BILL GATES' NEXT CHALLENGE His aim: to lead the information revolution of the 1990s. That will land Microsoft, already the envy of its rivals, in a vast new competitive free-for-all.
By Alan Deutschman REPORTER ASSOCIATE Mark D. Fefer

(FORTUNE Magazine) – MICROSOFT'S wealth and power just grows and grows. On October 28, the day CEO Bill Gates turned 37, the stock closed at $88.50 a share. On paper, the value of his 30% stake reached $7.3 billion. He could buy out an entire year's production of his 99 nearest competitors, burn it, and still be worth more than Rupert Murdoch or Ted Turner. Microsoft's $25 billion market value tops that of Ford, General Motors, 3M, Boeing, RJR Nabisco, General Mills, Anheuser-Busch, or Eastman Kodak. Worldwide, 120 million PCs run on Microsoft's MS-DOS operating system. By 1994 the figure should reach 140 million. Seemingly untouched by the troubled economy, Microsoft hired 2,500 people in 1992. It plans to add that many again in 1993, bringing its head count to 14,500 -- an increase of more than 50% in just two years. The company netted $200 million last quarter, twice as much as Apple Computer, the biggest PC maker. In the past four quarters revenues rose by half, to $3 billion. Microsoft outsells its three largest competitors -- Lotus, Novell, and WordPerfect -- combined. The biggest potential threat to this bonanza: a Federal Trade Commission investigation into competitors' allegations of unfair and monopolistic trade practices. But few expect lasting damage to the company. Software analyst Rick Sherlund of Goldman Sachs, among others, believes the FTC will announce a decision soon, though Gates isn't so sure. Sherlund predicts that Microsoft will submit to some regulation, but the feds won't break it up or force major changes in how it does business. Although Microsoft looks to emerge more or less intact, it faces formidable challenges nonetheless. Looking ahead, the company's sales and profits won't continue to rise at such a consistently explosive pace. In 1993 Microsoft will have to push hard to establish its new PC operating system -- Windows NT, which fosters better networking, among other things -- in the high end of the market. And there's no guarantee that Microsoft's strength in today's PC market will make it a winner in the vast technological upheavals ahead. By 1995, the way software is written will change utterly. The new approach, called object- oriented programming, could throw the game wide open. Apple and IBM have teamed up in a joint venture, Taligent, to create a new standard for operating systems based on it. Their goal: to wrest control of personal computing from Gates. Microsoft will also have to fight to get in on the biggest new market in electronics -- interactive TV, which will merge the PC and the television set into a single device that even computerphobes will like. Microsoft must forge alliances with the powers that be in consumer electronics, telecommunications, broadcasting, and cable TV, or risk getting shut out of the 85% of American households that still don't own PCs. As computing and communications technologies rise and converge in the TV-PC, Microsoft will have to fend off a broad array of rivals it has never dealt with before. The company's competitive zeal intimidates and angers many in the PC business who play for enormous stakes but naively yearn for the collegial counterculture ethos they started out with. Naturally enough, Microsoft's extraordinary success, especially at a time when others are struggling, provokes envy. Microsoft bashing has become so endemic that during the charity chili contest at November's Comdex, the industry's annual supershow in Las Vegas, Microsoft's beans were openly booed. If anyone is up to these challenges, it's probably Bill Gates. Nine years ago, Gates explained his vision to FORTUNE (''Microsoft's Drive to Dominate Software,'' January 23, 1984). Back then his company was comparatively puny, with 500 employees and annual revenues of only $50 million. But his prescience was extraordinary. He predicted that the industry's new standard for operating systems would be Microsoft's Windows, then a laughably crude prototype aimed at giving PC screens the friendly look of the Apple Macintosh. WITH RESILIENCE and tenacity, Gates succeeded in imposing his own long-term strategy on the rest of the industry. Windows flopped at its debut, and by 1986 Gates' advisers were pleading with him to abandon it. Every other major software company lined up behind IBM's OS/2 instead. But Gates persevered -- and ultimately prevailed. When OS/2 appeared in 1988, it was sluggish and took up too much memory for most PCs. Microsoft dramatically improved Windows, and its fourth version, Windows 3.0, finally took off. This October, Gates assembled his 7,200 Seattle-area staffers in the huge Kingdome arena, home of the Seahawks and Mariners, for the company's annual employee meeting. He called his speech ''Microsoft's Vision.'' He talked about how the company's current success sprang from the bets it made years ago and stuck with. And he outlined the bets Microsoft was making now that should pay off in the Nineties -- multimedia, interactive TV, object-oriented programming, far-out projects like a wallet PC. His immodest aim: to transform not just Microsoft, or even the computer industry, but how people everywhere tap into information. In a sense Microsoft has never invented anything -- Gates bought most of the original DOS from another programmer -- except perhaps the idea of software as big business, no small achievement. Software is a hybrid, an amalgam of high tech and consumer packaged goods; brand names and the ability to hold on to consumer confidence are as important as what the product actually does. Now, for the first time, Microsoft finds it must speculate in totally new, ground- breaking technologies to ensure itself a central role in the future of computing. This report offers an inside look at Microsoft's management -- and scrutinizes Gates' vision of how information technology will evolve over the rest of the decade. Will he turn out to be as farsighted this time as he was back in 1984? Great empires, ancient (Rome) or modern (GM, IBM), tend to grow fat and complacent, forsaking austerity as they get sucked into believing in their own invincibility. Don't count on this fate befalling Microsoft, at least while Gates is in charge. The culture that got Microsoft where it is today remains remarkably strong, its values uncorrupted. For one thing, Microsoft is frugal. At November's Comdex, two officers of the company shared a hotel room. While Gates can splurge with his own cash -- the $380,000 Porsche 959, the $35 million house he's building -- he remains unfailingly tight with the company's money. He even flies coach to Japan. Recently Gates' administrative assistant, swamped by phone calls and letters, asked if he could hire someone to help out. Gates' response: ''Who am I, the Queen?'' Then there's the Microsoft work ethic. Rather than gloating over all they've accomplished, Gates and his followers remain as relentlessly industrious as ever. Pete Higgins, 35, who's in charge of word processors and spreadsheets, steals time by shaving as he drives to the office. ''Complaining about how hard you work at Microsoft,'' he says, ''is like complaining about the weather in Seattle.'' Everyone knows that Microsoft is fearsome and dominant -- everyone, that is, except the people who work there. ''It's etched in our brains: Don't get complacent,'' says Jeff Raikes, 34, head of U.S. sales, a protege of Gates' and something of a look-alike. David Coursey, editor of P.C. Letter in San Mateo, California, says Microsoft has a ''siege mentality.'' Do the Microsoft people suffer from a ''reality disconnect'' here? Not necessarily. Microsoft has failed in a number of key markets, beaten by smaller, more sharply focused competitors. Network operating systems belong to Novell, the down-home, Mormon-run company in Provo, Utah. Databases and programming languages are dominated by Borland International, the Scotts Valley, California, firm headed by motorcycle-riding Philippe Kahn. Personal finance software is led by Intuit in Menlo Park, California, co-founded by Scott Cook, a former Crisco brand manager at Procter & Gamble. BUT MICROSOFT is unique in trying to compete in virtually every niche -- and it never, never surrenders. ''Like the Japanese, they get it wrong several times before they get it right,'' says Richard Shaffer, editor of ComputerLetter in New York City. ''But they have the money, the market recognition, and the momentum to hang in there until they finally get it right.'' Microsoft ranks No. 1 overall in software, but in most categories of applications it's No. 2, No. 3, or No. 4 -- and obsessively focused on the market leader. When Raikes was in charge of Microsoft's word-processing software, Gates challenged him to learn everything about Pete Peterson, who ran the top competitor, WordPerfect. Raikes took Gates literally: He even memorized the names, ages, and birthdays of Peterson's six children. To save money, ease communication, and preserve that underdog spirit, Microsoft intentionally understaffs its product teams. Gates wants to have fewer spreadsheet programmers than Lotus. Microsoft is organized into small bands of ''people with a mission who can pound, pound, pound,'' says sales head Steve Ballmer, 36, striking his palm with his fist. A 50% increase in Microsoft's work force over just two years seems to violate the company's strategy of keeping head count low, but many of the new recruits are to work either overseas or answering questions in an expanded customer support department. For its crucial line positions -- programmers and product managers -- Microsoft can still pick with extreme selectivity from the graduates of elite universities and business schools. The chosen few get lots of responsibility right away. Gates earns high marks for pushing authority down through the ranks. He limits his own role largely to conceiving and spreading the vision, helping sell to key customers, and vetting R&D closely. Products chief Mike Maples, 50, an amiable Oklahoman who spent 23 years at IBM, goes on some two dozen off-site retreats a year with younger managers and asks them to look at Microsoft's culture -- both its strengths and the weaknesses they could give rise to. We're smart -- how not to be arrogant? We're aggressive -- how to make sure we negotiate win-win contracts rather than going for all we can get? Gates dismisses most Microsoft bashing as mere griping by Lotus, Borland, and WordPerfect. After all, leading an industry -- any industry -- doesn't mean you'll win popularity contests. Gates recently met with top executives of Disney, which is widely admired on Wall Street as a well-managed business. Gates was surprised to discover that inside Hollywood, Disney is hated. He wonders: ''Why weren't there more stories on the small businesses Sam Walton put out of business with Wal-Mart? Most success is driven that way. In its heyday, IBM was never loved.'' In some ways, Gates sees his company taking over the mantle of market leadership once held by IBM, which gave Microsoft its big break in 1981 by tapping it to provide the operating system for the original PC. ''Our customers want us to be bigger and better,'' Gates says. ''They're looking at the trust and confidence they had in IBM -- that's disappeared. The one thing they miss from the old days is someone they can turn to, who will stand behind what they're going to do. People say, 'Step up to this because IBM is fading and there's a vacuum.' Microsoft is moving into that role.'' Gates wears his success inconspicuously. Except for the Porsche and the house, nothing about him even whispers ''America's richest man.'' In public he seems colorless, unprepossessing. Nor is he a stirring speaker, though he can mesmerize an audience when he holds forth on a technical subject he really cares about. He dresses casually at the office, like everyone else at Microsoft's college-like campus 15 miles from Seattle in Redmond, Washington. At a November press conference, the jacket of Gates' rumpled, off-the-rack suit was fastened by the bottom button, making it bulge awkwardly. ''He'd rather talk about technology than himself,'' says Susan Hauser, a Microsoft sales representative in New York City whom Gates has accompanied on visits to customers. ''He's so down-to-earth that clients feel comfortable with him right away.'' A reputation for intellectual arrogance still clings to Gates. He sometimes seems aloof when asked to discuss issues that aren't particularly new or complex, responding like the smartest kid in class who feels he's being held back by the others. Says David Coursey of P.C. Letter: ''Bill has tried to become more charming, but it's sort of like Dan Rather trying to be cuddlier.'' A harder-edged persona emerges at headquarters than in public. Gates demands that his colleagues be remarkably well informed, logical, vocal, and thick- skinned. FORTUNE recently sat in on a so-called ''Bill meeting'' with the teams that develop and market programming languages. A product manager, just five years out of Princeton, opened with an energetic, rapid-fire, and confident analysis of the market. Gates interrupted often, questioning facts and assertions. Always calm and controlled, at times witty or profane, he shot criticisms and challenges at the youthful managers, who stood up to the chairman as if he were a classmate. Gates still presides over the ''spec review'' for every new or revised key product, scrutinizing its features point by point with its programmers and managers. It would be hard to find a CEO in any industry with such in-depth knowledge of his company's products. Vice president Brad Silverberg says Gates recalls details from meetings six months earlier -- even if the product team doesn't. Gates reads voraciously and devours detailed information. One frequently used term in the Microsoft lexicon is ''granularity'' -- meaning fineness of detail. Another rumpled, frugal billionaire with a strong analytical bent has become a friend of Gates': Warren Buffett. They went to the last two Washington- Nebraska football games together. ''I'm not competent to judge his technical ability, but I regard his business savvy as extraordinary,'' says Buffett. ''If Bill had started a hot dog stand, he would have become the hot dog king of the world. He will win in any game. He would be very good at my business, but I wouldn't be at his.'' Gates comes by his prowess in business naturally. Says Vern Raburn, CEO of software maker Slate Corp. and a former Microsoft vice president: ''It's not widely understood that Bill grew up around power and is very comfortable with it.'' His parents -- Bill, a prominent Seattle lawyer, and Mary, a regent of the University of Washington -- sit on many boards. U.S. Senator Brock Adams was a family friend, and young Bill did a stint as a Capitol Hill page. Raburn has been a friend and observer of Gates since 1976. The frantic quality is gone, Raburn says, and Gates no longer goes without sleep -- or a shower -- through marathon bouts of work. ''But has Bill changed? Fundamentally, no.'' SEARCHING FOR ideas on how to run his company, Gates has called on such elder statesmen of computerdom as David Packard of Hewlett-Packard and Digital Equipment founder Ken Olsen. He is often likened to Olsen; both are those rare entrepreneurs who combine the technical expertise with the business skill necessary to start and run a great high-tech company. But Olsen, who steered Digital through his mid-60s, eventually lost touch with changes in the computer market. ''I won't stay on when I'm his age,'' Gates pledges. Given all Gates has accomplished, why does he still push so relentlessly, spending half his time on the road, often seeming somewhat weary? Why doesn't he move to Nepal, or take on a totally new challenge -- perhaps starting a company in biotechnology, a field that fascinates him? ''I have the freedom to do whatever I want,'' he says. ''We have this challenge of playing a leadership role in the information age. We're very early in that. It's the only industry I think that's more interesting than biotech. Maybe ten years from now we'll be far enough along, and I'll put my head up and look around.''

Gates' long-range vision will take at least a decade or two to realize. He calls it Information at Your Fingertips. ''The idea here is very ambitious,'' says Gates. ''Any piece of information you want should be available to you.'' No need to remember whether a particular piece of data is stored somewhere in a spreadsheet, a database, a slide presentation, or a long memo. Simply ask, in your own words, what you need to know. On-line data and electronic mail enriched with video and sound will make the PC more a communications tool than a computing device. At its core, of course, will be Gates' software. He wants Windows, in one % guise or another, to find its way into devices of every conceivable size and purpose: PCs that recognize handwriting and speech, hand-held pocket-size PCs, notebook PCs and desktop PCs, TV-PCs and wall PCs and whiteboard PCs, PC networks that CEOs will entrust with their most vital enterprise-wide information flows. Microsoft can afford to look far ahead, buoyed by recurring revenues from its key products. Applications software -- word processing, spreadsheets, databases, and the like -- is the high-margin part of the business and accounts for nearly half of sales; another 40% comes from DOS and Windows, which are sold at lower margins to build market share. The balance sheet is robust: Totally free of long-term debt, Microsoft sits on $1.5 billion in cash and liquid short-term investments, more than its annual operating expenses. R& D comes to $350 million a year, 13% of revenues (vs. 11% for Merck and 10% for IBM). Gates and Ballmer seem unconcerned about the conspicuous slowing of the company's phenomenal growth or the probable narrowing of its 25% net profit margins. Nor is Gates worried by the prospect that if financial results slide a bit, some Wall Streeters may dump the stock. (The shares fell from $95 to $88.50 on November 23 after Sherlund of Goldman Sachs, concerned about a price war in Europe, cut his earnings estimates.) ''This company will have its ups and downs in profitability and products that fail,'' Gates says matter-of- factly. Sherlund expects Microsoft's revenues to increase a mere 30% for the fiscal year ending in June, down from two years of 50% or more. In the fiscal year after that, ending in June 1994, Microsoft will bring out new versions of all its major products. It will then reap the rewards of a canny strategy adopted years ago. Having created an enormous installed base by licensing its operating systems on the cheap to hardware makers, Microsoft charges retail customers significantly more for DOS and Windows upgrades. Sherlund figures that if 10% of the by then 140 million DOS users go to their local PC stores to buy the new version, DOS 7.0, in 1994, and 25% of the by then 40 million Windows users trade up to Windows 4.0, that will bring in some $1 billion to Redmond from the upgrades alone. ''That's what people miss when looking at Microsoft's momentum,'' says Sherlund. ''They sell the razor blades for more than the razor costs.'' Another reliable cash generator: applications software for the Macintosh, a lucrative market that Microsoft dominates. Forging into new markets will be much harder. A major test will come in 1993 with Windows NT (for ''new technology''), a more powerful operating system written from scratch. (Repeated delays have led to jokes that NT really means ''not there.'') Like IBM's OS/2, NT incorporates features such as multitasking -- handling several assignments at once -- that have long been associated with Unix, the system developed by AT&T and used in many workstations. While Windows 3.1, introduced last April, should continue to gain on the desktop, NT gives Microsoft entree into the management information systems of sophisticated corporate clients, such as Wall Street financial institutions. Unix, while proven through more than 20 years of experience, is tough to work with and comes in any number of hardly uniform versions. Gates predicts that in its first year, NT will outsell Unix ''by a factor of five or ten.'' That sounds overconfident; few in the industry expect Microsoft to take over this market. Sherlund of Goldman Sachs thinks the field will be highly fragmented, with at least five major players: Windows NT, IBM's OS/2, Univel (a joint venture of Novell and AT&T), Sun Microsystems' Solaris, and Steve Jobs' NextStep. A FIERCE BATTLE is shaping up for the mid-Nineties, when that mysterious thing called object-oriented programming should arrive in full force. It could create the same kind of seismic rift in the market that Windows did, and players that pick the wrong side could fall into the chasm. Object-oriented programming, or OOP, means constructing software out of separate, reusable, prefabricated building blocks or modules (''objects'') that can easily be changed or removed for repair work without bringing down the whole structure and requiring it to be rebuilt from scratch. With OOP, ambitious new programs can be written with around 20% of the hundreds of thousands of lines of new code previously required. Steve Jobs claims that with his NextStep, five programmers can do in three to six months what normally takes 50 of them more than two years. Cairo, the Microsoft object-oriented operating system, is scheduled to debut in 1995. Microsoft brings to the OOP horse race its market presence, considerable brainpower, and strong ties to PC hardware makers worldwide. But it faces a major challenge in this field from the Apple-IBM joint venture, Taligent. And Jobs could be a dark horse. He's been working on OOP for six years. While promoting NT, Gates is using his public appearances to evangelize for two near-term steps toward Information at Your Fingertips: pen-based computers and multimedia PCs. Silicon Valley has grown skeptical about the tablets that recognize handwriting and replace a mouse with specially designed styluses; the technology hasn't lived up to its early hype. But Gates implores the critics to wait for improved hardware arriving in 1993. One example: the Grid Convertible, a pen tablet that can be turned into a conventional notebook computer, keyboard and all, with a flip of its top. Convenience is the great advantage of pen PCs. They offer a good solution for professionals -- doctors, for example -- who need access to detailed information while on their feet. Gates is busily spreading the gospel of multimedia, another field he describes as ''very important but taking time to develop.'' Microsoft held its first multimedia conference a decade ago. In 1986 it began work on Encarta, a full encyclopedia on CD-ROM (compact disk read-only memory). Microsoft stuck with Encarta even though market acceptance of CD-ROM has proved disappointing; drives for these disks retail for $500 today, a lot compared with the $1,000 price of an entire PC. Before long, however, these CD readers will be standard on PCs. Software titles will doubtless sell in greater numbers, and CD-ROM prices -- now typically $80 or more per disk -- should fall dramatically. Each disk holds the equivalent of 350,000 typewritten pages. Rob Glaser, 30, head of Microsoft's multimedia efforts, bluntly describes most CD-ROM titles as ''shovelware'' -- the manufacturers shovel in whatever they can find. (One choice topic: the complete history of cows.) But that's changing. Currently around 15 CD-ROM titles are better than anything you can get in other media, Glaser figures, and another 40 are pretty good: ''We're reaching toward critical mass.'' Indeed, among the endless exhibitions at the November Comdex, the multimedia booths got the most attention. Some of the most promising CD-ROM titles are coming from Microsoft. Following the success of its Cinemania movie guide, which has 19,000 capsule reviews, bios of actors and directors, still photos, and sound bites, Microsoft released the delightful Musical Instruments in December. It's an educational disk that recounts the history of instruments from all over the world and illustrates their sounds -- a violin, for example, in bluegrass and a Bach concerto. The Encarta encyclopedia will follow early in 1993. This marks a turning point far more significant than the introduction of just another piece of software. For the first time Microsoft is selling information, not just the means to manipulate it, thus entering a wholly new competitive environment. As Gates sees the world developing, a bit further out -- perhaps in two to five years -- will come a truly explosive new market, interactive TV. Here's the premise: Only 15 million American households have personal computers. The figure is increasing now that name brands sell for under $1,000, but it's nothing next to the 93 million households that have at least one TV. With the advent of high-definition TV, the box will display digitized information, just like a PC. What if the two could merge into one appliance? And what if all those TV-PCs could be linked by fiber-optic cables with the capacity to transmit vast amounts of information to and from the home? The idea isn't new, but the cost of installing all those cables is high. By the late 1990s phone and cable TV companies are likely to make the investment anyway, attracted by the huge potential market for pay-per-view entertainment. Once the hardware is in place, the possibilities for more creative uses are intriguing. How will TV-PCs work? Microsoft began thinking about the issues in the late 1980s. The key was attracting people who wouldn't go near computers. To be popular, the company concluded, the device -- microprocessor, CD drive, and all -- must sell for $500 or less. It would have to be exceptionally easy to use -- ''plug and play,'' they call it in the industry. No keyboard. Just turn on the TV monitor and insert a CD-ROM disk. The gimmicks that made Windows friendly and useful for the typical PC -- pull-down menus, multiple overlapping windows -- would be too complicated for the computing-impaired. Instead, the screen would use big, chunky ''buttons.'' Viewers nestled comfortably on their sofas would simply point at the buttons with a cordless ''air mouse'' much like today's videogame controls. Entertainment and services will be the first big markets. Compressing digital signals will bring 150 or more cable TV channels to the home, but it could take ten minutes of dizzying channel flipping to survey all the offerings. What if you could ask an on-screen TV guide: Any Schwarzenegger flicks on tonight? Turns out that one of Arnold's pix is on pay-per-view. ^ Should you shell out the four bucks? To make sure, click on a ''coming attractions'' video clip. Then call up the Siskel and Ebert review. Hey, it got two thumbs up. There's more. While watching the San Francisco Giants, you'll be able to check the scores of other games under way, scan the lineups, or see a ''baseball card'' with the stats of any player. Switch to a Michael Jackson video on MTV: You can send him fan mail, order the CD, or call up subtitles with the lyrics if you can't make out his words. Flip to Beverly Hills 90210. That cool blouse Brenda is wearing -- you can order it for your teenager. Click. The latest stock quotes appear. Scrutinize a company's financials, then place a buy order directly with your broker. To realize every couch potato's fantasy of at-home, on-line information, Microsoft is talking with cable TV, phone, and satellite companies plus ''content'' providers such as publishers and moviemakers. In Microsoft's planning exercise, the $500 pricetag imposed sharp limitations. Windows, which takes up eight to ten megabytes of memory, had to be pared down to a one-megabyte version. The new ''modular Windows'' can handle 75% of the functions of the full-fledged version while taking only 10% as much memory. Impressive? Yes. But why does the world need Windows for interactive TV, which is more a consumer electronics product than a computer? The industry standard could just as easily be set by one of the hugely successful Japanese videogame outfits, Nintendo or Sega, which are software powerhouses in their own right. The 3DO Co., a startup that has Silicon Valley buzzing, is aiming at this market too. Indeed, why Windows? Microsoft argues that its flag bearer would encourage programming innovation by bringing to interactive TV the thousands of software developers who currently write programs for PCs. Remember the Wang machines of the 1970s that did only word processing? They died when the real revolution in computing came and developers could write their own applications. Research chief Nathan Myhrvold, 33, thinks that pattern will recur in consumer electronics, with a standard operating system emerging after a period of ''incredible chaos.'' Beyond the mid-1990s, Microsoft's success will depend on its ability to hatch and promote radical innovation. To walk on the technological edge, visit a bit with Myhrvold, Microsoft's most prolific E-mail author (he sends six megabytes' worth a year, more text than Shakespeare wrote). He reports % directly to Gates, a powerful statement about the company's commitment to translating ideas into products. ''We have to take computing off the desktop and into the pocket, the wallet, the briefcase, the car, anywhere there's information,'' says Myhrvold. To demonstrate the point, he empties his pockets. What's there? His Microsoft pass card and Lexus door key. Both are digital (the toothless key uses a digitally encoded radio signal to unlock the doors). He opens his wallet, which holds IDs, receipts, credit cards, and photos of his kids. All can be converted into digital form. As computer memory continues to get cheaper, the barriers to digitizing virtually any form of information will drop. Myhrvold also carries a pager, which has icons and a tiny screen for text messages -- somewhat like a computer. Why not create a ''wallet PC'' combining it all? Ten years from now, Myhrvold goes on, you'll send a video Christmas card with special effects rivaling those in Terminator 2. You'll splice your kids' faces into TV shows. Jim Allchin, head of the Cairo team, envisions the ultimate in miniaturization -- a wristwatch PC. Output isn't a problem; the watch would project a display onto any nearby wall. Work needs to be done, though, on how users would load information into the device, since it would be smaller than a keyboard or a mouse or even a pen. IT'S STILL to be seen whether Microsoft -- essentially a high-volume, low- cost producer of packaged goods -- can continually reinvent itself to keep up with new technologies and changes in the market. Is Gates' crew, so accustomed to an upward trajectory, ready for the turbulence ahead? ''Management is the strongest in the software industry,'' says analyst Betty Lyter of Montgomery Securities. ''But Microsoft has never been tested by a time of slow growth, or a quarter when expenses got out of control. You really don't know how good a management team is until they've gone through bad times.'' Even IBM and GM faltered after decades of success. But by that time, the visionary founder was no longer in command. Granted, Microsoft is much bigger than Gates. Richard Shaffer of ComputerLetter figures that ''even if Bill were replaced by the anti-Bill,'' it would still take a decade for the company to fall apart. But Gates isn't leaving, and he isn't letting up. Says Warren Buffett: ''I'd just bet on him.'' Nobody has lost money doing that yet.