Goldman Sachs’ analyst Sara Friar is at it again. Continue reading →
Five Things Politicians Need to Understand About Data Centers
The Office of Governor Bob McDonnell of Virginia issued a press release today trumpetting their success in convincing Microsoft to build its latest Gen4 Data Center in the state. Given huge gulf between the real long-term local economic benefit of a data center like this and the content of the press release I am left to conclude that either A) The Governor really does not understand the economics of these things or B) He really does understand the true economic impact and the press release is a cynical attempt to fool the voters.
For other politicians who might be tempted to spend tax payers money to secure the locations of a data center here are some things you really do need to understand:
- Today’s modern global data centers do not create any meaningful number of jobs. Modern global data centers are remotely operated which means that even the few jobs that are created are not high skilled software or computer engineering roles. The type of jobs created tend to be in the building maintenance, HVAC, electrical engineering and security domains.
- There’s a high price to be paid for securing relatively few jobs. The fifty number touted by Virginia sounds about right. However, from the Governor’s press release, it sounds like at least $6.9 Million of direct incentives and probably an unspecified amount of long-term commercial property tax exemptions were used to secure those 50 jobs. Is that a good rate of return?
- When a technology company says they will invest $499 Million in building a new data center that does not mean they are investing $499 Million in your state. Far from it. Most of that cost will be in the computing infrastructure, communications, and other electrical machinery. That equipment is by and large not built in the state where the data center will be located. In fact a lot of it will be sourced from outside the country creating jobs and employment elsewhere, but not in your state.
- Modern data centers are ‘Shells’ of a building. Microsoft’s Gen 4 data centers employ pre-assembled container ‘Lego Blocks’ which are rolled onto a concrete slab and plugged into power, cooling and data pipes. If they could get away without building anything other than the concrete slab and HVAC containment buildings they would and in years to come they will. This all means that very few construction jobs will be created and certainly not any that require significant new up-skilling of your labor force.
- On a positive note a modern global data center is one of the most dense power consumption facilities around. That is why many sites are selected based on access to hydro-power where the cost of energy and distribution challenges can be kept to a minimum. It is possible that the location of a major global data center in Virginia will create the downstream need to upgrade the state’s electricity distribution and generation infrastructure. Being forced to do this obviously creates ancillary benefits for other company’s but again at what price?
Politicians really do need to understand the reality of these things. It is far too easy to give away the tax payers money today on the assumption of major downstream economic benefits tomorrow. In the case of data centers those benefits are likely to be few and far between.
Why Its Time to Break Up Microsoft
Microsoft posted a record quarterly profit of $4.5B on record revenue of $16.04B after the markets closed yesterday. The EPS of 51 cents blew away analysts consensus forecasts of 46 cents for the quarter. Any other company announcing a financial performance of this magnitude would have seen its shares pop in after hours trading; not Microsoft. Of course that may change when the market open today but it is a telling marker of investor sentiment towards the company.
In my view its one more indication that the company’s true value is being overshadowed by a ‘Crisis of Perception.’ Investors see Microsoft as a vision-less consumer company struggling to compete with Apple and Google while in actuality its an innovation machine transforming the world of enterprise IT. You only have to look at numbers like the unearned revenue line (A proxy for new long term annuity contract signings with enterprise customers) to see just how much an enterprise machine the company is. That number grew 20% in FY’10!
Of course the lack of pop in the stock is likely relate to the fact that the company continued to pour cash into its search and mobile phone efforts as well as the other loss-making consumer focused on-line properties.
In my view it is time to stop the pretense that Microsoft can become a ‘Cool’ high growth and highly profitable consumer products company. The enterprise DNA of the company just isn’t going to mutate quickly enough to let that happen in any reasonable period of time. In my opinion the situation requires radical surgery. This would include spinning off XBox into a separate games focused company, merging the consumer on-line assets with Yahoo to give them scale in a competitive race with Google and finally ditching the phone business.
Yes I did say get out of the phone business. Here’s my prediction: Windows Phone 7 will be the ‘Zune’ to Apple’s iPhone and Google’s Android i.e. cool competitive technology with no chance of building the scale required to compete with those other platforms. It’s time to stop wasting money on phone which could be better leveraged elsewhere in the product portfolio.
A slimmed down Microsoft that was entirely focused on delivering the worlds best enterprise business platforms might not be ‘Cool’ but it would be a lot more interesting for both customers and shareholders. The development teams would regain the focus and investment dollars they need to extend their competitive advantages in this market and the move to achieving and maintaining leadership in cloud services would be accelerated. The change would also address the ‘Perception’ issues which are overshadowing investors opinions about the stock. Without the consumer business ‘Boat anchor’ the company could increase R&D spending in its core business AND return substantially more to share-holders in the form of dividend payments. Turning Microsoft into a dividend paying machine is one sure way to move the stock.
If the board and executive team really do recognize their responsibility to maximize value for shareholders then its time for them to focus the company on what it does really well; building the world’s best enterprise software and cloud services. Unfortunately stories about new attempts to re-brand the company just reinforce the view that senior leadership is missing the point and is intent on continuing the long march to irrelevance. If that’s the case then maybe it really is time for new management.
Why Regulators Need to Mandate Open Data Protocols in the Cloud
TechCrunch’s article about Intuit’s decision to shut down Quicken OnLine and not let users migrate their data to the new service Mint.com is an outstanding example of the emerging problem of ‘Data Lock-In’ and an issue which regulators need to get ahead of before its too late.
As the market for ‘Cloud’ services takes off we’re going to witness an explosion of new services whose value proposition is based on managing some aspects of the consumers life on-line. The big buckets already are life-centric services such as health and fitness, personal finances and of course managing you social graph. The expanding roster of new services will be accompanied by an equally large number of failures. That is the natural order of things in new markets. Not all new entrants will find a business model which works or is sustainable over the long term. Regulators need to start thinking about the consumer protection regimes that need to be put in place as this happens.
I was struck by some of the debate surrounding the Intuit issue by the number of folks who think its not a big deal because Quicken On-Line is a ‘Free’ service. That could not be further off the mark. One of the challenges for any new entrant in the crowded market for ‘Cloud’ services will be figuring out how to make their service as ‘Sticky’ as possible. After having invested a great deal to acquire new customers you want to make sure its not easy for them to leave or switch to a competitors service (Ever wonder why its incredibly difficult to dump you mobile provider? It’s called ‘Churn’ and ‘ARPU’)
One way to build ‘Stickiness’ is to ensure that new customers have to invest a significant amount of personal effort to extract the full benefits of the service. In Quicken Online’s case that was the time required to upload banking information and months and months of entering individual financial transactions. Making it easy for customers to export their data from the service would undermine ‘Stickiness’ and therefore increase the likely hood that customers might switch to a competitor’s services. In the highly competitive ‘Cloud’ service market it will be very tempting to find ways to bind users to services by making it difficult for them to take their data and run.
Consumers need to be educated about the dangers of ‘Data Lock-In’ so that they increasingly demand Open Data Access (ODA) from ‘Cloud’ service providers. I think its also about time that government regulators started thinking about mandating ODA for all service providers. These regulations would be a natural extension of existing privacy regulations by enshrining the principle that personal information of any sort belongs to the consumer, not the provider, and the consumer has the right to take that data with them when they leave a service. This would be a direct analog to ‘Number Portability’ requirements in the mobile telephony sector. Service providers would be required to ensure that all consumer owned data can be exported from their service using open standard formats and protocols.
Such a regulatory requirement would protect consumers of the sort of mess now faced by Inuit’s customers. It would also force service providers to focus on broader value proposition of their service rather than relying on ‘Data Lock-In’ as a competitive lever. This focus on ‘Functional’ competition would be a great thing for consumers and the market.
Fix for iPad ‘Error 14’
[Updated with Windows 7 File location]
The update of my iPad to version 3.2.1 of iOS failed last night. iTunes reported that an ‘Error 14’ had occured (Not very helpful) Subsequent attempts at un-docking and re-docking resulted in iTunes trying and failing to restore the device. Here’s how I fixed the problem.
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Do Home PCs Have a Negative Impact on Student Achievement?
The answer to that question is a big yes if you believe the results of a large study carried out by Professors Malamud of the University of Chicago and his collaborator, Cristian Pop-Eleches of the University of Columbia. This is not the first time that research has pointed to PCs in the home having a negative effect on student academic achievement. I read about the study last month but was prompted to comment on it by Randall Stross’ very interesting article in the NY Times this week.
The basic finding of these multiple studies is that student academic achievement declines after the introduction of a PC and broadband connection in their home. Disturbingly, the impact is most pronounced with children living in lower income homes i.e. the very group you would intuitively think would benefit most.
In my opinion, while the effect may be real (The sample sizes are very large and across multiple geographies) the conclusions being drawn are dangerously wrong.
To accept the findings of the study you also have to accept the logical counter conclusion that low income students would be better off academically if they were not distracted by having an Internet connected PC at home. Every fiber of my body tells me that this conclusion cannot be correct.
Having wrestled with this contradiction since reading about the study back in May I have arrived at my own conclusions. The problem with the study findings is bound up in what is being measured i.e. academic achievement.
We live in a society and increasingly face a future where the PC and the Internet have become the basic tools of economic value creation. In the 17th century you needed to know how to join wood or bend iron. Today you need to know how to access and interpret information, how to draw you own conclusions, how to synthesize new ideas and how to communicate those ideas to an increasingly distributed set of collaborators.
In my opinion the conclusions being drawn from this study say far more about foundational problems in our academic system; what is taught and how we assess student’s readiness to enter a 21st century workforce. It is largely the case (Exceptions do exist) that the public K-12 system is still designed to turn out workers for a 19th century industrial economy. We teach kids how to learn facts, be able to follow instruction and to respect authority. If you are lucky enough to come from a middle or upper income family you can of course obtain a much more progressive and technology enabled education in the private sector.
What these studies tell us is that the affected students got worse at doing standardized tests. I would ask so what? We already know that family income level has a profound effect on standardized testing scores which impacts the long term economic potential of children from these environments. The problem isn’t the kids or the PC the problem is an education system which is has an inbuilt biased against them.
That standardized testing has become the single determinant of academic achievement borders on the criminal. When I hire talent for my business I am not interested in their standardized test scores. I want to know if they can think creatively, solve problems, communicate their ideas effectively and are smart enough to know that life is about learning all the time. These studies do not tell us anything about how access to PCs and the Internet might possibly improve or develop these skills. It might just be the case that collaborative problem solving with a network of friends on FaceBook is a far more valuable economic life skill than leraning to remember the who was the 33rd President of the United States.
I really do believe that these studies are dangerous. The danger is that they will become an impediment to programs which are focused on closing a very important digital divide that exists between rich and poor families and between rich and poor nations. I can’t help believing that a similar research project in the 17th century would have found that having a hammer, saw, wood and nails in the home was distracting children from their religious studies. Pause for a second before you conclude that this is a ridiculous analogy.
Does Economic Growth Require a Growing Population?
The UK’s Royal Society has just announced a major new research project on the implications of population growth. The study is to be headed by the Nobel Laureate, Sir John Sulston. As the RI points out populations studies is quite a cyclical area of research. The ’60s and ’70s were a boom time for the field with less focus being given the the subject in the ’80s and ’90s. The fact that the topic is moving back up the political agenda probably has much to do with the intersection of population on two key policy issues; economic growth and climate change.
The political debate about population growth has being going on for nearly three hundred years. Thomas Malthus, seen as the father of demography, clearly held the view that exponential population growth would outstrip improvements in agricultural production, condemning economies to a permanent state of subsistence. Adam Smith on the other hand believed that economic growth and improvements in people’s socioeconomic circumstances would reduce fertility rates over time.
There’s a prima facie case supporting Smith’s assertions. The fertility rate of many of the world’s most developed economies (Much of Europe, UK, Japan etc. but notably not the United States due in large part to the impacts of immigration) has tumbled over the last forty years. That decline has mirrored a period of massive economic growth and rising living standards in these countries. The ‘Baby boom’ has become the ‘Baby bust’ with very significant implications for affected geographies. As the demographic mix inverts there are fewer and fewer younger workers able to carry the social cost of the rising number of elderly in the population.
Interestingly, even though the total global population is still growing the rate of growth has in decline since the mid-sixties. There is a diversity of research which shows that fertility rate has an inverse relationship with factors like educational level (Particularly in Women) and income level. If the RI study is to be useful in guiding policy makers then it needs to deliver some definitive research on which factors really do impact fertility rates, and in what manner.
There is a perspective (One I do not subscribe to) that a growing global population is required to sustain the needed levels of economic growth. The argument is put forward that continued growth in the production of manufactured goods will require and expanding workforce to make those goods. This gets to the heart of one of my personal interests regarding the impact of technology on economic growth. I would argue that the opposite scenario is more likely i.e. that even an increasing supply of manufactured goods will requires less, not more workers over time.
The number of workers now employed in building cars in the most advanced and automated factories today is diminishingly small compared to just thirty years ago. With continued advances in robotics, process control technology and information systems this trend is likely to continue. Fifty years from now its likely that many factories will ingest raw materials at one end and spit out finished good at the other with very few human workers required in-between.
To date this trend has been countered by the relative ease with which manufacturing facilities can be trans-located into low wage economies. However, the very act of introducing manufacturing into low wage economies has the effect of raising living standards and worker expectations which in turn leads to demands to higher wages. When combined with worker shortages this can place a significant upward pressure on wages undermining the location’s original cost advantage. China is now witnessing this phenomenon with many manufacturers now looking to move to other lower wage cost East Asian economies. In my view this will over time lead to a leveling of the global wage cost ‘Playing field’. As we reach that point the pressure to innovate in manufacturing automation will become extreme because that will be the only way to avoid being caught between the ‘Pin factory’ and the ‘Invisible hand’. As global manufacturing competition shifts from trying to find the lowest wage economy to finding the cheapest way to manufacture through automation we will see a dramatic reduction in the global manufacturing work force.
The challenges with this scenario are daunting. If there is truly a correlation between rising income levels and declining fertility rates then a long period of technology lead efficiency improvements in manufacturing and its concomitant positive impact on economic output should correlate with a continued slowing of the global population growth rate. If the point is reached where global population growth rate becomes negative then you enter into the potentially ‘Utopian’ situation where a smaller and smaller global population shares an ever growing economic pie. Alternatively, if the global manufacturing work force continues to shrink due to automation while the population continues to grow and those lost manufacturing jobs can not be more than offset by growth in services sector employment then you have a political time-bomb on your hands.
I seriously hope the RI study will look at the the correlation of population dynamics and economic growth and will factor in the role that technology will play on both sides of the equation. The likely impact of climate change on these issues I will leave for another post.
Microsoft’s Crisis in Perception (Part 4)
In parts 1, 2 and 3 of this series I made the case that Microsoft is mistakenly viewed as a consumer products company when in reality the core of its business comes from selling enterprise platform software. I also described the inherent complexities in the business which are constraining the company’s ability to overcome it’s strategic challenges.
In this final chapter I will look forward at the opportunities which lie ahead and discuss my own personal views about the strategic decisions which need to be made.
If you read most of the press about Microsoft over recent years the coverage seems to have become a never ending torrent of negativity; much of it calling into question the company’s future viability. If its not Google Docs and Apps undermining the Office business, it is Apple taking share in away from Windows in both the mobile phone and laptop market. Its understandable that the press loves to write about the potential for competitors to undermine the ‘Twin turbos’ of the Microsoft revenue engine. Unfortunately journalists who write these stories are demonstrating that they as well as many others have fallen into the trap of over estimating the strategic value of the consumer market to Microsoft’s business.
Ten years ago Microsoft could not have imagined a world in which they did not need strategic control over the end user’s device. This was the company whose operating system ran on over 95% of network connected devices. There are two opposing but complimentary views on this issue; both of which are part of a huge strategic debate within the company.
On the one hand it can be argued that the growing sophistication of web standards like HTML 5 will mean that the end device really does not matter. Every device will ultimately offer an equivalent browsing experience and the strategic issue will become who controls the service layers to which these devices connect. Microsoft has another secret weapon in this debate called Silverlight. Silverlight enables the development of very rich interactive consumer client experiences and, remarkably for Microsoft, is truly cross-platform, running on Windows, Apple’s OS X, Nokia’s Symbian and one would assume at some point, iOS and Android. One can imagine that the Windows and Internet Explorer teams would not be huge fans of Silverlight because it limits the ability for them to establish a clear value proposition for developers to uniquely target Windows. However, Silverlight is a huge opportunity for Microsoft to grab developer mind share and in my view only lacks a seamless monetization strategy, like Apple’s App Store before it takes off.
The other side of the argument would say that native applications will always offer a superior consumer experience and that there money to be made from both the applications and the devices. In both cases it becomes strategically important to have control of the end device. There is some merit in this argument. In a world where even the best mobile devices are not always connected via high speed broadband, native applications will remain compelling. Of course there is also the small issue of the cost of mobile broadband. While data rate plans remain comparatively expensive then native applications will still play a significant role.
The question is whether it is still a strategic necessity to be in the mobile device OS business? In my opinion, and taking a long term view, the strategic value of being in the mobile device operating system business is much lower than it was ten years ago to the point where the costs of trying to win market share in that business cannot be justified. If I was being hardcore I would shut the Windows Phone business down tomorrow. I would apply the resulting savings to ensuring that developers have a compelling reason (Revenue) to target Silverlight and that all of Microsoft’s on-line services provide an amazing and compelling consumer experience on all of the major mobile platforms.
I can hear the howls of objection already. However, I doubt that even the most ardent Microsoft promoter could make the case the Windows Phone will garner more than 30-40% market share in the growing smart phone market. That in itself would be amazing but it still does not make it strategic and, in my view, the expense and resources wasted to accomplish that limited goal would be better spent on a more strategic objective.
I’ve already alluded to where I think the real strategic play is. In all the irrational exuberance surrounding Apple’s success with the App Store everyone seems to forget that most of the time when a little .99c mobile application gets sold there’s a little incremental computing power required on the back end to service that application. The real money to be made in the global networked economy is in services and the infrastructure required to run those services. In short the ‘Cloud’ has a very silver lining.
When Steve says Microsoft is ‘All In’ he means it. The management team is literally betting the company on being able to transition Microsoft’s products and revenue stream to the ‘Cloud’. Yesterday’s Motley Fool article about whether Microsoft can dominate the cloud is an indication that some in the press and analyst communities are starting to wake up to just how comprehensive and compelling Microsoft’s ‘Cloud’ strategy really is. You can expect that advantage to be further amplified at next week’s World Wide Partner Conference.
Microsoft’s ‘Cloud’ strategy is another perfect example of the ‘Integrated Innovation’ strategy at work, with the company leveraging the complete range of its enterprise product portfolio, and a lot of new innovation thrown in, to build a set of ‘Cloud’ services which are starting to look very compelling for customers. By customers I of course mean small, medium and large enterprise customers. I do not mean consumers. With Bing, excellent as it is, running a distant third to Google its is still impossible to see how Microsoft will monetize their consumer on-line business in any meaningful way. An additional requirement for being in the consumer products business is that you make money from consumers. Microsoft, in large part does not.
Microsoft’s biggest future revenue opportunity is driven by the compelling nature of it’s ‘Cloud’ infrastructure, services and developer strategy. It will depend on convincing enterprise customers of all sizes that they can trust Microsoft to run their IT and will require a sales strategy which avoids cannibalizing the very lucrative long term licensing agreements that most enterprise customers are locked into today.
On the competitive front Microsoft’s charge into ‘Cloud’ services really does pose a major strategic headache for players such as Google, Amazon, SalesForce, VMWare and the like. Each of them own bits of the puzzle but not one of them can walk in and have the type of compelling conversation with CIOs and CTOs that Microsoft’s field sales force are now enjoying today. I said before that negative opinions about Microsoft’s ability to innovate almost always focus on ‘consumer’ technology innovation. If you were a fly on the wall of the board rooms of any of the companies I mention above you’d here a lot of concern about how innovative and dangerous Microsoft’s ‘Cloud’ strategy really is.
There are risks. One risk that concerns me is that Microsoft’s sales leadership lead by Turner may think that as enterprise customers move to a self service and automatically provisioned model then the requirement to have dedicated, very smart sales and technical professionals in the field will diminish. This is a very dangerous ‘Wal-Markian’ dream. In my view exactly the opposite will happen.
As customers hand the keys of their very strategic IT operations to Microsoft they will demand a closer, not more distant, working relationship. The expertise, skill set, experience and cost of the field resources required for this new reality will rise not decline. There are also very valid strategic reasons why you would want the trend to move in that direction. Lots of Microsoft’s field resources, including expensive sales people, spend far too much time helping customers understand which ‘Bits to flip’ to optimize or overcome some server or Office deployment challenge. Meanwhile the IBM account team is wining and dining the ‘C’ level executives of the company talking about how IBM can help restructure the business or realign strategy etc. If customers move to Microsoft’s ‘Cloud’ platform then it will be critical for the sales force to move up the food chain to ensure they are influencing how customers design their next generation of strategic services. Rather than de-investing the company needs to be ready to over-invest in strengthening these strategic relationships.
One could argue that with the strength of it’s ‘Cloud’ offerings Microsoft is perfectly poised to drive the next phase of growth for the company. That is almost certainly true but to do so without a strategy to simplify and streamline the business would, in my opinion, be a mistake. Too many compromises are placed on both the enterprise and consumer sides of the business by the forced interlocking of both the technologies and business models. In my view its time to give both business the freedom they deserve. The freedom to innovate and find their own way in the world. If you been following the argument I’ve laid out throughout this series of articles then the remedy I have in mind will not come as a shock.
In June 2000, at the height of the DOJ anti-trust action, the judge in the case, Samuel Penfield Jackson shocked the entire company by ruling that the company should be broken up into two companies: one owning the applications business and the other the operating systems business. It shows just how far the company has come that there was no mention or recognition of an enterprise server and tools business at this time. Jackson’s ruling was eventually overturned by the Federal Appeals Court but not before the breakup became the discussion topic of the industry. Jackson’s ruling was wrong in substance but I’m beginning to believe that its time to revisit the idea in another form.
If you were approaching the problem today you would almost certainly not break the company apart by product line. Value is defined by customer segment today and, as I’ve outlined before, it is the integration across product lines which provides perhaps the most value to enterprise customers.
To unlock the full value of the company’s assets I believe they should be split between a new ‘ConsumCo’ and an ‘EntCo’. Some of the distribution of assets would be very obvious. The Server and Tools division and the Business Division would become part of ‘EntCo’. Their revenue streams almost entirely derive from small, medium and large enterprise customers today. The Entertainment and Devices division would go to ‘ConsumCo.’ I might argue that XBox should be spun off as its own company given the uniqueness of the gaming market but the investment cycle required probably means that it would continue to need the support of more mature businesses. The Online Services division’s assets would need to be split with the Business Productivity On-line and other hosted application offerings going to ‘EntCo’ and Bing and the MSN properties go to ‘ConsumCo’.
The most difficult decision would be what to do with the Windows and Windows Live division. One approach would be to fork the Windows code base and give both EntCo and ‘ConsumCo’ the opportunity to drive their own client OS strategies targeted at the unique needs of their audiences. Windows Live belongs over in ‘ConsumCo’. The revenue from the Windows business would be split by channel. OEM retail revenue going to ‘ConsumCo’ and OEM enterprise revenue flowing to ‘EntCo’. The bolder strategy would be to give Windows to ‘EntCo’ and then tell ‘ConsumCo’ to go figure out whether they even need to be in the client OS business. They probably do not. The focus of ‘ConsumCo’ should be to build the worlds most compelling on-line services and to make sure they are a great experience on every network connected device on the planet. Being beholden to one OS or particular browser limits the scope of your ambition.
One objection which immediately springs to mind is the duplication of overhead (Read cost) that would be required for services which are shared between the two companies. That’s not really an issue with things like HR and finance. You would just divide up the existing resources as required. In fact without the overhead of trying to get the whole complex integrated machine to work together there might actually be an opportunity for some efficiency in these areas. The split of field sales resources would not be that difficult with most of them ending up in ‘EntCo’ serving the same customers and partners they do today. The big question would be what to do with any shared computing infrastructure. As Microsoft is setting itself up to become a global service provider of computing infrastructure then perhaps that should also be hived off into a separate operating company providing compute services to both ‘EntCo’ and ‘ConsumCo’.
I believe the long term benefits of freeing each part of the company in this way would outweigh the short term complexity and disruption such a change would require. Freeing the leadership teams of ‘EntCo’ and ‘ConsumCo’ to pursue both a technology and marketing strategy which is focused on the unique needs of their audiences rather than internal demands has to be a positive move. This would likely unlock a new round of innovation in each business as the shackles of co-dependency are removed. This approach might also give birth to some radical strategies such as closer partnerships with Apple and Google as channels for a whole new range of consumer and enterprise services. On the other hand maybe that would remain a step to far 🙂
One final objection I can foresee would relate to the financial viability of ‘ConsumCo’ and there we’ve touched on the crux of the problem. For too long and at too high a price the core enterprise business has subsidized Microsoft’s multiple failed attempts to become credible in the consumer space. That subsidy limits innovation and R&D investment, it limits marketing investment and it limits the field resources investments required for Microsoft to achieve its full potential as the worlds leading enterprise software and services company. In my view the experiment has gone on for too long. Setting ‘ConsumCo’ free would be a blessing. Finally the management teams running those businesses would feel the heavy weight of competition without the soft blanket of subsidy. Maybe that is what is needed to spark the true innovation and dedication to winning that is required for success. Perhaps there would even be a rationale for Yahoo to buy ‘ConsumCo’. On face value that alignment makes far more strategic sense than the alignment between consumer and enterprise businesses inside Microsoft today. I am convinced of one thing; with the enterprise ‘Cloud’ business poised to take off it is time to drop the consumer ‘Boat anchor’ to ensure that Microsoft can rise with the massive tide of opportunity that is about to come in.
I’ve covered a lot of ground in the last four posts. I’ve tried to balance my concerns with my optimism about the opportunities available to the company. Ultimately I have no deeper interest in what happens than any other very minor share holder. However, I do have a lot of former colleagues, many of whom I count as close friends. In the end I want them to have the opportunity to work for a company that they can be proud of and which continues to change the world in a positive way. Much of the negative commentary directed at the company is founded on a false premise and a real lack of understanding of how bright the company’s future can be. However, it remains the sole responsibility of the senior management team, lead by SteveB to make the tough strategic choices that will ultimately prove the detractors wrong.
Microsoft’s Crisis in Perception (Part 3)
In the parts 1 and 2 of this series I made the case that Microsoft is mistaken for a consumer products company when, at the core it is really an enterprise software company.
This misalignment between reality and perception is largely self inflicted and continues to be be dangerously reinforced by Microsoft’s marketing and PR machinery. The net effect of this ‘Crisis in Perception’ has been an undervaluing of the company’s assets and a distraction which has prevented the management team from pursuing a more focused strategy which would unlock that value. In this chapter I will discuss some of the structural challenges facing the company today and how they combine to place limits on the company’s room for maneuver.
When I joined the Microsoft in 1994 the structures and decision making processes at the company were quite straightforward. There were product development groups who all answered to BillG and there were sales, marketing and support organizations who all answered to SteveB. The COO was responsible for making sure the bills got paid and things like manufacturing and distribution were run as efficiently as possible. There was only a small legal team and HR was there to help you identify the best talent to hire from outside and then to keep the talent happy when it joined the company.
Of course the company was far smaller then and with fewer employees operating across a much smaller number of geographies. In 1995 Microsoft was ranked number 250 on the Fortune 500 list with revenues of just over $4.5 Billion. In the intervening period the company has become a behemoth and will check in around $60 Billion dollars in revenue this year (Disclaimer: All the revenue numbers I discuss here are projections based on Microsoft published third quarter results and publicly available historic data available here. I have no knowledge of fourth quarter FY’10 performance.) It is illuminating to compare the P&L performance for the 10 years prior to 2000 and for the ten years since.
In the period fiscal year 1990 to 1999 Microsoft’s revenue grew 1665%. Operating expense grew by less than revenue 1207% contributing to a bottom line net income growth of a massive 2787% over that ten year period. At the same time R&D investment went up by 1641% driven almost entirely by the company’s push to become a credible player in the enterprise. Scarily, the cost of administering all of this growth accelerated faster than revenue at 1833%. Finally, sales and marketing costs grew by 1079% as the company expanded both its global presence and enterprise sales capabilities.
Now compare the period 1990-1999 with the subsequent decade from fiscal 2000 to fiscal 2009. If you want to understand why the stock price has been depressed for so long these numbers tell the story. The company’s top line revenue grew by only 255% during this period (Obviously the law of large numbers starts to kick in and a 255% growth on Microsoft 2000 base revenue is a huge amount of revenue.) However, operating expenses during the same period outgrew revenue at 319% (Ouch!) and as a result net income grew a paltry 155%, exactly 100% less than revenue. At the same time general and administrative (G&A) costs soared by 352%, sales and marketing expense by 312% and costs associated with getting all the revenue (Support, licensing, distribution, channel etc.) rose a whopping 405%. No wonder the stock hasn’t done anything in 10 years.
G&A costs as a percentage of revenue are one proxy for the ‘Complexity’ of a company. The simpler the business model, product line and organizations structure needed to take it to market the lower your G&A needs to be as a percentage of income. In the period ’90-’99 G&A averaged 3% of revenue. In the period ’00-’09 that ratio had nearly tripled to 8%. G&A costs combined with the ‘Cost of Revenue’ and ‘Sales and Marketing’ lines is also a very good metric for efficiency. The fact that all of those costs grew substantially faster than top line revenue growth points to Microsoft facing its very own ‘Malthusian catastrophe‘. The situation is not sustainable and needs radical action today even more than it did in 2000.
One of SteveB’s first strategic decisions as CEO was the introduction of a GE like P&L structure. Each product group would become an ‘Independent’ division with it’s own P&L meant to represent the true costs associated with building, marketing and selling each of the products. In my opinion, there were only one or two ‘Minor’ problems with this plan.
The health care, lighting and aircraft engines businesses at GE really are independent of each other. There is almost not overlap between the technology in their products or the markets into which they sell. Each of the GE’s divisions has its own independent and dedicated sales and marketing resources. A strategic decision taken by the president of the health care business can be taken without reference to other divisions and with the knowledge that he or she has complete control over the execution of the strategy. The only thing GE Group cares about is whether a division meets it’s revenue growth and profitability targets.
Microsoft’s business is almost the antithesis of GE’s. In 2004 the company came up with the tag line ‘Integrated Innovation‘ which almost perfectly captured Microsoft’s development philosophy in one compact phrase. It also put a dagger in the heart of any plan to run development divisions as truly independent businesses. The strategy of ‘Integrated Innovation’ creates such a dense web of interlocking dependencies between all of Microsoft’s products that one division cannot sneeze without asking the permission of three other divisions first. ‘Integrated Innovation’ is absolutely the right strategy for an enterprise software company bent on meeting the needs of complex customers. However the strategy puts a straitjacket on any attempts to leverage your assets into other markets. Being held hostage to the ‘Integrated Innovation’ strategy is one of the primary reasons why Microsoft’s previous Windows Mobile operating systems compared so badly to iOS and Android. (It remains to been seen whether Windows Phone 7 can break the bonds imposed by the ‘Integrated Innovation’ model.) The ‘Integrated Innovation’ messaging was also like red meat to the wolves of the Linux community and government regulatory classes who saw it as an attempt to leverage Microsoft’s dominant position in one market to gain advantage in another.
The other difference between GE and Microsoft is how you get your products to market. Microsoft has one sales force which sells through partners but has a direct relationship with small, medium and large enterprises. Each of the ‘Independent’ product divisions has to negotiate access to the sales resources required to get a product in front of customers. The life of a front line sales person at Microsoft has become unbelievably complex. They are the one point in the whole messy business where Microsoft’s product portfolio comes together and has to be integrated into a consistent conversation with the customer. Far from simplifying the business the new P&L model likely added complexity and cost due to the overhead in resources now needed to manage all the internal negotiations. No wonder all those operational expense items on the P&L have risen faster than income.
Then there’s the issue of leadership talent. When Steve introduced the P&L model he made it clear that he was expecting the the divisional leaders to step up to the role of CEO for their businesses. That of course requires that the company had the skills in its existing management team to act and lead like CEOs. Its important to put the size of these businesses in context. The Windows and Office divisions will generate $18-20 Billion revenue in 2010. If those were independent companies they would rank no lower than 120 on the Fortune 500 list. The server and tools division is a $13-15 Billion revenue business which would rank no lower than 177 on the Fortune list if it was a separate company.
To be the CEO of any company of this size requires: The ability to define and articulate a clear and exciting vision of the future, excellence in personal communications, an outstanding ability to select and nurture talent, the confidence to admit your mistakes and learn from them and a deft ‘political’ sensibility amongst many others. Not quite the skill mix you find in most great engineers and yet most of the presidents running these mega-businesses today rose through Microsoft’s engineering ranks. There are a few true superstars in this role like Stephen Elop who is a breath of fresh air but was hired in from outside where he already held a CEO position. As a shareholder I really do hope he can continue to thrive and succeed in the Microsoft culture.
As things were spiraling out of control in the early 2000s Steve made another management selection which proved controversial at the time. When it came time to pick a new Chief Operating Officer for Microsoft Steve reached out to an individual and an organization her knew well. His pick was Kevin Turner, then CEO of Wal-Mart’s Sam’s Club division.
Turner’s selection was unorthodox. Here was someone whose entire mindset and expertise was defined by a lifelong career in a company with a completely unique world view; Sell simple products in huge volume to consumers whose primary value driver is low cost, and squeeze every last cent out of your operations no matter what the cost in terms of morale or relationship with your suppliers (If you are the largest retailer in the world then your suppliers depend on you, not the other way round.) Of course if you believe in the fallacy that Microsoft is or can become a consumer products company then Turner might be the perfect COO. On the other hand, if the reality is that your business depends on selling very complex enterprise software solutions to complex customers who expect care and feeding for the millions of dollars they spend with you, then perhaps you need a COO with a broader professional skill set.
Ironically, I defended the hiring of Turner at the time to my organization and anyone else that would listen. My view was that the sales organization in particular was in desperate need of some discipline and structure if we were ever to get cost of sales under control. To his credit, Turner did just that in his first two or three years, forcing everyone to adopt rigid new scorecard and revenue forecasting processes. However, as with all things there is a law of diminishing returns and ultimately other strategic issues which need to be balanced. Unfortunately if you have a ‘Wal-Markian’ world view then there is no such thing as a diminishing return. In the consumer retail business where margins run at 5-6% one more penny squeezed from the cost line makes a difference. In the world of complex enterprise software sales, squeezing another penny out of the cost line just demoralizes the talent in your sales team who you depend on to explain the complexity of your product offering to customers who spend millions of dollars with you every year.
In my view its a pity that Steve did not take the opportunity to shake Turner’s hand, thank him for his great contributions and then let him go when his contract expired several months ago. If cost cutting becomes so endemic that the quality of your sales talent begins to decline and the ‘Tyranny of the scorecard’ becomes so stultifying that you leave no room for innovation and initiative, then your enterprise customer relationships and revenue will follow. If that happens Microsoft will enter a death spiral because there is no other business, not consumer, not on-line which can cover a shrinking enterprise business. In my opinion, we’re entering a very dangerous phase where the rigidity enforced by the network of dependencies between products, and the ever decreasing freedom to innovate in the field, is severely impeding the company from finding any creative way out of it’s very serious problems.
In the next and final chapter I will discuss some bright spots on the horizon and give my personal take on what strategy the company needs to pursue in order to achieve it’s full potential.
Why Steve Ballmer Should Not Be Opening CES 2011
Nick Eaton’s Microsoft blog for the Seattle PI announced yesterday that Microsoft’s CEO Steve Ballmer would once again be giving the opening keynote at the Consumer Electronics Show in Las Vegas on January 5th 2011. In my opinion having Steve open CES is a strategic error on the part of the company.
Microsoft has a perception problem; It is viewed as a consumer company when at its heart it is really an enterprise platforms company. For over ten years that mistaken assumption has depressed the stock price, caused the company to set expectations that his has failed to deliver on and has massively undervalued the assets of the company.
The sad thing about this “Crisis in Perception” is that its largely of the company’s own making. Microsoft’s global brand marketing and PR engines continue to promote the false view of Microsoft as a consumer company. Lifestyle commercials like the “I’m a PC” campaign would be perfect coming from a Coca Cola or Nike. Coming from Microsoft they very dangerously reinforce a mistaken impression of what Microsoft is. Steve Ballmer standing on stage at the ‘Consumer’ Electronics Show does exactly the same.
You would have thought the company would have learned their lesson from the PR mess which followed Steve showcasing HP’s slate computer during last year’s CES keynote. You need no other evidence to understand just how much Microsoft is not a consumer company. Steve was set up to use the HP slate as a counter to Apple’s expected launch of the iPad. Within six months the HP Slate was canceled, HP was buying Palms assets and the iPad became the fastest selling consumer device in history. Where did that leave Microsoft; looking ridiculous, even less clear about its counter strategy to Apple and still dependent on partners who can and will change their loyalties at the drop of a hat.
There’s only one scenario under which I would have Steve get up on stage at CES in 2011: If Microsoft is going to unveil a branded, clearly class leading computing device in which they control the complete end-to-end consumer experience. If that is not what the company is ready to talk about then anything else is likely to be putting just one more nail in the coffin.