The Third Wave: An Entrepreneur's Vision of the Future (7 page)

This trend isn’t
lost on investors. When they look at food-tech startups to fund, it will be those best able to tap into that culture—those best able to reap value from a healthy eating revolution.

When I was growing up in Hawaii, I’d often head to the beach to bodysurf. One afternoon I watched a fellow surfer riding the waves with easy confidence. He was much better than I was. I paddled over to him, waiting for another swell to come our way, and asked if he had any advice he could offer.

“There’s only one thing you need to know,” he said. “When the wave is cresting, you’re either in the tube or you’re in the sand.”

The Third Wave is cresting. And whether you’re an entrepreneur looking to embrace it or a corporation trying to brace for it, this is not an event you can afford to ignore.

D
ESPITE AOL’S
success, there was always a feeling that just around the corner, there could be a new technology lurking—a fierce new competitor ready to pounce. There were a few startups popping up, and we kept our eyes on them, but most of our fears were focused on the big companies making moves in the space. Some of the world’s largest and best-capitalized companies—General Electric, Microsoft, and AT&T among them—were plotting to enter the market, and we worried that if they attacked with overwhelming force, we could be squashed.

We also had to worry about Prodigy, which in the late ’80s was one of the largest online services. Their initial product was a little clunky. Prodigy spent millions of dollars conducting research about what consumers might want but misread the signals, and ended up designing a flawed product. They talked to “typical”
consumers via focus groups in shopping malls all across the country, and the feedback they got led them to design a service for people who had never used a PC. But their primary market, at least initially, was people who
were
using PCs, and who were getting used to graphical user interfaces like Windows. All their applications used similar menuing interfaces, and they expected their online service to do so as well.

Still, we had real concerns about the company. Prodigy had the backing of IBM, CBS, and Sears, who together put hundreds of millions of dollars into user acquisition. They were a very real threat.

We plotted and planned, then made a couple of clever moves to maintain our edge. The first was a deal we did with IBM to create a private-label online service called Promenade. At the time, no one could understand why IBM would agree to partner with us after having spent $500 million to launch a competitor. But we had found the perfect opening.

A few years earlier, IBM’s first home computer, the PCjr, had failed. IBM executives didn’t want it to cannibalize sales of their higher-margin business PCs, so they crippled the PCjr’s capabilities, and consumers rejected it, choosing to buy from Apple and Commodore instead. IBM wanted to relaunch a home computer, and was committed to getting it right this time. So they set up a dedicated team, freed from the corporate bureaucracy, and tasked it with designing, manufacturing, and marketing a computer that would (finally) resonate with the growing consumer PC market.

The IBM team came to visit us. We were worried that they might just be visiting to gain some intelligence for Prodigy, but we decided to engage with them and try to turn things to our advantage. We urged them to be the first consumer PC manufacturer to build a modem into every PC as a standard item (up until then, it had been sold as an add-on “peripheral” device). They decided to do so, in part to help Prodigy.

Once we knew IBM was going to make modems a standard feature of their new home computers, we plotted to get our service into their bundle. After several discussions with IBM and lots of internal brainstorming, we came up with an interesting angle. We reminded IBM that Prodigy was available to every PC user, so including Prodigy in their bundle would offer no real differentiation to potential PC buyers. So, we argued, IBM should pay us to create a proprietary service. We suggested that it have a learning focus so that it would appeal to parents who were buying the computer to give their kids an edge. IBM agreed to the deal and agreed to pay us several million dollars to create the new service, called Promenade. Needless to say, Prodigy wasn’t pleased.

We also figured out a cheap and easy way to go directly after Prodigy’s customers. Prodigy, like other online services, was testing different ways to monetize the platform. At some point, they decided to start charging companies to send emails through their system to Prodigy subscribers. So we figured, if other companies could sell their products directly to Prodigy subscribers, why not AOL? We got in contact with a sales executive within Prodigy who agreed to let us do just that. We sent
emails offering AOL to Prodigy subscribers via Prodigy’s own email service. We were one of the first customers of this new marketing service and quickly became a meaningful source of revenue for them. Prodigy would spend hundreds of millions of dollars to build their membership, and we would spend a few million to cherry-pick their customers. This arrangement lasted about a year, until somebody higher up figured out that while they were generating revenue in the short run, they were doing so in the least strategic way imaginable.

Another big potential threat was CompuServe. One of the earliest online services, the company was owned by H&R Block and headquartered in Columbus, Ohio. In the early days, most would have predicted that CompuServe would emerge as the dominant player in the market. They were much larger than we were, and watched us with some concern as we started to get traction. When they concluded we were a real threat, they decided to contain the threat by trying to acquire us. They approached Jim Kimsey and initially offered $50 million. As their offer climbed to $60 million, interest in selling rose. Jim was in favor of selling, as he was worried about the coming competition, convinced that our early momentum could dissipate under the inevitable onslaught. The board was split, with about half favoring a take-the-money-and-run sale now and the other half inclined to stay the course as an independent company. I was forced to push back aggressively, advocating strongly against selling. “It is crazy to sell now,” I told the board. “It’s the bottom of the first inning, and this market is
only now about to take off.” I implored them to remember our grander ambitions, even threatening to resign in protest if the sale went through. Eventually I prevailed, defeating the acquisition by a single vote.

A lesser-known competitor was GEnie, a service from General Electric. When GEnie first came on the scene, I was very nervous. As competitors go, America’s most iconic brand is not generally the one you want to go up against. They should have been our biggest threat.

As it turned out, the project wasn’t a priority of the company’s. It wasn’t even a priority of the division it was created under. It turned out to be the pet project of a handful of employees, and it had very little attention or resources behind it. Partly for that reason, GEnie’s head of marketing, Jean Wackes, applied for a job with us in 1988. She started working for us shortly thereafter and became one of our most important executives. Ten years later, we were married in a private ceremony at our home in McLean, Virginia.

As careful as we were in monitoring GEnie, Prodigy, and CompuServe, the true threat, in our eyes, was Microsoft.

We had already had some difficulty with Microsoft. Soon after AOL went public, in 1992 Paul Allen, one of the founders of Microsoft, started buying our stock—then quickly bought more. Initially, we were friendly about it and started having
discussions with Allen and his team about ways we could work together. We told him we’d be comfortable having him buy up to 10 percent of our shares. But he kept buying. We got worried that he might be planning to launch a hostile takeover (perhaps fronting for Microsoft, as he remained a board member and large shareholder), so our board hired investment bankers, who advised us to put a “poison pill” in place to block such a move. The board decided to meet to approve such a provision, which would have allowed Allen or others to buy up to 15 percent of our stock but no more. As the board was meeting to vote on the poison pill, we learned that Allen’s buying had accelerated, and that he had already passed the 15 percent threshold, essentially negating the value of the planned provision. The board had no choice but to raise the threshold to 20 percent.

The board also decided that we couldn’t trust Allen. We put ourselves on a war footing, preparing for what many assumed was an inevitable hostile takeover attempt. Microsoft was plotting to enter the online market itself, and we knew that they were debating whether it would be better to build something themselves or invest in or acquire an existing online company. I flew with our team to Seattle to meet with Allen and his advisors. We told him we had passed the poison pill, limiting him to a 20 percent stake. We told him we would aggressively oppose any efforts to take over the company. And, because he had breached our trust, we would no longer consider offering him a board seat and would no longer be willing to partner with him in any capacity. It was a difficult meeting—Allen felt he should be
able to do whatever he wanted (at one point he said, “This is America” and suggested that our moves were anti-American).

After a few months of our freezing him out, he realized we were serious. We encouraged him to sell his 20 percent stake and offered to help him find a buyer. I spent a few months trying to place the stake in friendly hands, including Time Warner’s. Our advocate in that effort was Walter Isaacson, then head of new media for Time Inc. Walter had already been one of AOL’s earliest—and most respected—partners. He was one of the digital pioneers, responsible for making
Time
one of the very first magazines to go online. He saw the potential in the Internet at a time when most people were dismissing it as a fad, and he saw enormous upside potential for Time Warner to purchase a stake in our future. But he couldn’t get any support internally. Skepticism about the Internet ran deep at Time Warner—a lesson I would relearn many times.

Tensions with Microsoft continued, and soon I was returning to Seattle, this time at Bill Gates’s invitation. It’s hard to fully capture how dominant Microsoft was in those days, or how aggressive they would be in situations like this. This was not the first time Gates had held a meeting like this; it was part of his modus operandi. To stay on top, Microsoft had made a habit of buying potential competitors and using their market dominance to leverage a favorable deal for themselves. The message was simple: Accept our terms or we’ll destroy you. It was not an empty threat.

• • •

When I arrived in Seattle, I knew what to expect from him but wasn’t sure what to expect from myself. Would he be able to tell I was nervous? Would my sweaty palms give me away? I waited for a few minutes in the lobby before being ushered into his office.

“Come on in, Steve,” he said, pointing to a chair across the desk. We shook hands and then got right down to business. He started by praising AOL effusively, telling me how impressed he was with what we’d built, how well it was designed, and how much traction it was gaining. He told me that we deserved credit for creating the consumer online market and that we should be proud. Then came the squeeze.

“We think the online market is extremely significant,” he said, “and I want you to know that Microsoft has every intention of being the dominant player.” I tried not to react, to steel myself for what was coming next.

He told me about a competitive service Microsoft was developing, which would be called MSN. It would work much like AOL, but, he disclosed, unlike AOL, MSN would be bundled with every copy of Microsoft’s Windows operating system. That meant that in almost every PC coming onto the market, MSN would be the default portal to the Internet.

“I tell you this as a courtesy, Steve,” he said, the threat implicit in his words.

“But there is an alternative. We’d consider acquiring all of AOL, possibly even just a part of it. If it was up to us, we’d rather have you on our team than left out in the cold.”

I told him I would take the offer back with me. And I did my best not to show my cards. But when I left his office, I was shaken. This was a threat, and I had no idea how we would overcome it.

Our board held a special meeting to discuss the Microsoft situation. As a public company, we had a fiduciary responsibility to entertain any acquisition offer seriously. There was considerable debate, as many did favor a sale, and did fear Microsoft’s entry into the market. But ultimately I was able to convince the board that a sale was still premature. If Paul Allen was so eager to buy the company and now Bill Gates was, too, we must be on to something, I argued. After going back and forth on the merits of entertaining a formal offer from Microsoft, we decided to shut down any discussions. I called Gates and told him our board had met and decided we had no interest in entertaining an acquisition, as we believed we could create a lot of value for shareholders if we remained an independent company. Gates seemed surprised and a little miffed, and he reminded us that Microsoft would soon enter the market in an aggressive, win-at-all-costs way.

Not long after, we finally cut a deal to sell Allen’s stake to John Malone, CEO of the cable giant TCI (Tele-Communications Inc.). But the night before the transaction was supposed to take place, Bill Gates offered Malone a 20 percent stake in MSN instead. Gates didn’t want TCI in our camp, fearing that Malone would help line up the cable industry to support AOL. Malone walked away from our deal. (He later told me that it was the worst investment decision he’d ever made, as he made little on
his MSN investment, and, by jilting us at the altar, he passed up the opportunity to make billions as an AOL shareholder.) Eventually, Paul Allen sold his stock back into the market. But Microsoft was clearly a threat—and they wanted us to know it.