Why Microsoft is Still Speculative

Why Microsoft is Still Speculative

Hope springs eternal in the human breast” (Alexander Pope)

As it does for most investors.  People do not like to accept the notion that a business will lose relevancy, and its value will fall.  Especially really big companies that are household brand names.  Investors, like customers, prefer to think large, established companies will continue to be around, and even do well.  It makes everyone feel better to have a optimistic attitude about large, entrenched organizations.

And with such optimism investors have cheered Microsoft for the last 15 months.  After a decade of trading up and down around $26/share, Microsoft stock has made a significant upward move to $41 – a new decade-long high. This price has people excited Microsoft will reach the dot.com/internet boom high of $60 in 2000.

After discovering that Windows 8, and the Surface tablet, were nowhere near reaching sales expectations after Christmas 2012 – and that PC sales were declining faster than expected – investors were cheered in 2013 to hear that CEO Steve Ballmer would resign.  After much speculation, insider Satya Nadella was named CEO, and he quickly made it clear he was refocusing the company on mobile and cloud.  This started the analysts, and investors, on their recent optimistic bent.

CEO Nadella has cut the price of Windows by 70% in order to keep hardware manufacturers on Windows for lower cost machines, and he announced the company’s #1 sales and profit product – Office – was being released on iOS for iPad users.  Investors are happy to see this action, as they hope that it will keep PC sales humming. Or at least slow the decline in sales while keeping manufacturers (like HP) in the Microsoft Windows fold.  And investors are likewise hopeful that the long awaited Office announcement will mean booming sales of Office 365 for all those Apple products in the installed base.

But, there’s a lot more needed for Microsoft to succeed than these announcements.  While Microsoft is the world’s #1 software company, it is still under considerable threat and its long-term viability remains unsure.

Windows is in a tough spot.  After this price decline, Microsoft will need to increase sales volume by 2.5X to recoup lost profits.  Meanwhile, Chrome laptops are considerably cheaper for customers and more profitable for manufacturers.  And whether this price cut will have any impact on the decline in PC sales is unclear, as users are switching to mobile products for ease-of-use reasons that go far beyond price.  Microsoft has taken an action to defend and extend its installed base of manufacturers who have been threatening to move, but the impact on profits is still likely to be negative and PC sales are still going to decline.

Meanwhile, the move to offer Office on iOS is clearly another offer to defend the installed Office marketplace, and unlikely to create a lot of incremental revenue and profit growth.  The PC market has long been much bigger than tablets, and almost every PC had Office installed.  Shrinking at 12-14% means a lot less Windows Office is being sold. And, In tablets iOS is not 100% of the market, as Android has substantial share.  Offering Office on iOS reaches a lot of potential machines, but certainly not 100% as has been the case with PCs.

Further, while there are folks who look forward to running Office on an iOS device, Office is not without competition.  Both Apple and Google offer competitive products to Office, and the price is free.  For price sensitive users, both individuals and corporations, after 4 years of using competitive products it is by no means a given they all are ready to pay $60-$100 per device per year.  Yes, there will be Office sales Microsoft did not previously have, but whether it will be large enough to cover the declining sales of Office on the PC is far from clear.  And whether current pricing is viable is far, far from certain.

While these Microsoft products are the easiest for consumers to understand, Nadella’s move to make Microsoft successful in the mobile/cloud world requires succeeding with cloud products sold to corporations and software-as-service providers.  Here Microsoft is late, and facing substantial competition as well.

Just last week Google cut the price of its Compute Engine cloud infrastructure (IaaS) platform and App Engine cloud app platform (PaaS) products 30-32%.  Google cut the price of its Cloud Storage and BigQuery (big data analytics) services by 68% and 85% as it competes headlong for customers with Amazon.  Amazon, which has the first-mover position and large customers including the U.S. federal government, cut prices within 24 hours for its EC2 cloud computing service by 30%, and for its S3 storage service by over 50%. Amazon also reduced prices on its RDS database service approximately 28%, and its Elasticache caching service by over 33%.

To remain competitive, Microsoft had to react this week by chopping prices on its Azure cloud computing products 27%-35%, reducing cloud storage pricing 44%-65%, and whacking prices on its Windows and Linux memory-intensive computing products 27%-35%.  While these products have allowed the networking division formerly run by now CEO Nadella to be profitable, it will be increasingly difficult to maintain old profit levels on existing customers, and even a tougher problem to profitably steal share from the early cloud leaders – even as the market grows.

While optimism has grown for Microsoft fans, and the share price has moved distinctly higher, it is smart to look at other market leaders who obtained investor favorability, only to quickly lose it.

Blackberry was known as RIM (Research in Motion) in June, 2007 when the iPhone was launched.  RIM was the market leader, a near monopoly in smart phones, and its stock was riding high at $70.  In August, 2007, on the back of its dominant status, the stock split – and moved on to a split adjusted $140 by end of 2008.  But by 2010, as competition with iOS and Android took its toll RIM was back to $80 (and below.)  Today the rechristened company trades for $8.

Sears was once the country’s largest and most successful retailer.  By 2004 much of the luster was coming off when KMart purchased the company and took its name, trading at only $20/share.  Following great enthusiasm for a new CEO (Ed Lampert) investors flocked to the stock, sure it would take advantage of historical brands such as DieHard, Kenmore and Craftsman, plus leverage its substantial real estate asset base.  By 2007 the stock had risen to $180 (a 9x gain.) But competition was taking its toll on Sears, despite its great legacy, and sales/store started to decline, total sales started declining and profits turned to losses which began to stretch into 20 straight quarters of negative numbers.  Meanwhile, demand for retail space declined, and prices declined, cutting the value of those historical assets. By 2009 the stock had dropped back to $40, and still trades around that value today — as some wonder if Sears can avoid bankruptcy.

Best Buy was a tremendous success in its early years, grew quickly and built a loyal customer base as the #1 retail electronics purveyor.  But streaming video and music decimated CD and DVD sales.  On-line retailers took a huge bite out of consumer electronic sales.  By January, 2013 the stock traded at $13.  A change of CEO, and promises of new formats and store revitalization propped up optimism amongst investors and by November, 2014 the stock was at $44.  However, market trends – which had been in place for several years – did not change and as store sales lagged the stock dropped, today trading at only $25.

Microsoft has a great legacy.  It’s products were market leaders.  But the market has shifted – substantially.  So far new management has only shown incremental efforts to defend its historical business with product extensions – which are up against tremendous competition that in these new markets have a tremendous lead.  Microsoft so far is still losing money in on-line and gaming (xBox) where it has lost almost all its top leadership since 2014 began and has been forced to re-organize.   Nadella has yet to show any new products that will create new markets in order to “turn the tide” of sales and profits that are under threat of eventual extinction by ever-more-capable mobile products.

While optimism springs eternal long-term investors would be smart to be skeptical about this recent improvement in the stock price.  Things could easily go from mediocre to worse in these extremely competitive global tech markets, leaving Microsoft optimists with broken dreams, broken hearts and broken portfolios.

Update: On April 2 Microsoft announced it is providing Windows for free to all manufacturers with a 9″ or smaller display.  This is an action to help keep Microsoft competitive in the mobile marketplace – but it does little for Microsoft profitability.  Android from Google may be free, but Google’s business is built on ad sales – not software sales – and that’s dramatically different from Microsoft that relies almost entirely on Windows and Office for its profitability

Update: April 3 CRN (Computer Reseller News) reviewed Office products for iOS – “We predict that once the novelty of “Office for iPad” wears off, companies will go back to relying on the humble, hard-working third parties building apps that are as stable, as handsome and far more capable than those of Redmond. It’s not that hard to do.”

 

 

Microsoft – Another GM in the Making?

"Is the Party Over for Microsoft?" is the headline at Marketwatch.com.  In case you missed it, last week Microsoft reported sales and earnings, and "Microsoft declines on disappointing results" was the most appropriate headline.  Sales dropped 17%.  Let's see, the last  time we heard about a mega-corporation with double-digit revenue declines that would have been – oh yes – GM – and Chrysler.

This blog has been brutally negative on Microsoft for over 3 years.  A quick look at the long-term chart and you'll note that the stock has not come near its 2000 high this decade.  It's been mired in a go-nowhere range, and has recently broken down to prices last seen in the late 1990s.  For investors, Microsoft has been only a disappointment. 

But that's because the company has been equally disappointing for customers.  Microsoft has been very consistent about trying to "milk" it's near-monopoly in desktop operating systems and office software.  Even though the market has moved, Microsoft has done little to move with it.  It's applications are "more of the same."  It's operating systems have become bloated, and new versions have offered practically no advantages to switch.  Meanwhile, customers are learning to enjoy Linux – and Macs again – as well as Unix for servers.  There's literally been nothing for customers, investors — or suppliers to get excited about.  Ask Dell, itself stuck in the doldrums as a Microsoft devotee.

It's not due to a lack of opportunities in the dynamic IT world.  Since 2000 we've seen the emergence of Google, which simply cleaned Microsoft's clock in search and ad placement.  The world of digital music became dominant, but that was claimed by Apple.  Hot websites for information became valuable – but Marketwatch and HuffingtonPost (examples) are laying claim to attracting lots of readers.  Microsoft simply missed these marketsAlways late, and never really in step with shifting market requirements.  The company tried, failed, and just kept "clipping coupons" from its near- monopoly.

It hasn't been hard to see the market shifting.  Customers were put off by Microsoft's disregard for their needs in the 1990s.  They searched for better solutions, and found them.  Microsoft kept being Microsoft, but the world moved.  Now, Microsoft is stuck.  And what are they going to do to get out of their rut? 

When a company is large, has a lot of cash, and has strong market share analysts are reluctant to predict it will do poorly.  But Microsoft has been so Locked-in, for so long, it has been quietly letting all new markets go to new competitors.  There have been NO Disruptions to the Success FormulaWindows and Office have dominated the investments.  "Taking care of the franchise" has been the mantra.  That meant doing more of the same.  Which got us Vista – an operating system that was over a year late to market, and very easy to ignore.  There hasn't been any White Space to develop new solutions.  And as a result whenever Microsoft has tried to do anything new it has been late, with inferior product, a significant lack of knowledge about what the market really wanted, and out of step with new requirements for performance and price.

Microsoft won't declare bankruptcy in 2009 – or 2010.  But it's acting just like GM.  It's spending all its time trying to Defend & Extend its past.  But in fast changing markets, that's not enough to remain viable.  In markets moving as fast as IT, it's deadly.  Remember DEC?  Wang?  Lanier?  Burroughs?  Univac?  IBM mainframes?  Cray supercomputers?  Microsoft is more like GM than it's like Google.  Thus, it's future isn't hard to predict.  If you're an employee, time to brush up the resume.  If you're an investor, time to look for the exit.

Do'nt miss the new ebook "The Fall of GM:  What Went Wrong and How To Avoid It's Mistakes"

Why Google isn’t like GM

Google is growing, and GM is trying to get out of bankruptcy.  On the surface there are lots of obvious differences.  Different markets, different customers, different products, different size of company, different age.  But none of these get to the heart of what's different about the two companies.  None of these really describe why one is doing well while the other is doing poorly.

GM followed, one could even say helped create, the "best practices" of the industrial era.  GM focused on one industry, and sought to dominate that market.  GM eschewed other businesses, selling off profitable businesses in IT services and aircraft electronics.  Even selling off the parts business for its own automobiles.  GM focused on what it knew how to do, and didn't do anything else. 

GM also figured out its own magic formula to succeed, and then embedded that formula into its operating processes so the same decisions were replicated again and again.  GM Locked-in on that Success Formula, doing everything possible to Defend & Extend it.  GM built tight processes for everything from procurement to manufacturing operations to new product development to pricing and distribution.  GM didn't focus on doing new things, it focused on trying to make its early money making processes better.  As time went by GM remained committed to reinforcing its processes, believing every year that the tide would turn and instead of losing share to competitors it would again gain share.  GM believed in doing what it had always done, only better, faster and cheaper.  Even into bankruptcy, GM believed that if it followed its early Success Formula it would recapture earlier rates of return.

Google is an information era company, defining the new "best practices".  It's early success was in search engine development, which the company turned into a massive on-line advertising placement business that superceded the first major player (Yahoo!).  But after making huge progress in that area, Google did not remain focused alone on doing "search" better year after year.  Since that success Google has also launched an operating system for mobile phones (Android), which got it into another high-growth market.  It has entered the paid search marketplace.  And now, "Google takes on Windows with Chrome OS" is the CNN headline. 

"Google to unveil operating system to rival Microsoft" is the Marketwatch headline.  This is not dissimilar from GM buying into the airline business.  For people outside the industry, it seems somewhat related.  But to those inside the industry this seems like a dramatic move. For participants, these are entirely different technologies and entirely different markets. Not only that, but Microsoft's Windows has dominated (over 90% market share) the desktop and laptop computer markets for years.  To an industrial era strategist the Windows entry barriers would be considered insurmountable, making it not worthwhile to pursue any products in this market.

Google is unlike GM in that

  1. it has looked into the future and recognizes that Windows has many obstacles to operating effictively in a widely connected world.  Future scenarios show that alternative products can make a significant difference in the user experience, and even though a company currently dominates the opportunity exists to Disrupt the marketplace;
  2. Google remains focused on competitors, not just customers.  Instead of talking to customers, who would ask for better search and ad placement improvements, Google has observed alternative, competitive operating system products, like Unix and Linux, making headway in both servers and the new netbooks.  While still small share, these products are proving adept at helping people do what they want with small computers and these customers are not switching to Windows;
  3. Google is not afraid to Disrupt its operations to consider doing something new.  It is not focused on doing one thing, and doing it right.  Instead open to bringing to market new technologies rapidly when they can Disrupt a market; and
  4. Google uses extensive White Space to test new solutions and learn what is needed in the product, distribution, pricing and promotion.  Google gives new teams the permission and resources to investigate how to succeed – rather than following a predetermined path toward an internally set goal (like GM did with its failed electric car project).

Nobody today wants to be like GM.  Struggling to turn around after falling into bankruptcy.  To be like Google you need to quit following old ideas about focusing on your core and entry barriers – instead develop scenarios about the future, study competitors for early market insights, Disrupt your practices so you can do new things and test lots of ideas in White Space to find out what the market really wants so you can continue growing.

Don't forget to download the new, free ebook "The Fall of GM: What Went Wrong and How To Avoid Its Mistakes"

“Cash Cows” are like unicorns, a myth – GM, Chrysler

"Chrysler delivers the bad news to 789 dealers" was yesterday's headline.  Today the headline read "GM notifies dealers of shutdowns" as the company sent 1,100 dealers the notice they would no longer be allowed to stay in business.  Thousands are losing jobsChrysler is bankrupt, and GM looks destined to file shortly.  But wait a minute, GM was the market share leader for the last 50 years!!  These big companies, in manufacturing, were supposed to be able to protect their business and become "cash cows."  They weren't supposed to get beaten up, see their cash sucked away and end up with nothing!

About 30 years ago a fairly small management consultancy that was started as a group to advise a bank's clients hit upon an idea that skyrcketed its popularity.  The fledgling firm was The Boston Consulting Group, and its idea was the Growth/Share matrix.   It created many millions of dollars in fees over the years, and is now a staple in textbooks on strategic planning.  Unfortunately, like a lot of  business ideas from that era, we're learning from companies like GM and Chrysler that it doesn't work so well.

The idea was simple.  Growth markets are easier to compete in because people throw money at the companies – either via sales or investment.  So it's easier to make money in growing businessesMarket share was considered a metric for market power.  If you have high share, you supposedly could pretty much dictate prices.  High share meant you were the biggest, which supposedly meant you had the biggest assets (plant, etc.) and thus you had the lowest cost.  So, low growth and low share meant your business was a dog.  High growth and low share was a question mark – maybe you'd make money if you eventually get high share.  High growth and high share was a star.  And low growth but high share is a cash cow because you could dominate a business using your market clout to print money – or in the venacular of the matix – milk the money from this cow into which you put very little feed.

In the 1970s/80s, looking at the industrial era, this wasn't a bad chart.  Especially in asset intensive businesses that had what were then called "scale advantages."  In the industrial world, having big plants with lots of volume was interpreted as the way to being a low-cost company.  Of  course, this assumed most cost was tied up in plant and equipment – rather than inventory, people, computers, advertising, PR, viral marketing, etc.  The first part of the matrix has held up pretty well; the last part hasn't.  We now know that it's easier to make money in growth.  But it doesn't turn out that share really gives you all that much power nor does it have a big determination in profitability.

We know that having share is no defense of profitsThe assumption about entry barriers keeping competitors at bay, and thus creating a "defensive moat" around profits, is simply not true.  Today, companies build "scale" facilities overnight.  They obtain operating knowledge by hiring competitor employees, or simply obtaining the "best practices" from the internet.  Distribution systems are copied with third party vendors and web sites.  Even advertising scale can be obtained with aggressive web marketing at low cost.  And so many facilities are "scale" in size that overcapacity abounds – meaning the competitor with no capacity (using outsourced manufacturing) can be the "low cost" competitor (like Dell.).

Thus, all markets are overrun with competitors that drive down profits any time growth slows.  As GM learned, even with  more than 50% share (which they once had) they could not stop competitors from differentiating and effectively competing.  Not even Chrysler, with the backing of Mercedes, could maintain its share and profits against far less well healed competitors.  When growth slows, the cash disappears into the competitive battles of the remaining players.  Unfortunately, even new players enter the market just when you'd think everyone would run for the hills (look at Tata Motors launching itself these days wtih the Nano).  Competitors never run out of new ideas for trying to compete – even when there's no growth – so they keep hammering away at the declining returns of once dominant players until they can no longer survive.

Competition exists in all businesses except monopolies, and threatens returns of even those with highest share.  Today it might be easy to say that Google cannot be challenged.  That is short-sighted.  People said that about Microsoft 20 years ago – and today between Apple, Linux and Google Microsoft's revenue growth is plummeting and the company is unable to produce historical results.  People once said Sears could not be challenged in retailing.  Kodak in amateur photography.  And GM in cars.  Competitors don't quit when growth slows – until they go bankrupt – and even then they don't quit (again, look at Chrysler).  High share is no protection against competition. 

And thus, there is no "easy cash in the cow" to be milked It all gets spent fighting to stay alive.  Trying to protect share by cutting price, paying for distribution, advertising.  And if you don't spend it, you simply vanish.  Really fast.  Like Lehman Brothers.  Or Bennigans. 

The only way to make money, long term, is to keep growing.  To keep growing you have to move into new markets, new technologies, new services – in other words you have to keep moving with the marketplace.  And that produces success more than anything else.  It's all about growthForget about trying to have the "cash cow" – it's like the unicorn – it never existed and it never will.

Why Sun Failed – unwillingness to adapt

"With Oracle, Sun avoids becoming another Yahoo," headlines Marketwatch.com today.  As talks broke down because IBM was unwilling to up its price for Sun Microsystems, Oracle Systems swept in and made a counter-offer that looks sure to acquire the company.  Unlike Yahoo – Sun will now disappear.  The shareholders will get about 5% of the value Sun was worth a decade ago at its peak.  That's a pretty serious value destruction, in any book.  And if you don't think this is bad news for the employees and vendors just wait a year and see how many remain part of Oracle.  A sale to IBM would have fared no better for investors, employees or vendors.

It was clear Sun wasn't able to survive several years ago.  That's why I wrote about the company in my book Create Marketplace Disruption.  Because the company was unwilling to allow any internal Disruptions to its Success Formula and any White Space to exist which might transform the company.  In the fast paced world of information products, no company can survive if it isn't willing to build an organization that can identify market shifts and change with them

I was at a Sun analyst conference in 1995 where Chairman McNealy told the analysts "have you seen the explosive growth over at Cisco System?  I ask myself, how did we miss that?"  And that's when it was clear Sun was in for big, big trouble.  He was admitting then that Sun was so focused on its business, so focused on its core, that there was very little effort being expended on evaluating market shifts – which meant opportunities were being missed and Sun would be in big trouble when its "core" business slowed – as happens to all IT product companies.  Sun had built its Success Formula selling hardware.  Even though the real value Sun created shifted more and more to the software that drove its hardware, which became more and more generic (and less competitive) every year, Sun wouldn't change its strategy or tacticswhich supported its identity as a hardware company – its Success Formula.  Even though Sun became a leader in Unix operating systems, extensions for networking and accessing lots of data, as well as the creator and developer of Java for network applications because software was incompatible with the Success Formula, the company could not maintain independent software sales and the company failed. 

Sort of like Xerox inventing the GUI (graphical user interface), mouse, local area network to connect a PC to a printer, and the laser printer but never capturing any of the PC, printer or desktop publishing market.  Just because Xerox (and Sun) invented a lot of what became future growth markets did not insure success, because the slavish dedication to the old Success Formula (in Xerox's case big copiers) kept the company from moving forward with the marketplace

Instead, Sun Microsystems kept trying to Defend & Extend its old, original Success Formula to the end.  Even after several years struggling to sell hardware, Sun refused to change into the software company it needed to become. To unleash this value, Sun had to be acquired by another software company, Oracle, willing to let the hardware go and keep the software – according to the MercuryNews.com "With Oracle's acquisition of Sun, Larry Ellison's empire grows."  Scott McNealy wouldn't Disrupt Sun and use White Space to change Sun, so its value deteriorated until it was a cheap buy for someone who could use the software pieces to greater value in another company.

Compare this with Steve Jobs.  When Jobs left Apple in disrepute he founded NeXt to be another hardware company – something like a cross between Apple and Sun.  But he found the Unix box business tough sledding.  So he changed focus to a top application for high powered workstations – graphics – intending to compete with Silicon Graphics (SGI).  But as he learned about the market, he realized he was better off developing application software, and he took over leadership of Pixar.  He let NeXt die as he focused on high end graphics software at Pixar, only to learn that people weren't as interesed in buying his software as he thought they would be.  So he transitioned Pixar into a movie production company making animated full-length features as well as commercials and short subjects.  Mr. Jobs went through 3 Success Formulas getting the business right – using Disruptions and White Space to move from a box company to a software company to a movie studio (that also supplied software to box companies).  By focusing on future scenarios, obsessing about competitors and Disrupting his approach he kept pushing into White Space.  Instead of letting Lock-in keep him pushing a bad idea until it failed, he let White Space evolve the business into something of high value for the marketplace.  As a result, Pixar is a viable competitor today – while SGI and Sun Microsystems have failed within a few months of each other.

It's incredibly easy to Defend & Extend your Success Formula, even after the business starts failing.  It's easy to remain Locked-in to the original Success Formula and keep working harder and faster to make it a little better or cheaper.  But when markets shift, you will fail if you don't realize that longevity requires you change the Success Formula.  Where Unix boxes were once what the market wanted (in high volume), shifts in competitive hardware (PC) and software (Linux) products kept sucking the value out of that original Success Formula. 

Sun needed to Disrupt its Lock-ins – attack them – in order to open White Space where it could build value for its software products.  Where it could learn to sell them instead of force-bundling them with hardware, or giving them away (like Java.)  And this is a lesson all companies need to take to heart.  If Sun had made these moves it could have preserved much more of its value – even if acquired by someone else.  Or it might have been able to survive as a different kind of company.  Instead, Sun has failed costing its investors, employees and vendors billions.