I’m coming to you from Microsoft’s campus in Redmond, where just a few hours ago, Microsoft announced that the next version of the Bing search engine would be powered by OpenAI, the company that makes ChatGPT. There’s also a new version of the Edge web browser with OpenAI chat tech in a window that can help you browse and understand web pages. The in-depth presentation showed how OpenAI running in Bing and Edge could radically increase your productivity. They demo’d it making a travel itinerary, posting to LinkedIn, and rewriting code to work in a different programming language.

After the presentation, I was able to get some time with Microsoft CEO Satya Nadella.

Q: …A really interesting piece of the puzzle here is that a lot of what you described is powered by OpenAI and OpenAI’s technology. OpenAI CEO Sam Altman was onstage with you today. You have worked with OpenAI for 3 years, but you haven’t acquired them. Instead, you made a huge investment in them. Why work with an outside technology vendor for the largest software category in the world?
A: First of all, you have to remember the relationship with OpenAI and our cooperation with OpenAI has many facets. The most important thing is what we’ve done over the last 4 years to actually build out the core infrastructure on which OpenAI is built: these large models, the training infrastructure—and the infrastructure doesn’t look like regular cloud infrastructure. We had to evolve Azure to have specialized AI infrastructure on which OpenAI is built. And by the way, Inception and Character.ai are also using Azure. There will be many others who will use Azure infrastructure. So we are very excited about that part. And then, of course, we get to incorporate these large models inside of our products and make those large models available as Azure AI. And in all of this, we have both an investment return and a commercial return. And so we think we are well placed to partner. I will never assume that great partnerships can’t have great returns for our customers, shareholders, and Microsoft.

…Up to now, you’re absolutely right. Google has dominated this market by a substantial margin. We hope, in fact, if anything, having two or multiple search engines—there’s not just us, there’ll be other competitors—that by having more evenly spread search share, it will only help publishers get traffic from multiple sources. And by the way, advertisers [will get] better pricing. And so publishers will make more money, advertisers will make more money, and users will have great innovation. Think about what a great day it’ll be.

…First of all, look, I have the greatest of admiration for Google and what they’ve done. They’re an unbelievable company with great talent, and I have a lot of respect for Sundar [Pichai] and his team. So therefore, I just want us to innovate. We competed today. Today was a day where we brought some more competition to search. Believe me, I’ve been at it for 20 years, and I’ve been waiting for it.

But look, at the end of the day, they’re the 800-pound gorilla in this. That is what they are. And I hope that, with our innovation, they will definitely want to come out and show that they can dance. And I want people to know that we made them dance, and I think that’ll be a great day.

Q: …What was the moment in the development of the product where you said, “Okay, it’s ready. We should announce it like this”—with a pretty direct shot at the 800-pound gorilla? Was there a light switch that flipped for you? Was it a committee decision? How’d that work?
A: So when I first saw this new model… because the model that you saw today is the next-generation model—
Q: Is it GPT-4?
A: Let Sam [Altman, OpenAI CEO], at the right time, talk about his numbers.

So, it is the next-generation model, and it’s been done. We called it the Prometheus model because, as I said, we’ve done a lot to the model to ground it in search. [Prometheus turns out to be a snapshot of GPT-4 from early in training, and before any RLHF or other safety training was done.] So the search use case is pretty unique, and so, we needed to ground it in that as well. So when I first saw the raw model back in the summer of, I would say, 2022, that’s where I thought that this is a game-changer in terms of the search category, aside from everything else that I’m excited about, because I do care about Azure having these APIs even.

So we’ve been at it. In fact, I’ll never forget my first query I did on the model, which, I think for me, growing up, I always felt, if only I could read Rumi translated into Urdu translated into English, that is my dream. I just put that in as one long query, and it was magical to see it generated. And I said, “Man, this is different.”

…It’s like how Microsoft had to pivot for the cloud to rethink Exchange. It was not an Exchange server. It was Exchange as a service or what we had to do with our server infrastructure. We had to rebuild, essentially, a new core stack in Azure. So every time, with transitions, you have to essentially rewrite it. That’s how I think about it. The second thing is you also have to think about the business model. Sometimes these transitions are pretty harsh. I’ll tell you, the last transition from having the high share server business with great gross margins to saying, “Hey, the new business is called cloud, and it’s going to have one-fourth the margins” as the new news was pretty harsh, but we made it.

Whereas in here, I look at this, there are two things. One is it’s absolutely new tech, but it builds on cloud. So that’s one place where we already have relevance, and so, there is the next generation of cloud. And second, in search, the economics are interesting, which is that we already have a profitable business but with very little share. And so, every day, I just want a few users and a little bit more gross margin. So, yeah, I did see, I think, a tremendous opportunity for us to make some real progress here.

Q: So the model right now is an $11 billion a year revenue business, something like that?
A: Something like that. I think Amy [Hood, Microsoft CFO] is going to talk about—I don’t know how she wants to talk about it. Yeah.
Q: Incredible hobby. I wish I had an $11 billion a year hobby. You want to grow that into a real business. You want to take market share. But obviously, the new technology does not have the same cost structure as the old search query. I’m sure that whatever you’re doing with OpenAI, it’s more compute-intensive, and then obviously you have a partner sitting in the middle of it. And then the monetization model is still search ads. It’s direct response search ads. But as you bring more and more content on the screen, that model might change or the price of those ads might change.
A: It’s so wonderful. Think about what you just said. You said, “Okay, here is the largest software category where we have the smallest share”, and what you just painted out is an unbelievable picture of incremental gross margin. If [former Microsoft CEO] Steve Ballmer saw that, he would’ve lit up and said, “Oh my God.”

Very few times in history do opportunities like that show up where you suddenly can start a new race with a base where every day is incremental gross margin for you and someone else has to play to protect it all: every user and all the gross margin.