Anthony J. Pennings, PhD


Microsoft and the IBM PC Case Study: The Deal of the Century

Posted on | November 1, 2015 | No Comments

The microcomputer was starting to become popular in the late 1970s and finally caught the attention of IBM. Initially resistant, “Big Blue” became concerned that they were “losing the hearts and minds” of their clients. However, when the Apple II started to show up in many corporate environments, IBM officials were concerned about the encroachment of these small “microcomputers” into their minicomputer and mainframe businesses.[1]

Although the Apple II’s capabilities were limited, it had exciting software such as the VisiCalc spreadsheet software. IBM had attempted another microcomputer in September of 1975, the 5100, but at 55 lbs and a cost of $20,000, the laptop computer failed to take off. IBM responded to the growing popularity of the personal computer by going outside its company and contracting with new hardware and software suppliers to produce its own “Personal Computer” or PC as it came to be called. By mid-1980, “Big Blue” moved quickly to assemble and market their version of a microcomputer.

The key to the emerging microcomputer business was the microprocessor “chip.” IBM chose to build the PC around the cheaper 8-bit Intel 8088 chip, despite the availability of the much more powerful 16-bit 8086 chip. Its decision was based on two reasons. The first was that IBM feared their microcomputer might compete with their mini and mainframe businesses and wanted the less powerful chip to keep the PC in a different class. The second and probably more important reason was that a small industry of hardware and software products had already been developed for the Intel 8088. Many more supporting chips were available for the older chip, and this meant that a functioning system could be assembled within a shorter period.

One of the new suppliers that IBM contacted was Micro-soft. Initially, they approached them for software and a computer operating system. The meeting was facilitated by the connection between the IBM CEO and Gates’ mother Mary; both served on the board for the same United Way charity. Apparently IBM’s briefing books listed Microsoft as the major producer of operating systems. Bill Gates was surprised by the request for an operating system and quickly referred the IBM representatives to Gary Kildall and his operation called Intergalactic Digital Research. Kildall had written CP/M and was the predominant figure in microcomputer operating systems.

When the IBM representatives arrived, they were disappointed with their reception. The story varies but apparently Dr. Kildall had plans to go flying his airplane during the morning hours and asked his wife Dorothy to meet with the visitors. She stalled them and asked her lawyer to go over the IBM nondisclosure agreement (NDA). Together they decided not to sign it. Another story, however, was that Kildall returned in the afternoon, signed the NDA, but refused IBM’s offer to buy CP/M outright for $250,000, holding out instead for licensing it at $10 a copy. In any case, IBM’s representatives left disappointed and returned to Microsoft. Afraid to lose the opportunity to sell BASIC and other languages with the new IBM microcomputer, Gates told them he could get them an operating system.

Their secret “ace-in-the-hole” was Paul Allen’s dubious connection to a programmer who was working on a variation of the CP/M operating system that IBM wanted. The programmer was Tim Patterson who worked at a company called Seattle Computer Products (SCP). Patterson had spent nearly half of 1976 reworking the code from a manual he bought. When Allen approached the company, SCP was suspicious of Microsoft’s intentions. But they were very interested in getting a cash settlement. Eventually, they agreed to turn over the software, called Q-DOS (Quick and Dirty Operating System), for royalties that totaled some $50,000. This was the software that was soon going to make Gates and Allen, the richest men in the world.

On August 12, 1981, Big Blue introduced its personal computer. The Intel 8088 chip operated at 4.77 MHz and contained some 29,000 transistors. It handled data internally in 16-bit words but was limited to 8 bits externally. It used ASCII code for representing information that made its characters show up crisply on the 80 character monochrome screen, a major improvement over the Apple II, especially for word processing and other office applications.[2] At its core was PC-DOS, licensed from Microsoft but also available were CP/M-86 and another Pascal-based OS from the University of California at San Diego.[3] The IBM PC sold initially for $2,880 and had 64 Kbytes of memory along with a floppy disk.[4] It was a major success that first year with over 670,000 computers sold.[5]

Microsoft and the Clones

But, in one of the biggest business blunders of all time, IBM did not get an exclusive contract for PC-DOS. Gates pushed for an agreement that would allow them to license the OS to other manufacturers. Lessons from the mainframe business showed that companies could develop “plug-compatible” machines that were compatible with large IBM computers. The Amdahl Corporation, for example, developed a processor for its Model 470 V/6 that ran IBM 360 software. Japanese companies also made significant entries into American computer market via the plug-compatible business. Fujitsu began building Amdahl computers in Japan and Hitachi began selling similar machines in the USA under the name of National Advanced Systems, a division of the National Semiconductor Corporation. With this agreement, Gates was free to make similar deals with companies who could “legally” replicate the IBM computer and run the “MS-DOS” software.

While the IBM PC became the industry standard behind an expensive marketing campaign using a Charlie Chaplin look-alike, Compaq was leading the way for other microcomputer manufacturers looking to produce “IBM-compatible” machines. Compaq invested in the legal and technical expertise to “reverse engineer” a crucial part of the IBM architecture that was produced in-house by IBM. This was the BIOS, the Basic Input/Output System.

Originally developed by Gary Kildall, the BIOS concentrated the hardware-dependent aspect of his CP/M operating system into “a separate computer code module” that was stored in a read-only memory chip, thus the name ROM-BIOS. This chip allowed CP/M to be adapted to many different computers that were being developed around Intel chips.[6] IBM had developed and copyrighted its own BIOS, which needed to be “reverse engineered” to allow another manufacturer to produce it.

Compaq put 15 engineers on the job and invested over a million dollars in the project to produce a portable PC. Despite IBM’s strength, they ultimately had lower overhead than IBM and could compete with a cheaper computer. What made these clones popular though was that they could run the same software as the IBM machine. Compaq and others such as Commodore, Tandy, Zenith and most impressively, Dell provided “IBM-compatible” machines that could run the most popular non-Apple programs. The result was a proliferation of PCs, or as they came to be known, “PC clones.” Compaq sold over US$100 million of their “portable” personal computers in its first full year of business.

In one of the most extraordinary business arrangements in modern history, Microsoft leveraged its knowledge of the Intel microprocessor environment to outmaneuver IBM and establish its operating system as the dominant operating system for the PC. In a strategy Microsoft executive Steve Ballmer called, “Riding the Bear,” Microsoft worked with IBM to the point where it was strong enough to go on its own, ultimately becoming one of the richest companies in the world by having their software on nearly every PC in the world. This would first include developing programming software for the fledgling Intel-based microcomputer industry and then in association with IBM, standardizing an operating system for the non-Apple microcomputer industry.

Triumph of the Nerds video on reverse engineering and Compaq by Robert X. Cringely.

The development of the microprocessor-based computer industry by Intel and Apple resulted in the wide-scale use of electronic spreadsheets, what some would call the “killer app” of the personal computing revolution. VisiCalc, Multiplan, SuperCalc, Lotus 1-2-3, and Quattro were the first spreadsheets to become available. By the mid-1980s, electronic spreadsheets would make their way into the corporate world and became an integral tool for the progression of digital monetarism.


[1] Quote from Jack Sams, IBM PC project manager as interviewed by Robert X. Cringely in Triumph of the Nerds based on his book Accidental Empires: How the Boys of Silicon Valley Make Their Millions, Battle Foreign Competition, and Still Can’t Get a Date. Cringely has a new book about the decline of IBM.
[2] The impact of ASCII on the IBM PC from Paul E. Ceruzzi’s A History of Modern Computing. Second Edition. Cambridge, MA: MIT Press. p. 268.
[3] The three operating systems from Paul E. Ceruzzi’s A History of Modern Computing. Second Edition. Cambridge, MA: MIT Press. p. 268.
[4] Cambell-Kelly and Aspray’s (1996) Computer: A History of the Information Machine. Basic Books. p. 257.
[5] Information on IBM PC release from Michael J. Miller’s editorial in the September 4, 2001 issue of PC MAGAZINE dedicated to the PC 20th anniversary.
[6] BIOS information from Cringely, p. 58.



AnthonybwAnthony J. Pennings, PhD is Professor and Associate Chair of the Department of Technology and Society, State University of New York, Korea. Before joining SUNY, he taught at Hannam University in South Korea and from 2002-2012 was on the faculty of New York University. Previously, he taught at St. Edwards University in Austin, Texas, Marist College in New York, and Victoria University in New Zealand. He has also spent time as a Fellow at the East-West Center in Honolulu, Hawaii.


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