HK1039 ALI FARHOOMAND MICROSOFT: NEW WINE IN AN OLD BOTTLE? Within four weeks of becoming the new CEO of Microsoft, Satya Nadella laid out the major challenges that awaited him in the two letters he sent to everyone at Microsoft.1 He defined Microsoft’s battlefield as the “mobile-first and cloud-first world.” 2 That was where Microsoft needed to get its products and technology right, to build platforms and ecosystems and to integrate Nokia devices, services and the new mobile capabilities. In order to do so, Microsoft needed to zero in on a mobile and cloud-first world and do new things. In his view, “industry does not respect tradition – it only respects innovation.” And in order to innovate, he needed his 130,000-strong staff around the world to lead and help drive cultural change, to find Microsoft’s swing so that the team was “in such perfect unison that no single action by any one is out of synch with those of all the others.”3 Many challenges awaited Microsoft in its transformative journey. On platforms, the future of Windows was not clear. On devices, Microsoft needed to find ways to woo application developers to build its mobile ecosystem. On integration, the company had to find ways to transfer and to grow the mobile capability acquired from Nokia. And most importantly, Nadella had to figure out how he could achieve cultural changes to focus everyone on innovation via collaboration. The Business Legacy Business Performance When Steve Ballmer retired, he left behind a record high revenue year in 2013 but a trail of sluggish stock performance [see Exhibit 1 for the company’s revenue and net income figures 1 Nadella, S. (3 March 2014) “Satya Nadella Announces Changes to Senior Leadership Team,” Microsoft press release, http://www.microsoft.com/en-us/news/press/2014/mar14/03-03email.aspx (accessed 30 March 2014); Nadella, S. (4 February 2014) “Satya Nadella Email to Employees on First Day as CEO”, Microsoft press release, http://www.microsoft.com/en- us/news/press/2014/feb14/02-04mail2.aspx (accessed 30 March 2014). 2 Satya used the phrase “mobile and cloud-first world” in his letters to the Microsoft staff to stand for “mobile-first, cloud-first world,” which he reiterated many times during public and press meetings and events. 3 All quotes were from Nadella’s memo mentioned in footnote 1. W. H. Lo prepared this case under the supervision of Professor Ali Farhoomand for class discussion. This case is not intended to show effective or ineffective handling of decision or business processes. © 2014 by The Asia Case Research Centre, The University of Hong Kong. No part of this publication may be reproduced or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise (including the internet)—without the permission of The University of Hong Kong. Ref. 14/541C 1 This document is authorized for use only in MBA Culminating Experience by Dr. Richard Koza, CSC Dept. of Business Faculty at Chadron State College from September 2014 to March 2015. 14/541C Microsoft: New Wine in an Old Bottle? 2000-2013; Exhibit 2 for a chart showing the stock price of Microsoft 1986-2013]. The company had also generated ample cash and had handsomely sent its shareholders consistent returns of dividends over the years [for a history of Microsoft, see Exhibit 3A and Exhibit 3B]. Its financial metrics of profits, dividends, and cash returns of the last decade had beaten those of Amazon, Google, IBM, Oracle, and Salesforce. Apple was its only competitor that produced better financials [see Exhibit 4 for the comparison presented by Ballmer during the company’s latest financial analyst meeting]. The company’s flagship products were the Windows operating systems and the Office applications for personal computers and servers. Microsoft also had two profit-making lines of businesses: the growing servers and enterprise cloud business and the Entertainment and Device Division that housed the well-known Xbox. The company’s only losing product group was its online service division, which included Bing and its online advertising service [see Exhibit 5 for a breakdown of Microsoft’s product divisions’ income 2005-2013]. Until the end of the last decade, Microsoft had never departed from its tradition of relentlessly protecting its dominance in personal computer operating systems and software licensing. The shift of technology to smartphones and tablets gradually meant personal computers were displaced, and at the turn of the decade, Microsoft came to terms with the end of the dominance of its flagship operating system. In 2011, it released the Office applications for Mac. In 2012, its Azure cloud enterprise offerings began to support Linux, which competed head-to-head with Windows for server dominance. These were followed by Office for iPhone and Android in mid-2013. Limited Success beyond the Comfort Zone of Windows and Office Beyond the comfort zone of Windows and the Office applications, Microsoft achieved traction in the consumer market with its Xbox and in the enterprise segment with its cloud service offerings. Xbox The first-generation Xbox was released in 2001. It immediately allowed Microsoft to take the second place in the market, albeit a distant second, behind Sony’s PlayStation 2 and slightly ahead of Nintendo’s GameCube. With the rolling out of Xbox One in October 2013 with Skype pre-installed, the company ambitiously positioned the device to be the single interface for all living room experiences, from entertainment to communication and networking. Despite its success, the Entertainment and Devices Division, where the Xbox was housed, had cumulative losses of over US$3.5 billion as of 2013, though it started to make a positive contribution to the company’s bottom line in 2008.4 Azure and the Cloud Microsoft’s cloud activities started in its heyday in 1997 after its acquisition of Hotmail. For over a decade, its cloud offerings took the form of “Software as a Service” applications; revenues were mainly generated from consumer offerings, such as Bing and Hotmail. The company deliberately focused on these cloud offerings only so that the cloud-based applications would not be in the way of its traditional products of Windows, Office, and Windows Server. 5 The decade-long delay of Microsoft to properly address the market potential of cloud computing caused the company to trail behind Amazon’s 71% market share. A major change occurred in the company’s cloud strategy in 2010. The company rolled out 4 Microsoft (2002–2013) “Annual Reports,” http://www.microsoft.com/investor/AnnualReports/default.aspx (accessed 30 March 2014); the contributions and losses of the Entertainment and Devices Division were calculated from information available from Microsoft’s annual reports from 2002 to 2013. 5 Iansiti, M. and Serels, A. (4 April 2013) “Microsoft Server and Tools,” Harvard Business School Business Case No. 9-613-031. 2 This document is authorized for use only in MBA Culminating Experience by Dr. Richard Koza, CSC Dept. of Business Faculty at Chadron State College from September 2014 to March 2015. 14/541C Microsoft: New Wine in an Old Bottle? Windows Azure and SQL Azure, the company’s “Platform as a Service” cloud offerings that were positioned to compete with traditional server businesses, including Windows Server. By April 2013, the company’s enterprise cloud platform offerings claimed a distant second market position with its US$1 billion billings. It was expected to grow stronger, challenging Amazon’s huge lead of an over 70% market share; an analyst at Forrester Research Inc. anticipated that Microsoft could narrow the gap substantially by commanding as much as a 35% market share in a year’s time. 6 Failures to Catch the Shift to Mobile Devices Tablets Despite the fact that Bill Gates predicted tablets’ cannibalization of desktop computers and notebooks, Microsoft consciously chose to give up the strategic development of tablets and touch-screen smartphones.7 It viewed the tablet as a complement to Windows, instead of seeing the potential of tablets to revamp consumers’ digital and technological lives. It therefore put the development and marketing of the tablet PC under its Windows division, which meant the company’s attention was not on getting the tablet experience right. Rumor had it that Microsoft’s Pioneer Lab had a similar concept with a Courier tablet around the time when Apple was developing the iPad. But Microsoft’s Windows-powered tablet would not arrive until two and a half years after the iPad. However, the device and the operating system did not live up to market expectations, and the company had to include a US$900 million inventory write-off of the device in its 2013 books.8 The company had three different Windows operating systems that ran on different platforms: Windows RT ran Surface RT, Surface Windows 8 / 8.1 powered Surface Pro and PCs, and there was Windows Phone OS powered smartphones. In an in-house interview with Gates, he described the direction as a plan to “merge all of the operating systems, which work well with the company’s long-term endeavors in both cloud storage and cloud-based personalization across multiple devices.”9 Mobile Operating Systems and Devices When Microsoft launched Windows Mobile in 2003, all major mobile vendors were reluctant to adopt the platform lest it would claim dominance in the mobile operating system domain, like what Windows had achieved in the PC market. But Microsoft never managed to achieve the critical mass required for a dominant position. It failed to develop an operating system that would offer the right smartphone experience, which was not the usual Windows experience crammed in a cell phone.