In late June, CEO Satya Nadella emailed Microsoft’s staff with an announcement that was part updated mission statement and part warning shot. In it, Nadella articulated his vision for Microsoft, which is “is to empower every person and every organization on the planet to achieve more.” A little less concrete than “a PC on every desk and in every home,” but it certainly doesn’t lack for ambition. Nadella also served notice, however, that “tough choices in areas where things are not working” were coming. The only question was what he meant.
On July 8th, he provided the answer. Microsoft cut 7,800 jobs from its phone business, or around 6% of its total work force, in what is generally understood to be a repudiation of Steve Ballmer’s acquisition of Nokia. Microsoft isn’t exiting the phone business entirely, but the company’s plans for the business have been dramatically scaled back to something more closely resembling Google’s Nexus hardware line.
While it’s difficult to argue the point that Microsoft’s phone business was, to borrow Nadella’s words, “not working,” there was nevertheless some surprise and discontent amongst observers of the company. The principal objection to this decommitment is perhaps best encapsulated by the Ars Technica piece “Analysis: Nadella threatens to consign Microsoft to a future of desktop obscurity.” These arguments can be summed up relatively simply: mobile is a vital and growing market, particularly when measured against its massive but stagnant desktop counterpart, and therefore Microsoft has no choice but compete in this market regardless of its performance to date.
Given the stakes of mobile, this argument is understandable. Former Microsoft CEO Steve Ballmer, the man responsible for the Nokia deal, was hardly the first to take major risks in search of mobile rewards. Google, who once enjoyed a close relationship with Apple, earned the Cupertino manufacturer’s undying enmity when the search giant felt compelled to jump into the market itself with Android.
But there are a few problems with the argument that Microsoft should have continued its Charge of the Light Brigade with what remained of Nokia.
- First, there’s the question of approach. Even the critics of Nadella’s move would likely concede that Microsoft’s mobile platforms – both hardware and software – are also rans in their respective markets. This is in spite of years of investment and the multi-billion dollar acquisition of what was once one of the handset market’s preeminent manufacturers. If you’re going to argue, then, that Microsoft should not backtrack from the Nokia assets, then, it is necessary to provide a strategy for success in the market that Microsoft has not attempted yet. Otherwise, you’re essentially arguing that the company should throw good money after bad. If you want to argue that they should compete in a given market, that’s fine, but you have to be able to at the same time plausibly explain how they could compete in the market in question.
- Second, there is the question of return. Let’s assume, counterfactually, that a unique and untried strategy was conceived and propelled Microsoft back to relevance. What would the return be? The market suggests that the financial return would be limited. As has been documented many times, in spite of its marketshare minority, the overwhelming majority of profits in the handset market are owned by Apple.
Apple sells less than 20% of smartphones. Its share of the industry's profits: 92%. pic.twitter.com/v0V8PmDzf3
— WSJ Tech (@WSJTech) July 13, 2015
It’s difficult to conceive of a scenario in which this would not be true of Microsoft as well. Microsoft has tried to duplicate Apple like margins in other hardware lines such as the marginally more successful Surface, but markets without carrier intermediaries are more straightforward. To be relevant in this market, Microsoft would likely have to follow the same course as the Android manufacturers, which is to keep margins minimal.
Some have argued that Microsoft’s return for a minimally profitable hardware business would come elsewhere. The question is where? They don’t need a mobile platform to sell Office, that’s already available – thanks in part to Nadella – on both of the most popular mobile platforms. They don’t need a hardware platform to sell OS licenses, because the company has already conceded to the market reality: the market value of a mobile OS is $0, thanks to Google. What about the message of “Universal Windows Apps” for the legions of Windows developers out there? This idea has some intrinsic problems, in that independent of technology, universal applications are very diffcult to build because of intrinsic differences in form factors and input methods. But Microsoft also doesn’t need a flagship handset business to make this argument.
- Third, there are other opportunities. Arguments that it’s mobile or else ignore the reality that the public cloud is going to be a large and growing market. And unlike mobile, where it was likely facing a sisphyean task, Microsoft is as well positioned in the public cloud as anyone save Amazon to capitalize on that growth. Some will look at Apple’s comical, absurd profit lines and conclude that Nadella’s decision to abandon the path Ballmer tried to set the company on is like walking away from a potentially winning lottery ticket. But thus far, that lottery has only produced one Apple.
It is also worth asking whether or not Microsoft was positioned to compete effectively in a consumer market. While there are obvious exceptions – the Xbox, for example – Microsoft is at its core more business oriented than consumer. Gates may have wanted the PC in every home, but for most consumers the operating system was an afterthought: it was never an object of desire in the way that an iPhone is. Microsoft did well to extend into the home from the business, and to get consumers using its business-focused Office software, but the company was never really about consumers.
Azure, on the other hand, is explicitly and expressly a business play, in a market that offers massive opportunities for growth. One that Microsoft has the DNA to be far more successful – and profitable – in than handsets.
Even if, as reported, Nadella was not in favor of the Nokia acquisition originally, it was undoubtedly, as he put it, a tough decision for the company. There’s the human cost of telling almost eight thousand people that they need to seek employment elsewhere, and there’s the public relations cost of telling the market the company you lead had effectively made a $7 billion dollar mistake. But as tough as it must have been, Nadella made the logical decision for the company. Now it’s up to Microsoft to capitalize on the focus he has afforded it.
Disclosure: Microsoft is not currently a RedMonk customer.
