(FORTUNE Magazine) – Ray Ozzie didn't need to do it again. Back in the days before the Internet explosion, back when Websites were still unknown and desktop software was all the rage, Ozzie invented Lotus Notes, one of the most elegant client-server applications ever. Then known as groupware, Notes helped people quickly spread knowledge and information across organizations. In 1995, IBM bought Lotus for $3.5 billion just to get its hands on Notes; more than 68 million Notes licenses have been sold.

A lot has happened in the interim. The World Wide Web, for one thing, which makes it even easier to exchange data and share ideas. After IBM swallowed Lotus, Ray Ozzie left to pursue a dream: to harness the Internet with an amazing new program that does Notes one better. His creation is Groove, software that enables small ad hoc groups of workers to get together quickly online to collaborate on projects. Three years in the making, Groove is emerging just in time to supercharge the trend toward peer-to-peer computing, the first great evolution of software beyond the Web.

Think of Groove as Napster for business. That famous outlaw software connects one PC directly to another so that their owners can share music. Groove links workers via their PCs without the assistance of a central Web server so they can share all kinds of digital data. Such on-the-fly collaboration holds huge promise in today's ever faster business environment. Though much Web software is great for automating projects, it falls short when human interaction must be involved. Groove fills that gap, which is why companies like General Electric and Intel, among others, are thinking of adding it to their Web-based supply-chain projects.

Ozzie is normally a pretty modest guy, but his ambition for Groove is massive. "Ultimately, we do see Groove everywhere," he says, when prodded. Lest you think this is just another Web huckster blowing smoke, consider what others think of Ozzie and his creation. Industry godmother Esther Dyson says, "I would bet on it, and I was disappointed not to be allowed to invest." Publisher and software expert Tim O'Reilly calls Groove's design "prescient" and says it will "prefigure an awful lot of other software." Asked to rate Ozzie as a programmer, Charles Fitzgerald, who heads relations with software developers for Microsoft, calls him a ten. Bill Gates has declared Groove "a deep and innovative software product that is a great indicator of where the Internet is going"--even though some observers expect Microsoft to try to squash Groove eventually.

Such accolades come as no surprise. Charming, unassuming, and polite, Ozzie, 45, seems to have no enemies in the often cutthroat software industry. His biggest problem may be overcoming shyness--"I have unbelievable stage fright," he confesses. But he is working to solve that methodically, as if it were a vexing software problem. For Groove to succeed, Ozzie needs to sell it--to programmers, companies, and users. And he wants it to succeed; Groove is what he's been working toward his entire career.

Ever since his stint as a computer science major at the University of Illinois in the late 1970s, this keyboard maestro has been fascinated by the problem of getting people to communicate and work together. In college Ozzie encountered the education-based network PLATO (programmed logic for automated teaching operations). Its terminals at universities around the world let users post comments on bulletin boards and chat onscreen. But when Ozzie graduated and got a job, "there was none of this stuff," he says. "Nobody communicated. There wasn't even e-mail." By 1984 he was a top programmer at Lotus Development in Cambridge, Mass., and he persuaded then CEO Mitch Kapor to fund a project to bring the features of PLATO to business. It took five years to complete the first version of Notes.

Notes allowed workers to post messages in databases that fellow employees could see, refer to, and augment--whether the messages related to the best way to service a paint plant or what restaurant in Sunnyvale served the best sushi. It was an entirely new way of working--so new, in fact, that few companies understood why they might want Notes. "I can't tell you how agonizing it was," recalls Ozzie. "It was like, 'Your company can do better if you share information with one another--no kidding!'"

Finally Price Waterhouse bought in, followed by other consulting firms. Soon they were singing the software's praises to clients, and by 1995, Notes had more than two million users. After IBM bought Lotus, Ozzie stayed long enough to oversee one more version of Notes. But he began thinking more and more about its limitations. Notes wasn't malleable enough to support the kind of impromptu brainstorming that can lead small groups to breakthrough ideas. And Notes posed managerial challenges: It was expensive--hundreds of dollars per user, plus the cost of the server computers--and required lots of support from techies.

Ozzie, meanwhile, was doing a little experiment at home. He'd made the family house a kind of informal computing lab, complete with a T-1 line and an Ethernet network. "I wanted to see how my two kids would use computers," he says. Daughter Jill began socializing over the Web and became a big user of instant messaging. Son Neil got into computer games, and by 1997, at age 14, he was deep into long-lasting online tournaments of the game Quake. For months, Ozzie and his wife nagged Neil about all the time he was wasting. Then one night it struck Ozzie that instant messaging and Quake were a glimpse of the future. He says about his son's online games: "These kids ran their own servers and self-organized into teams. They talked to each other in real time over speakers. It was so much more effective than the way people in business used PCs." Here was PLATO again, transformed by 20 years of computing progress.

Not long after his revelation, Ozzie founded Groove Networks, surrounding himself with longtime associates, including his brother Jack and several others from Iris, the skunkworks that created Notes. Says co-founder Ken Moore: "It was sort of like getting the band back together."

Ozzie is an idea factory. Every week or so he turns out a paper outlining potential product features, business models, or market opportunities. That was especially true when Groove started out. Says co-founder Eric Patey: "We learned to dread his cross-country trips. When he had time on an airplane, he would come back with a three-page memo asking for more capabilities." Ozzie spent so much time thinking about Groove in the shower that company employees jokingly measure the complexity of ideas in "shower units." One day Ozzie actually brought in three wet sheets of paper, full of ideas he'd scrawled while still dripping. Moore then bought him special waterproof paper. Ozzie really uses the stuff.

Ozzie himself is a unique combination of people and computing skills. "Ray has a kind of grace and thoughtfulness about him that is rare in our industry," marvels O'Reilly. Says Dyson: "Ray has a beautiful mind. He thinks like an angel. He's elegant. Most people who enjoy the complexity and richness and humanness of human beings, as he does, are not very good at writing code."

Developing Groove, Ozzie tapped into his experience as a manager. He has always believed that the best way to solve tough problems is in small, tight-knit groups. Way back in 1984 he set up tiny Iris as a development effort insulated from the larger Lotus culture. He encourages free speaking and independence at Groove. "My philosophy is setting up a group of direct reports who work with one another in a peer fashion and trust each other implicitly," he says. "I try to get as much parallelism as possible. People go on vacations, but I don't want things to stop." Groove software is designed for such an organization, whereas Notes was better suited for a command-and-control company. "Notes is like an orchestra where you have a conductor trying to lead," Ozzie explains over a dinner interview at a noisy restaurant. "Groove is more like this interaction here. We don't know where it's headed. Somebody sets the rhythm, and you just go."

That's the theory. So exactly how does Groove work?

When you download Groove onto your PC (a beta test version is available at www.groove.net; the official launch is expected by April), the software creates a space on your PC that can be accessed by other Groove users whom you invite in. That space appears exactly the same on the screen of every member of your group and includes tools to support collaboration: sharing Microsoft Office documents, text chat, live-voice chat, photo viewing, a drawing pad, and a browser. Whenever two or more people are online at the same time, they can use Groove to work on a document or brainstorm. Any changes they make to the document are transmitted live over the Net to other members' PCs, using a technology called XML. If the other members aren't online, the modifications are stored on a relay server; as soon as a member plugs back in, his Groove space is updated. The software is designed to work best for groups of 25 people or fewer but can be adapted for larger get-togethers.

Others will extend Groove in different ways--a key part of Ozzie's plan is to encourage other companies to write special applications on top of the Groove platform. (Inside the company they call such software "Groovy.") For example, Phil Stanhope, who until January ran an e-consulting unit for Perot Systems, has started Componentry Solutions to build applications for managing insurance claims and other group tasks. Negotiating an international letter of credit is a perfect example of how Groove might work. Let's say the negotiators include someone at an Asian manufacturing plant, a representative of that company's finance department, the company's banker, someone from the purchasing department of a U.S. customer, a finance person there, and a representative of the company that ships the product from Asia to the U.S. Using Groove, each person could examine all the relevant documents, including product specifications, interest-rate calculations, and shipping timetables. Each might do this online at the same time or check in on the space at different times. Participants could manipulate spreadsheets to see how modifying one variable might affect other aspects of the deal. And finally everyone could sign off online.

Alliance Consulting is building Groove tools for assisting transactions in business supply chains. "Trying to get collaboration among three or more parties without a technology like Groove is tough," says Alliance's John Wollman. "It's not easy to anticipate all the ways in which people need to share applications and data." Another big opportunity for Groove: modules that incorporate data from enterprise software systems into a Groove session. SAP is interested in such applications.

As Groove starts to evolve into a platform for all kinds of applications, companies are getting intrigued. GlaxoSmithKline CIO Ford Calhoun has been a big Notes customer for years. He says Groove may prove useful in drug discovery and development, which often requires that diverse experts inside and outside the company quickly gather and share data. "Groove has this great ability to set up relationships more or less on the fly," he says. That's one way it's different from Notes. Among Groove's special tricks is an ability to securely bring in people who are normally locked out of the corporate network by a security firewall.

Some smaller companies already use Groove for more basic purposes. At Beaumonde, which hosts Websites for modeling and talent agencies, ten employees in the Boston and New York City offices who need to share documents securely now do so. Technical architect John Siqueira had spent months trying to set up a virtual private network to achieve the same result; setting up Groove took about a day. Hong Kong's Inlooktech.com uses Groove for software projects that include contributors from Taiwan and China. And since Groove is a kind of blank slate, it may well find its way into consumer applications too. Teenagers who today gab about clothes, hair, music, and homework on AOL may find it a more useful tool. They may even do that homework together onscreen, if some company comes along with the right Groove application.

This kind of collaboration is made easier thanks to two crucial bets that Ozzie made back in 1997--bets that today seem downright inspired. The first was to make Groove a peer-to-peer system, and the second was to base its inner workings on the XML data-exchange standard. Other companies are now trying to cash in on these hot trends, but Ozzie estimates that Groove has an 18- to 24-month lead. Outsiders don't disagree. Groove also had a head start because Ozzie, who had made plenty from his Lotus stock, bankrolled the company for its first year. So Groove had lots of time in stealth mode before it had to open up at all. When Ozzie did unveil Groove, he did so to bring in investors who could help launch it as something big. Mitch Kapor invested as soon as Ozzie revealed what he was up to. And in January 1999, Accel Partners, a top Silicon Valley venture capital firm that Kapor had joined, kicked in its biggest investment ever--$30 million.

How does Accel hope to recover that investment, given that Groove so far is free? For starters, companies that deploy it on a large scale will be charged per-user license fees. Those could add up--a movie studio, for example, might pay handsomely to use Groove to help fans interact. Other likely revenue sources: charging for premium versions with enhanced features, much the way RealNetworks does with its RealPlayer music software; offering special services, like allowing larger groups to use Groove offline; and eventually consulting. Initially, Groove's sales force will target big companies in financial services, manufacturing, and pharmaceuticals.

Making money is one big problem. An even bigger strategic one is that this other company, in Redmond, Wash., considers itself the real expert on PC software platforms. Microsoft will certainly try to give its Windows operating system the collaborative potential of Groove. The only reason Ozzie built certain parts of Groove, says Microsoft's Fitzgerald, is that those elements don't exist as "standard shared infrastructure." Translation: Windows doesn't have them yet. But he says Windows will, over time, include some peer-to-peer tools. Ozzie replies that if it does, Groove will probably take advantage of them.

It all sounds friendly enough. But remember, Microsoft did its best to kill Notes. Gates early on called it "basically just a bad operating system," and he and other execs promised for years that all of Notes' features would be available as part of either Windows or the Microsoft Exchange e-mail and messaging system. That deterred some customers from buying Notes, even though Exchange still doesn't match a few of the program's most powerful features. Fitzgerald insists Microsoft has no interest in duplicating all of Groove. But Accel managing partner Jim Breyer, one of Groove Networks' three board members (with Ozzie and Kapor), admits, "We have always thought that Microsoft very well could be the most significant competitor."

While Ozzie calls Microsoft a "formidable force," he seems unfazed. Several weeks before he released the beta version of Groove, he journeyed to Redmond to give a detailed demo to Gates and CEO Steve Ballmer. "I told them everything they were going to end up finding out anyway," says Ozzie. "Why mess around?" Fitzgerald says the companies are working toward the same future, in which today's client/server systems move toward setups in which PCs at the edges of the network do much of the work.

Still, it's hard to imagine Groove and Microsoft on the same page. In a recent magazine devoted to "The Future of Software," Ozzie wrote in language that evoked his 1970s anti-establishment roots: "We should distrust any elaborately planned, centrally deployed, and carefully developed business system or process. Successful systems and processes will be agile and dynamically adaptive; they'll grow and evolve as needed over time." Groove the software was designed to be consummately adaptable. Only time will tell if Groove the company is adaptable too--enough to stay ahead of Ozzie's so-fervent admirers at Microsoft.

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