For the first time in 20 years, Apple’s quarterly profit exceeded Microsoft’s (see BusinessWeek.com “Microsoft’s Net Falls Below Apple As iPad Eats Into Sales.) Thus, on the face of things, the companies should be roughly equally valued. But they aren’t. This week Microsoft’s market capitalization is about $215B, while Apple’s is about $365B – about 70% higher. The difference is, of course, growth – and how a lack of it changes management!
According to the Conference Board, growth stalls are deadly.
When companies hit a growth stall, 93% of the time they are unable to maintain even a 2% growth rate. 75% fall into a no growth, or declining revenue environment, and 70% of them will lose at least half their market capitalization. That’s because the market has shifted, and the business is no longer selling what customers really want.
At Microsoft, we see a company that has been completely unable to deal with the market shift toward smartphones and tablets:
- Consumer PC shipments dropped 8% last quarter
- Netbook sales plunged 40%
Quite simply, when revenues stall earnings become meaningless. Even though Microsoft earnings were up, it wasn’t because they are selling what customers really want to buy. In stalled companies, executives cut costs in sales, marketing, new product development and outsource like crazy in order to prop up earnings. They can outsource many functions. And they go to the reservoir of accounting rules to restate depreciation and expenses, delaying expenses while working to accelerate revenue recognition.
Stalled company management will tout earnings growth, even though revenues are flat or declining. But smart investors know this effort to “manufacture earnings” does not create long-term value. They want “real” earnings created by selling products customers desire; that create incremental, new demand. Success doesn’t come from wringing a few coins out of a declining market – but rather from being in markets where people prefer the new solutions.
Mobile phone sales increased 20% (according to IDC), and Apple achieved 14% market share – #3 – in USA (according to MediaPost.com) last quarter. And in this business, Apple is taking the lion’s share of the profits:
Image provided by BusinessInsider.com
When companies are growing, investors like that they pump earnings (and cash) back into growth opportunities. Investors benefit because their value compounds. In a stalled company investors would be better off if the company paid out all their earnings in dividends – so investors could invest in the growth markets.
But, of course, stalled companies like Microsoft and Research in Motion, don’t do that. Because they spend their cash trying to defend the old business. Trying to fight off the market shift. At Microsoft, money is poured into trying to protect the PC business, even as the trend to new solutions is obvious. Microsoft spent 8 times as much on R&D in 2009 as Apple – and all investors received was updates to the old operating system and office automation products. That generated almost no incremental demand. While revenue is stalling, costs are rising.
At Gurufocus.com the argument is made “Microsoft Q3 2011: Priced for Failure“. Author Alex Morris contends that because Microsoft is unlikely to fail this year, it is underpriced. Actually, all we need to know is that Microsoft is unlikely to grow. Its cost to defend the old business is too high in the face of market shifts, and the money being spent to defend Microsoft will not go to investors – will not yield a positive rate of return – so investors are smart to get out now!
Additionally, Microsoft’s cost to extend its business into other markets where it enters far too late is wildly unprofitable. Take for example search and other on-line products:
Chart source BusinessInsider.com
While much has been made of the ballyhooed relationship between Nokia and Microsoft to help the latter enter the smartphone and tablet businesses, it is really far too late. Customer solutions are now in the market, and the early leaders – Apple and Google Android – are far, far in front. The costs to “catch up” – like in on-line – are impossibly huge. Especially since both Apple and Google are going to keep advancing their solutions and raising the competitive challenge. What we’ll see are more huge losses, bleeding out the remaining cash from Microsoft as its “core” PC business continues declining.
Many analysts will examine a company’s earnings and make the case for a “value play” after growth slows. Only, that’s a mythical bet. When a leader misses a market shift, by investing too long trying to defend its historical business, the late-stage earnings often contain a goodly measure of “adjustments” and other machinations. To the extent earnings do exist, they are wasted away in defensive efforts to pretend the market shift will not make the company obsolete. Late investments to catch the market shift cost far too much, and are impossibly late to catch the leading new market players. The company is well on its way to failure, even if on the surface it looks reasonably healthy. It’s a sucker’s bet to buy these stocks.
Rarely do we see such a stark example as the shift Apple has created, and the defend & extend management that has completely obsessed Microsoft. But it has happened several times. Small printing press manufacturers went bankrupt as customers shifted to xerography, and Xerox waned as customers shifted on to desktop publishing. Kodak declined as customers moved on to film-less digital photography. CALMA and DEC disappeared as CAD/CAM customers shifted to PC-based Autocad. Woolworths was crushed by discount retailers like KMart and WalMart. B.Dalton and other booksellers disappeared in the market shift to Amazon.com. And even mighty GM faltered and went bankrupt after decades of defend behavior, as customers shifted to different products from new competitors.
Not all earnings are equal. A dollar of earnings in a growth company is worth a multiple. Earnings in a declining company are, well, often worthless. Those who see this early get out while they can – before the company collapses.
Update 5/10/11 – Regarding announced Skype acquisition by Microsoft
That Microsoft has apparently agreed to buy Skype does not change the above article. It just proves Microsoft has a lot of cash, and can find places to spend it. It doesn’t mean Microsoft is changing its business approach.
Skype provides PC-to-PC video conferencing. In other words, a product that defends and extends the PC product. Exactly what I predicted Microsoft would do. Spend money on outdated products and efforts to (hopefully) keep people buying PCs.
But smartphones and tablets will soon support video chat from the device; built in. And these devices are already connected to networks – telecom and wifi – when sold. The future for Skype does not look rosy. To the contrary, we can expect Skype to become one of those features we recall, but don’t need, in about 24 to 36 months. Why boot up a PC to do a video chat you can do right from your hand-held, always-on, device?
The Skype acquisition is a predictable Defend & Extend management move. It gives the illusion of excitement and growth, when it’s really “so much ado about nothing.” And now there are $8.5B fewer dollars to pay investors to invest in REAL growth opportunities in growth markets. The ongoing wasting of cash resources in an effort to defend & extend, when the market trends are in another direction.
Thanks for a very good post.
I was wondering though, where does the data from the first graph come from? It is very interesting.
/Per
Per, the data came from the Conference Board. My firm did the analysis, and it was published, along with this chart, in “Create Marketplace Disruption: How to Stay Ahead of the Competition” (Financial Times Press) available in print or Kindle format at Amazon.com.
Subsequently the Conference Board published its own book called, I believe, “Stall Points” and also available on Amazon.com. It does not contain this chart as we did not contribute to that book.
The article is very aged. Its talking about only core PC market and not the future goodies and non-PC based business divisions of Microsoft. eg:
a. Home Entertainment,
b. Cloud Provider [ias,pas]
c. Cloud-based Business Solutions [sas]
Ofcourse ppl at MS already know about all the PC-will-be-dead thing! so they have now 4 options:
1. milk the existing franchise[pc] to the max possible time
2. make a dent and get a pie in latest offerings[mobile]! i beleive even though its really tough but you can become a 3rd player in the ecosystem in the long run.
3. become king in home entertainment with the already proven kinnect and all the related research projects
4. become king in business solutions which run oncloud[sas] [no windows required]
5. become king in cloud[pas,ias] provider [no windows required]
Really? You guys are positing the death of the PC? The PC market can’t experience infinite growth, but neither can any market. The phrase you need to apply here is “Full Market Penetration.” When most homes have at least one PC in it, the market has been penetrated, and there isn’t room to grow in the PC market.
Microsoft SHOULD be defending it’s PC empire, and it is. They have failed to anticipate or effectively participate in NEW markets, but that’s a mutually exclusive ecosystem from the existing PC market.
PCs aren’t going anywhere. Desktops are losing marketshare to laptops, but a tablet or mobile device can’t replace a workstation.
Skype: Rewind 5-10 years. AIM, MSN, ICQ, how many other Instant Message programs were competing with each other? No one “won”. Skype comes along and redefines instant messaging, adds useful VoIP and video messaging with conferencing abilities in it that no other service had adequately bundled together.
I can use Skype to call anyone else around the world who also has Skype for free. Skype monetized the principle pretty well too. Neither a tablet nor a mobile phone can replicate those same abilities….for FREE.
And finally, recall to mind that the gaming industry is outselling the movie industry. Ten million gamers playing World of Warcraft while talking over Skype or Ventrilo disagree with the PC market dying. The 50 million kiddies playing Maple Story Online and Hello Kitty Online disagree with the PC market dying.
Hell, the Kindle Fire is the first tablet able to provide flash support for the hundreds of millions of casual gamers playing flash games online…and it’s abilities are crude and lacking in sufficient memory to serve the purpose. SSD and multi-slot RAM are years away from being in tablets and mobile devices, which aren’t MEANT to replace PCs.
C’mon. A bit of MS hate is well and good. They have done a lot of very stupid things. But while both Mac and Linux (all distro types) serve their niche functions, there is an entire world of people that require a PC (desktop or laptop) with a Microsoft OS for a myraid of reasons.
I was hoping I’d read something along those lines in the comments, Dashofpepper. I couldn’t agree more.
This article was well written, but lacked serious understanding of the PC market.
Skype is an excellent product, by the way; I was using it for a four-way video call while reading the article, and I’m on it now talking to a friend while posting this comment. A nice headset beats holding a phone to your ear, or worse yet, having to stick a tablet or smartphone on speaker mode and hold it in front of you just to see the person you’re attempting to video chat with.
A lesson, Mr. Hartung; what is convenient for you is not necessarily convenient for everyone.
To Rob and Dashofpepper,
The article was talking about looking forward. Yes DOS worked. But aside from being inside Windows 8, who is using DOS??
The gaming market will not die but it will change. It always has. And that is what this article is about. Not that Windows or Microsoft will die, but it may very well wither and shrink on the vine.
Erm, really? – people talking about the benefits of Skype? – It was great maybe 4-5 years ago, ridiculous bloatware nowadays. Even google hangouts are better than Skype (holy CPU usage, and the interface is vile).
Also: it’s FAR easier to call someone via FaceTime than it is with Skype, from my mobile phone (or my computer, for that matter).
Nobody thinks the PC will die. Rather, companies which have banked on guaranteed PC market growth will be in for a big surprise, and these companies may die.
Because of a growth stall ,there are many reasons why not to stall but only a few why the stall is coming , base this on more that the DOLLAR$ . When one does not use the we than an I is turned into a victim by we, who can have the most accomplished the we, the I, or neither, simplicity is confusing. Microsoft a feeling of a jet waiting for the tanker in flight to fill it up s the trip does not come to a full stop, as what help growing slower or cost cutting or should we say cutting cost. How many great companies worked there self out of a job because they where not looking ahead while doing there job. Then of coarse you have those who simply looked like this was it, the simple look from the doctor before you ask how much time do I have left. Look at the IBM’s of the world and how many times this cycle has ran it.s coarse and have prospered by the competitions greed till it turns into there growing pain only to have the IBM’s feed off there not looking ahead. When the hunter becomes the hunted is the nature of the markets 1 night stand or only one hit single but the best is when one of the players thinks they don’t need the other , that is why the R@D must never die, imagination must be cost worthy like an attorney on a retainer, oh yes the attorney will not loose track of time.
“Try doing work on a tablet!”
Ha!
Try doing work on a Windows 8 machine. Or better yet, try and support such a system. What a disaster!