With Hotmail established as a popular, free e-mail service with almost nine million members, Microsoft moved to acquire the company and add it to its range of online services.
One of the most successful start-up companies of the Internet boom, Hotmail was launched in Mountain View, California, on July 4, 1996, a date chosen to represent the product’s ability to free its users from reliance on Internet service providers (ISPs). Hotmail was a free e-mail service that could be accessed through a Web browser. The rapidly expanding company was acquired at the end of 1997 by Microsoft Corporation in Microsoft’s largest acquisition of the year.
Hotmail—originally HoTMaiL, to reference the Web markup language HTML—was established by entrepreneurs Sabeer Bhatia and Jack Smith, who were funded by the venture capital firm Draper Fisher Jurvetson. The firm’s Steve Jurvetson was one of the strongest supporters of the enterprise. The firm also funded Four11, another free e-mail service that was purchased by Yahoo! for $94 million in the same three-month period as the Microsoft acquisition.
In their meeting with Jurvetson (their twenty-first meeting with venture capitalists), Bhatia and Smith had pitched an idea for Internet-based database software. Jurvetson was unimpressed by the overall idea. As the two entrepreneurs packed up the rest of the presentation, however, he asked what other ideas they had. They mentioned another idea involving a free, advertising-supported e-mail service that would be available over the World Wide Web. One week later, Jurvetson gave them $300,000, despite the lack of a business plan, and would continue to remain a major influence on the company.
The result of that collaboration was Hotmail, which Jurvetson would lead through five rounds of financing to become one of the Internet’s first “killer applications,” a program whose usefulness soon made it ubiquitous and capable of driving competing “apps” from the market rapidly and efficiently. It was originally run on the FreeBSD, a free operating system.
Hotmail expanded its user base with amazing speed, in part due to its viral marketing strategy. The company appended an advertisement for Hotmail to every outgoing e-mail sent through its service, thereby selling itself every time a person read a message from a Hotmail user. At the time, the major source of e-mail was the offerings supplied by the various ISPs, which were often unreliable, limited, or subject to other difficulties. By the end of 1997, the Hotmail service had acquired more than 8.5 million subscribers.
In the mid-1990’s, Microsoft had come to realize that it needed to find new territory in which it could expand. The Internet, a place of rapidly evolving technology and flux, seemed the perfect new space in which to profit, and Microsoft began exploring the Web services and software already in place, with an aim to acquiring the companies and thus getting a preestablished Internet presence. In 1995, it launched a major online service provider, Microsoft Network (MSN), which was intended to be a direct competitor to the leader in the field, America Online.
In its campaign to claim the Internet, Microsoft purchased WebTV for $425 million in 1997. Microsoft tacticians soon realized that Hotmail would form another vital part of their online offerings. Acquisition of the service would allow Microsoft to capture Hotmail’s lead position by rebranding the product as its own. Later, in a similar strategy, Microsoft would introduce an instant messenging service.
The initial acquisition offer made to Hotmail’s owners was $120 million in cash. However, the partners were advised not to take the offer but to hold onto their valuable and rapidly growing company. It was not until intense negotiations had taken place over a period of several weeks that the partners ended up settling for $400 million in Microsoft shares.
Within one year after its acquisition and rebranding as MSN Hotmail, the Hotmail service had tripled in size; within another year, the company reported more than thirty million active members and supported seventeen languages, establishing Microsoft as a major presence in this segment of the online market.
In October, 1998, the U.S. Department of Justice filed a motion charging that Microsoft had forced computer makers to include its Internet Explorer with its popular Windows operating system. William Harris pointed to Microsoft’s acquisition of Hotmail as an example of the corporation’s monopolistic tendencies, testifying that the e-mail service had become “the default electronic mail system.”
The acquisition of Hotmail signaled an important shift in Microsoft’s strategy. In its early days, the company had worked to establish dominance over the desktop; by the mid-1990’s, it had nearly unshakable control of the market as well as the emerging Internet. The technological innovations introduced by entrepreneurs eager to take advantage of the Internet represented a pool of income and talent that Microsoft wanted to co-opt as quickly and efficiently as possible. Rather than beginning from scratch and trying to catch up with advances in the field, the company looked for the leaders in this new arena and moved to acquire them as quickly as possible.
The acquisition of Hotmail demonstrated that a “trade sale” could be almost as lucrative as an initial public offering and started a trend in which many entrepreneurs and investors worked on building companies with an eye to selling them as quickly and as lucratively as possible. The acquisition also demonstrated how much Microsoft’s innovation depends on competition. It was not until the appearance of Google’s Gmail service almost a decade later that Microsoft began expanding Hotmail’s features and storage space.
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Auletta, Ken. World War 3.0: Microsoft vs. the U.S. Government, and the Battle to Rule the Digital Age. New York: Broadway Books, 2002. This discussion of the case against Microsoft uses Hotmail as an example of the company’s monopolistic practices. -
Cusumano, Michael. Microsoft Secrets: How the World’s Most Powerful Software Company Creates Technology, Shapes Markets, and Manages People. New York: Free Press, 1998. Discussion of Microsoft business practices that uses Hotmail as an example of building the company through acquisitions. -
Microsoft Corporation. Inside Out: Microsoft—In Our Own Words. New York: Warner Business Books, 2000. This commemoration of Microsoft’s twenty-fifth anniversary looks at numerous aspects of the company from the viewpoint of its employees and includes several notes on Hotmail’s acquisition and development. -
Slater, Robert. Microsoft Rebooted: How Bill Gates and Steve Ballmer Reinvented Their Company. New York: Portfolio Hardcover, 2004. Discussion of how Gates and Ballmer reshaped their business strategy in order to take advantage of and establish control over the Internet. -
Wallace, James. Hard Drive: Bill Gates and the Making of the Microsoft Empire. New York: Collins, 1993. Discusses Microsoft and its evolution in the years before the move to the Internet.
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