August 18, 1999

Like most technology revolutions, the Internet is sweeping across the world in waves. The first wave revolutionized how we get information and communicate, changing the way we live, work and learn. Now we’re set to ride a second wave, one that will have as much impact on the world of physical products as the first wave had on the world of information. Because as bandwidth soars and the PC is augmented by everything from handheld wireless devices and e-books to auto PCs and interactive television, we’ll see a massive transformation of products and services from physical to digital form.

It’s not surprising that one of the first products to start seeing this transformation is recorded music. Since the 1980s transition from analog LP to compact disc, music has been in digital form anyway—you just had to buy a physical object with the bits burned into it. Now, with Windows Media Audio, MP3 and other formats, you don’t need a physical CD or a CD player to listen to music. The bits are wherever you want them—on your PC, palm-sized computer, or handheld music player. That’s great for music lovers: you can select entire “virtual CDs,” simply download the tracks you want, or mix and match different artists. Free the bits from the physical product (in this case, the CD), and the music is also set free.

The same process is happening to software. Although most software retailers have been selling online since the early years of the Internet, for the most part they have continued to deliver the bits physically, on floppy disks or CDs. But as access to the Internet has increased, we’ve seen rapid growth in the amount of software being digitally distributed over that global network. And as bandwidth continues to explode, the size of program it’s practical to download will grow exponentially. In a few years most software will be delivered over the Internet—or via wireless networks to handheld devices. Software updates will be automatic and transparent, so you’ll always have the latest release. For businesses, network administration will be much simpler.

Books are also an obvious candidate to go digital, and I believe that will happen broadly in the next five years. We’re already working with other industry leaders and publishers to establish an open e-book standard. And we’re seeing incredible breakthroughs in screens, hardware and the software that lets you read the text. At Microsoft we made a key advance in font display technology called ClearType, which makes it as easy to read long texts on a screen as on the printed page. Color LCD screens consist of pixels that are themselves made up of red, green and blue sub-pixels, meaning that the screen has a much better theoretical text resolution than is being utilized today. ClearType uses this fact to fool the eye into perceiving that higher resolution.

E-books will change the way the world reads. You’ll be able to store hundreds of novels on a device the size of a paperback. People with disabilities will have the same access to books that everyone else has. Every book will be available in large print—or whatever font size of style you like. And every book will be an audio book, because software will translate any e-novel into the spoken word. In fact, audio books are already going digital. And the digital version is less costly than the cassette, because there’s no hardware to make, package or distribute. Plus you don’t have to buy the entire book—you can simply choose extracts. You can already buy Garrison Keillor monologues for about a dollar apiece.

As products morph from physical to digital, the economics of each business will be dramatically transformed. Part of this is simply a result of a decline in the cost of goods, thanks to a reduction in the use of physical materials and manufacturing processes. But inventory costs will also shrink due to the increased efficiency of “manufacturing” and the effect of streamlining merchandising and distribution. Going digital also enables real mass customization for the first time, together with entirely new concepts of self-service. But the most fundamental change to how companies do business will be a massive increase in the variety in pricing models.

Do you want to read a book or listen to music once, or pay for lifetime use? Would you prefer to buy everything a particular author or rock group produces under a package deal? Do you want to buy software, or rent and have it updated automatically? Would you like to sample the product for free, with an option to buy later? How do you want the bits delivered—immediately, at a premium price, or overnight, at a discount? Do you want automatic updates and new editions?

These almost limitless variations on the fundamental commercial pricing model will revolutionize the way companies do business. At the same time, however, the fact that it will also be trivial to make perfect counterfeit copies of an increasing number of products raises tough issues about how intellectual property rights are protected. Digital rights management is an important focus for us at Microsoft.

Whatever pricing option you choose, there’ll also be another aspect of your purchase that will soon be digital rather than physical—the bill. At present, U.S homes receive 15 billion paper bills each year. The overhead and inefficiencies in this process are phenomenal. About $6 billion is spent preparing and delivering those bills, $4 billion responding to them, and another $1.5 billion collecting and posting payments. That’s an $11.5 billion reason why we’ve won so much support from billers and banks for our TransPoint e-bill joint venture. Paying bills digitally saves billers money and offers greater marketing opportunities, plus it’s easier and cheaper for consumers.

As for the physical products you’ll still need to buy: you’ll probably pay for many of those with e-cash, because dollar bills are going digital too.