Gates has achieved some incredible things in his life. Accumulating wealth is not one I think he would list in his top ten.
Try not to base your value of someone by the contents of their wallet.
11-16-2006 @ 10:48PM
r e davidson said...
Hey ROBB.....I really admire your logic.....duh.....Microsoft sells more than Apple...duh...... that means Microsoft is better....... For sure, Sherlock........
Think about it (or am I being presumptuous here to assume that you are even capable)... McDonalds has a HUGE percentage of America’s “dining out” market and yet Micky-D's still serves tons of toxic shit to the ignorant, moronic, and indiscriminate masses of clueless idiots that (unfortunately) comprise the bulk of this great country…… Are you among them, Einstein.
BTW, just because the masses buy Chevys… and only a few purchase BMWs….. doesn’t make the fuckin’ Chevy a better car…… you friggin’ genius....You define the genre of the easy target at which Bill Gates has leveled his aim.....you’re a slow moving, mouth breathing slug......a fat fish in a barrel of stagnate and putrid water... and you (and millions of other Americans) will pass on without ever realizing who and what you really are ....
..........Not so the Chinese or the Indians.......They will soon enough own this country and your progeny - - - and rightly so. Sleep on, you hapless, slack-jawed, fist-pumping Neanderthal.......The disciplined await.......