Microsoft’s Crisis in Perception (Part 4)

In parts 1, 2 and 3 of this series I made the case that Microsoft is mistakenly viewed as a consumer products company when in reality the core of its business comes from selling enterprise platform software. I also described the inherent complexities in the business which are constraining the company’s ability to overcome it’s strategic challenges.

In this final chapter I will look forward at the opportunities which lie ahead and discuss my own personal views about the strategic decisions which need to be made.

If you read most of the press about Microsoft over recent years the coverage seems to have become a never ending torrent of negativity; much of it calling into question the company’s future viability. If its not Google Docs and Apps undermining the Office business, it is Apple taking share in away from Windows in both the mobile phone and laptop market. Its understandable that the press loves to write about the potential for competitors to undermine the 'Twin turbos' of the Microsoft revenue engine. Unfortunately journalists who write these stories are demonstrating that they as well as many others have fallen into the trap of over estimating the strategic value of the consumer market to Microsoft’s business.

Ten years ago Microsoft could not have imagined a world in which they did not need strategic control over the end user’s device. This was the company whose operating system ran on over 95% of network connected devices. There are two opposing but complimentary views on this issue; both of which are part of a huge strategic debate within the company.

On the one hand it can be argued that the growing sophistication of web standards like HTML 5 will mean that the end device really does not matter. Every device will ultimately offer an equivalent browsing experience and the strategic issue will become who controls the service layers to which these devices connect. Microsoft has another secret weapon in this debate called Silverlight. Silverlight enables the development of very rich interactive consumer client experiences and, remarkably for Microsoft, is truly cross-platform, running on Windows, Apple’s OS X, Nokia’s Symbian and one would assume at some point, iOS and Android. One can imagine that the Windows and Internet Explorer teams would not be huge fans of Silverlight because it limits the ability for them to establish a clear value proposition for developers to uniquely target Windows. However, Silverlight is a huge opportunity for Microsoft to grab developer mind share and in my view only lacks a seamless monetization strategy, like Apple’s App Store before it takes off.

The other side of the argument would say that native applications will always offer a superior consumer experience and that there money to be made from both the applications and the devices. In both cases it becomes strategically important to have control of the end device. There is some merit in this argument. In a world where even the best mobile devices are not always connected via high speed broadband, native applications will remain compelling. Of course there is also the small issue of the cost of mobile broadband. While data rate plans remain comparatively expensive then native applications will still play a significant role.

The question is whether it is still a strategic necessity to be in the mobile device OS business? In my opinion, and taking a long term view, the strategic value of being in the mobile device operating system business is much lower than it was ten years ago to the point where the costs of trying to win market share in that business cannot be justified. If I was being hardcore I would shut the Windows Phone business down tomorrow. I would apply the resulting savings to ensuring that developers have a compelling reason (Revenue) to target Silverlight and that all of Microsoft’s on-line services provide an amazing and compelling consumer experience on all of the major mobile platforms.

I can hear the howls of objection already. However, I doubt that even the most ardent Microsoft promoter could make the case the Windows Phone will garner more than 30−40% market share in the growing smart phone market. That in itself would be amazing but it still does not make it strategic and, in my view, the expense and resources wasted to accomplish that limited goal would be better spent on a more strategic objective.

I’ve already alluded to where I think the real strategic play is. In all the irrational exuberance surrounding Apple’s success with the App Store everyone seems to forget that most of the time when a little .99c mobile application gets sold there’s a little incremental computing power required on the back end to service that application. The real money to be made in the global networked economy is in services and the infrastructure required to run those services. In short the 'Cloud' has a very silver lining.

When Steve says Microsoft is 'All In' he means it. The management team is literally betting the company on being able to transition Microsoft’s products and revenue stream to the 'Cloud'. Yesterday’s Motley Fool article about whether Microsoft can dominate the cloud is an indication that some in the press and analyst communities are starting to wake up to just how comprehensive and compelling Microsoft’s 'Cloud' strategy really is. You can expect that advantage to be further amplified at next week’s World Wide Partner Conference.

Microsoft’s 'Cloud' strategy is another perfect example of the 'Integrated Innovation' strategy at work, with the company leveraging the complete range of its enterprise product portfolio, and a lot of new innovation thrown in, to build a set of 'Cloud' services which are starting to look very compelling for customers. By customers I of course mean small, medium and large enterprise customers. I do not mean consumers. With Bing, excellent as it is, running a distant third to Google its is still impossible to see how Microsoft will monetize their consumer on-line business in any meaningful way. An additional requirement for being in the consumer products business is that you make money from consumers. Microsoft, in large part does not.

Microsoft’s biggest future revenue opportunity is driven by the compelling nature of it’s 'Cloud' infrastructure, services and developer strategy. It will depend on convincing enterprise customers of all sizes that they can trust Microsoft to run their IT and will require a sales strategy which avoids cannibalizing the very lucrative long term licensing agreements that most enterprise customers are locked into today.

On the competitive front Microsoft’s charge into 'Cloud' services really does pose a major strategic headache for players such as Google, Amazon, SalesForce, VMWare and the like. Each of them own bits of the puzzle but not one of them can walk in and have the type of compelling conversation with CIOs and CTOs that Microsoft’s field sales force are now enjoying today. I said before that negative opinions about Microsoft’s ability to innovate almost always focus on 'consumer' technology innovation. If you were a fly on the wall of the board rooms of any of the companies I mention above you’d here a lot of concern about how innovative and dangerous Microsoft’s 'Cloud' strategy really is.

There are risks. One risk that concerns me is that Microsoft’s sales leadership lead by Turner may think that as enterprise customers move to a self service and automatically provisioned model then the requirement to have dedicated, very smart sales and technical professionals in the field will diminish. This is a very dangerous 'Wal-Markian' dream. In my view exactly the opposite will happen.

As customers hand the keys of their very strategic IT operations to Microsoft they will demand a closer, not more distant, working relationship. The expertise, skill set, experience and cost of the field resources required for this new reality will rise not decline. There are also very valid strategic reasons why you would want the trend to move in that direction. Lots of Microsoft’s field resources, including expensive sales people, spend far too much time helping customers understand which 'Bits to flip' to optimize or overcome some server or Office deployment challenge. Meanwhile the IBM account team is wining and dining the 'C' level executives of the company talking about how IBM can help restructure the business or realign strategy etc. If customers move to Microsoft’s 'Cloud' platform then it will be critical for the sales force to move up the food chain to ensure they are influencing how customers design their next generation of strategic services. Rather than de-investing the company needs to be ready to over-invest in strengthening these strategic relationships.

One could argue that with the strength of it’s 'Cloud' offerings Microsoft is perfectly poised to drive the next phase of growth for the company. That is almost certainly true but to do so without a strategy to simplify and streamline the business would, in my opinion, be a mistake. Too many compromises are placed on both the enterprise and consumer sides of the business by the forced interlocking of both the technologies and business models. In my view its time to give both business the freedom they deserve. The freedom to innovate and find their own way in the world. If you been following the argument I’ve laid out throughout this series of articles then the remedy I have in mind will not come as a shock.

In June 2000, at the height of the DOJ anti-trust action, the judge in the case, Samuel Penfield Jackson shocked the entire company by ruling that the company should be broken up into two companies: one owning the applications business and the other the operating systems business. It shows just how far the company has come that there was no mention or recognition of an enterprise server and tools business at this time. Jackson’s ruling was eventually overturned by the Federal Appeals Court but not before the breakup became the discussion topic of the industry. Jackson’s ruling was wrong in substance but I’m beginning to believe that its time to revisit the idea in another form.

If you were approaching the problem today you would almost certainly not break the company apart by product line. Value is defined by customer segment today and, as I’ve outlined before, it is the integration across product lines which provides perhaps the most value to enterprise customers.

To unlock the full value of the company’s assets I believe they should be split between a new 'ConsumCo' and an 'EntCo'. Some of the distribution of assets would be very obvious. The Server and Tools division and the Business Division would become part of 'EntCo'. Their revenue streams almost entirely derive from small, medium and large enterprise customers today. The Entertainment and Devices division would go to 'ConsumCo.' I might argue that XBox should be spun off as its own company given the uniqueness of the gaming market but the investment cycle required probably means that it would continue to need the support of more mature businesses. The Online Services division’s assets would need to be split with the Business Productivity On-line and other hosted application offerings going to 'EntCo' and Bing and the MSN properties go to 'ConsumCo'.

The most difficult decision would be what to do with the Windows and Windows Live division. One approach would be to fork the Windows code base and give both EntCo and 'ConsumCo' the opportunity to drive their own client OS strategies targeted at the unique needs of their audiences. Windows Live belongs over in 'ConsumCo'. The revenue from the Windows business would be split by channel. OEM retail revenue going to 'ConsumCo' and OEM enterprise revenue flowing to 'EntCo'. The bolder strategy would be to give Windows to 'EntCo' and then tell 'ConsumCo' to go figure out whether they even need to be in the client OS business. They probably do not. The focus of 'ConsumCo' should be to build the worlds most compelling on-line services and to make sure they are a great experience on every network connected device on the planet. Being beholden to one OS or particular browser limits the scope of your ambition.

One objection which immediately springs to mind is the duplication of overhead (Read cost) that would be required for services which are shared between the two companies. That’s not really an issue with things like HR and finance. You would just divide up the existing resources as required. In fact without the overhead of trying to get the whole complex integrated machine to work together there might actually be an opportunity for some efficiency in these areas. The split of field sales resources would not be that difficult with most of them ending up in 'EntCo' serving the same customers and partners they do today. The big question would be what to do with any shared computing infrastructure. As Microsoft is setting itself up to become a global service provider of computing infrastructure then perhaps that should also be hived off into a separate operating company providing compute services to both 'EntCo' and 'ConsumCo'.

I believe the long term benefits of freeing each part of the company in this way would outweigh the short term complexity and disruption such a change would require. Freeing the leadership teams of 'EntCo' and 'ConsumCo' to pursue both a technology and marketing strategy which is focused on the unique needs of their audiences rather than internal demands has to be a positive move. This would likely unlock a new round of innovation in each business as the shackles of co-dependency are removed. This approach might also give birth to some radical strategies such as closer partnerships with Apple and Google as channels for a whole new range of consumer and enterprise services. On the other hand maybe that would remain a step to far :-)

One final objection I can foresee would relate to the financial viability of 'ConsumCo' and there we’ve touched on the crux of the problem. For too long and at too high a price the core enterprise business has subsidized Microsoft’s multiple failed attempts to become credible in the consumer space. That subsidy limits innovation and R&D investment, it limits marketing investment and it limits the field resources investments required for Microsoft to achieve its full potential as the worlds leading enterprise software and services company. In my view the experiment has gone on for too long. Setting 'ConsumCo' free would be a blessing. Finally the management teams running those businesses would feel the heavy weight of competition without the soft blanket of subsidy. Maybe that is what is needed to spark the true innovation and dedication to winning that is required for success. Perhaps there would even be a rationale for Yahoo to buy 'ConsumCo'. On face value that alignment makes far more strategic sense than the alignment between consumer and enterprise businesses inside Microsoft today. I am convinced of one thing; with the enterprise 'Cloud' business poised to take off it is time to drop the consumer 'Boat anchor' to ensure that Microsoft can rise with the massive tide of opportunity that is about to come in.

I’ve covered a lot of ground in the last four posts. I’ve tried to balance my concerns with my optimism about the opportunities available to the company. Ultimately I have no deeper interest in what happens than any other very minor share holder. However, I do have a lot of former colleagues, many of whom I count as close friends. In the end I want them to have the opportunity to work for a company that they can be proud of and which continues to change the world in a positive way. Much of the negative commentary directed at the company is founded on a false premise and a real lack of understanding of how bright the company’s future can be. However, it remains the sole responsibility of the senior management team, lead by SteveB to make the tough strategic choices that will ultimately prove the detractors wrong.

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