Microsoft's Current Situation: Like IBM in the '80s

A flurry of stories about Microsoft (MSFT) recently got me thinking today about computer history. First was the story yesterday in the Wall Street Journal about whether it's Time to Dump Your Desktop? Another was the recent revelation that Microsoft is developing its own Zune music player and is creating yet another music store to compete with iTunes. Another was about how Google's new spreadsheet service could ultimately dent Microsoft's Office business. And then there was this compendium of articles about Bill Gates stepping down and another marketing executive leaving. These stories seemed to be saying something, but no one told the whole story. And then it hit me.

Microsoft is about to lose the software business the same way that IBM lost the PC business in the 1980s.

Now, for those of you who didn't live through it, a quick refresher: In the 1980s, it wasn't Microsoft who dominated PCs, it was IBM. The IBM PC was the fastest-selling product IBM ever had, and it was the gold standard for desktop machines. But even so, MIS departments (Management Information Systems organizations, what IT was called in those days) still called PCs "toys" and snidely thought that they would never be able to handle "real" work like their IBM mainframes and minicomputers.

IBM planned to change all that with OS/2, which would be its best and most compatible system. And best of all, it would work seamlessly with the rest of IBM's systems and be supported by the IT department. It was complex and needed the latest and greatest hardware (the IBM PS/2) to run, but it worked.

Trouble was, OS/2 was too late. The PC "toys" powered by Microsoft software took over -- they could be bought off the shelf and snuck into the business without the approval of MIS. And despite the fact they were less capable, no one except MIS cared; they did the job for people who wanted to do a few simple things and who couldn't wait for MIS. And the PCs got better and better until MIS had to embrace them or become irrelevant.

That same process is happening right now, except this time, it's Microsoft and Microsoft-centric IT departments calling Internet services and non-Windows PCs "toys". They call Google's spreadsheet a toy that is nowhere as powerful as Microsoft Excel. They insist Apple's (AAPL) Macs will never be accepted in corporations. And they insist Linux is just too difficult to work for real business. And besides, Windows Vista and the new Microsoft Office -- complete with a completely new interface designed to befuddle users used to the old one -- will work so much better and more seamlessly with all other things Redmond. Everyone just has to upgrade, and life will be grand.

The only problem with Microsoft's story is that just as with IBM's story in the 1980s, there's now competition from "toys". The "toys" made by competitors just do stuff that users want. And they do it fast. And the users vote with their dollars.

Look at Apple. In the time since Windows XP was released, Apple has released five versions of its Mac OS X operating system, which, of course, run on Macintoshes, computers IT considers toys. Each one has gotten better than the last. Today, if you go to a developer's conference, the cool kids have Mac OS X laptops. Why? They evolved faster than Microsoft-powered laptops, to the point where both the laptops and the OS are fashion statements.

Or look at Google (GOOG). Last week, it reported that it doubled profits to more than $700 million for the quarter, most of it from advertising on search results and its ad network. Microsoft keeps saying, "we'll be there with a better search and ad network soon", despite the fact that it is more than five years behind Google with customer experience. How many iterations has Google's Adsense been through in the meantime? A lot. How many people are waiting for Microsoft and expecting it will hit it out of the park with its first try? Not a lot.

The reality of Microsoft is that only two products, Office and Windows, bring in 90% of its revenue and all of its profits. And the toys are slowly destroying the monopolies and value of both those franchises. You don't need Windows or Office to build a spreadsheet with Google Spreadsheets, edit a document with Writely, build a Web page with Google Pages, or collaborate online with Skype or Gizmo. Nor do you have to pay for any of them. Which means that Microsoft's revenue is under attack.

With toys attacking its cash cows of Windows and Office, what is Microsoft doing? It me-tooing the toy companies. The XBox 360 is attempting to catch up to Sony (SNE), the company that launched 100 million Playstation 2 consoles; XBox 360 has shipped five million in eight months. Today, Microsoft confirmed that it will build it's own Zune music player, in an attempt to catch up with Apple's nearly 60 million iPods. And both businesses will lose money for years, depending on the Windows and Office cash cows -- yes the same cash cows being attacked by the toys -- to support them. Just this quarter alone, the home entertainment business unit at Microsoft -- home of both XBox 1 and Xbox 360 -- lost nearly half a billion dollars. On a yearly basis, that division has never made money.

Think Microsoft has something in the labs that will pull it through? Here's a test: name three technologies that Microsoft has deployed and profited from in the last five years, when it has invested more than $20 billion in research and development. For $20 billion, you'd think at least one of those toys would have made it to market.

Now some have said that Microsoft can always buy its way into a market with its billions of dollars in cash. That sounds possible, but history doesn't support that theory. IBM wasn't able to buy its way to being competitive in minicomputers. Microsoft hasn't been shy about throwing money at AOL-killers (MSN), iTunes-killers (URGE, MSN Music, and countless others), and Yahoo (YHOO) Mail-killers (Hotmail). None of the Microsoft efforts have yielded profitable businesses, despite multi-billion dollars investments over time. In fact, it's hard to find any example of buying into a market yielding a profitable long-term business. Subsidies kill innovation.

Microsoft suffers from a classic case of American obesity. It is too rich and comfortable to move quickly and win in new markets without its monopoly to prop it up. The two monopoly products that fund Microsoft's are falling subject to David Pogue's software paradox: "if you upgrade software enough times, you eventually ruin it." Meanwhile, the hungry toy makers are running fast to deliver new solutions, make profits, and steal Microsoft's customers.

Microsoft is not alone in seeing its business hurt by more nimble competitors. Just last week, the stock market bruised Intel, Dell, and Yahoo for similar reasons. But Microsoft is alone in not employing the billions of dollars in its cash horde to create new profitable business value. It even admitted as much by announcing a stock buy-back program. You only buy back stock when you can't earn more using that money in the business. And with 10 billion shares outstanding -- one and a half or every man, woman, and child on earth -- even the $20 billion allocated to the stock buyback will only delay an inevitable decline.

The Bill and Melinda Gates Foundation will spend billions this year to cure disease throughout the world. It's a tragedy that the company that created those billions can't cure the disease within itself.

MSFT 10-yr chart:

Disclosure: The author is long shares of Apple, and has no holdings in other stocks mentioned.

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Comments

[Saul Sterman]

I agree.

Once MSFT burns through the first 20 billion, I hope they wise up before dumping the second 20.

MSFT could have bought 5 companies (like Electronic Arts) by now and start building a new empire from the bottom up. The culture problem is that they are so used to being a monopoly that they have forgotten the meaning of hard work.

Disclosure: This is my personal opinion and may not reflect the opinion of CrossProfit.com.
www.crossprofit.com

[Ray Myers]

Nice comparison. The difference is that the suitors waiting in the wings aren't nearly as disruptive as Microsoft was to OS/2. This means "more time" to fail/succeed for MSFT.

Will they pick up the gauntlet? History says no. The caveat? Ray Ozzie. He must not only LEAD MFST toward differenct profitability streams but, he must do it INNOVATIVELY and with SPEED. These are two (2) attributes heretofore unknown to Microsoft employees and ones they must LEARN...quickly.

So, I say to Ray Ozzie: don't just create solutions...recreate a company! Lean, fast-moving, innovative. And, Ray...do it now! Or, it truly WILL be the 1980's for Microsoft...just not as fast.

[Blu vg]

There are a lot of gaps/leaps of reasoning and non sequiturs in this article. Where to start?

IBM may have "dominated" in the early 1980s, but that was based on hardware, it wasn't the same degree of domination of that market, and the market was completely different. Now, just about everyone owns a computer in the US. That certainly wasn't the case back then, when computers were mostly geeks' toys.

It's easy to talk about things like Google's spreadsheet offering from a consumer perspective, but these applications receive spotty traction in the business market. One big reason is that enterprises have to be able to implement change management processes, particularly with applications. So far, this is not an option with most widely-hosted applications--when Google makes an update, you're getting it, ready or not, and like it or not. Another reason is that you need a reliable offline mode--essentially a thick/fat client... at which point it's simply Google reinventing the wheel.

Macs are not accepted in most corporations, for a whole host of reasons: premium cost (though it's not as great as before), additional support requirements, additional security considerations, integration costs, application availability, 3rd party support, etc. etc. And to clarify, the application availability is a huge problem for Mac adoption--there are tons of odd apps (particularly old and/or vertical market stuff) that are critical to businesses and simply have no functional equivalent on the Mac. If there is a cross-platform version, it is often a couple revs behind, lacks features, and/or is marginally supported. Furthermore, XP has been updated significantly since it was released (many add-ons, service packs, updates, etc.), but the difference is that Microsoft did not charge for them--think how everyone would complain if they took a cue from Apple and charged yearly for a package of updates! Plus, they've released several editions: Media Center (original, 2004, 2005), Tablet PC (original and 2004), x64 edition, the Starter Edition, an Embedded Edition, and more. And despite the oft-repeated notion that Apple is growing and changing the game, the numbers don't agree--yes, their shipments are up, but PC shipments as a whole are also up. Their market share remains unchanged (2.28% in 2005).

Those are just a few examples. I have read a host of articles like this as well, but working in the IT industry, I think a lot of them are really out-of-touch, or perhaps just wishful thinking for those that have a bone to pick with Microsoft (e.g., the suggestion that the next version of Office was "designed to befuddle" users... ignoring how much user testing goes into these changes, and that users are affecting the final outcome through the beta process--and even via Microsoft's blogs; in other words, people give them grief when they don't innovate, and give them even more when they do). It's easy to throw stones at the big guy.

Applying double-standards to them is also in fashion, such as the accusation that they have tried to buy their way into new industries. So, why not apply the same logic to Google with Writely, or Keyhole/Google Earth, and so on? For some reason, Google gets a pass--because they're Google. For some reason, there's this desire to perceive the facts differently when it comes to Microsoft.

[Saul Sterman]

You missed the point and confirmed both the author’s assertion and the culture comment posted above.

No one is saying that Apple will replace MSFT today. The point is that MSFT is putting all of its eggs in one basket and every attempt to diversify has met with failure because its approach is from a monopolistic skew.

No one can build from the top down. New markets are built from the bottom up. If MSFT can repeat its success story again, then and only then will it have a new monopoly.

The “we are the biggest and best” syndrome is what cut Big Blue down to size. The same is happening to MSFT. If I didn’t care about MSFT or ‘have a bone to pick with Microsoft’ I wouldn’t bother writing about it.

[Blu vg]

Yes... I guess I am conforming to the stereotypical "draconian IT Director" mold a bit! But that shouldn't be reason to dismiss my comments categorically. There is no reason to believe that the IBM PC example will hold true today as it did then. For instance, I've worked in a half-Mac, half-PC environment--I've dealt with the issues personally and am in an industry where my peers/friends are dealing with the same thing. A very high percentage of the time, those "switch to Mac" projects fail, and come the next hardware cycle, those groups go back to PC. I assure you, it's not that they didn't try to make it work!

I think perhaps some industry watchers get stock/financial performance and industry performance mixed up a little bit. Take the XBox 360--Microsoft has produced a device with performance that many developers are saying is better than Sony's, and yet the cost is about half. They both are selling the consoles at a loss, and in Sony's case, it will be a huge, huge amount. From a financial standpoint, the numbers right now are terrible for both... but both companies are looking at a bigger long-term picture. Within the industry, the XBox is a tremendous success--but there is a short-term pain for a long-term gain. One thing is for sure, though--a company isn't going to pick its next computer or software package based on the stock performance of the vendor. Excitement--whether real or, more often than not, perceived--and speculation don't push product in the IT world.

Where is IBM today, anyhow? They are still huge and very relevant. However, the desktop market is a commodity market, and IBM is simply not good at that; they aren't even willing to play that game. It's not that IBM lost the PC business. They tried to turn it into something it's not, and when they realized that, they gave up.

Don't get me wrong--Microsoft is not invincible by any means, but the examples used here just don't support the conclusions.

[cdhowe]

Great comments all. To Blue vg, the Wall Street Journal article cited actually notes that many firms actually want to move away from Microsoft; interestingly, that was not the case with IBM when Microsoft attacked it with Windows.

Regarding hardware versus software, frankly, I don't think it matters. IBM had just as firm a lock on the IT market in the 1980s as MIcrosoft does today. It also had a similar pattern of behaviors, such as preannouncing products to freeze the market and using its strength in mainframes to drive all-IBM purchases. And yet, change happened.

Google buying its way into markets? Yes, it is trying, and so far without huge success. Search and advertising remain its bread and butter according to the latest earning reports, and yet it still doesn't have a monopoly there, with only 50% market share.

I think Saul's points were particularly good, that new markets are built from the bottom up, not from the top down. And I do believe MSFT's size has a lot to do with it. I wrote a memo in 1999 to the judge to swing the axe on MIcrosoft because it was the only way it was going to regain any nimbleness and innovation. He did, but MSFT resisted. Now, they are paying the price.

I reiterate my point in the article: name three profitable technologies Microsoft has launched with its $20 billion in R&D over the last five years. It hasn't even been able to update its own monopoly products. If that isn't evidence of stagnation, I don't know what is.

Again, thanks for the dialog and your observations,
Carl

[Blu vg]

Not to beat a dead horse, but so many still don't realize that Microsoft *has* updated its "monopoly products" in the past five years (as I pointed out). XP SP2 alone was a huge release... and furthermore, it was free! Maybe this is a failure in marketing more than anything. If they had called it "XP R2" and slapped a $130 price tag on it, these discussions wouldn't exist (except instead everyone would complain that they charged for it). I remember not all that long ago (as 98, 98SE, 2000, and ME came out) many people complained that they "had to upgrade" way too often. Microsoft is everyone's favorite punching bag--no matter what they do, people will complain.

I agree, though, that they haven't had a good track record in some other markets. However, the Windows Server market is relatively new, and there is still a lot of room for growth there. The Dynamics division has products that are getting attention and making inroads. As I mentioned above, the XBox may not be profitable by itself (and subsidies in that market are nothing new), but this is the price they're paying to get their foot in the door--and it has been very successful so far. They've pushed Sony into a tough corner, and who's to benefit? The consumer. This is hardly stagnation.

I've seen in recent history some of the strongest products they've ever made. Attitudes among many who hated the company are thawing, particularly because some of their products have improved so dramatically, but also because they are more transparent than ever. They still have plenty of faults, of course, but I hardly see a company that is stagnant. Like all, with the new ventures, they will win some and lose some. Their failures receive much more of the spotlight. They very likely will fall someday (although perhaps just like IBM "fell"), but again, I don't think the examples given here really point to that conclusion.