IBM

The IBM contract itself earned Microsoft only a small one-time fee for PC DOS, but the prestige of IBM's adoption transformed the firm, and the licensing structure turned that prestige into an empire. Because Gates had declined to transfer the copyright on the operating system to IBM, believing other makers would clone the PC's hardware, Microsoft kept the right to sell its own derivative, MS-DOS, to anyone. Columbia Data Products successfully cloned the IBM BIOS, Eagle Computer and Compaq followed, and a flood of IBM-compatible machines all needed an operating system that Microsoft was free to license non-exclusively, one deal at a time. Through aggressive marketing to clone makers, Microsoft rose from a small player to one of the industry's major vendors, and by the mid-1980s more than ninety percent of the fifteen million Americans using PCs at work were running its operating system. PC Magazine asked whether Gates was the man behind the machine.

86-DOS began in April 1980, when Seattle Computer Products assigned twenty-four-year-old Tim Paterson to build a substitute for CP/M-86, which Digital Research had not yet finished for the new 8086 processor, so the company could sell its memory boards with a working operating system. The result was a CP/M work-alike for 8086 hardware that Microsoft spotted as the answer to IBM's operating-system problem. In December 1980, Microsoft purchased a non-exclusive license for 86-DOS from Seattle Computer Products for $25,000, enough to begin adapting it while the IBM negotiations proceeded. Then, in July 1981, one month before the IBM PC's release, Microsoft bought all remaining rights to the system outright for an additional $50,000. Those two payments, totaling $75,000, secured the asset that MS-DOS was built on, and Paterson himself joined Microsoft to adapt the code for the PC, a transaction that ranks among the great bargains in the industry's history.

The commercial that introduced the Macintosh was conceived by Steve Hayden, Brent Thomas, and Lee Clow at the Chiat/Day agency, produced by Fairbanks Films in New York, and directed by Ridley Scott, on a budget reported between $370,000 and $900,000. A reference to George Orwell's 1949 novel of a dystopia ruled by a televised Big Brother, the sixty-second spot opens on rows of bald, grey-clad workers marching through a blue-gray tunnel of telescreens, intercut with a full-color athlete in red shorts and a white tank top bearing a Picasso-style drawing of the Macintosh, sprinting from four black-uniformed pursuers and hurling a brass-headed sledgehammer through the screen of Big Brother's rant. English athlete Anya Major played the heroine, and David Graham supplied Big Brother's voice. The ad closes by promising that the viewer will see why 1984 will not be like the novel's 1984 — Apple casting itself explicitly as the antidote to conformity.

Think different, Apple's advertising slogan from 1997 to 2002, was created by the Los Angeles office of TBWA/Chiat/Day and read widely as a riposte to IBM's Think. The campaign's birth was scrappy: in 1986 chief executive John Sculley had replaced Chiat/Day with BBDO, and in 1997, under Gil Amelio, BBDO pitched a brand campaign with the slogan We're back. Everyone in the room approved except the recently returned Jobs, who called the slogan stupid on the ground that Apple was not back yet. He then invited three agencies to present ideas reflecting the philosophy he wanted reinforced inside the company he had co-founded. Art director Craig Tanimoto coined the phrase, and Jobs insisted on different as a noun — think victory, think beauty, colloquial like think big — rejecting the grammatically safer think differently. The slogan was still printed on iMac packaging decades later.

By the mid-1990s Apple's distress was existential. In 1995 the chief financial officer asked directors to find a buyer, judging the company no longer able to support itself, and resigned when the board refused; Fortune wrote in February 1996 that the company which invented the personal computer would likely disappear, noting that $1,000 invested in Apple a decade earlier was worth $2,900 against $22,000 in Compaq. Apple came hours from acquisition by Sun Microsystems, refused an IBM offer it later sought again, and failed to ship a modern operating system after the Copland project collapsed into feature creep. Choosing between Be's BeOS and NeXT, Apple announced on December 20, 1996, that it would purchase NeXT and its NeXTSTEP operating system for roughly $429 million plus 1.5 million shares of Apple stock, bringing Jobs back into management for the first time since 1985 and giving the Mac its next technological foundation.

IBM approached Microsoft in July 1980 about software for its forthcoming personal computer, a connection eased by Gates's mother's service on a United Way board alongside IBM chief executive John Opel. IBM initially asked Microsoft to write the BASIC interpreter and, when the subject of an operating system arose, Gates referred the company to Digital Research, maker of the dominant CP/M system; those negotiations failed. When IBM's Jack Sams reported the impasse, Gates and Allen proposed 86-DOS, a CP/M-like system Tim Paterson had built at Seattle Computer Products. Microsoft first licensed and then fully acquired the system, hired Paterson to adapt it for the IBM PC, and delivered it as PC DOS for a one-time fee of $50,000. Gates deliberately did not transfer the copyright to IBM, betting other manufacturers would clone the hardware; they did, and MS-DOS became the industry's de facto standard.

Gates committed Microsoft to the graphical interface years before it paid off. Computerworld noted in 1987 that he had pushed Windows almost fanatically for years while much of industry treated it as a joke, and a Microsoft manager later recalled that betting the company on it was an enormous wager. Windows 3.0, launched May 22, 1990, sold more than 100,000 copies in two weeks and pulled resources away from OS/2, the operating system Microsoft had been co-developing with IBM since an August 1986 agreement; in a May 16, 1991 internal memo, Gates declared the OS/2 partnership over and redirected the company to Windows and the Windows NT kernel, a switch developers who had backed OS/2 called the head-fake. By 1993 Windows was the world's most widely used graphical operating system, vindicating a decade of insistence. Windows 3.1 followed in March 1992 and sold more than three million copies in its first two months on the market.

In 1983 Jobs recruited John Sculley, president of Pepsi-Cola, to become Apple's chief executive with the famous pitch contrasting a career spent selling sugared water with a chance to change the world. The hire was meant to give the founder operational cover while he focused on the Macintosh; instead it created a rival power center with board backing. Their visions diverged sharply: Sculley favored open-architecture machines like the Apple II aimed at education, small business, and home markets less exposed to IBM, while Jobs wanted the closed-architecture Macintosh positioned as the business alternative to the IBM PC. The two divisions operated like separate companies, duplicating services, and the January 1985 annual meeting failed even to mention the Apple II group still providing 85 percent of sales, an omission that helped push Wozniak to leave amicably, sell most of his stock, and complain the company had been heading wrong for five years.

It requires not only a grasp of investment analysis but also an iron constitution to ignore the periodic shenanigans of the stock market and reap the rewards of long-term equity investment. I thought it would be amiss not to mention two events which marked 2023. The first event is the rise of Artificial Intelligence, or AI, as one of the driving forces behind the rise of most of the Magnificent Seven and especially Nvidia. What to make of it? I would offer a few observations. Firstly, AI is not quite as new as the rise in interest in AI in the stock market this year, driven by Microsoft’s investment in OpenAI and the adoption of its ChatGPT large language model (actually launched in November 2022). IBM launched an AI model called Watson which beat two human champions in the US quiz show Jeopardy! in 2011. Google (now Alphabet) acquired the AI developer DeepMind in 2014. Secondly, the stock market, in a fashion exemplified by the earlier cartoon, has decided at the outset that it can identify winners in AI in the form of Nvidia designing the chips on which the generative AI models will run and Microsoft as a provider of an AI model. If it can do so at this stage it would seem to me to be a break with tradition.

earnings had more than doubled to 31 percent. That can’t surprise you. Nearly all large U.S. firms can be characterized as “global” in their reach. Think Coca-Cola, IBM, Microsoft, GE, General Motors, and Citigroup, and you’ll get the idea. And, in this “one world” of interconnection and competition, global stock markets continue to produce similar long-term returns. For example (this may surprise you), since 1980 the annual return on the S&P 500 has averaged 13.0 percent compared with the return of 11.6 percent for the non-U.S. EAFE Index (the Morgan Stanley Capital International Europe, Australia, and Far East Index). A percentage point of that return, in fairness, has resulted from the moderate weakness of the dollar over that long span; the EAFE annual return, measured in local currencies, was 10.6 percent. That is not to deny that there can be extended waves of superiority in one segment or the other. During the 1980s, international (i.e., non-U.S.) stocks substantially outpaced U.S. stocks (22 percent per year vs. 17 percent) and then fell far behind in the 1990s (U.S.per

a star system not unlike Hollywood’s has emerged, with the brightest stars attracting the largest cash flows from investors. Doubtless some managers have used this New Era of infinite information to their advantage. After all, the new Compaq 700 has 5000 times(!) the power of a 1985 IBM PC. But it is in the nature of markets that for each winner there must be a loser. Beating the market is a zero-sum game. The average fund manager can’t win. When asked if the average manager could win, Columbia University’s legendary Benjamin Graham, mentor to the even more legendary Warren Buffett, said: “No. That would mean that the stock market experts as a whole could beat themselves—a logical contradiction.” Which quickly leads to the second truth: While all investors as a group share the market’s gross return, their net return is reduced, dollar for dollar, by the costs of financial intermediaries. After costs, beating the market is a loser’s game. Yet in the New Era, the relative returns earned by mutual fund investors have not merely stayed the same; they have gotten worse. Why? Because the costs paid by mutual fund investors have risen. Result: the share of market return earned by fund investors has declined even further. How much have costs risen? In the Old Industry, the average equity fund carried an expense ratio of about 0.75% of assets per year; in the New Industry, the average is more than 1.6%—an increase of more than 100%.

(IBM, which was to be the star performer of the subsequent two decades, didn’t join the Index until 1957.) Surprisingly, AT&T, with a market capitalization larger than General Motors’, was conspicuous by its absence. Despite its initial “Old Economy” base, the S&P Index dominated the active fund managers during the era that followed. Now advance the calendar to 1964. AT&T, now part of the index, had a 9.1% weight, followed by General Motors at 7.3%, Standard Oil of New Jersey at 5.0%, and IBM at 3.7%. The “top ten” then accounted for 39% of the index, again far higher than today’s top ten weight of 24%. But even this continued reliance on the Old Economy of autos, chemicals, oils, and utilities—together, 52% of the index—failed to diminish its sharp advantage over the average mutual fund during the subsequent decade, despite the surge of the “go-go” concept stocks during the middle of the period.

But in aggregate, on a pre-tax basis, the portfolio of Nifty 50 stocks earned an average return of 12.4%, compared to 11.7% for the overall stock market, a positive margin of 0.7%. This relative advantage grows on an after-tax basis, as the spread between the two returns increases to fully 2% (9.8% vs. 7.8%). This example of long-term returns on a "static portfolio," oriented to growth but bought at a high price, is surely reassuring. There is, Ecclesiastes tells us, nothing new under the sun. And that ancient maxim is in a sense true of my "new" idea. 1 may be one of a tiny handful of mutual fund historians who retain the memory of a similar fund formed in 1938, which provides further confIrmation of the buy-and-hold idea. Structured as a fIxed trust, Founders Mutual Fund originally picked an equal-weighted portfolio of 36 of the blue-chip stocks of the day, which it held, as it happens, until 1983, when the fund abandoned the strategy. And in fact, at the end of that 45 year period, the fimd held the same thirty-six stocks it had owned at the outset, including IBM, Procter & Gamble, duPont, Union PacifIc, and Eastman Kodak-not only durable (by defInition), but successful, enterprises. Prior to the change in its strategy (1 couldn't locate a record of its fIrst fIve years), the Fund earned an average annual return of 10.3% pre-tax, less than the return of 11.6% on the Standard & Poor's 500 Index, a gap predictably engendered in part by the Fund's operating costs of 0.5%.

Charlie Munger: The one I was most excited about was getting the contract from the Los Angeles courts. That’s one of the biggest court systems on earth, and that was a crucial milestone as far as I was concerned.... The new business is interesting because it’s a big market, and if we get entrenched in it, it will be very sticky. Which has occurred to us as we suffered all this agony. At least we were suffering agonies in the attempt to get in a position from which we’d be hard to dislodge. The main threat or hurdle is that we want to be the most important player in this new niche. I don’t regard that battle as won. I regard that as going well but not won. I’d go further: going very well but not won. Questioner: You’ve said that the only thing you want to know is where you’re going to die so you never go there. It is a very powerful philosophy. And when you talk about investing, you want to stay in that circle of competence. And a few years ago, Warren Buffett decided to buy IBM, and then I think he’s still very optimistic. And some people would say he maybe stepped out of his circle of competence? Charlie Munger: IBM is a lot like us. They have a traditional business that is very large and very steady. And of course the world changed, and in a lot of what was the new world they were not the leader of. Oracle and Microsoft and all kinds of other people that were formerly not so large. And they didn’t do well in personal computers, even though they pretty well started it.

-3- And so IBM is in a position a lot like us in that they have an old business from which cash continues to flow, but they want a new product that’s a hit. Now, the product they have chosen to back is this automated checklist. Well, automated checklists are a very good idea and it may be particularly useful in things like medicine. I would say the jury is out on that. I don’t really have an opinion. I’m neither a believer nor a disbeliever . . . It could happen, it could not happen, as far as I’m concerned. I do think the old business of IBM is very sticky and will die slowly. . . . the matter is . . . we make great big bets and hold them for long periods. That’s a tough game. We have to make bets that are not the kind of shooting fish in a barrel [bets] . . . and that’s one of them. So on that one, the answer my friend is blowin’ in the wind. It may work in a mediocre way, it may work big. I just don’t know. Questioner: What advice do you give your grandchildren? And the second question is do you have a favorite investment story? Charlie Munger: Concerning the grandchildren: I was not able to change my children very much . . . Clarence Darrow quoted, “I am the master of my fate, I am the captain of my soul.” Clarence Darrow said, “Master of my fate? Hell, I don’t even pull an oar.” That’s the way I feel about changing the children. As for my grandchildren, I think, thank God they’re somebody else’s problem. I served my time.

Munger used the 2015 meeting to draw an explicitly Darwinian picture of corporate mortality. The room was watching one business die while the company tried to replace it with another. Most of the other newspaper companies that had tried to do the same thing had failed. Some of them had bought other businesses - television stations, for instance - with the profits they had, but most of the ones that simply tried to take their newspaper and transform it into something else had failed. That, Munger said, is the common result. The lesson was that technological change is one of the hardest things to cope with, which is why so many incumbents fail at it. He reached for three exhibits. Kodak had owned the world in silver-based photography, was the dominant company on the planet, the second most important trademark in the world, with armies of PhD chemists who knew more about silver-based photography than anybody. It had been a fabulous business right through the Great Depression - a total widow-and-orphan stock. And then it wiped out its shareholders with technological change. General Motors had been the most important automobile company in the world when Munger was young - number two was not close - and it too wiped out its shareholders. IBM had gone from butchers' scales to dominating the early computer market, and when the next evolution came along it failed a lot. Munger said Bill Gates had told him it happens again and again and again when the technology changes enough. The age of Daily Journal's board - the youngest director was 60 and Munger, the chairman, was 91 - only underlined the absurdity of attempting a Half Dome pivot. He told the room, with characteristic understatement, that he didn't understand computing. But he was doing it anyway, because the alternative was to accept the slow death of the print franchise.

The Wisdom of Warren Buffett About Mutual Fund “Independent” Directors: “Companies are not looking for Dobermans on the board; they are looking for cocker spaniels. Then they make sure their tails are wagging.” “Negotiating with oneself seldom produces a barroom brawl.” Warren Buffett 52. Corporate Pensions: The Elusive 8% Corporate pension funds make unreasonable assumptions about future returns Pension de-risking and high expected returns are not compatible. Example: IBM Asset Allocation Asset Allocation Required Return Reasonable Assumptions Bonds 56% 3.75% 3% Stocks 25 13.6 4 Others (Hedge Funds, Private Equity, etc.) 19 18.5 10 Total/Gross Return 100% 9.0% 4.6% Less Investment Costs -1.0% -1.0% Net Return 8.0% 3.6%

So, the next thing that happens is I can't remember whether I went to Silicon Valley or I talked to some 22-year-old with Asperger's. But whoever it was, they convinced me about this new tech boom that was going to take place. So I went and hired a couple of gun slingers because we only knew about IBM and Hewlett-Packard. I needed Veritas and Verisign. I wanted the six. So, we hired this guy and we end up on the Year — we had been down 15 and we ended up like 35 percent on the year. And the Nasdaq's gone up 400 percent.

But now if you do stupid research, you buy some company that has no sales, no earnings, a terrible financial position and it goes down, you say, "Well, it because of the programmed trading of those professionals," that's because you didn't do your homework. So I -- I've tried to convince people they can do a job, they can do very well, but they have to do certain things. Wouldn't one of those things be letting you do it for them? Well, the small investor can do three things. They can avoid the market entirely. They can just say, ah, "I can't stand it. It's too volatile for me. I'll just put my money in money market funds or put my money in the bank." That's one choice. The other choice is they can invest directly in the stock market by buying stocks individually, or they can buy mutual funds and invest in stock. I think they can do the course of investing in mutual funds and every now and then, they find some stocks, they have a chance the make a big hit. I think the average person could know three or four or five companies very well. They could lecture on those three or four or five companies, and if one or two of 'em becomes attractive, they buy 'em. They just can't wake up in the morning and say, "Now's the time to buy this. Now's the time to buy IBM. Now's the time to by GE. Now's the time to buy Dow Chemical. Now's the time to buy some biotechnology company," if they don't know something about it. You have to know the story.

[19:30] You could have waited three years after Microsoft went public and made 10 times your money.. If you knew something about software (I know nothing about software) you would have said, “These guys have it. I don’t care who’s going to win, Compaq, IBM. I don’t know who’s going to win, Japanese computers. I know Microsoft MS-DOS is the right thing.” You could’ve bought Microsoft.

A little digression illustrating this point may be interesting. Berkshire Fine Spinning Associates and Hathaway Manufacturing were merged in 1955 to form Berkshire Hathaway Inc. In 1948, on a pro forma combined basis, they had earnings after tax of almost $18 million and employed 10,000 people at a dozen large mills throughout New England. In the business world of that period they were an economic powerhouse. For example, in that same year earnings of IBM were $28 million (now $2.7 billion), Safeway Stores, $10 million, Minnesota Mining, $13 million, and Time, Inc., $9 million. But, in the decade following the 1955 merger aggregate sales of $595 million produced an aggregate loss for Berkshire Hathaway of $10 million. By 1964 the operation had been reduced to two mills and net worth had shrunk to $22 million, from $53 million at the time of the merger. So much for single year snapshots as adequate portrayals of a business.