It’s easy to forget today but Microsoft got its start as a highly disruptive company. The IBM PC running Microsoft software revolutionized business computing in the 1980s, bringing down the priesthood of the mainframe. As cheap clones and better applications flooded the market, Microsoft was everywhere. In the mid-1990s, the friendlier Windows 95 and the explosion of the World Wide Web made personal computing accessible to a mass consumer market, again dominated by Microsoft.
Twenty years later though, it’s time to contemplate a future in which Microsoft mainly retreats to the back offices its once disrupted so thoroughly. Microsoft’s client business has gotten into deeper trouble faster than I imagined possible. A years ago, the company launched three new client operating systems. Windows RT, the OS designed for tablets with ARM system-on-chip processors, is an unmitigated disaster. Asus, the last OEM with any real commitment to RT products, appears to be bailing out, and Microsoft, after taking a $900 million writedown on unsold inventory of Surface RT tablets, reported that it sold just $853 million worth. Windows 8, the version for traditional PCs and Intel-powered tablets, is not doing much better. For the first time, the introduction of a new version of windows has not only failed to boost PC sales but may actually have helped accelerate the decline, while Windows tablets and new convertible designs have failed to gain much traction.
In this field, Windows Phone 8 looks like the winner. At least it is gaining market share. But Windows Phone, with about 4% of the U.S. market, is a very distant third in what increasingly appears to be a two-horse race. So where does this leave Microsoft: Nowhere in the rapidly growing space of tablets. Still dominant in PCs, but in a market facing slow but inevitable decline. And hanging on by its fingernails in a smartphone market in which growth may be slowing substantially. The bottom line is that it is not at all clear that Microsoft has a viable future in client systems. To be sure, the Windows PC will be with us for a long time to come, but its future for Microsoft is one of managing decline. What would a Microsoft without clients look like?
On the revenue side, it’s not too bad. The Windows Division (these data do not reflect Microsoft’s most recent corporate reorganization), which consists of, well, Windows, accounted for just over a quarter of Microsoft’s gross in the most recent 12 months. Of course, the decline in clients is also going to affect client applications. Office falls into the Microsoft Business Division, which also includes Microsoft’s growing Dynamics line of enterprise management software. Best guess is that Windows and Office combined provide about half of Microsoft’s revenue. The self-explanatory Server and Tools unit and the Entertainment and Devices Division–mostly Xbox–make up most of the rest.
On a pro forma basis, a clientless Microsoft would still be a $40 billion company. The problems come when you look at profits rather than revenues. Windows and Microsoft Business provide nearly all the profit. This picture is not quite a grim as it appears at first glance. If Microsoft were to contract sharply, the $6.6 billion in overhead (“Corporate-level activity”) should also shrink considerably. And the Online Services Division, which includes Bing Search, Skype, and a variety of other services, appears to be in a serious turnaround, trimming its massive losses to $1.3 billion in the most recent 12 months. Server and Tools turns in a very nice 40% margin.
What you might be left with is a company with $40 billion in revenues and a 30% profit margin in place of one with $78 billion in revenue and a 35% margin. No great, but clearly viable. And the fact that Microsoft will go on receiving streams of legacy income for years to come buys it the time it needs for change. The big question is how you get from here to there. Corporate reinventions, in which a company sheds what were once thought to be core businesses to set the stage for future growth, are hardly unheard of. IBM is probably the outstanding example of such a successful transformation. But the process is wrenching and brutal. And I have never heard of a reinvention on this scale being carried out by the management that landed the company on the rocks. Whoever will lead Microsoft to calmer waters, it will not be Steve Ballmer.