Why Nadella Could Be Poised for Microsoft Success

Steve Wildstrom / February 5th, 2014
Photo of Microsoft management (Microsoft)

From left: Chairman John Thompson, CEO Satya Nadella, Bill Gates, Steve Ballmer

When Richard Nixon was elected president, Herblock, the ascerbic Washington Post cartoonist who loved to draw Nixon with a menacing 5 o’clock shadow, promised the new president a clean shave. I’ve been a bit rough on Microsoft lately, but the appointment of Satya Nadella as chief executive officer merits a fresh look. And while the company faces many challenges, especially in consumer markets, Nadella also takes over a company with tremendous strengths, many of them in the areas for which he has been responsible.

The important thing to note about Microsoft is that while the company faces serious long-term problems resulting from the stagnation (at best) of its traditional PC business and its failure to gain notable traction in the growing mobile market, the company is nowhere close to being in crisis. It is not IBM in 1992 or Apple in 1997 or even Nintendo today.

In effect, the choice of Nadella to head the company is a decision by the board to reward strength rather than reinforce failure.

The money machine. In fact, Microsoft remains a money machine. In the six months ended Dec. 31, Microsoft earned an operating profit of $14.3 billion on revenues of $29.7 billion, a gross operating margin of 48% (the profit would, of course, have been significantly lower if the losses of the Nokia handset operations Microsoft is buying were incorporated on a pro forma basis.) Microsoft’s commercial operations, of which Nadella’s cloud and enterprise group is a large part, account for 55% of the sales and 66% of the profits of the corporation. In effect, the choice of Nadella to head the company is a decision by the board to reward strength rather than reinforce failure.

Technology journalism and analysis is so tightly focussed on consumer and mobile markets that it has largely ignored Microsoft’s remarkable success in business software and services. The enterprise, and to a very significant extent, small and medium business, remain Microsoft territory. Tablets, mostly the iPad, are gaining ground but business is still overwhelmingly PC country, it is likely to remain so, and it runs on Windows and Office. Corporate mail and collaboration is largely Exchange and SharePoint, SQL Server has a big chunk of the mid-range database business and Dynamics has been coming on strong in CRM, ERP, and analytics.

Cloud success. Microsoft has had considerable success converting its software business into a subscription model for both business and consumers. And it has made great strides moving into the cloud, from  its Azure Platform as a Service business to OneDrive (formerly SkyDrive, until it lost a trademark battle with Sky Broadcasting.)

As venture capitalist Brad Silverberg, who headed Microsoft’s Windows 95 development, wrote for Cnet:

Satya has reinvigorated Microsoft’s server and tools business. He’s done a remarkable job getting Microsoft to move fast on the cloud and begin staking out a strong position against difficult competitors, such as Amazon. Most of all, he recognized that the world has changed and that to be relevant and become a leader again, Microsoft needs to embrace those changes and offer solutions for customers that fit in that new world. Whereas once open source was regarded as a cancer at Microsoft, Satya has found a way for Microsoft to add value while supporting new standards, like Linux, Hadoop, Ruby on Rails. It’s exciting to see Microsoft play well in this new world and offer differentiated solutions.

Keeping the parts of the company he knows well on track is the easy part for Nadella. Fortunately, the cash that continues to pour out of the Microsoft enterprise engine buys plenty of time to fix the not so good parts. The first challenge is dealing with Windows. Not being a stupid company, Microsoft realizes that it made a fundamental mistake in the design of Windows 8. The notion that cramming both touch-based and keyboard-and-mouse driven user interfaces into a single package and forcing both table and traditional PC users to deal with both to varying extents was a really awful idea. But Microsoft took a step back with Windows 8.1, is about to take another with Windows 8.1 Update 1 and may go the rest of the way with what may or may not be called Windows 9. due to be previewed at the Build developer conference in April.

Winning the  enterprise. To win enterprise support for Windows 9 and keep Windows 7 from becoming the XP for the next decade, Microsoft needs to give customers the good stuff from Windows 8, such as the cloud integration, while freeing it from a touch-first UI that no one wants on traditional laptops and desktops that are still the backbone of business. At the same time it needs to free tablet users from the legacies of the desktop, which require that the Surface be shackled to a keyboard. The answer may be a rebirth of Windows RT, but this time backed by a rich suite of touch-only apps, including a new version of Office.

Fixing Windows Phone is even more difficult. Many of the same people who hate Windows 8 actually like Windows Phone and also like the new Nokia handsets. But outside of a few markets in Europe and Latin America, it just hasn’t gotten much traction in a field dominated by Apple and Android. Microsoft’s existing hardware business, which consists of both Surface tablets and Xbox consoles, along with a profitable range of accessories, eked out a gross margin of $617 million on sales of $6.1 billion last year–Microsoft did not report the operating margin for hardware, the but the businesses were probably in the red after expenses were fully allocated. Nokia is continuing to lose money by the bucketful.

Struggling phones. There’s no easy way out of this mess. Microsoft has picked up all the business it can from the collapse of BlackBerry, leaving it to fight iPhone and Android. Windows Phone gains have come mainly in the low end of the market, where sales are easier to come by than profits, and it could end up fighting for share with the Nokia Asha feature phones it will still own. Fortunately, the losses from the phone business are modest, even with the Nokia red ink added in, and Microsoft can go on absorbing them for some time while it looks for a solution.

Another interesting dynamic for Nadella will be the role played by Microsoft founder Bill Gates, stepped down as nonexecutive chairman to be succeeded by John Thompson, a former IBM executive and one-time CEO of Symantec who headed the search committee. Gates will become a part-time, but potentially highly influential technology adviser to Nardella. There has been much speculation of where Gates thinks Microsoft should move but he, typically, has kept his own counsel. Ballmer also surprised many observers by keeping his seat on the board, though he will have no management role.

 

 

Steve Wildstrom

Steve Wildstrom is veteran technology reporter, writer, and analyst based in the Washington, D.C. area. He created and wrote BusinessWeek’s Technology & You column for 15 years. Since leaving BusinessWeek in the fall of 2009, he has written his own blog, Wildstrom on Tech and has contributed to corporate blogs, including those of Cisco and AMD and also consults for major technology companies.
  • blindfolded

    We’ve been deeply mired in confusion for two years but we’ll keep the same top people who were responsible for it.

    Competition? We don’t have any. We’re Microsoft.

    A downward spiral? We don’t know what you’re talking about.

    • steve_wildstrom

      The problem is that people keep looking at a piece of Microsoft’s business–the piece that interests them and the piece that is in difficulty–and see a company “mired in confusion.” From 2006 to 2013, Microsoft’s profits grew at a compound annual growth rate of more than 8%.

      The crazy thing to me is that a lot of Microsoft critics seem to be prepared to forget about the monumentally successful part of the business to focus all of its efforts on the troubled part.

      Nadella faces many challenges as CEO, but the company’s record suggests the board knew what it was doing when it picked him, however long it took.

      • blindfolded

        Oh you’re referring to the enterprise business which includes Windows 8, the flagship OS that the enterprise doesn’t want. And for 10 years Microsoft’s stock has been dead money.

        And as far as mobile goes, no monumental success there, even though Microsoft tried very hard in what many people have referred to as the future of computing.

        The board chose a mirror of themselves. If they’re on the wrong path they should definitely stay on it, because only they know how to run their business.

        • Bill Smith

          I sometimes ask my most creative clients whether they understand that going public or being acquired by a public company will fundamentally change their company. Even if you’re wildly successful, you’ll have people making mountains out of molehills until, one day, you’ll attract the attention of an Icahn or another activist investor who has no concern about the company and what it may accomplish. Instead, it will be all about “maximizing shareholder value”, playing “not to lose” rather than to win, not investing in the future because you can buy back stock and increase EPS.

          As Mr. Wildstrom points out, this is a very short-sighted, though popular view of Microsoft, but it’s the correct view for a shareholder. It’s tightly related to why Apple can have an incredible, record-breaking quarter and still get taken to the woodshed.

          • steve_wildstrom

            This is why I look at companies and industries, not stock prices.

          • klahanas

            I don’t play the stock market at all, so I’m not qualified to really judge. As an outsider’s view, however, don’t you think that when it hit $700+ AAPL wasn’t the beneficiary of hype, just as it’s the victim of hype now? 700+!!! Exxon practically owns several small countries and had a lower valuation. Does this really make sense?

          • Bill Smith

            Too bad about that “peak oil” theory. While Apple can always have another brilliant idea, Exxon can’t innovate its way out of a shortage or (even) political change.

            One man’s valuations are another man’s smoke and mirrors.

          • klahanas

            Indeed, but one solves an “all world problem”, the other a “first world problem”. 🙂

          • Bill Smith

            Mostly agree, but I doubt that a villager in the Congo is spending much time thinking about the price of premium unleaded.

          • klahanas

            The villager in the Congo probably worries slightly less than the average iOS user worries about what they are not allowed to do with their devices. Point being, freedom, openness should win…

          • Bill Smith

            Not to get too philosophical, but it’s only the illusion of freedom and/or openness that wins. The real thing almost never does, and is continually squished under the boot of the powers that be. Surely you’ve read Orwell.

        • steve_wildstrom

          In Microsoft’s current organization, Windows and Office are split between Consumer and Commercial depending on sales channel. Windows 8 sales to the enterprise are very small, though windows 9 could be a different story.

      • Stig Bull

        «The problem is that people keep looking at a piece of Microsoft’s business–the piece that interests them and the piece that is in difficulty–and see a company “mired in confusion.” From 2006 to 2013, Microsoft’s profits grew at a compound annual growth rate of more than 8%.»

        Ballmer is not average or stupid, far from it. Just let that be clear.

        However Microsoft is a convicted monopolist. Their foremost business areas are those where they have little to no competition (Exchange server, Office suite, anyone?), and IT admins and managers are way too tied into their homogeneous ecosystem – as the saying goes, nobody has ever gotten fired for buying a Microsoft product? – in order to consider alternatives.
        I’ve been in the industry for 20 years, and I see on a daily basis IT admins and IT technicians who oppose anything if it isn’t Microsoft, because they don’t know anything but Microsoft.

        So as new and more data demands more servers, and Microsoft is moving its product to a licencing model where you rent their software on a annual basis (because hey, who can honestly say they need to upgrade to every new Office version once it’s out? And of course, since they don’t, it is a huge problem for Microsoft) – of course their income is increasing.
        But as others have pointed out, in business and technological areas where they have competition and no monopoly leverage, they are struggling to make a dent.
        Fortunately the times are changing.

  • RATBURL

    Microsoft should have made this change a long time ago,like before the iPhone came out when the outgoing CEO thought it was a joke.

  • Recision

    It doesn’t matter if they have successful parts of their business, if they continue to bundle together the good bits with the bad bits. You sourer the customer experience by forcing them to accept parts they don’t want in order to get the bits they do.
    Sure you might monetize the integrated ecosystem for now, but it builds up a wellspring of antipathy over time. Also, it disguises the parts of your business that are dying on the vine, and creates the impression that everyone loves what you are doing – because it sells “so well”. That Hubris and arrogance has become an integral part of the Microsoft DNA.
    Re-shuffling the management positions, but keeping the same people wont change anything. if they could have changed anything they would have already. And the biggest change they need is to change their minds. I see no evidence they have done that. When a sea-change happens around them, all they do is deny that it is relevant. And of course it isn’t – until it is.
    But you can’t prepare for change if you can’t see it coming.
    Disasters are caused by not one thing, but by a whole string of minor factors that happen to conspire/combine together (and are often ignored). Particularly if you are already making money under the old system.
    So MS wont see it coming, and when it hits they will be surprised at how “fast” it happened.
    My prediction is that MS will broken up and sold within the next 5-10 years. And it will be the fault of management and the company culture they created. They “believe” in themselves, and will continue to believe right into the grave – because hey, they are winners…!
    Bad mindset will corrupt any good that exists.

  • Mauryan

    Microsoft has taken the first step towards some recovery – showing Ballmer the door. The next thing they have to do is help Gates retire gracefully and help the poor. Then they have a chance to really do things radical – for example, replace that dirty word, “Windows” and call it something else. Much like Kentucky Fried Chicken changing to KFC, Microsoft has to change its brand name product to something else. The public have developed a bad taste association for it. In consumer business names and appearance matter a lot. It is all psychological. Consumer market is where all the money is going to come from. Enterprise market does not care for elegance.

    • Bill Smith

      Ballmer gets bashed far too often. It’s not that he was a bad CEO; he wasn’t “great.” Many of us would do well to be a sustainer, like Ballmer. Not everybody has the talent (or the good timing) to get a plane into the air, but don’t underestimate how much skill it takes to not crash!

  • mscritic

    Nothing has really changed in the leadership at Microsoft. They display an ignorant arrogance which has seriously cost them in the past, and will cost them more in the future.

  • JoeS54

    Unfortunately many people who comment on these subjects on the internet don’t have a clear grasp of what they’re talking about. Few even know or understand what Azure is, they have no clue how enterprise systems are configured, and they have no grasp of the real numbers behind the companies involved. For example, Windows 8 is often depicted as some sort of catastrophic disaster that will bankrupt Microsoft. They don’t realize that these things are all relative. Windows 8 sold 100 million copies in the first 6 months if it’s release. That’s more than the total number of iPhones and iPads combined sold by Apple in all of 2013. So while it has been disappointing by Windows standards, it’ not exactly the path to extinction.

    • steve_wildstrom

      Wonders may never cease. I almost agree with you, at least the part about people not understanding the importance of Azure and other Microsoft back office efforts.

      Windows 8 is another matter. Windows 8 adoption is a disaster. The 100 million number is not particularly good, and is not meaningful anyway when you consider the number of commercial systems sold with Windows 8 but downgraded to Windows 7. I’m sure that somewhere out there is an enterprise that has done a large-scale Windows 8 adoption, but I haven’t encountered it.

      • JasonJoyner

        You’re right, Microsoft isn’t stupid. Which is why they experimented with metro and what they did with Windows 8, right after Windows 7. They can get away with it then. Microsoft knows the enterprise moves slowly, and generally skips every other release. Even if Windows 8 looked exactly like Windows 7, and was universally reviewed as the second coming of Christ, the enterprise wasn’t going to adopt it. They spent years testing and prepping to move to Windows 7. They aren’t going to just drop everything and move to a completely untested OS. Microsoft knows this, and will probably have all of the kinks worked out by Windows 9, which is what the enterprise will move to. It doesn’t matter to the enterprise that Windows 7 won’t be for sale anymore. They have Software Assurance agreements that let them get Windows 7 licenses until Windows 7 is no longer supported.

  • Muslim Mahmood

    Ultimately it boils down to Windows 9 for Desktops & Laptops, and Windows RT for Tablet PCs, if Microsoft can get that right then they be fine at least

Protected by Gerben Law