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Cash-King Port

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The Birth of Computers
A look back to find value
by Rob Landley (landley@flash.net)

Austin, TX (Oct. 22, 1998) -- I've decided to take a breather from yesterday's warring debate between Amazon.com and Microsoft. Instead, today I'm going to provide a brief, colorful history of the development of the computer industry. And I may shock many of you by not only NOT pummeling Microsoft, but actually applauding Mr. Softy's ability to enterprisingly grab new markets.

But, let's begin at the beginning. It will tell us about how $600 billion of new value can be created for investors over a fifteen-year period.

When IBM (NYSE: IBM) made the original personal computer, it was really a throw-away product in what the company considered to be a very small niche. At the time, IBM's PCs suggested that it was far more interested in preventing any real business in personal computers than in actually making a machine that people wanted. (Does that sound familiar? Yeah, IBM got sued for anti-trust a lot, too.)

In its infancy, the PC market was just too small to interest Big Blue. And, the standard phrasing to describe what happened is that the personal computer benefited from IBM's "benign neglect." IBM's big mistake early on was to disinterestedly outsource the making of all computer parts, even the CPU and operating system. By doing so, Big Blue created a computer that was very easy to clone. Instead of squelching the PC industry, IBM actually standardized it.

And in so doing, they created two future titan companies. Microsoft and Intel were, initially, merely third parties that IBM had gone to when it outsourced components. They were successful enough to attract IBM's attention as parts suppliers, but that's about it. Then one day dozens of other companies interested in making "IBM-Compatible" PCs started showing up at the doorsteps of Microsoft and Intel, pushing large contracts. Their message and plea was simple, "Help us compete with IBM." And thus was born a growing demand for what would become a lucrative WinTel alliance.

In fairly short order, Microsoft gained its first monopoly via its DOS operating software, and it actually happened because Microsoft needed to protect itself against piracy. Microsoft established a policy whereby computer manufacturers could only get the best price on the DOS system (which later became Windows) by paying up for a copy with each motherboard that they manufactured. In the Justice Department's original 1995 consent decree against Microsoft, that practice was nicknamed the "CPU Tax" licensing fee.

It succeeded at its original intent -- to virtually eliminate pirated copies of DOS. But what it also eliminated was all competing operating systems. Even if customers didn't intend to use DOS, they paid for it when they bought their motherboard. The cost was actually embedded in the total cost of their computer. And given what looked like a "free" copy of an operating system to run on their new computer, few people looked for alternatives. Microsoft brilliantly -- and almost unintentionally -- locked down pole position on providing operating systems to those machine makers that were fighting to take market-share away from IBM.

All this activity harmonized nicely with another trend in the computer industry: The Need For Standards. Computer hardware companies build their organization by making a better sound card, or video card, or hard drive -- by creating something that people will crave enough to buy a new machine. If the PC makers have to worry about plugging their new stuff in varying slots for varying machines, they get bogged down. In the same vein, software companies are busy trying to write programs that will work on any machine, wherever the most customers are. Standardization, simplicity, a mass market -- these were the aims of every great consumer technology business.

They were and are staple principles to Microsoft's business.

Microsoft gained the leg up on this mass-market model when IBM decided to ship its PCs with the DOS system installed. No other PC maker wanted to get caught out in the cold, so they shipped with DOS, too. And then all the third-party software developers wrote programs for Microsoft's DOS. Finally, since DOS took advantage of the original PC's capabilities pretty well (which included 64k of RAM, black & white graphics, and no sound other than the little speaker that went "beep" when you booted up), there simply was no reason to look for alternatives.

And yes, for a long while there, Microsoft's DOS kept up with the needs of the PC industry pretty well. DOS Version 2.0 then introduced the concept of "subdirectories," taken from the UNIX world (although using the "\" key instead of the "/" key to separate them from each other). Subdirectories were a great advance for DOS, since they allowed for much better organization of files on the floppy disk. Remember that's the origin of the name the Disk Operating System (DOS); everything booted and ran entirely off of floppy disks. And when high-density floppy disks and drives came along, subdirectory management of files became that much more important. Best of all, as users upgraded to DOS 2.0, they found it was "backwards compatible," allowing them to run all of their old programs written for DOS 1.0.

Backwards compatibility is extremely important. We take this for granted now, but back in the 1980's the concept was still being developed. Those who didn't adapt were sunk by it. Like the computer company Commodore, which had the very popular computer called the Commodore 64. The Commodore computer was actually more powerful than the original IBM PC; it had better graphics and sound, just as much RAM, and a slightly slower CPU. And it ruled the home market for years.

But the sequel to the Commodore 64, the Commodore 128 did a screwy thing. It could only run the original C-64 programs by switching into a compatibility mode that emulated the original 64. And the Commodore 128 had to emulate it so accurately that there was no way to then access the 128's new features without hitting a switch back. You were forced to flip between 64 and 128 functionality. Put more concisely, it was a serious pain in the arse.

Finally, when Commodore's next new computer the Amiga came out (a truly impressive machine, years ahead of its time), it featured no backwards compatibility to the Commodore 64 at all. None. Because of this, Commodore's original user base was very slow to move to that new machine. And, in the end, when the Commodore 64 really started lagging behind the industry, its users were as likely to migrate to other platforms, like the PC or the Macintosh, as to the Amiga. The Amiga, though it was in many ways a superior machine, was a commercial disaster. It lacked backwards compatibility. It was the straw that broke the camel's back, responsible for driving Commodore into bankruptcy court.

The mass market, simplicity, standardization, and a few strong alliances -- of all technology companies, Microsoft understood all of this best. Tomorrow, we press onward in trying to understand how this small software business, a company that many called "behind the times" in 1980, grew into the $270 billion company it is today.

Fool on,

- Rob Landley (Oak)

Cash-King Strategy Folder
Cash-King Companies Folder


10/22/98 Close
Stock  Change    Bid 
 AXP   +1 15/16  89.00 
 CHV   -5 3/4    81.50 
 CSCO  +  13/16  58.44 
 KO    +2 1/2    69.44 
 GPS   +  13/16  57.81 
 EK    -1 15/16  74.56 
 XON   -3 13/16  71.75 
 GM    +  9/16   61.50 
 INTC  +  5/16   87.38 
 MSFT  +3 9/16  110.00 
 PFE   +2 3/4   100.75 
 SGP   +  7/16  101.31 
 TROW  -  1/2    31.63 
 

 
                  Day     Month   Year    History 
         C-K      +0.44%   2.77%   8.55%   8.55% 
         S&P:     +0.80%   6.04%   7.20%   7.20% 
         NASDAQ:  +1.67%   0.52%   2.18%   2.18% 
  
 Cash-King Stocks 
  
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   24 Microsoft     78.27    110.00    40.54% 
     2/3/98   22 Pfizer        82.30    100.75    22.42% 
     5/1/98   37 Gap Inc.      51.09     57.81    13.16% 
    8/21/98   22 Schering-P    95.99    101.31     5.55% 
    2/13/98   22 Intel         84.67     87.38     3.19% 
    6/23/98 34.5 Cisco Syst    57.56     58.44     1.52% 
    2/27/98   27 Coca-Cola     69.11     69.44     0.48% 
     2/6/98   56 T. Rowe Pr    33.67     31.63    -6.08% 
    5/26/98   18 AmExpress    104.07     89.00   -14.48% 
  
 Foolish Four Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko    63.15     74.56    18.08% 
    3/12/98   20 Exxon         64.34     71.75    11.53% 
    3/12/98   15 Chevron       83.34     81.50    -2.21% 
    3/12/98   17 General Mo    72.41     61.50   -15.06% 
  
 Cash-King Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
     2/3/98   24 Microsoft   1878.45   2640.00   $761.55 
     2/3/98   22 Pfizer      1810.58   2216.50   $405.92 
     5/1/98   37 Gap Inc.    1890.33   2139.06   $248.73 
    8/21/98   22 Schering-P   2111.7   2228.88   $117.18 
    2/13/98   22 Intel       1862.83   1922.25    $59.42 
    6/23/98 34.5 Cisco Syst  1985.95   2016.09    $30.14 
    2/27/98   27 Coca-Cola   1865.89   1874.81     $8.92 
     2/6/98   56 T. Rowe Pr  1885.70   1771.00  -$114.70 
    5/26/98   18 AmExpress   1873.20   1602.00  -$271.20 
  
 Foolish Four Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko  1262.95   1491.25   $228.30 
    3/12/98   20 Exxon       1286.70   1435.00   $148.30 
    3/12/98   15 Chevron     1250.14   1222.50   -$27.64 
    3/12/98   17 General Mo  1230.89   1045.50  -$185.39 
  
                               CASH     $48.07 
                              TOTAL  $23652.91 
   
 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.

*The year for the S&P and Nasdaq is as of 02/03/98

</THE CASH-KING PORTFOLIO>

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