Microsoft announced some key, but not terribly surprising, changes to their management teams yesterday. The headline was Stephen Elop, former Nokia CEO, will be leaving Microsoft. Most public commentary has been viewing the moves in light of Microsoft’s role in the industry making their own branded hardware, namely smartphones through the acquisition of Nokia. There are some cloud and services organisation movements included in this re-org but I’m going to focus more on the hardware part of the discussion.
As a part of the new organization, Terry Myerson will now be running the Windows and Devices Group. Here is the exact statement from an internal email.
Terry Myerson will lead a new team, Windows and Devices Group (WDG), enabling our vision of a more personal computing experience powered by the Windows ecosystem. We will combine the engineering efforts of our current Operating Systems Group and Microsoft Devices Group (MDG) led by Stephen Elop. This new team brings together all the engineering capability required to drive breakthrough innovations that will propel the Windows ecosystem forward. WDG will drive Windows as a service across devices of all types and build all of our Microsoft devices including Surface, HoloLens, Lumia, Surface Hub, Band and Xbox. This enables us to create new categories while generating enthusiasm and demand for Windows broadly.
One of the most debated topics in my analyst circles is Microsoft’s efforts in hardware, particularly around Surface and smartphones. Many believe Microsoft should not be in hardware and both their Surface and Windows Phone efforts are counter-productive to their partner software licensing model. This argument is stronger with Surface than it is with Windows Phone since Nokia was the only major vendor committed to shipping them. Microsoft owning Nokia, in reality, was not a competitive move against other hardware partners since there were no other truly committed OEMs to Windows Phone. This is also why Microsoft felt they needed to buy Nokia. We now know Nokia was on the brink of shipping Android, which would have likely led them down a path to abandoning Windows Phone entirely. Microsoft, at the time, felt strongly about Windows Phone remaining in the marketplace and couldn’t risk their only true smartphone partner to drop them and move to Android.
Should Microsoft still be making Windows-based smartphones? One can argue their global smartphone market share is not only growing extremely slowly but is also quite small.
Ben Thompson, in his daily subscriber($) email, wrote he believes this is the beginning of the end of Microsoft’s efforts in hardware. I’m not ready to go that far yet for a number of reasons.
There is still a lot of opportunity in hardware. Perhaps we can argue those opportunities are not in areas Microsoft is in yet, but this is where the last line of the quote I pulled from Nadella’s email comes into play. “This enables us to create new categories.” I think Microsoft still sees hardware opportunities on the horizon in both current hardware businesses and future ones.
You can make money in hardware. FitBit demonstrates a great example of monetizing hardware. FitBit currently makes quite a bit of money in hardware and in a space where Microsoft is looking to gain share with their own health and fitness band. FitBit’s margins are roughly 50% today and with their IPO going live today there has been solid commentary on their profitability. In regards to FitBit, I would be skeptical they can keep their hardware profits/margins going as history teaches us how, in many categories, hardware becomes commoditized. The bear narrative for FitBit is actually the bull narrative for Microsoft. Should Microsoft be able to grow their health band hardware business, they will be able to make money on hardware but, more importantly, they can tie that hardware business to their services. There is money in hardware, but I’ve frequently argued the best-positioned companies to succeed in hardware are services companies who don’t rely solely on the hardware margins to survive. I believe this will also work in favor of Microsoft even though it may not be immediately apparent.
Filling Existing Holes. If I was Microsoft, I’d be taking a hard look at the consumer PC market and asking myself how much longer my OEM partners will stay serious about consumer desktops, notebooks, and tablets. When you look at how Lenovo, Dell, and HP are positioning themselves, it is clear more of their resources and focus is consumed by the commercial segments of the industry rather than the consumer segments. While the Surface project started as a way to kickstart innovation in PCs and used as a showcase, it could likely become Microsoft’s best chance to serve the global consumer PC segment.
Similarly, I’m intrigued by a new feature called Continuum which will let owners of Windows Phones plug their phone into a monitor, keyboard, and mouse and use the device as a desktop computer. The idea your smartphone is your primary CPU and drives the intelligence of other displays is not a new one. Motorola tried this with their Atrix design. This idea struggled in developed markets, but I’m interested in this idea for emerging markets. Say someone in India buys a Windows Phone for $200 and that phone can also be docked with a big screen, keyboard, and mouse and function as their desktop as well. It becomes a 2-1 where it’s both a smartphone and a desktop PC. I’m intrigued to see how this plays out in emerging markets since we have data to suggest interest in PCs is high in these markets but price keeps them out of reach for rural India, Africa, China, and SE Asia. Viewing Microsoft through a software and services lens, this strategy is a way to bring software and services to brand new customers and empower them in the way Satya Nadella desires.
The point of the hardware is if Microsoft doesn’t do these things and fill these holes, who will? Others have conflicting interests since the business model is shifting from hardware to services. Other companies will want to get in on the services side and could cut Microsoft out. In this regard, both Microsoft and Google are in tricky positions when it comes to the next billion if that is indeed a segment they want to capture growth from.
While it may not be the popular position, I’m a bit more positive on Microsoft’s hardware initiatives. Even if some of them fail, I believe there will be new hardware categories which will need deep services integration that Microsoft can play in. Hopefully, what Microsoft is getting better at is identifying these areas early so they can participate before it is too late.