Microsoft: Dazed and Confused

Overview

Microsoft. This was a name that inspired fear and loathing among those in both technology and corporate purchasing circles, certainly until the end of the 1990s. Given their dominance in operating systems and control of the desktop, how could they be stopped? A rapidly rising stock price, a market cap approaching $600 billion, the ability to buy top talent from any company, any place, around the globe, a vaunted R&D capability, the propensity to spend vast sums staking out (seemingly) related but non-core domains (i.e., Nextel, Comcast, AT&T). How could they ever hit the wall?

Well, they did. Hard. Massive crumpling. Fast forward to today, a mere six years later. Slow. Bloated. Stagnant stock price. Hemorraging top talent. Anti-trust problems. The perception as being yesterday's news, being left in the dust by smaller, more flexible, more nimble competitors like Google. Even their founder has shifted his emphasis from value creation to value distribution. You can feel time passing them by. And it is this perception that was reinforced by a very candid article in yesterday's New York Times. It simply reinforced many of the things I have been feeling about Microsoft, and which I will write about in greater detail in subsequent posts:

Microsoft is an amalgam of businesses they'd like to believe are related, but they're not. And it is this lack of insight and self-awareness that will prevent that growth-stock luster from returning. Ever. In the absence of the ruthless focus required to compete in each of its key businesses, which are inherently different, they will die a long, slow death. And maybe Carlyle or Blackstone will help them out of this value trap.

A pretty dire prediction for a company generating the billions in free cash flow that it does. But what is it doing with all that cash? Is it really going to drive high-PE growth opportunities? Frankly, I'm cynical.

Steve Berkowitz - Driving Strategy and Software or a Supertanker?

Steve has a lot of work to do, leveraging its search and portal strategy for the benefit of its Windows and Office Live products. Huh? How to do this in the face of a big, bureaucratic, fossilized Microsoft organizational structure? According to Steve:

There is a lot about the way Microsoft has run its Internet business that Steve Berkowitz wants to change. But he is finding that redirecting such a behemoth is slow going.

“I’m used to being in companies where I am in a rowboat and I stick an oar in the water to change direction,” said Mr. Berkowitz, who ran the Ask Jeeves search engine until Microsoft hired him away in April to run its online services unit. “Now I’m in a cruise ship and I have to call down, ‘Hello, engine room!’ ” he adds with an echo in his voice. “Sometimes the connections to the engine room aren’t there.”

Steve isn't an online executive, he is a supertanker pilot. I do not envy Steve.

Microsoft - Technology company or Customer-solutions Company?

It doesn't take a genius to see how today's most successful technology companies (and, in fact, any customer-facing company, for that matter) are ruthlessly focused on the customer experience. They ask questions like: What do my customers really want? How can we make our value as easy as possible for our customers to access? If there is a problem, how can I best address my customer's problems? How can my customers know that I am thinking about them all the time, making our products and customer experience ever better? Does this sound like Microsoft? Uh, well, no. Even Steve recognizes this attitude gap:

Microsoft lost its way, Mr. Berkowitz says, because it became too enamored with software wizardry, like its new three-dimensional map service, and failed to make a search engine people liked to use.

“A lot of decisions were driven by technology; they were not driven by the consumer,” he said. “It isn’t always the best technology that wins. It is the best experience.”

It is no small task to run an Internet operation that can move as fast, be as popular and make as much money as Google. (That explains why Yahoo announced this week that its chief operating officer was leaving, and why the chief executive of AOL was fired last month.)

No doubt Microsoft has some wicked-cool technology. I saw this on display at Web 2.0 when they unveiled their Photosynth tool. But this isn't enough to compete against the likes of Google. Lots of whiz-bang, but how are you changing my life? I'm not feeling the magic. And it ain't coming from MSN. Is it really going to come from Vista?

Hedging Bets due to Lack of Strategic Direction?

Is it just me or is it pretty obvious that whenever a company in a super-competitive, dog-eat-dog field gets unfocused, it gets crushed (i.e., like Yahoo! with its Lloyd Braun-fueled content creation strategy)? Sticking to one's knitting and branching out only in truly related areas when you are pushed there by your customers, that seems to be a durable and successful strategy. So what is Microsoft up to with its online strategy?

So for now, Mr. Berkowitz has decreed that Microsoft will promote at least two Internet services. MSN, in Mr. Berkowitz’s conception, is a conventional portal with links to programming on various topics that competes with Yahoo and AOL. Windows Live, which uses the Live.com site, is meant to look much like Google, a spare-looking page that can be customized with modules from various services and news feeds.

Reflecting the many conflicting strategies, Microsoft’s Internet unit has been slowed by the same sort of organizational drag that caused the latest upgrade of Windows to fall years behind schedule. And of course, the competitive pace of the Internet is far faster than that of operating systems.

I'm confused, I really am. It's not Steve's fault, it's the hand he's been dealt, I think. But is this really a time for hedging bets or for establishing a unified, coherent online strategy leveraging Microsoft's competitive strengths, acknowledging past errors and moving on? Draconian action is called for here, folks. Yahoo! is feeling the heat, knows they've screwed up and gotten slow and bloated and is working like hell to try and change it. Massive headcount cuts, senior level shake-up, real attempts at effecting change. Whether or not it will be successful only time will tell, but at least they're trying. They're giving themselves a chance to succeed. And Microsoft? Nada. But hey, Vista's coming out. Woo hoo! Not.

This is reminscent to me of Microsoft's gigantic investments in companies such as AT&T, Comcast and Nextel. Over $7 billion, if memory serves me well. Were they listening to Paul Allen's vision of a "Wired World?" (We know how that movie has played out - not well). No. It was due to a lack of clarity of vision and strategic direction. While it was, at first, stunning to think that Microsoft could gain a toe-hold in such industry stalwarts simply by writing a check (which it could due to its mind-boggling success in prior years), it was not all it was cracked up to be. Did they ever get strategic mileage out of this or was it simply a distraction? My vote based upon what I know - a distraction. That money and management focus could have been spent on much better things like, say, a better search algorithm?

Messed up Corporate Culture = Brain Drain + Inability to Plug the Holes

Rallying the troops is great if the strategy is sound and senior management has set people up to succeed. Unfortunately, this does not appear to be what happened. First, legacy bureauracy remained. Second, stock price fell, weakening existing employees' resolve and making it hard to attract outsiders to the team. Third, Google continued its relentless push to preserve a small-company culture in an ever-expanding search-cum-advertising titan, making it THE place to work if you are an engineer with a desire to push the limits of one's gray matter:

Even as the company’s leaders tried to rally a charge against Google, the staff was hampered by conflicting priorities and overlapping organizations, employees said. Moreover, last summer, when Microsoft’s stock fell after it disclosed a sharp increase in research spending, directions changed again.

“They had a lot of new initiatives, and people ran fast out of the gate,” said Niall Kennedy, an expert on Internet publishing who joined Microsoft last spring but quickly became disillusioned and quit in August. After the stock fell, he said, “I wasn’t able to hire anybody for my group.”

Mr. Kennedy says this culture is inhospitable for talented engineers.

“Microsoft is no longer the primary place for technical talent,” he said. “If there is a superstar, Google will be on their minds.” (Indeed, Google has set up shop in Kirkland, Wash., six miles from Microsoft’s headquarters in Redmond, specifically to welcome Microsoft refugees.)

This is pretty brutal stuff. Think about how hard its been for Yahoo! to wake up to the competitive imperative, making difficult, public changes when it has only been around for about 10 years. What about Microsoft, which just turned 30? It may not be GM, but it certainly isn't the nimble spring chicken Bill, Paul et al founded in the mid-1980s. I don't know what it is going to take for them to initiate a radical organizational re-design. But it has to happen. And fast.

Conclusion

Microsoft was a great company, and, in many ways, still is. It still makes gobs of cash off the software business. It still has great R&D and a cadre of brilliant engineers. But it probably could be 5 excellent companies instead of one stalled company. Can you imagine a business that housed the cash-cow software operation, that paid a gigantic dividend and was ruthlessly focused on squeezing every bit of cash out of this franchise? How about a unified MSN/Live.com business that competed in search and advertising without worrying about all the other stuff? You could even spin a venture capital firm out of the Microsoft Bus. Dev. team, with all the connections they've got and all the deal flow they see. I'm sure there's lots of other stuff as well. I don't know much, but I do know that corporate bureaucracy can kill creativity, kill spirit, kill fun. Which kills recruiting, retention and, ultimately, stock price. And this just isn't going to cut it against the Googles of the world who are rocking the house and the Yahoo!s that are willing to incur massive short-term pain for long-term gain. Sorry, Bill. Sorry, Steve. You've built a great company. But it isn't as great any more. Set it free. Please.

Comments

[Dennis Byron]

Interesting analysis but it's hard to bet on it because Microsoft hasn't yet decided what it wants to be when it grows up: enterprise-oriented technology provider (let's call it the Ballmer Strategy for lack of a better name) or consumer-oriented service provider (the Ozzie Strategy perhaps). It has not decided whether it wants to be the electric utility or the company that makes the dynamos.

Microsoft's Ballmer strategy for the last five years indicates that it wants (or wanted) to be a technology provider primarily to enterprises. Even most of its consumer businesses seemed to be aimed at making all of us C's better ends of the B2C equation. To that end, Microsoft has blown by all other technology providers except IBM and HP (and IBM doesn't really want to be a technology provider anymore). In this mode Microsoft seemed to realize that the IT world is going to a service mode but that it could profit from that growth by supplying technology all the service providers.

Lately it looks like Microsoft might be changing to a services provider strategy that is consumer rather than enterprise led. This could be because Microsoft's massive market research efforts are picking up indications of a sea change in technology acquisition. More likely, I believe Microsoft is thinking about changing because selling technology to service providers (even being the leading seller of technology to service providers) is boring. And low margin (which is why IBM is changing). And it might just be because those other guys are getting all the cool press in SV.

However if Microsoft chooses the strategy behind door two, they will move quickly and Microsoft has many more of the required pieces than Google. What Berkowitz is now in charge of is just a scouting mission. But some other Microsoft scouting mission could return to camp first and keep Microsoft happy just spinning out the cash.

[Yaser Anwar]

Interesting thoughts- I'd like to add some with regards to its upcoming products and recent moves management has been up to.

MSFT management expects the consumer business division to turn profitable for the year in 08, requiring a $1+ billion improvement in the P&L. MSFT expects the Xbox business to turn profitable, then will focus on Zune (not so sure about Zune succeeding given the lackluster "buzz", if I may say, around it), while the Mobile & Embedded and Consumer Products businesses are profitable.

The Street assumes that 29-35% of the PC installed base will be running Vista by the end of 08 and that 51% will be running Vista by the end of 09. Higher adoption rates (35% in 08 and 56% in 09) would add significantly to EPS- $0.04 in 08 and $0.06 in 09.

The penetration rates may seem a little high but historically these rates are achievable. I'm expecting Vista’s adoption rate to be somewhat similar to XP’s, where the earliest stages of the cycle are driven by consumers and with a longer, more sustainable corporate cycle kicking in upon the release of service packs.

Given the 23% rise since July in MSFT, I'm concerned that the Vista cycle is fully reflected in the company’s share price. To the contrary The Street believes that the potential for Vista-driven revenue upside still exists.

In my opinion MSFT in some ways is similar to Citigroup. They both need a change at top of the management.

[John K]

Overall, I agree, but I put a little more blame on Steve Berkowitz for getting hired into this mess in the first place:

http://gotads.blogspot.com/2006/12/microsoft-live-gets-vote-of-no.html

[Kris Tuttle]

MSFT is very similar to IBM in the mid-90's. IBM eventually figured out a plan and was able to execute it but for a few years they had no idea what to do. MSFT feels like such an entity today. I haven't been able to figure out what they should do.

Maybe they need a outside CEO to come in that can get the company focused. Ballmer certainly isn't the guy if you ask me. Neither is Gates. Of course if MSFT really does continue to slide I can only imagine the rapture a Larry Ellison would have in making a bid for the company. Given the cash flow and the ability to finance such a purchase maybe it's not such a crazy idea...