Big Changes at Microsoft: Define “Platform”

on August 13, 2014

Satya Nadella is just the third CEO in Microsoft’s nearly 40 year history. For most of that time, Microsoft followed a fairly simple strategy: license operating system software to OEMs and sell software to consumers, and later, enterprises.

Bill Gates’ Microsoft: Licensed Software
During Bill Gates’ time as CEO, Microsoft did offer a limited line of hardware, but the mice and keyboards were clearly both opportunistic and complementary to Microsoft’s PC OEM partners. Microsoft’s hardware only really competed with Logitech and Belkin, not Dell, Compaq, Gateway, or HP. Licensing OS software was wildly successful and Microsoft accrued the majority of profits to be had in the PC market. (At times, Apple has also been quite profitable making PCs, but that’s the subject of a different column.)

Steve Ballmer’s Microsoft: Reacting to Google and Apple Leads to Devices and Services
When Steve Ballmer took over as Microsoft CEO at the turn of the millennium, his focus was on holding off regulators, consolidating Microsoft’s hold on consumer software, and expanding Microsoft’s enterprise software and developer tools. However, the computing landscape began to change. Apple’s iPod showed an integrated approach in consumer electronics could be wildly successful and began building on a foundation of software and services that turned into the iPhone and the iPad. Google proved cloud services were a huge source of future computing revenue and growth. In response to Google, Microsoft launched the Bing search engine and invested in creating a platform for its own cloud services offerings (Azure, which was run by Satya Nadella).

In response to the iPod, Ballmer killed Microsoft’s PlaysForSure program and launched the vertically integrated Zune, upsetting his MP3 player OEM partners. By the time Zune was introduced in 2006, Apple had such complete control over the market for media players that vendors could be forgiven for thinking the shift to a vertical strategy was an aberration. This was not Microsoft’s first move towards a vertically integrated product – Microsoft launched the Xbox in 2001, building its own hardware and system software, and tightly controlling third party game titles. This was the established business model for game consoles, but it was quite different to Microsoft’s approach to PC gaming.

Even as Microsoft adopted vertically integrated hardware strategies for media players and game consoles, its largest business, Windows, was still fully horizontal, with Microsoft licensing software to OEMs who built PCs, laptops, and tablets. In 2010, Apple launched the iPad and, by 2012, it had redefined tablet computing. The iPad posed such a serious threat to Microsoft’s PC cash cow, Microsoft was willing to compete directly with its hardware licensees by building its own tablet, the Surface. Surface has not helped slow the decline of PCs and Microsoft had to take a billion dollar write-off to get units to sell at steep discounts.

Stephen Elop’s Nokia: Betting Big on Windows Phone (and Losing)
Even as Microsoft started building its own tablets, it kept licensing Windows Phone to OEMs. Microsoft had invested early in smartphone OS platforms, but failed to react quickly to Apple’s iPhone revolution. BlackBerry, Palm, and Nokia all had the same problem; only Google radically shifted its Android user experience and caught up to Apple. When Microsoft belatedly realized a reset was required, it kept its business model. The first generation of Windows Phone 7 devices were flops, and Microsoft’s smartphone market share declined further. When Stephen Elop, an ex-Microsoft executive, was chosen to run Nokia, he (with the blessing of Nokia’s board of directors) chose to throw Nokia’s hat in with Microsoft anyway, hoping Nokia could make the market for Windows Phone rather than competing head-to-head with Samsung on Android.

It didn’t work – Nokia’s sales volumes and profitability shrank further. As a last ditch effort, Nokia launched the X line of Android AOSP phones with ties to Microsoft services on top. Android phones were one possible way out but rather than throw more money into smartphones, Nokia was using all of its cash to invest in the profitable business of network infrastructure. The clear plan: shut down the phone business and focus on infrastructure and IP. Ballmer was not willing to let Windows Phone die without vendor support, and therefore bought Nokia. Stephen Elop moved back to Microsoft as head of the devices business.

Satya Nadella’s Microsoft: Productivity and Platforms
With hardware businesses for game consoles, tablets, and now phones, Steve Ballmer formally declared Microsoft’s strategy was to build devices and services. Even after Ballmer was pushed out and Satya Nadella promoted to CEO, this message was reinforced at Microsoft’s BUILD developer conference. Just three months later, Nadella published an email on Microsoft’s website repudiating devices and services:

“While the devices and services description was helpful in starting our transformation, we now need to hone in on our unique strategy. At our core, Microsoft is the productivity and platform company for the mobile-first and cloud-first world.”

This was followed by a memo from Nadella and an email from Elop – both published on Microsoft’s site – laying out some of the changes.

    1. • Microsoft is cutting its Nokia headcount quick and deep, but even with the productivity and platforms emphasis, Microsoft is unwilling to pull out of phones entirely – the Windows Phone market would collapse.
    2. • Nadella is killing further development on Nokia’s X line of phones. While the X phones sold well and brought users into Microsoft’s services ecosystem, they presented a strategic challenge to Windows Phone. Microsoft is a platforms and productivity company now; killing X is about protecting the Windows Phone platform.
    3. • Microsoft is also winding down development Asha and Series 40 phones. Microsoft is not going to sell hardware for the sake of selling hardware or growing the Nokia brand – a brand it has a time-limited license to in any case.
    4. • The Xbox itself is not strategic to a productivity orientation, but it is not being shuttered for pragmatic reasons: it generates cash flow and serves as an incubator for new technologies like motion control that may be applied elsewhere. However, Microsoft-originated TV shows and documentaries are distractions from the company’s new mission, so those have been killed.

Define “Platforms,” and You Define Your Business Model Going Forward
Despite what some investors have been calling for, Microsoft is not getting out of the consumer business. Microsoft defines “productivity” fairly broadly, including not only corporate productivity but personal productivity as well. Presumably, even this inclusive definition excludes entertainment, and Microsoft has made moves to cut back on original Xbox content, but not much else.

The problem is that even if “productivity” is meaningful, Microsoft has not defined what “platforms” means, and Microsoft’s business model depends on whether “platform” is defined to mean cloud services (Azure, Bing, Office) or software operating systems (Windows, Windows Phone). Nadella comes from the cloud services division, but he is running a company where Windows is both a sacred cow culturally and a cash one financially. The current direction is to apply to both, but these are mutually exclusive paths. If Microsoft wants its cloud services platforms to succeed, it will need to work as broadly as possible on rival devices and operating systems. (This is Google’s business model; Google sells advertising, and while it builds its own platforms to expand its reach, it does its best to bring its apps and services to iOS.) If Microsoft wants its OS platforms to succeed, it should be keeping its software and services tied as closely as possible to those operating system platforms. (This is Apple’s business model, though Apple monetizes it with hardware sales. If Microsoft wants its OS platforms to succeed as licensed software, it should be licensing the OS platforms as widely as possible, not building hardware to compete with other OEMs.)

Can a Market Be Made?
No matter how “platforms” are defined, if Microsoft is a productivity and platforms company, it should not need to be in the hardware business. Microsoft thinks it does need to build its own hardware – but only up to a point. Nadella notes his goal for the Nokia acquisition is to “responsibly make the market for Windows Phone.” Microsoft does not see itself as a competitor to hardware licensees; it is trying to grow the market so that everyone can thrive.

That may be Microsoft’s desire, but that is unlikely to be the result.

Microsoft cannot cut its way to Windows Phone sales growth. Apple and Google are entrenched in the mobile market and Microsoft will not be able to dislodge them. The only question is whether Microsoft can create a niche market for a third OS that is profitable and sustainable. Even that limited goal will be difficult to accomplish and, while Microsoft tries to make the market, its branded hardware will compete with its licensees.