Microsoft’s Crown Jewel: What Happened To Hotmail?

Executive Summary:

Hotmail is a free as well as paid service that allows users to send and receive emails over its web client.

Hotmail was shut down in 2013 because Microsoft wanted to move users towards Outlook, which had a much better reputation and cleaner codebase.

What Is Hotmail?

Hotmail is a free as well as paid service that allows users to send and receive emails. Once registered, users would receive their own email address under the domain.

Hotmail was initially made available as a web-based email service but later also offered a desktop version.

The email account came with a variety of features, including:

  • 5 gigabytes of free storage (later upgraded to higher amounts)
  • Being able to attach files
  • The ability to listen to MP3 and WAV files such as songs or voice messages
  • Filtering and tagging emails based on categories
  • Automated spam protection

… and dozens more. The paid version of Hotmail simply extended some of these features, for example by offering larger storage capabilities.

The service was ultimately shut down in the summer of 2013 and folded into Outlook. How it came to be, who is behind it, and what ultimately led to its shutdown will be covered in the coming chapters.

What Happened To Hotmail?

Hotmail, formerly headquartered in San Francisco, California, was founded in 1995 by Sabeer Bhatia and Jack Smith.

The two met a few months prior when they joined Firepower Systems to design Power PCs. Bhatia, an Indian native, had immigrated into the United States in 1988 after Caltech had offered him a very rare transfer scholarship.

After his graduation, he went on to work for Apple as a chip designer until eventually joining Firepower Systems. Bhatia and Smith became immediate friends over their shared desire of wanting to start a business.

The first idea that the two were working on was JavaSoft, an internet-based personal database. However, they soon pivoted towards creating an email client for the web, the first of its kind.

In fact, the two thought that their idea was so powerful that they wouldn’t even present it in front of investors over fears of the product being copied. However, after dozens of rejections, they finally let the cat out of the bag.

During one of his presentations at Draper Fisher Associates, Bhatia finally revealed his idea for what would eventually become Hotmail. After some intense negotiations, the founding team managed to raise a seed round of $300,000 at a $2 million valuation.

The funding allowed the two to quit their jobs and focus on building out Hotmail on a full-time basis. On July 4th, 1996, after months of hard work, they finally unveiled Hotmail to the public.

The product, being essentially the first of its kind, spread like a literal wildfire. By early January 1997, Hotmail had already amassed over one million registered users, less than six months after being launched.

One of the major reasons for its instant popularity was the fact that members would use as their email registrar. This essentially acted as a quasi-marketing channel for the product. The more users began sending out emails, the more would encounter the product for the first time.

This ultimately allowed the company to grow at an exponential rate. A month after reaching one million registered members, Hotmail already doubled its user count. In order to keep up with the ever-increasing demand (the product suffered multiple outages as well), CTO Smith implemented a completely new architecture.

The growth, furthermore, allowed the team to raise additional rounds of funding. In April, Menlo Ventures as well as existing backers Draper Fisher Associates invested another $3 million into Hotmail soon after it reached three million users.

At the time, Hotmail was generating revenue through advertising that was displayed on its website. To diversify the service, it also added digital greeting cards in September. By October, Hotmail was considered to be one of the world’s hottest internet commodities.

That month, it recorded its eighth millionth subscriber, with an additional 60,000 people signing on every day. Hotmail had almost as many users as AOL and was only trailing browsing pioneer Netscape.

Existing backer Draper Fisher Associates even contacted the founders to provide them with more cash, which they eventually rejected. Not giving up additional equity would luckily turn out to be the right move.

After months of negotiating, Microsoft announced that it would acquire Hotmail on December 31st, 1997 in an all-stock deal. Although Microsoft did not reveal the purchase price, it was later revealed that 2,769,148 shares of Microsoft had been exchanged – worth around $400 million at the time.

The reason why Microsoft acquired Hotmail was to power its MSN (Microsoft Network) portal. Not long before, it also signed a licensing deal with Inktomi to power search on its platform. Back then, and until the arrival of Google and mobile phones, the overwhelming majority of users were accessing the internet via portals. AOL and Yahoo were the dominant ones while others, such as AltaVista, Microsoft, or Netscape, even pivoted their businesses towards becoming one.

Interestingly enough, Yahoo had just acquired one of Hotmail’s biggest competitors, Four11, for $92 million to power its own portal. In the coming months, Microsoft would experience first-hand how tough it was to run an email platform.

In the early days of email, many platforms were riddled with spammers who would use those services for malicious purposes. In January 1998, just weeks after the acquisition, Microsoft filed a lawsuit against eight spammers over the unsolicited usage of the domain. For example, a fake [email protected] domain had sent out various emails about a potential premium service, asking people to sign up for $10 per year.

In June, Hotmail celebrated its first win against those spammers. Three separate companies, namely LCGM Incorporated, Palmer & Associates, and Financial Research Group, were ordered to pay Hotmail $275,000, $55,000, and $7,500 in fines, respectively.

A month later, Microsoft finally completed its Hotmail integration and was able to display and promote the service on the homepage of MSN. Unfortunately, this opened up a completely new set of issues.

Over the span of three weeks, from late August to mid-September, multiple reports emerged that highlighted various security flaws within Hotmail. For example, hackers would use so-called trojan horses (namely malicious programs) as code hidden in the body of an email, allowing them to retrieve usernames and passwords at will.

Luckily, Microsoft eventually managed to close those vulnerabilities before greater damage was done. And despite those security concerns, Hotmail continued to grow like gangbusters. By early December 1998, it had managed to attract more than 30 million people to its platform.

In order to keep up with that demand, Microsoft completely redesigned and revamped the platform in April 1999. This entailed, amongst others, beefing up its server capacity since Hotmail had suffered multiple outages in the previous weeks due to that demand. It also updates its terms of service to penalize spammers with a $5 per message fine for any unsolicited email sent.

That same month, co-founders Bhatia and Smith both departed from Hotmail to launch new businesses. Ironically, Bhatia, in 2007 would launch a web-based competitor to Microsoft Word called Live Documents, which like many of his other subsequent business endeavors, never really took off.

In the meantime, Microsoft stayed busy fending off hackers, outages, and spammers. A group known as Hackers Unite, in late August, disclosed a security breach that exposed sensitive information about all of Hotmail’s now 50 million strong userbase.

After vehemently denying any wrongdoing, Microsoft eventually announced that it had hired a third-party auditor to test the security of Hotmail. It even adopted a controversial spam filter called the Mail Abuse Prevention System (MAPS). Unfortunately, this not only led normal emails to be classified as spam but didn’t ultimately reduce the number of spam emails that users received.

Microsoft continued to add various other spam-combating features, for example by introducing a special spam folder in March 2000. Over the coming months, it also managed to fix a dozen bugs that would’ve left its user accounts exposed to malicious actors. Back then, Microsoft was announcing a new bug fix almost every month. The founding team, in all likeliness, wasn’t too concerned with security as it focused on increasing its userbase, which Microsoft (especially being a public company) scrambled to fix post-acquisition.

Sometimes, those solutions would also backfire on its users. A spam filter that Microsoft implemented in late 2000, for example, caused emails to not be sent out for days. However, as Microsoft managed to fix Hotmail’s most severe issues, negative news surrounding the email service soon began to die down.

Another reason for the improved service was that spam filtering systems simply got better as time progressed. In September 2002, for example, Microsoft announced a deal with BrightMail, which would implement a spam filtering system for its 110 million-strong userbase.

Despite those woes, Hotmail continued to be the undisputed leader in free email. This, however, massively changed in the summer of 2004 when Google launched Gmail. Microsoft, as a result of that increased competition, upped its free storage limit to 250MB to at least keep up with the 1GB of storage Gmail offered right from the get-go.

Although Google became an instant competitor, Hotmail continued to grow simply because of the increase in internet usage. By the end of 2004, more than 200 million people had registered an account.

To keep up with the competition, Microsoft underwent a complete shift in strategy. In December 2005, it introduced the beta version of Windows Live, which aimed to provide Internet-based personal tools such as blogging and instant messaging software (as well as email) in one all-encompassing software suite.

It would, given Microsoft’s size and its intention to rebuild Hotmail from scratch, take over a year for the desktop client to finally launch. Along the way, Microsoft executives also thought about getting rid of the Hotmail name but later landed on Windows Live Hotmail (instead of Windows Live Mail).

Microsoft even contemplated adding a completely new design which users immediately began to protest. Instead, it incorporated Hotmail’s “classic” design. After two years of development, the beta tag on Windows Live was finally dropped in May 2007.

The Seattle-based software giant, furthermore, introduced some major upgrades along the way. For example, in August, it bumped the free storage limit from 2GB to 5GB, which even surpassed the likes of Google (2.8GB for free users at the time).

Hotmail continued to receive major updates as time passed, most notably improved performance speed, being able to categorize or tag emails, as well as more secure sign-in options, amongst others.

Despite Microsoft’s best efforts, the competition didn’t necessarily stay inactive either. In fact, it would soon catch up to Hotmail. In the summer of 2012, Gmail finally managed to surpass Hotmail in terms of visitor numbers.

It, therefore, only came as somewhat of a surprise when Microsoft announced its intentions to shut down Hotmail. On July 31st, 2012, it disclosed that it would be moving Hotmail users towards, which it tightly integrated into its Windows and Office products.

By May 2013, Microsoft finally managed to migrate all users (400 million, in fact) who opted into the new Outlook system. These days, accessing Hotmail automatically redirects users to the domain. While new accounts cannot be registered anymore, previous users still get to keep their addresses.

Interestingly enough, this wasn’t the last we heard of Hotmail. In late December 2015, Reuters reported that Chinese authorities in 2011 had gained access to over 1,000 accounts. Instead of notifying the affected accounts, which included Japanese and African diplomats, human rights lawyers, and Tibetan and Uighur leaders, Microsoft simply decided to change their passwords.

After some serious public backlash, Microsoft eventually adopted its privacy policy and pledged to immediately inform users once it learns that their accounts have been subject to a hacking attack.

Why Was Hotmail Shut Down?

Hotmail was shut down because Microsoft wanted to move users towards Outlook, which had a much better reputation and cleaner codebase.

Hotmail’s brand, due to the years of spam email, hacks, as well as outages, eventually diminished to the point where users were embarrassed to share their accounts. Some even outright refused to hire people with a Hotmail account.

While Microsoft eventually managed to combat these problems, Hotmail’s reputation never really recovered.

It often lagged behind other services, in particular Google’s Gmail, which were able to provide more features and greater performance (such as higher storage).

Moreover, due to Hotmail’s legacy infrastructure, it also became extremely costly to run. Microsoft, therefore, decided to migrate its Hotmail users towards Outlook, which itself was running on a much cleaner (and thus cheaper) codebase.

Furthermore, Outlook was created by Microsoft itself (and ironically launched a few weeks after the Hotmail acquisition), which meant it was part of its core product suite comprised of Office and Windows.

Instead of trying to revitalize a tarnished brand, Microsoft likely figured that it was easier to just get rid of it. And unlike the late 1990s where portals were all the rage and free email a great way to attract users, Microsoft’s business was simply not nearly as dependent on Hotmail anymore.

Hi folks, Viktor checking in! Years of experience in various tech-related roles have led me to start this blog, which I hope provides you with as much enjoyment to read as I have writing the content.