Microsoft Shouldn’t Break Up, But Break Away from its Antiquated Business Model

… And the debate about breaking up Microsoft still rages on …

By Joe Wilcox, Betanews

Ten years ago this month, Microsoft settled its antitrust case with the US Justice Department and handful of suing states. The settlement eventually ended government plans to break up Microsoft into two companies. Yesterday, a Microsoft shareholder asked why the company doesn’t breakup now. It’s a good question. From a shareholder perspective, breakup is probably the best way to return value back to company owners.

Strategically, however, such action would undermine Microsoft plans to reinvent itself for the post-PC era, in part by dragging on the personal computer’s relevance long beyond its obsolescence. Breakup’s timing would cripple Microsoft competitively, too. But that doesn’t mean Microsoft should stick together. There is a case for bringing back internal startups like Live Labs or spinning out one or more companies from the core.

There is no easy answer to the breakup question, because of where Microsoft is today compared to 2001 or even 2007. CEO Steve Ballmer and his subordinates have bet the company’s future on extending the Office-Windows-Windows Server apps stack to the cloud. It’s a bold preserve-the-status-quo strategy that promises to solve Microsoft’s biggest problem: Finding new stuff for long, established customers to buy. But to get there, Microsoft must fundamentally rethink its partner-dependent software distribution model.

Asking the Breakup Question

The breakup question isn’t a new one. I long ago advocated Microsoft voluntarily splitting into three or more separate companies. Shareholders are the main reason. Nimbler breakoffs freed from development obligations to integrate could innovate, rapidly growing and returning greater value to shareholders. There are plenty of precedents for such a divide-and-conquer strategy. Instead, Microsoft not only stayed intact but took on weight, nearly doubling payroll between fiscal 2001 and fiscal 2009 — 48,030 to 92,736 employees.

Investors have punished bulging middle-aged Microsoft. Last week, I asked “Why won’t Wall Street give Microsoft a break?” The stock has been moribund for a decade. On Nov. 2, 2001 — the day Microsoft announced its U.S. antitrust settlement — the stock sold for $30.70. Microsoft shares have since only occasionally risen above $30. Microsoft opened today at $25.91. For some comparison, Apple traded for $9.28 on Nov. 2, 2001, and opened at $301.08 this morning. Surely some investors are asking if Apple, why not Microsoft?

Near the end of Microsoft’s annual shareholders meeting yesterday, one questioner expressed dismay about the stock and corporate strategy:

I’m another frustrated shareholder for more years than I’d care to admit…I’m a shareholder of another very large software company that’s up 12 percent this year. Microsoft is down 12 percent. Is it time to consider breaking this company up, taking these great core businesses that we have, and getting shareholder value by divesting them into maybe not eight — maybe four, maybe six, I don’t know what the right number is — but is it time to break up Microsoft?

Part of Ballmer’s response:

I obviously don’t think it is time. I don’t think it would be useful. I think it creates economic dissynergies, in fact. It’s not — you know, how do I say this — it’s not in my natural genetic makeup to think that way, but when you get enough people telling you to think that way, you at least go through the proper discipline kind of look.

And in almost all cases the market goes the other way. All of the people we compete with in devices will be in phone, PC, and TV, which in our case means Xbox, Windows, and Windows Phones. It’s Apple, it’s Google, it’s us. I mean, divesting something only means creating a harder time competing for all relevant parties.

When Synergy Isn’t

Microsoft’s CEO is talking about two seemingly related things that, looking at the historical Microsoft, aren’t practically or strategically connected at all. Ballmer talks about the problem of creating dissynergies as one reason not to break up. But synergy may be the core problem. Since the early 1980s, synergies between products is a core Microsoft development objective. In the early 2000s, company executives and product managers referred to this synergy strategy as “integrated innovation.” Microsoft accelerated the vertical feature integration among Office, Windows and server software after completing the antitrust settlement in November 2002. Over the last decade, synergy failed to return value back to shareholders, by in part creating the perception Microsoft is no longer a growth company. More importantly, the synergy mandate means that Microsoft developers have a greater priority to integrate new stuff with cash cows Office and Windows than to truly innovate. At Microsoft, innovation is all about integrating with status quo products. Azure is classic example.

Ballmer wrongly relates synergy to changes now taking place as computing and informational relevance shifts from the PC to cloud-connected devices. There, some of the most successful companies offer complete hardware, software and services solutions. The synergy that, say, Apple creates is different from Microsoft. Apple controls everything. Microsoft doesn’t and won’t as long as third parties build stuff around its software. Ballmer is wrong if he sees Microsoft’s past approach to synergy as being validated in the shift to cloud-connected devices. Microsoft is trying to have it both ways — be a developer of platforms and applications. The two approaches are incongruous and are a major reason why Microsoft has failed to grow the majority of profits beyond Office and Windows.

Office’s debut in the early 1980s put Microsoft in competition with its developers. Today, among Windows developers, their largest competitor is Microsoft. In the mid Noughties, Microsoft tried to establish Office as a development platform (again), but really went on to extend applications competition to its server software. Microsoft is now at a juxtaposition: Is it going to be a platform developer or applications supplier? That’s the essence of Microsoft’s push into the cloud. Ballmer and his subordinates can’t have it both ways, something I’ll better explain in the next section.

Microsoft Chairman also answered the breakup question:

If you look at the evolution of Office and how it uses the cloud, if you look at the evolution of some of the gaming assets and how those connect to the communications things we’re doing, you know, I don’t think there’s a line where you’d find net simplicity by trying to create a new company.

He is absolutely right. Microsoft has gone too far down the path of extending its core Office-Windows-Windows Server apps stack to the cloud. There is no turning back now. But how should Microsoft go forward?

‘To the Cloud!’

Microsoft’s newest marketing tagline is “to the cloud.” It pops up in new commercials aimed at businesses and consumers. The tagline is more than marketing. Ballmer and his subordinates have bet Microsoft’s future on extending its core software stack to the cloud. What’s uncertain — and as I’m hearing even still being debated within Microsoft — is where that strategy ends up. Can Microsoft continue to be, or even should it be, a company supporting a broad partner ecosystem? Right now, Microsoft is dependent upon third parties to distribute, to sell and to service its software. The approach worked for Microsoft when it was younger and growing but in some ways has worked against growth in the new century. Microsoft’s current business model of licensing software that others sell and service precipitates five related strategic and competitive problems:

1. Since most businesses or consumers already use some Microsoft product, the company is essentially reselling to the same customers over and over.

2. Microsoft’s biggest competitor is itself. Customers with Microsoft software that they find to be “good enough” have less incentive to buy the newest thing. Upgrade cycles stretch out, particularly for businesses finding it cheaper to stick with what they’ve got than to invest in something new.

3. Microsoft has a huge fragmentation problem, since so many versions of its software are in use. Developers must support multiple software versions over many years, and customers grow dissatisfied when they encounter problems using older software no longer supported by newer third-party products.

4. Many Microsoft partners make much more from servicing than selling Microsoft software or supporting hardware. This despite Microsoft fees for selling licensing contracts. As such, some partners have more incentive to maintain fragmentation than end it. For cost reasons, many IT organizations want to upgrade piecemeal, an approach that also benefits integrators’ long-term business prospects with their customers. The point: There is built-in conflict-of-business-interest between Microsoft’s objectives and many of its partners.

5. Microsoft’s second-biggest competitor is the software pirate. The company still has lots of sales growth headroom in emerging markets, which, according to Business Software Alliance, generally have the highest piracy rates. Additionally, much of the pirated software reaching mature markets comes from some of the larger emerging markets with high software piracy rates. Related: These same markets also account for the bulk of Internet spam and scams, and from them criminals infect pirated software with Trojans and other botnet-creating malware.

The cloud strategy solves all these problems, eventually. It’s also the fundamental reason why Microsoft shouldn’t break up now. I’ll couch by explaining how the cloud strategy solves the five problems:

1. By extending the Office-Windows-Windows Server apps stack to the cloud, Microsoft gives existing customers in established markets something new to buy — and there are many benefits, such as anytime, anywhere access on anything. Customers also can benefit from lower upfront pricing, lower long-term costs (which includes maintenance and hardware) and access to the newest Microsoft software (with no physical upgrade required). These benefits apply most when customers adopt hosted software.

2. Market saturation becomes an asset rather than liability. Now, millions of customers have something better to get from Microsoft. Cloud customers buy differently, whether they go hosted-only or not. Hosted-only means committing to subscription contracts that give customers access to applications and always the newest stuff, without the hassle or expense of maintenance and upgrades. Customers with existing software gain benefits by adding on the cloud; Microsoft gains when these customers upgrade to newer software better supporting cloud services.

3. Ideally, if all Microsoft customers choose host-only, there would be no fragmentation. For certain, there will be lots more customers using the current versions of Microsoft software and so much less fragmentation.

4. The cloud, whether hosted-only or software hybrid, removes customers’ incentive to use older software. What that means for Microsoft partners is uncertain. Microsoft should commit everything to the cloud and provide an end-to-end software, datacenter and services stack to customers, pushing partners to hardware and services supporting other software and some local integration of Microsoft stuff.

5. There can’t be software piracy if there is no software to steal. The more Microsoft offers in the cloud, the more it can sell to every market, particularly growth ones, without hefty losses to piracy. Plan, pure and simple.

Now isn’t the time to break up Microsoft. But it is time for Microsoft executives to decide what the company will be. The cloud strategy is pulling away from an older software distribution strategy that is antiquated in the cloud-connected device era. Applications will remain important, but they will be lighter than bloaters like Office. The question shouldn’t be about Microsoft breaking up, but whether it should break away from a business model that competes with developers and depends too much on third-party partners to sell and service the software.

It’s Microsoft’s midlife crisis. What do you want to be, Microsoft?

Copyright Betanews, Inc. 2010

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