We are currently witnessing a major pivot in Microsoft’s core business model. It is starting to become clear that — as Steve Ballmer recently announced — Microsoft is deadly serious about becoming a global leader in consumer «Devices and Services.» Successful execution of this strategy will require the company to control everything from manufacturing, distribution logistics through to retail.
The company appears to be focused on executing a 'Leader' strategy in the devices business which would give them even greater control than Apple famously does over the end user experience. In addition the company is likely to repurpose its online service investments to add value to this new device-led strategy. A-la Apple, consumers will have no choice but to use Microsoft own services when using a Microsoft mobile device and competition authorities will be powerless to prevent it.
If correct, this pivot will has profound implications for the structure of the company, shareholder value and for the entire mobile technology industry.
In the beginning…
I was reminded recently by a couple of former Microsoft colleagues about a presentation Steve Ballmer gave to the sales force several years ago. It was Steve’s keynote at the annual sales meeting and it was one of the more emotional presentations by Steve that I or any of the other attendees had witnessed. The theme of Steve’s presentation was Muhammad Ali’s legendary 'Rumble in the Jungle' with George Foreman. In his presentation Steve — a huge sports fan — analogized Microsoft to Ali — an underdog in the fight of its life against younger, fitter and more agile competition. Ali of course won the fight supported by 60,000 fans chanting «Ali, bomaye! Ali, bomaye!», «Ali Kill Him.» You can picture Steve energetically bounding around the stage screaming «Microsoft Bomaye!» getting 15,00 Microsoft sales staff wound up into an enthusiastic frenzy.
On face value this revving up of the sales team was vintage Ballmer, ever the master salesman himself, getting the troops pumped up to go do battle with the enemy. But recent conversation have caused me to suspect that there was a much more important hidden message. Ali did not enter the ring in Zaire to fight Foreman without a plan. Far from it. In fact Ali was very clear before the fight that his strategy would be to absorb all of Foreman’s punishment in the early rounds, tire him out and then land a killer knockout blow. That’s exactly what he did.
I now suspect that Steve came to that annual sales meeting with a long-term strategic plan already developed. Steve was pumped up because he realized that Microsoft would need to live through a punishing period where everyone would write-off the company, competitors would land punishing blows and eventually — when the time was right — Microsoft would — like Ali — deliver a knockout blow.
After years of punishment by the likes of Google and Apple we may now be approaching the point where — at least in Steve’s view — Microsoft is about to land a killer punch.
Out of Advertising
At another annual sales meeting a few years after «Microsoft Boomaye!» my team met with Steve to discuss a number of technology policy challenges we were facing. We felt there was an opportunity for Microsoft to take the high-ground on personal data privacy issues as a competitive position against Google. Steve agreed that this was clearly an opportunity but while sympathetic to taking that position he was not yet ready to support it. He felt that putting a stake in the ground at this stage would be premature. Once the company committed to a policy position it needed to stick with that position. Steve felt that putting a stake in the ground on consumer privacy before the online advertising market had matured might unnecessarily limit the company’s future options.
Three recent announcements clearly indicate that Microsoft is now ready to put that stake in the ground and that the company’s experiment with an independently targeted advertising based revenue model is over.
The company’s write-off of the $6,2 Billion investment in aQuantive was the first indicator. Microsoft made than investment as a competitive bulwark against Google and now its being written off. In effect the online advertising business — at least in its current form — has been judged to not be core to Microsoft long-term strategic success. This not to say that the company will withdraw from the advertising business altogether but I believe Steve and Co. have a different and more focused model in mind.
Microsoft’s May 2012 announcement that the next version of Internet Explorer would enable «Do Not Track» by default has caused outrage across the advertiser community. That is certainly one very large and very clearly marked stake in the ground. In the most direct way it can Microsoft is saying to advertisers that they are no-longer perceived as important to the company’s long-term success.
Finally, The company’s announcement this Monday (October 22nd 2012) — clarifying that it will not use consumers personal data for targeted advertising— is a final nail in the coffin for the once imagined head-to-head battle with Google for advertiser’s dollars. That game is over and Microsoft is moving on with what it believes is a far more compelling advertising augmented revenue strategy.
Steve Ballmer’s recent announcement that Microsoft should now be considered a «Devices and Software» company was met with derision by the digerati and commentariat. The company’s track record in devices — beyond keyboards, mice and the XBox — is lamentable. Zune players anyone? Even XBox — a huge success by any criteria — had its share of manufacturing problems which have not exactly burnished Microsoft’s hardware credentials. But what if everything to date was — as they say — a learning opportunity?
It famously takes three version for any Microsoft product to reach its full potential. Its quite possible that version three of «Microsoft as a device manufacturer» is about to be unleashed on the world. The evidence for this can be pieced together from a number of moves over recent years. Apple’s acquisition of Intrinsity — an ARM processor design company — in 2010 generated a huge amount of commentary but — strategically — not such a surprising move by a hardware company. What might be more surprising is knowing that Microsoft established a Silicon Architectures «SiArch» team long before Apple got into that business and has been hiring some top chip design talent.
In July 2010 Microsoft signed a new «Architecture» license with ARM. This license gives Microsoft the rights to design its own processors based on the ARM architecture. Just the sort of thing you would need if — like apple — you want to be in the business of creating differentiated processor capability for your own range of devices.
This week saw the publication of a story claiming that Microsoft was manufacturing the new surface tablets in its own manufacturing facility in China. The tenuous nature of the sourcing for this story lead many to question its validity. I’m surprised by that reaction because Microsoft confirmed that they has dedicated manufacturing capabilities back in 2007.
From what I can piece together I suspect the company’s manufacturing capability has advanced significantly over the last five years. It would not surprise me to learn that Microsoft has invested in the level of massive dedicated manufacturing capability that would enable it to compete as a global device manufacturer. Anything less than that would be a 'follower' strategy and I don’t think the Microsoft leadership team see themselves as followers.
I believe that the pivot towards a «Devices and Services» business strategy is premised on the company becoming a category leader, not a follower. If that is the case then they would want to have much more control over supply chain and distribution logistics than even Apple achieves. Instead of merely assembling components a truly agressive 'Leader' strategy would have the company moving upstream into component production. We already know that the company has the ability to create custom processor designs. Are those really nice surface tablet displays also designed and perhaps even manufactured in house?
Becoming A Consumer Business
I have been a long and constant critic of the Microsoft management team for their lack of focus and obsession with becoming a consumer company. I would not be the first to suggest that — over the last 10 years — Microsoft has become the 'Rodney Dangerfield' of the technology industry: Unable to get respect from anyone.
The reality is that by revenue and profitability measures alone Microsoft is quite clearly an enterprise software company — not a consumer products company. The evidence presented indicates that the company maybe getting ready to finally bring clarity to its schizoid business model with a massive pivot towards a «Devices and Service» consumer facing business model. That pivot would require very significant investments in an end-to-end value chain.
We know that Microsoft has device design and manufacturing capability. We also know that the company has invested in its own retail presence over the last few years. That was viewed as an attempt to mimic Apple. But what if this retail strategy had always been about creating a storefront for the company’s own manufactured devices. Such a strategy would allow Microsoft to by-pass traditional low-rent — but margin eating — outlets such as Best Buy.
If the company is focused on becoming an end-to-end device manufacturer then the retail strategy takes on a much larger significance. With in-house manufacturing capability at one and and retail distribution at the other Microsoft would need to join the two. A 'Leader' strategy would require the company to take far greater control of distribution logistics. A 'Leader' would not sub-contract logistics to a 3rd party but rather would build an end-to-end managed distribution network from manufacture to consumer hands.
If Microsoft is committed to taking control of its own distribution network then hiring of Kevin Turner — a former senior WalMart executive — makes a lot more sense. Turner was viewed as a 'square peg in a round hole' overseeing Microsoft’s — core — enterprise sales business. During my time with the company Turner was widely disliked by Microsoft’s enterprise sales staff and was viewed as 'Not getting it' or understanding what was required to meet enterprise customer’s expectations.
What Turner does understand — from his years at WalMart — is consumer retail and supply chain management. These are just the skills to have on hand if Microsoft’s is about to pivot it’s business model towards a consumer «Devices and Services» company.
Serving The Device
Microsoft’s moves to put a stake in the ground regarding online consumer data protection change the company’s calculus about advertising as an intrinsic revenue stream.
The company clearly sees an opportunity to put Google on the back-foot. Microsoft can position itself a champion of consumer data protection and rights while placing Google in the uncomfortable position of either defending its agressive monetization of consumer data or backing away from its current business strategy. Neither of those are palatable outcomes for Google and the latter is certainly untenable given how dependent Google is on it’s advertising revenue stream.
To say that Microsoft has not performed in online consumer services would be a gross understatement. Bilions and billions and billions of dollars have been invested over many years with the company gaining almost zero traction in any meaningful service category. The investment in Bing search and the partnership with Yahoo have hardly yielded the type of market redefining results both company’s had hoped for. If the company is in the midst of pivoting its business model towards a consumer devices-led strategy then expect the company’s online services to be re-focused and re-purposed to that end.
Under this new device-led strategy online services would become value enhancers for devices rather than stand-alone businesses in their own right. Today services like Bing have to compete in an open market where consumers have choice. When a consumer is using a Surface device then the only search, maps or music service they will have access to will be those provided by Microsoft.
Microsoft has had its fair share of anti-trust problems with both the United States Department of Justice and with The European Commissions Competition authorities. In each case Microsoft was judged to have mis-used its monopoly position in the market for PC operating systems. No such claims will be possible against the company when it enters the device business for two reasons. Firstly, Apple and Google already dominate the market for mobile devices. Microsoft quite clearly would not have a monopoly to abuse. In addition Microsoft has rather cleverly cleaved its operating system strategy.
Win8-RT is an entirely different operating system from classic Windows. If Microsoft ties its own services to Win8-RT then competiton authorities are going to have a hard time make any abuse of monopoly case stick.
Wither the OEMs
In a recent article I concluded that Microsoft’s ambitions to be an true consumer products company would remain an expensive fantasy until Steve and the management team were willing to «Throw the OEM partner community under the bus.» It now appears that the company is ready to do just that.
Microsoft’s public pronouncements about the importance of the OEM in the wake of the release of Surface are more than a little disingenuous. Microsoft finally does appear to have crossed the rubicon in regards to the long-term value of their OEM partners. The company appears to embarking on a strategy that — while accommodating the OEM channel — is not going to throw them a life raft. OEMs who do not already have an alternative business strategy when Microsoft becomes their largest and most agressive competitor are in deep trouble.
Ironically the OEM channel is about to commit collective suicide by enabling Microsoft to become their executioner.
Microsoft desperately needs the OEMs right now. They are needed because that’s the only way to get Windows 8 into the hands of hundreds of millions of consumers. But — wittingly or unwittingly — the OEMs are acting as the vector for the «Virus» that will ultimately kill them off. Once a critical mass of consumers have become hooked on Windows 8 Microsoft will have established the reach and credibility of the operating system that is required to execute the company’s devices strategy.
Once Microsoft has its own volume device capability it will have no strategic need for the OEM channel. Microsoft’s message to the OEMs can be summed up as «Enjoy the ride while it lasts.»
Perhaps the company most likely to be impacted by Microsoft consumer devices strategy is Nokia. I have absolutely no doubt that Microsoft is going to become a manufacturer of a full range of Windows 8 based smartphones. That is going to happen sooner rather than later. When Microsoft launches a 'Surface Phone' it is quite simply game over for Nokia.
Consumers already have a hard time choosing betweens phones running Windows Phone 7 and competing offers from Apple and the Android OEMs. If Microsoft comes to market with a range of world-class devices running Windows 8 and sells them through its own retail channel then I don’t see much opportunity for Nokia - or any other Win8 phone OEM for that matter.
Nokia’s strategic options are shrinking rapidly. It’s my view that when Microsoft enters the phone business with its own devices Nokia will have run out of time as an independent company. The most likely final chapter in its storied history sees Microsoft buying up Nokia’s sizable patent portfolio, its in-house design and engineering expertise and — perhaps — the brand rights. Perhaps Nokia’s CEO Stephen Elop will even rejoin the Microsoft leadership team to run the phone business. Alternatives to this outcome seem to be very few and far between.
Truly a sad end to a once dominant company.
Two OS to Rule Them All?
Can Microsoft maintain its current corporate structure if it successfully pivots its business model to become the leading devices and services company? I suspect not.
Successfully executing on the strategy outlined in this article would clearly give Microsoft a new lease on life. On growth prospects alone you would want to own the stock. However, effecting this level of radical change in strategy would amplify — rather than mitigate — the schizoid nature of the company’s operating model. Microsoft would become a company of two polar opposites: A defined, successful and moderate growth enterprise software company at one extreme and a very high growth devices-led consumer business at the other. A single stock ticker representing two such radically different business models makes little sense.
One of the many strategic issues posed when considering splitting up Microsoft has always been 'What to do with the Windows business.' It’s a relatively trivial exercise to bucket Microsoft’s business divisions into either the enterprise or consumer category. But the Windows division quite clearly serves both. If you were to split the company up then where would the Windows division end up?
The problem of where to put the Windows division would be made a lot easier if Microsoft had two operating systems, one consumer focused and the other designed for the enterprise. This realization puts a whole new spin on the Windows 8 strategy.
There are two versions of Windows 8 — one a direct descendant of Windows 7 designed for the Intel architecture and a second brand new 'RT' - version designed for ARM based devices. Initially this looked to be a retrograde step. The company spent years and billions of dollars trying to collapse it’s complex operating system portfolio down to single re-usable Windows code base. Now the company has gone in the opposite direction. Microsoft now has two versions of Windows; one enterprise focused and one purposefully designed for consumer devices.
Breaking the company up into independent consumer and enterprise focused entities would drive huge clarity and focus and unlock a lot of shareholder value. Having two distinct versions of Windows 8 aligned to each segment just made that a lot more straightforward.
Evidence and Supposition
Whether Steve and the leadership team ever decide that Microsoft and its shareholders would be better served by a managed breakup of the company remains to be seen. What is clear from recent evidence is that the company is embarking on the biggest change in business strategy in Microsoft’s history. Their ambition is no less than to become a global leader in consumer devices and services.
Microsoft’s leadership team understands that the only way to be successful with this strategy is to take control of the entire end-to-end value chain and to do so in a deeper way than even Apple has achieved. Such a radical strategy would give Microsoft significant margin advantages over its competitors and would enable it to take complete control over the end consumer experience — something it has desperately lacked in its battle with Apple.
The re-alignment of Microsoft’s online services as value enhancers for a device-led strategy will also bring much needed focus to those investments and in doing so would enable Microsoft to take the high-ground on consumer privacy in their battle with Google.
If Microsoft pull this off then the consumer technology business — and the company’s stock — is in for a wild ride.