Microsoft’s Pivot — A Plan to Dominate “Devices and Services”

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.

Into Devices

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.”

Nok Nok…

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.