20 Microsoft: From Gates to Satya Nadella Introduction On February 4, 2014, Satya Nadella became CEO of Microsoft. Nadella, a native of Hyderabad, India, was only the third CEO in Microsoft’s 39-year history. Cofounder Bill Gates was CEO from Microsoft’s establishment in April 1975 through January 2000 when he passed the reins to Steve Ballmer. Gates remained chairman though until February 2014. The Gates years were characterized by dramatic growth as Microsoft expanded from a small start-up to become the largest and most dominant software company on the planet, in the process making Gates the world’s richest man. The foundations of Microsoft’s success during this period were its two monopolies: the Windows operating system, which at its peak was used on 95% of the world’s personal computers (PCs), and Office, which had a 90% market share in 2012.1 Microsoft continued to expand both revenues and profits under the leadership of Steve Ballmer. During his tenure, revenues expanded from $25 billion to $70 billion while net income grew 215% to $23 billion. One area that did particularly during the Ballmer years was the Windows server business, a division that Nadella ran prior to becoming CEO. Servers sit at the center of networks of PCs, and are used to perform a variety of functions including database hosting, file services, Web services, print services, and applications services. Microsoft makes a version of Windows, Windows Server, which runs servers. The Windows server business was a $20-billion division by 2014. Microsoft gained share from competitors such as IBM, which promoted the rival Linux operating system. By 2014, 75% of servers built around Intel microprocessors used Windows Server as their operating system, as did around 50% of all servers.2 The Linux and Unix operating systems took the number 2 and 3 spots. Despite impressive growth, Microsoft’s stock price stagnated during the Ballmer era. This reflected a growing concern that Microsoft had lost its leadership in the computer industry to three firms, Google, Apple, and Amazon. Google had grown dramatically during the 2000s on the back of its dominant Internet search business. Along the way, Google had developed an operating system for smartphones (Android) and laptops (Chrome) that were now challenging Windows on computing devices, a category that had expanded beyond traditional PCs to included smartphones and tablets. Google was also offering a “cloud-based” suite of productivity tools, Google Docs, which competed directly with Office. C-151 02277_Case20_rev02.indd 151 01/10/15 6:03 PM C-152 Case 20 Microsoft: From Gates to Satya Nadella Apple, a firm that was nearly bankrupt in 1997, had done more than any other company to expand the definition of computing devices to include smartphones and tablets. Apple had introduced the first version of its smartphone, the iPhone, in 2007. Differentiated by elegant design and ease of use, two Apple hallmarks, the iPhone was a sensation that redefined what a smartphone should look like and do. Apple followed the iPhone with the 2010 introduction of the iPad, a tablet device that created an entirely new computing category, and one that cannibalized sales of laptop PCs. Both devices ran Apple’s iOS operating system, further reducing the relevance of Windows. As smartphones and tablets gained popularity, more and more computing was being done using these mobile devices—accessing applications and data stored on servers “in the cloud” rather than on a traditional PC. According to Microsoft’s own estimate, by mid- 2014, while 90% of traditional desktop and laptop PCs still used Windows, only 14% of all computing devices (a definition which included PCs, smartphones, and tablets), used Windows.3 Although under Ballmer’s leadership Microsoft had tried to grow its share by introducing a Windows smartphone and the Surface tablet, these offerings failed to gain traction. By 2014, Windows Phone had less than 3% of the global smartphone operating system market, while Apple’s iOS held 15.2%, and Android 81.1%.4 In the tablet market, Android had a 65.8% share, Apple’s iOS had 28.4%, and Windows tablets had 5.8%.5 Microsoft was assumed to be losing significant amounts of money on its phone and tablet businesses. To compound matters, after three decades of sustained growth, PC sales were declining: PC sales fell by 4% in 2012 and by 9.8% in 2013, although demand stabilized in 2014.6 Amazon, the world’s largest Internet retailer, was challenging Microsoft from another direction. By the mid-2000s, tens of thousands of servers were being grouped together into “server farms” located in the cloud to host high-traffic Internet websites. Google had built server farms to host its Internet search business, Microsoft likewise had server farms for its Bing search business and MSNBC Web offerings, and Amazon had built server farms to host its large online retail business. In 2005, Amazon leveraged the knowledge and capacity it had accumulated building server farms to start a new business, Amazon Web Services 02277_Case20_rev02.indd 152 (AWS). AWS hosted data, Web services, and applications for paying customer. These data, services, and applications could be accessed from anywhere by a user with a computing device and an appropriate wireless or hardwire connection. By 2014, AWS was viewed as the market-share leader in the emerging cloud-computing business. Microsoft entered the cloud-computing business in 2010 with Azure (later renamed Microsoft Cloud). Azure was founded within the Windows Server division that Nadella ran prior to becoming CEO. In addition to hosting data and websites, Azure allows clients to build and run applications that reside on Microsoft’s cloud. By 2014, Azure was thought to be number two in the emerging cloud business, with Google and IBM rounding out the top four. Industry wide, the cloud-computing business generated $16 billion in sales in 2014, but it was growing very rapidly and was thought by many to represent the future of computing. 7 Commenting on Microsoft’s overall competitive position in 2014, the general manger of one business unit noted that: “I think we have about 18 to 24 months to get it right. If we don’t, Microsoft is finished.”8 This statement reflected a widespread belief within the company that the computer industry was undergoing a massive paradigm shift, away from the client-server world based on PC architecture in which Microsoft had been so dominant, and toward a world of mobile devices and cloud computing in which Microsoft faced significant competitive challenges. Nadella was as cognizant of this as anyone. By March 2014, he had already honed his vision for the company. Microsoft, he said, was competing in a “mobilefirst, cloud-first” world.9 The task facing Nadella was deciding what actions to take to ensure that Microsoft survived and prospered in this brave new mobile-first, cloud-first world. He knew he had to act fast. Bill Gates and the Early History of Microsoft Bill Gates and Paul Allen established Microsoft in 1975. Gates was a 19-year-old Harvard dropout.10 Allen, who was 22, had dropped out of Washington 01/10/15 6:03 PM Case 20 Microsoft: From Gates to Satya Nadella State University to work as a programmer at Honeywell in Boston. Gates and Allen had both attended Seattle’s elite Lakeside high school, where they had bonded over their common interest in computers. By all accounts, the young Bill Gates was extremely intelligent, hypercompetitive, ambitious, hardworking, and a gifted programmer. One of his former teachers at Lakeside described him as the most intelligent student she had ever had. He could also be dismissive of people who lacked his technical acumen, abrasive, and hypercritical. One story widely circulated in Microsoft is that if he disagreed with the technical or product presentations of Microsoft employees, he would interject with sharp comments along the lines of “that’s the stupidest thing I have ever heard” or that the idea was “brain damaged.” Legend has it that on more than one occasion Gates reduced a presenter to tears, although Gates would argue that it was never the person he criticized, just the idea. Gates respected people who were smart and hardworking like him, who marshaled their facts, and who stuck to their guns when challenged by him if they knew they had the facts on their side. Gates ultimately relied upon such people to lead projects and businesses within Microsoft. In 1975, Allen persuaded Gates to drop out of Harvard and start Microsoft to write a version of the computer programming language, BASIC, to run on the world’s first commercially available PC, the MITS Altair 8800, which used an Intel 8080 microprocessor. Gates and Allen met with the founder of MITS and demonstrated their version of BASIC for the Altair 8800. This resulted in a deal under which MITS distributed Microsoft BASIC for the Altair 8800, making Microsoft the first company to sell software to run on a personal computer. Microsoft subsequently wrote versions of Microsoft BASIC that ran on other PCs of the time, including Apple’s first successful offering, the legendary Apple II, introduced in 1979. In June 1980, Steve Ballmer joined Microsoft. Ballmer had been a friend of Gates at Harvard, and was the only person who had outscored Gates on mathematics and microeconomics classes at Harvard. Ballmer had worked at Procter & Gamble after Harvard, and then moved on to Stanford Business School. Gates persuaded Ballmer to drop out of Stanford and manage business operations at Microsoft. He was employee number 30. In July 1980, IBM approached Microsoft about using a version of Microsoft BASIC for the IBM 02277_Case20_rev02.indd 153 C-153 PC, which was then in development. Gates persuaded IBM to adopt a 16-bit Intel processor (originally, IBM had been considering a less-powerful, 8-bit processor). Gates was also instrumental is pushing IBM to adopt an open architecture, arguing that IBM would benefit from the software and peripherals that other companies could make. Initially, IBM was intent on licensing the CP/M operating system, produced by Digital Research, for the IBM PC. However, the current version of CP/M was designed to work on an 8-bit processor, and Gates had persuaded IBM that it needed a 16-bit processor. In a series of quick moves, Gates purchased a 16-bit operating system from a nearby company, Seattle Computer, for $50,000. Gates then hired the designer of the operating system, Tim Paterson, renamed the system MS-DOS, and offered to license it to IBM. In what turned out to be a masterstroke, Gates persuaded IBM to accept a nonexclusive license for MS-DOS (which IBM called PC-DOS). MS-DOS had a command-line, text-based interface and could only run one program at a time, but, for 1981, it was state of the art. To drive sales, IBM commissioned developers to build a number of applications for the IBM PC. In addition to Microsoft Basic, these included a version of VisiCalc, an early spreadsheet that was a popular application for the Apple II, a word processor, EasyWriter, and a well-known series of business programs from Peachtree Software. Introduced in August 1981, the IBM PC was an instant success. Over the next 2 years, IBM would sell more than 500,000 PCs, seizing leadership from Apple, which had dominated the PC market with the Apple II. IBM had what Apple lacked—an ability to sell into corporate America. As sales of the IBM PC mounted, more independent software developers started to write programs to run on the IBM PC. These included two applications that drove adoptions of the IBM PC: word processing (WordStar and WordPerfect) and a spreadsheet (Lotus 1-2-3). The success of IBM gave birth to clone manufacturers who made “IBM-compatible” PCs that also utilized an Intel microprocessor and Microsoft’s MS-DOS operating system. The “clone” industry was born when engineers at Compaq Computer reverse engineered the BIOS chip in the original IBM PC. The BIOS chip converted the operating system into machine language, and was integral to the operation of the PC. It was the only key component of the IBM PC that IBM had not 01/10/15 6:03 PM C-154 Case 20 Microsoft: From Gates to Satya Nadella bought off the shelf from other manufacturers. Compaq’s BIOS chip was functionally equivalent to the chip in the IBM PC, but used different code and thus did not violate IBM’s copyright. Other PC companies soon followed Compaq’s lead, including Tandy, Zenith, Leading Edge, and Dell. The birth of the clone industry was a huge boon to Microsoft. By virtue of its nonexclusive license with IBM, Microsoft had the ability to sell MSDOS to a growing number of clone makers. In 1983, Microsoft expanded its product offering with the introduction of Word for MS-DOS, the company’s first word processor. Word was differentiated from other word processors at the time by being the first to use a mouse. In 1985, Microsoft introduced a version of Word to run on Apple’s latest machine, the Macintosh. In 1985, Microsoft released the first version of Excel, the company’s spreadsheet offering, which competed with the bestselling Lotus 1-2-3. In 1987, Microsoft purchased a start-up company that had developed presentation software for the Macintosh. This product ultimately became PowerPoint, the first version of which was introduced in 1990. The lead developer for Word and Excel was Charles Simonyi, a key hire at Microsoft who had formerly worked at PARC, Xerox’s legendary research center, which had pioneered the development of the computer mouse, on-screen icons, a graphical user interface (GUI), object-oriented programming, and the laser printer. In a quirk of business history, senior management at Xerox had passed on the opportunity to commercialize these innovations, which opened the doors to Apple and Microsoft to pick up the ideas and run with them. In 1982, with business booming, Paul Allen was diagnosed with Hodgkin’s lymphoma. His cancer was successfully treated with radiation therapy, but he took an extended leave and never again held an operating position at Microsoft. In 2000, he resigned from the company’s board of directors. Building the Double Monopoly By the mid-1980s, Microsoft was doing very well. It became apparent that the MS-DOS business had some compelling economics. While Microsoft bore 02277_Case20_rev02.indd 154 the costs of developing successive versions of MSDOS, the incremental or marginal costs of producing individual copies of MS-DOS were very low. In the case of new PCs, Microsoft simply gave the master code to the manufacturer, who installed MS-DOS on every machine built, and paid Microsoft a licensing fee per machine. This resulted in gross margins as high as 90%. In contrast, the gross margins of PC makers at the time were closer to 40%. The Development of Windows and Office In 1986, Microsoft went public. The IPO raised $61 million and valued Microsoft at $650 million. Microsoft now had over 700 employees. The company’s position, however, was not secure. Although MS-DOS was the most widely used operating system for PCs, Apple had shown what the future looked like in 1984 when it introduced the Macintosh. Borrowing many ideas from Xerox PARC, the Mac had a graphical user interface (GUI) which displayed programs as on screen icons. It also used a computer mouse with its point-and-click methodology for selecting tasks. This intuitive interface was a big improvement in usability over the clunky command-line interface of MSDOS, which could be intimidating for people without a computing background. Gates realized that a GUI interface was the future. Microsoft worked closely with Apple to develop the first version of Word for the Mac, which took full advantage of the Mac’s GUI interface and mouse capabilities. Word for the Mac soon became one of the bestselling Mac applications. At the same time, Microsoft took what it learnt from Apple and used it to start developing its own GUI interface, which was christened Windows. Apple inadvertently helped Microsoft in two ways. First, it licensed its “visual displays” to Microsoft in 1985, enabling Microsoft to legally develop a GUI that had a similar look and feel to the Mac. Second, it was difficult to develop applications for the Mac. Apple did a poor job of providing tools to help thirdparty software developers write programs for it. In contrast, Gates often said that the most important strategic business unit at Microsoft was its tools business. Microsoft invested heavily in the development of tools to boost developer productivity. This made 01/10/15 6:03 PM Case 20 Microsoft: From Gates to Satya Nadella it easy for third-party developers to write applications for MD-DOS, and later Windows, and drove adoption of Microsoft’s operating system offerings. The first version of Windows was introduced in November 1985. It was a GUI shell that displayed programs as on-screen icons allowed for multitasking (using more than one program at a time). Windows sat on top of MS-DOS. It was commercial failure. Many users lacked sufficiently powerful hardware to run Windows, and there were few programs available that took advantage of its features. Nevertheless, Microsoft continued development work on Windows. IBM, too, saw the importance of a GUI interface. IBM was losing market share to the clone makers, so it decided to replace MS-DOS with its own GUI operating system, OS/2. IBM contracted with Microsoft to develop OS/2. However, the arrangement was a difficult one. IBM resented the fact that Microsoft had facilitated the emergence of the clone businesses by licensing MS-DOS to IBM’s competitors. IBM was also concerned that Microsoft continued to work on Windows even while it developed OS/2. For its part, Microsoft knew that IBM was also investing in the UNIX operating systems, and had licensed a UNIX based PC operating system, NeXTSTEP, from NeXT, a PC company that Apple founder Steve Jobs established after he left Apple in 1985. Microsoft knew it would be in trouble if IBM scrapped OS/2 in favor of a UNIX alternative. The pivotal event was IBM’s announcement that it would release two versions of OS/2, a powerful version that would be exclusive to IBM machines, and a basic version for other PC makers. That wasn’t news that Microsoft wanted to hear. Gates decided to sever links with IBM and go for broke on Windows. The fruit of this effort, Windows 3.0, was introduced in 1990. Windows 3.0 was a big improvement over earlier versions. It was well reviewed and became a major commercial success. IBM’s OS/2, meanwhile, garnered mixed reviews and limited market traction. PC manufacturers, seeing a chance to deliver a body blow to IBM, which after all was a direct competitor, adopted Windows 3.0, bundling it with most new PCs. Market momentum toward Windows was also helped by the introduction versions of Microsoft’s increasingly popular applications products, Word, Excel, and PowerPoint, for Windows 3.0. At the time, each of these products was number 2 in its market space (Word was behind WordPerfect, Excel behind Lotus 02277_Case20_rev02.indd 155 C-155 1-2-3, and PowerPoint trailed Harvard Graphics). Microsoft’s rivals, however, were slow to introduce versions of their products for Windows, resulting in big market-share gains for Microsoft’s offerings. To further drive adoption of Windows, Microsoft redoubled its efforts to provide developers with the best tools, and to persuade them that Windows was best platform for which to develop applications. In 1992, Microsoft combined its three leading application programs—Word, Excel, and PowerPoint— into a single offering for Windows, which it called Office. Office was priced slightly below the combined price of each individual offering. Microsoft also promised interoperability between the three programs, although this took several versions to perfect. Microsoft’s rivals, including most notably WordPerfect and Lotus, lacked a comparable suite of offerings and were unable to match Office. From this point on, Office became the dominant suite of productivity programs for information workers. During the late 1980s, Microsoft started an operating system development project targeted primarily at servers. Servers were specialized PCs that sat at the heart of corporate networks of “client” PCs and “served” those “clients,” holding shared files and applications programs used by many machines, such as email systems. Dubbed Windows NT, this was a powerful, 32-bit operating system that could run on servers. Unlike Windows 3.0, it was not DOS based (“NT” stood for new technology). To develop Windows NT, Microsoft hired a team of software developers led by Dave Cutler from Digital Equipment Corporation (DEC). Cutler’s team drew on their prior experience developing 32-bit systems for DEC to develop Windows NT. The move into the server OS business represented recognition by Microsoft of the growing importance of client-server systems within large enterprises. The development of Windows NT constituted a strategic shift by Microsoft toward the enterprise market, where the primary demand for client-server systems resided. Windows NT was an attempt to make secure, stable software that could run “mission-critical” applications within enterprises. Client-server networks were taking business away from the mainframes and minicomputers sold by the likes of IBM, DEC, and Hewlett Packard. Microsoft wanted a piece of this business, and with Windows NT it intended to get it. Introduced in 1993, Windows NT was a solid, stable, secure system that gained increasing acceptance 01/10/15 6:03 PM C-156 Case 20 Microsoft: From Gates to Satya Nadella within enterprises. Windows NT marked the beginning of Microsoft’s server business. To gain further enterprise business, Microsoft added an email client to its Office suite, Outlook, which could connect with corporate email hosted on severs. By the time Windows NT was introduced, Microsoft was also selling a relational database offering, Microsoft SQL Server. A relational database is a product whose primary function is to store and retrieve data as requested by other software applications, be they on the same computer or running on another computer across a network. Microsoft SQL Server was the company’s entry into the enterprise-level database market, and it pitted Microsoft against Oracle and IBM, both of which had relational database offerings. The 32-bit technology underlying Windows NT was subsequently incorporated into the next two releases of Windows for PCs, Windows 95, and then Windows XP (introduced in 1995 and 1998, respectively). Increasingly, this made Windows more than just a GUI that sat on top of MS-DOS. Windows was becoming a fully-fledged operating system in its own right. By the time Windows 2000 was introduced, Windows had effectively shed it DOS heritage. Windows 95 was a landmark release. Its enhanced graphics effectively closed the gap between Windows and Apple’s Macintosh. Since the introduction of the IBM PC, Apple had been a niche player in the PC business, focused primarily on the education, graphic artist, and desktop publishing markets, where its graphic displays and ease of use gave it maximum advantage. With Windows 95, however, the differential appeal of the Mac all but vanished. By 1997, Apple was facing bankruptcy. The Internet Tidal Wave One other event occurred during the 1990s that helped to cement the dominance of Microsoft: the explosive growth of the World Wide Web (WWW). Tim Berners Lee, a British researcher at CERN in Europe, invented the Web during the early 1990s. The WWW sits on top of the Internet, which itself had been developed by American researchers during the 1960s and 1970s. As Berners Lee conceived it, the Web used hypertext markup language (HTML) and hypertext transfer protocol (HTTP) to enable links to be made to information anywhere the Internet, thereby creating an enormous “web” of information. In 1993, a team at the University 02277_Case20_rev02.indd 156 of Illinois led by a 22-year-old student, Marc Andreessen, developed the Mosaic Web browser. Mosaic could display information on the Web graphically. This was the beginning of the enormous growth of the WWW. After graduation, Andreessen joined up with Jim Clark, the former CEO of Silicon Graphics, to form Netscape. Netscape further developed the Mosaic Browser, releasing its version, Netscape Navigator, in November 1994. Netscape Navigator quickly became the dominant Web browser. In August 1995, Netscape held an IPO. The stock was offered at $28 a share, but closed its first day at $75, valuing Netscape at $2.9 billion. Prior to the explosive growth of the Web, Microsoft’s Internet strategy involved the creation of a dial-up online service, MSN, which was developed to be included with Windows 95. MSN was similar in conception to early versions of AOL, with email capabilities, message boards, chat rooms, and some news and weather offerings. The first version of MSN did not have a Web browser and users could not connect to the Internet. With MSN and Windows 95 in late development, Gates became aware of the rapid growth of the Web. Microsoft legend has it that the WWW was brought to the attention of Gates by memos from two junior engineers, Steve Sinofsky and Jay Allard. Gates immediately saw its strategic significance. In May 1995, Gates wrote a memo to his executive staff and direct reports, calling the growth of the Internet a “tidal wave.” Gates wrote that the Internet “is crucial to every part of our business” and “the most important single development to come along since the IBM PC was introduced in 1981”. In his memo, Gates went on to say that Netscape was a “new competitor”, and that Microsoft’s strategy should be to make it clear that “Windows machines are the best choice for the Internet.”11 To fulfill Gates’s vision, Microsoft acted rapidly. It licensed a version of the Mosaic Web browser from a company called Spyglass, improved on it and released it as Internet Explorer (IE) version 1.0 in August 1995. IE 1.0 was bundled with Windows 95 and appeared as an icon on the start screen. Although it was too late to change MSN in time for the release on Windows 95, MSN was reworked to utilize HTML and HTTP and give users access to the Web. In late 1996, the new version of MSN, MSN 2.0, was released. Microsoft also quickly added the ability to insert hypertext links into Office documents, allowing readers of those documents to navigate away to websites. 01/10/15 6:03 PM Case 20 Microsoft: From Gates to Satya Nadella Antitrust Issues All of these moves were successful for Microsoft. However, the bundling of IE with Windows bought Microsoft to the attention of the U.S. Department of Justice (DOJ). The DOJ argued that the bundling strategy put Netscape at a competitive disadvantage and was a deliberate attempt on Microsoft’s part to “squash” their rival. Whereas Netscape charged consumers for their browser, IE was perceived as being a “free” product. Moreover, the DOJ contented that Microsoft configured the Windows code such that it was slow and difficult for users to download Netscape Navigator and install it on the Windows desktop. For its part, Microsoft claimed that IE was part of the operating system and that users expected it to be there. In the end, the DOJ prevailed. The judge in the case ruled that Microsoft was a monopoly, and that the bundling strategy represented an abuse of Microsoft’s monopoly power. In 2002, Microsoft and the DOJ reached a settlement that required Microsoft to share its application programming interfaces (APIs) with third-party companies, so that they could write programs that worked well with Windows. Microsoft, however, was allowed to continue bundling IE and other products with Windows. For Netscape, this was a Pyrrhic victory. The company continued to lose market share against IE, and was not helped by reports that its products were inferior in quality to IE. In 1999, Netscape was sold to AOL for $10 billion, a price tag that left many scratching their heads. AOL discontinued the Netscape browser in 2008. At the time it had less than a 1% share of the browser market, down from over 90% in 1995. Managing the Company From the outset, Gates made a point of hiring people who were like him—young, bright, driven, competitive, technically sharp, and able to argue effectively for what they believed in. A small but influential number of these hires came from Xerox PARC, including Charles Simonyi, who led the development of the first versions of Word and Excel. Ballmer hired some of sales personnel. One of these was an aggressive salesman named Vern Raeburn. Gates had insisted that 02277_Case20_rev02.indd 157 C-157 Microsoft should not sell directly to end-users, but Raeburn marshaled his arguments and persuaded Gates to change course. Raeburn quickly pulled together a team to market and sell Microsoft’s products to consumers. This was the genesis of a split within Microsoft into two distinct functions that persist to this day: an engineering function that develops products, and a sales and marketing function that sells them. For years, Gates was the de facto head of engineering with responsibility for product development, whereas Ballmer was responsible for sales and marketing. Although Microsoft went on to create different business units—Windows, Windows Server & Tools, and Office all had their own business units, for example— the engineering and sales and marketing functions would cut across these units, creating a loose, matrix organization. Finance, legal, and human relations functions also cut across business units. To motivate key employees and encourage them to work long hours and commit to the company, Microsoft gave them stock options. When the company did well, and the stock price rose, these employees made substantial sums of money. As the stock price surged after the IPO in 1986, Microsoft stock options became a major draw, enabling Microsoft to hire the best and the brightest. By 2000, it is estimated that the surging stock price had created over 10,000 millionaires among Microsoft employees.12 Paradoxically, by the mid-1990s, some early employees were so secure financially that their competitive edge had been blunted. Some were said to have retired on the job. Many other key employees simply left the company to pursue other interests. Another notable feature of Microsoft that emerged over time was the tendency for people to circulate within the company. It was not unusual for people to change jobs every 18 months, and move from business to business. Formalizing Management Processes As the company’s growth began to accelerate in the early 1980s, Gates brought in people with business experience to help take the load of his shoulders and manage the day-to-day operations and finance side of the business, leaving him to focus on product development, technology, and strategy, and Ballmer to focus on sales. A key early hire was John Shirley. Shirley 01/10/15 6:03 PM C-158 Case 20 Microsoft: From Gates to Satya Nadella worked for Tandy Corporation, the parent company of Radio Shack. Shirley joined Microsoft as president in 1983 and stayed through 1990. He remained on the board until 2008. People within the company would joke that Shirley was there to provide some adult supervision. In 1994, Gates hired Bob Herbold as chief operating officer (COO). Herbold had a PhD in computer science and had worked at Procter & Gamble for 25 years, where he was responsible for P&Gs worldwide marketing and brand management. Herbold stayed at Microsoft until 2001. Another “adult” in charge of day-to-day operational issues, Herbold saw it as his job to bring discipline to the company without undermining the characteristics that had made it competitive. Herbold describes arriving at a company that was chaotic: “Incompatible systems and divergent practices companywide were causing all kinds of problems. Bills from suppliers weren’t being paid on time. We never knew precisely how many people worked for the company. Business units set projections using incompatible frameworks and measures that prevented a comparison of their performance.”13 Much of this chaos was the result of rapid revenue growth often exceeding 30% a year. Herbold notes “a balkanized system had grown up because, for years, Bill had focused on product development and Steve had focused on sales. Meanwhile, business and geographical units had relatively free rein to create local functional staffs, set business practices, and build stand-alone information systems. They weren’t particularly interested in giving up their autonomy.”14 Herbold moved fast to standardized, basic businesses processes at Microsoft, including financial reporting, vendor payments, and human resources policies. He also found a company with no formal strategic planning process in place. Herbold developed a rolling, 3-year planning process based on a standardized format that included historic and future projections of market share, revenues, costs, and profits. The process distinguished between established products, such as Windows and Office, and new products where there was a much greater degree of uncertainty. The plans were modified and streamlined every year based on new data. Herbold also formalized a human resources performance-appraisal process that had originally been developed by Gates. The appraisal process required managers to evaluate their direct reports, and it utilized a forced curve, such that some members of a 02277_Case20_rev02.indd 158 team would always end up being classified as star performers, and others as poor performers. The star performers would get big pay increases, whereas the underperformers would be “encouraged to find a job outside of the company” if they couldn’t bring up their rating over time. Critics of this system, known as stack ranking, noted that it pitted employees on a team against each other, encouraged backstabbing, and created a real problem for managers who had built strong teams, because they were forced to classify some of their team as underperformers, even though in an absolute sense they might be good.15 The Product Development Process Given the nature of Microsoft’s business, a key aspect of the company’s organization and management structure relates to the way it formalizes development of its software products. In the early years “superprogrammers” such as Simonyi and Gates drove the vision for products. Gates came to the realization that this model would not scale well. Superprogrammers were in short supply, had little interest in updating a product once it had been created, might not understand the market well, and were prone to clash with other superprogrammers. In response a formal system for developing, testing, and releasing products emerged in the mid-980s.16 The process starts with a program manager, who is responsible for specifying the vision of the product, its key features, development schedule, development process, and implementation tradeoffs. The program manager works closely with senior software developers and with product managers in marketing to achieve all of this. His or her role, in other words, is to coordinate engineering and marketing and distill out of this what the product should do, what its key features should be, and a schedule to achieve these. The program manger is then responsible for managing the overall development effort, and must make the call on features to add or cut in order to hit goals such as schedule. On complex products such as Windows and Office there is a hierarchy of program managers. For example, while there may be an overall program manager for a new version of Office, there will also be program managers for each constituent program— Word, Excel, PowerPoint, and so on. It is important to understand that many of the ideas for a product’s features come from developers 01/10/15 6:03 PM Case 20 Microsoft: From Gates to Satya Nadella and marketers. Program managers are leaders and facilitators of the process, rather than bosses, and they must work through persuasion and negotiation. In part, this may be due to the high status that developers in particular have within Microsoft’s culture, something that can be traced back to Gates and Simonyi. Indeed, most program managers were themselves star developers who rose through the engineering ranks. Once the product vision, key features, schedules, and the like have been mapped out, it is up to software developers to implement the vision and features. Developers write the code. Typically, a small team of senior developers and program managers will take charge of the product architecture, and developer leads (first-line managers) will provide detailed guidance to their teams of programmers. While developers may be the source of ideas for new features, they are required to clarify what each feature accomplishes, and to help program managers decide what to include in a product, and what to cut in order to stay on schedule. Testing the code is the responsibility of developers and testers. Developers are meant to test their own code frequently (typically every day). They also work in pairs with testers and are required to hand their code over to a tester for testing before adding their work to the “official build.” The goal in this process is to reduce the bug count to zero. Microsoft also has a specially trained group of people who perform final tests on a completed product to see if it is ready for shipment. As part of this process, beta versions of the product will be released to key customers for feedback, and the product will be tested in a usability lab. Microsoft has approximately one tester for every developer, an unusually high ratio but one that is consistent with the goal of producing stable, secure software that can run mission-critical applications for enterprises. Over time, Microsoft routinized this process, with offering such as Windows, Office, and SQL Server going through 3- to 5-year definition, development, test, and release schedules. As these products have grown in complexity and features, there was a tendency for the process to become more bureaucratic and harder to manage. This was made more challenging by the fact that many program managers, senior developers, and development leads were people who had excelled in a technical sense but had little management training or experience. In the mid-2000s, this led to 02277_Case20_rev02.indd 159 C-159 serious issues when Microsoft ran over budget and over schedule while trying to develop Windows Vista (discussed later in the case). The Ballmer Years When Bill Gates handed the CEO role over to Steve Ballmer in February 2000, the company was at the top of its game. Windows and Office dominated their respective markets, generating prodigious amounts of free cash flow. The stock price had hit an all-time high of $58.72 on December 23, 1999. Microsoft was the most valuable company on the planet, and Gates the world’s richest man. Gates continued to work full time at Microsoft until 2008, assuming the role of chief software architect, with primary oversight for product development. He also remained chairman of the company. During the Ballmer era, revenues increased 280%, to $70 billion, while net profit expanded by 215%, to $23 billion. The stock price, however, dropped below $40 a share in mid-2000, and did not break through that level again until 2014, after Ballmer had resigned. The failure of the stock price to advance despite growing top and bottom lines reflected a widely held belief among investors that Microsoft had lost its leadership position in the industry. Moreover, critics believed that the company was destroying economic value by investing in businesses that did not generate a positive ROI. These included the Xbox videogame business, Internet search, and the device businesses that encompassed the Zune music player, smartphones, and tablet computers. By the end of the Ballmer era, it was widely believed that the shift to a world characterized by mobile devices and cloud computing presented an existential threat to Microsoft’s core operating system business. One of the first problems that Ballmer had to confront was the risk of a slowdown in the rate of growth of both Windows and Office. The markets for both products were now mature in most developed nations, implying that revenues would increasingly come from replacement rather than first-time demand. Although there was still plenty of room for growth in developing nations, those markets were also characterized by extremely high levels of piracy—as much as 90% in markets like China and Vietnam. Indeed, even in 01/10/15 6:03 PM C-160 Case 20 Microsoft: From Gates to Satya Nadella developed markets such as the United States, piracy rates for software products are as high as 20 to 25%.17 Two trends helped Microsoft weather the maturation of its two primary product offerings. First, a significant number of consumers in developed markets purchased multiple devices: a laptop and a desktop for example. Second, Microsoft continued to grow its share of the enterprise markets for Windows Server and SQL Server, taking business from UNIX, LINUX, Oracle, and IBM. Microsoft’s success in the enterprise space reflected the fact that to a considerable extent, the company had succeeded in building stable, secure software that could run mission-critical applications in enterprises. Given that Windows for the client and Office were also widely used within enterprises, Microsoft was increasingly focused on its enterprise business. Indeed, by the early 2000s, Microsoft was more of an enterprise company than a consumer company. Product Diversification: Xbox Under Ballmer, Microsoft continued to diversify its product offerings, entering into new markets. The first was the videogame market. By the late 1990s, Sony dominated this market with its PlayStation console and related game offerings. The market was worth $20 billion globally and was growing. Microsoft saw the PlayStation as a threat. The PlayStation was a specialized computer that ran a non-Microsoft operating system, and could theoretically be connected to the Internet via a TV cable. Moreover, the PlayStation was often located in the living room. Bill Gates had long dreamed of having Internet-enabled computing devices in the living room that operated interactive TV, and could also be used for Web browsing, playing games, and online shopping; but Gates wanted those devices to run Windows. Microsoft had capabilities that persuaded management that the gaming market was a viable target. Microsoft had produced one of the bestselling PC games of all time—Microsoft Flight Simulator—and had published another, Age of Empires. Through MSN it also had the world’s largest online gaming site, MSN Gaming Zone, which had 12 million subscribers in the early 2000s. Moreover, Microsoft intended to use a customized version of the Windows operating system to power Xbox. This would save development costs and make it easier for developers to 02277_Case20_rev02.indd 160 write games for the Xbox, because many were already familiar with Windows programming APIs and tools. Microsoft lacked the ability to produce hardware, so it decided to outsource this to a contract manufacturer, Flextronics. Microsoft’s strategy was to price the Xbox at or below cost to drive adoption, and then make money on the sales of games, either directly in the case of games developed in house, or from royalty fees in the case of games developed by third parties. For this strategy to work, it had to guarantee Flextronics a profit margin, which meant paying Flextronics a subsidy on every machine manufactured. Xbox was introduced in late 2001, after $1.5 billion in development costs. The company faced tough competition from Sony’s new offering, PlayStation 2 (PS2). To drive adoption, it cut prices for hardware aggressively. By 2003, Microsoft was thought to be losing $100 on every Xbox it sold. To make that back and turn a profit, Microsoft reportedly had to sell six to nine games per Xbox.18 By late 2004, Xbox was still a distant second to PS2 in the videogame market, having sold 14 million consoles against Sony’s 70 million. While Sony was making good money from the business, Microsoft was registering losses. Microsoft’s home and entertainment division, of which Xbox was a part, lost $4 billion between the launch of Xbox and mid-2006. In November 2005, Microsoft introduced its nextgeneration console, Xbox 360. Again, contract manufacturers made the machine, and again Microsoft paid them a subsidy to ensure their profit margins. Sony followed a year later with its PS3 console, as did Nintendo with the Wii console. The Wii was a less powerful machine than either Xbox 360 or PS3, but it came with a motion sensor controller than changed the way players interacted with games. The Wii bought a new generation of casual gamers into the market and turned into a surprise hit for Nintendo. Meanwhile, Microsoft and Sony slugged it out in the hard core gaming market. Demand for Xbox was helped by Microsoft’s enormously popular Halo franchise. As the market expanded, all three companies were able to make profit on an operating basis in the business. However, both Microsoft and Sony hurt themselves with quality problems and component shortages early in the product cycle (Microsoft had to take a $1.05 billion write off in 2007 for replacing poor-quality consoles). Although Microsoft did achieve profitability on an operating basis for Xbox business by late in the Xbox 360 cycle, on a cumulative basis the return on 01/10/15 6:03 PM Case 20 Microsoft: From Gates to Satya Nadella investment was still believed to be negative. One bright spot for Microsoft was the growth of its online game subscription service, Xbox Live. Introduced in 2002, by mid-2013, Xbox Live had around 45 million paying subscribers who used it for everything from playing multiplayer games online to streaming movies from Netflix and browsing Facebook. At the time, Microsoft was thought to be generating annual revenues in excess of $3 billion from Xbox Live.19 Microsoft also garnered strong reviews and sales for its Kinect motion sensor controller. Introduced in late 2010 for the Xbox 360, Kinect was developed as a response to Nintendo’s Wii controller. In late 2013, Microsoft launched its third-generation game console, Xbox One. Sony matched with the launch of its PS4 system. At launch, Microsoft positioned Xbox One as an all-purpose entertainment system for the living room, controlling TV, music, and film streaming services through the Kinect motion and voice sensor, in addition to being a game console. Sony focused its marketing for the PS4 on the core gaming market. By mid-2014, Sony was believed to have sold 7 million PS4 consoles, versus 5 million Xbox One consoles. With Satya Nadella now in charge, Microsoft changed the marketing strategy for Xbox One, emphasizing its capabilities as a gaming machine and co- promoting it with new iterations of its popular Halo and Call of Duty franchises. Product Diversification: Internet Search Another hallmark of the Ballmer era was Microsoft’s expansion into Internet search. Microsoft had long had primitive Internet search functionality on its MSN service, but it had never seen search as a central feature. This changed with the rise of Google, a company that didn’t even exist until 1998. At the core of Google’s rise was a search algorithm that cleverly ranked the relevance of a page for a search query according to the number of pages that linked into that page. Google went to great lengths to make sure that its search results were “pure.” It did not mix organic and paid search results, thereby improving relevance to the user (paid search results were originally placed on the right hand side of a search page, separate from organic search results). What made Google a valuable company was its combination of highly relevant search results with a business model that made money out of search activity—lots of money. This was the ‘pay-for-click” 02277_Case20_rev02.indd 161 C-161 model, where advertisers paid Google every time someone clicked on an advertiser’s link. From a standing start in 2001, by 2014 Google had grown into a colossus with $68 billion in revenues, almost $21 billion in net profits, 67% of the market for Internet search in the United States, and an estimated 70% of worldwide search marketing spend. Along the way, Google had moved aggressively into Microsoft’s turf. Reasoning that with the growth of smartphones, ever more search would come through mobile devices, Google had pushed into the smartphone business with its Android operating system, which it licensed to hardware manufacturers for free. The economic logic was that Google would be the default search engine on Android phones, so every time someone search for something on an Android phone, and clicked on an advertising link, Google would make money. Google also developed its own Web browser, Chrome, which it distributed for free. The economic reasoning was similar. Since search is conducted within a Web-browser environment, and Google was the default search engine on Chrome, Google would capture more search based advertising collars if its own browser were widely used. Both of these products were phenomenally successful. By mid 2014, Android was found on 85% of the world’s smartphones, and Chrome was the browser of choice on 46% of all desktops and tablets (relegating Microsoft’s Internet Explorer, the long time market leader, to second place with 20%).20 Microsoft tried to counter Google’s rise in the Internet search business, but its success was limited,— and very expensive. Microsoft adopted Google’s pay for click search model, and developed a similar search algorithm, but was unable to gain much market traction and its market share remained stuck under 10%. Part of the problem was brand confusion. Microsoft’s search feature was initially known as MSN Search, sounded dull and uninspiring next to Google. In 2006, MSN search was rebranded as Windows Live Search, and given some new features. A year later, the name was changed again to Live Search. Ultimately, Microsoft came to the realization that the “Live” brand was not resonating with consumers, who found it confusing. In June 2009, Microsoft’s search engine was rebranded Bing. Microsoft supported the Bing launch with a $100-million ad campaign. In 2008, in an attempt to grow its share of the U.S. paid-search market, Microsoft launched an unsolicited takeover bid for Yahoo. Yahoo was number 2 in 01/10/15 6:03 PM C-162 Case 20 Microsoft: From Gates to Satya Nadella the US search market. Microsoft was number 3. Yahoo rejected the bid. A year later, however, following management changes at Yahoo, Microsoft and Yahoo entered into a 10-year partnership under which Bing would be the exclusive search platform on Yahoo. Although the precise terms of the deal were not made public, it is known that Microsoft pays Yahoo for search traffic. In 2013, 31% of Yahoo’s revenue apparently came from Microsoft payments.21 Product Diversification: Smartphones and Tablets Microsoft was an early leader in the smartphone business. It first offered an operating system for smartphones, Windows Mobile, in 2002. By 2007, 42% of all smartphones used the Windows Mobile operating system. Smartphone manufactures such as Motorola and HTC paid a licensing fee to Microsoft to use Windows Mobile. As was normal at the time, Windows Mobile powered smartphones had a physical keyboard and a small screen. The devices were primarily sold to enterprise customers, who used the phones for email, appointments, text messaging, and Web browsing. In 2007, Apple introduced the first iPhone, which revolutionized the smartphone market and significantly expanded demand (see Table 1). The combination of a touch screen, virtual keyboard, larger screen size, elegant design, and ease of use made the iPhone a huge hit in the consumer marketplace. Business people too, bought iPhones in droves, leading many companies to adopt a policy of “bring your own device” with regard to smartphones. Growth of the iPhone got a further boost from the development of third-party applications and the opening of the Apple App store in 2008, which made it easy for users to find and download apps onto their phones. The supply of Apps was facilitated by efforts on Apple’s part to make it easy for third-party developers to write Apps for the iPhone. In 2010, Apple introduced its tablet offering, the iPad. The iPad used the same iOS operating system as the iPhone and had most of the same attributes, including elegant design, a touch screen, and access to the App store through wireless connectivity. All of this helped drive rapid growth in consumer demand. When Apple released the iPhone, Google already had its own operating systems for a touch screen phone in development. Google had acquired the original developer, Android Inc., in 2005. The first smartphones running on Android appeared in 2008. Google’s business model was to offer Android for free and make money from advertising linked to mobile search. By 2013, Android was the dominant smartphone OS, followed by Apple’s iOS (see Table 1). Tablets that ran on Android stated to appear soon after the launch of the iPad in 2010, and by 2014 Android was also dominating the tablet OS market (see Table 2). Table 1 Global Smartphone Sales (millions) 2007–2013 Year Android iOS (Apple) Microsoft BlackBerry Nokia 2007 3 15 12 78 2008 11 17 23 73 2009 7 25 15 34 81 2010 67 47 12 47 112 2011 220 89 9 52 93 2012 451 130 17 34 0 2013 759 151 31 19 0 Source: Gartner.com, various press releases. 02277_Case20_rev02.indd 162 01/10/15 6:03 PM Case 20 Microsoft: From Gates to Satya Nadella Table 2 Global Tablet Sales (millions) 2010–2014 Year Android iOS (Apple) Microsoft 2011 17 40 0 2012 53 61 1 2013 121 70 4 2014 160 65 11 Source: Gartner.com, various press releases. The introduction of the iPhone, and then Android phones, decimated Microsoft’s market share (see Table 1). By 2011, Microsoft’s OS was found on just 9 million smartphones shipped that year. Android was on 220 million phones, and Apple sold 89 million iOS phones. The situation in the tablet market was no better, where Microsoft was caught completely flatfooted by the introduction of the iPad. Google, on the other hand, adapted very quickly and soon gained market leadership. In response to the rapid emergence of Apple and Android, Microsoft developed a new operating system for touch screen smartphones, Windows Phone. Windows Phone had an active-tile, “Metro” interface, rather than the on-screen icons used by Apple and Android. The first Windows Phones started to appear in late 2010. Microsoft also established its own App store, the Windows Phone Store. In early 2011, Microsoft entered into an alliance with Nokia to jointly develop Windows Phones. Like Microsoft, Nokia had been caught off guard by the emergence of the iPhone and had seen its market share slide. Nokia had used its own Symbian operating system in its smartphones. Like Windows Mobile, Symbian was a primitive, first-generation smartphone OS that lacked the full features and functions of Android and iOS, including touch screen capability, a virtual keyboard, and a supply of third-party apps that could be downloaded onto the device. Under the alliance, Nokia agreed to phase out Symbian and switch to Microsoft’s Windows Phone OS. The first products of this alliance, Nokia’s Lumina phones, were introduced in late 2011. Despite some favorable reviews, the Lumina phones grew more slowly than the market, and 02277_Case20_rev02.indd 163 C-163 Microsoft’s market share remained in the low single digits in most nations. Reasons given to explain this included the lack of appeal of the Metro interface and relative paucity of third-party apps for Windows Phone. In September 2013, Microsoft announced its intention to acquire Nokia’s mobile phone business for $7 billion. In justifying the acquisition, Ballmer argued that merging the two companies would streamline product development processes, lower costs, and result in better phones and higher gross profit margins.22 It was also noted that Nokia was the only company still willing to make Windows phones, and if Nokia pulled out, what would happen to Microsoft’s phone business? Critics wondered whether an acquisition that made Microsoft a phone maker might not alienate other phone makers, such as HTC, who would now see Microsoft as a direct competitor. In addition to the phone business, Microsoft entered the tablet business with its Surface offering. The Surface was positioned as a cross over between a conventional laptop and a tablet. Introduced in late 2012, it used a Windows 8.1 operating system, which by that time was also being used for Windows Phone. Like the Windows Phone, the Surface garnered some favorable reviews, but sales were slow to pick up and the product initially failed to make a dent in the dominance of Android and iOS in the tablet market. However, following the introduction of the Surface Pro 3 in mid 2014, sales appeared to be accelerating. In the last 6 months of 2014, Microsoft sold $2 billion worth of Surface tablets. Windows Offerings Under Ballmer Windows Vista was the first version of Windows completely developed under Ballmer’s leadership (although Bill Gates oversaw the project). Vista started out as a more ambitious project with the code name of Longhorn, but when that ran into difficulties, it was recast as Vista. A primary goal for Vista was to increase security. Released in January 2007, more than 5 years after its predecessor, Windows XP, it was not well received by the marketplace. Vista took 2 years longer than expected to develop and it was several billion dollars over budget. It was a huge program—with 50 million plus lines of code—and utilized a lot of computer memory to run, resulting in unacceptably slow performance for many users. It quickly drained battery life on laptop 01/10/15 6:03 PM C-164 Case 20 Microsoft: From Gates to Satya Nadella computers. Moreover, it irritated users with constant popup authorization prompts for user account control. Many potential adopters simply stuck with Windows XP rather than switch to the much-maligned Vista. By October 2009, Windows Vista had 19% of the PC operating system marketplace, while Windows XP, an 8-year-old OS, still enjoyed a 63% share. Many insiders blamed the poor performance of Vista on a development process that got out of hand. One problem was “too many VPs in reporting structures too narrow.” There were 12 layers of management between Bill Gates and a developer at the base of the Windows organization. As one former Windows development lead noted: “I once sat in a scheduled review meeting with at least six VPs and ten general managers. When that many people have a say, things get confusing. Not to mention, since so many bosses are in the room, there are often negotiations between project managers prior to such meetings to make sure no one looks bad . . . In general, Windows suffers from a proclivity for action control, not results control. Instead of clearly stating desired outcomes, there is a penchant for telling people exactly what steps they must take.”23 Other insiders complained about a lack of accountability, constant churning of features and specifications, with new features often being added without adequate testing, leading to system crashes and further development delays. Several people also noted that with Gates heading Vista, CEO Steve Ballmer was unwilling to step in and resolve problems that were resulting in delays and cost overruns. Once Vista shipped, many of the top engineers on the project retired. Steve Sinofsky, who had been running Office, was bought in the run Windows. At Office, Sinofsky had run a very tight ship, releasing new versions on schedule like clockwork. The Office organization was also much flatter than the Windows division, with only four levels of management. Sinofsky flattened the Windows organization, reducing the number of levels of management from 12 to 5. He pushed developers to get Vista’s successor, Windows 7, to market quickly. Originally conceived as an incremental update to Vista, Windows 7 was a more streamlined program that fixed many of the performance problems and irritations with Vista. Introduced 02277_Case20_rev02.indd 164 in 2009, reviewers saw Windows 7 as a big improvement over Vista, and the operating system sold well. Once Windows 7 shipped, Sinofsky and his team turned their attention to Windows 8. Released in 2012, Windows 8 was positioned as an operating system for the new era of digital devices. Windows 8 used the same Metro-style, tile-based interface that had first been used on Windows Phone. Despite the lukewarm reception of the Metro interface on the phone, Microsoft saw the interface as an important differentiator. Sinofsky was a major advocate of the Metro interface, going so far as to push Microsoft to kill a competing interface for tablets being developed within the company because it was inconsistent with the Metro theme that he wanted on all devices.24 Known as the Courier, the tablet was the brainchild of a group within Microsoft’s Entertainment and Devices Division, headed by Jay Allard. The Courier was on track to hit the market in 2010, just months behind the iPad. Widely admired within Microsoft, Allard was the force behind the creation of the Xbox business and was instrumental in pushing Microsoft to embrace the Web back in 1995. The Courier was a two-screen tablet that folded like a book and had a touch screens. Early prototypes had elicited rave reviews from outsiders who had seen it, some preferring what they saw to prototypes of the iPad, which was then under development. But the Courier used a modified version of Windows as its operating system, and the interface departed substantially from the Windows norm. When the Courier dispute surfaced, Ballmer found himself in the position of having to choose between two of his best managers. Unable to make up his mind, he brought Gates into the decision. Gates, who by now had given up all day-to-day operating responsibility, met with Allard and his team. His criticism was that Courier didn’t align with Microsoft’s key Windows and Office franchises. Not only did it use a customized version of Windows, and a nonstandard interface, but it also did not include an Outlook email client (Allard pointed out that users could get email through an onboard Web browser). For Gates, this was a fatal flaw, and the Courier was cancelled. Within months, Allard had left Microsoft along with his boss, Robbie Bach. It would be another 2 years before Microsoft had a tablet offering, the Surface. In addition to the Metro interface, Windows 8 also supported touch screen technology and could be used 01/10/15 6:03 PM Case 20 Microsoft: From Gates to Satya Nadella on a tablet in addition to desktop and laptop PCs. Released in 2012, Windows 8 received decidedly mixed reviews. Although reaction toward its performance improvements, security enhancements, and improved support for touchscreen devices was positive, the new user interface of the operating system was widely criticized for being potentially confusing and difficult to learn. Many users particularly disliked the fact that Microsoft had removed the start menu. Market take-up of Windows 8 was slower than Microsoft had hoped. Sinofsky abruptly left Microsoft in December 2012. Recognizing that the Metro interface was not resonating with many users, Microsoft announced that it would release an update, Windows 8.1, in October 2013. Windows 8.1 tried to address some of the criticisms, and gave users to ability to dispense with the Metro interface and revert to the traditional start button and menu. Despite this, adoption continued to be slow. By mid-2014, only 12.5% of PCs were using Windows 8 or 8.1. Most consumers and corporation stuck with Windows 7. The Cloud Computing Initiative By the mid-2000s, serious conversations about cloud computing were taking place within Microsoft. The “cloud” referred to the idea that data, operating systems, and applications could be hosted on server farms comprising of thousands of machines, rather than on servers and PCs within an enterprise. These conversations were based on a realization that in a world where computing device users were always connected to the Internet through wired or wireless links, there were compelling economic reasons for moving computing power and programs off servers located within enterprises and onto server farms. Specifically, the cloud could deliver more value to users at a lower cost than traditional client-server networks. On the value side, there was clearly great utility associated with storing files on the cloud and being able to access those files anywhere anytime through any connected device. The files could be in the form of documents, music, video, or databases. Moreover, by reaching out and accessing programs and data stored on the cloud, users with simple devices such as smartphones and tablets could theoretically access vast amounts of computing power when they needed it. On the cost side, it was apparent that moving computing resources onto the cloud could save ­businesses 02277_Case20_rev02.indd 165 C-165 a lot of money. Corporate IT departments traditionally shouldered the costs of buying and maintaining computer hardware and software, activities that accounted for almost 90% of all IT costs. Servers, however, often only ran at 5 to 10% capacity, while much of the software installed on corporate servers and PCs was only rarely used. By moving data and applications onto a server farm, demand for computing resources could be aggregated and servers could be run at closer to 90% capacity. This implied significant economies of scale in the costs of computation. Microsoft’s estimates suggested that, under optimal conditions, shifting to a cloud-based model could reduce IT costs by as much as 80%.25 Moreover, instead of paying for software that was rarely used, corporations might be able to pay for software only when they used it. Microsoft proposed to build a cloud-computing business that would host data and applications for corporations, taking the burden of infrastructure and maintenance costs off their hands. In return, corporations would pay a fee for storing data, and either a subscription or runtime fee for executing applications. As early as 2006, Steve Ballmer had stated that Microsoft had no choice but to go “all in” on the cloud.26 By 2010, this commitment had developed into Microsoft’s Azure cloud-computing initiative, which was located within the company’s Server & Tools Division. Cloud computing was seen as comprising of three segments; infrastructure as a service (IaaS), platform as a service (PaaS), and software as a service (SaaS). IaaS refers to basic hosting of data, websites, and the like. Amazon’s AWS is primarily an IaaS offering. PaaS refers to the idea of building a software platform upon which software applications can be built and run. Microsoft’s Azure platform is essentially a PaaS offering that uses Windows Server technology. Think of Azure as Windows for a server farm of 10,000 machines. SaaS is the idea that software applications can be hosted and run on the cloud. Salesforce.com was an early leader in SaaS with its customer relationship management (CRM) software. By 2011, Microsoft was committed to competing in all three segments. The company would host data for enterprises and consumers (IaaS), it would continue to develop Azure so that enterprises could write applications that would run well on the cloud (PaaS), and it would reposition many of its products such as Office, SQL Server, and Dynamics, as software as a 01/10/15 6:03 PM C-166 Case 20 Microsoft: From Gates to Satya Nadella service (SaaS) offerings. In June 2011, Microsoft introduced Office 365 to enterprise users. Office 365 was a cloud version of its bestselling Office suite. In 2013, Office 365 was offered to consumers. Enterprises paid a licensing fee and consumers an annual subscription fee for Office 365. Users could download the program to multiple devices (for consumers the limit was five). They could also store Office documents on Microsoft’s Cloud using its One Drive storage offering. Microsoft shifted to a rolling—release model for developing Office 365, updating the program on a quarterly basis—a marked departure from the historic 3- to 5-year development schedule at Microsoft. One problem Microsoft had to grapple with in shifting toward a cloud-computing model was that it represented a change in the underlying economics of its business. In the traditional model, most of Microsoft’s costs were associated with the fixed costs of developing programs such as Windows and Office. The marginal costs of producing more versions of a program were very low, so that at high volumes Microsoft earned gross margins in the 90% range on Windows and Office. In the cloud-computing model, however, Microsoft had to build and maintain server farms, which could cost anywhere from $500 million to $2 billion each in fixed costs, and which consumed large amounts of electricity. There was a general belief that even at high volumes, the gross margins associated with a cloud-computing business would be significantly lower than what Microsoft was accustomed to. As people within the company were fond of saying, “in the cloud business we actually have costs of goods sold.” On the other hand, while cloud computing was still a small business in 2013, generating perhaps less than $10 billion in revenues industrywide, rapid growth was predicted going forward. Industry revenues were projected to balloon to $150 billion by 2020. Clearly Microsoft had to embrace this business. Satay Nadella Takes Charge By early 2013, Ballmer was coming under increasing pressure from Microsoft’s board of directors. Despite robust revenue and earnings growth under his 02277_Case20_rev02.indd 166 leadership, Microsoft’s stock price had stagnated. Microsoft had lost its technological leadership in the industry to Apple and Google. The company’s problems with Vista and Windows 8, and its failures in the smartphone, tablet, and Internet search businesses, had led directors to question the direction of the company. Ballmer agreed that it was time for someone else to take the helm, and the board started to look for his successor. Satay Nadella was picked to succeed Ballmer and took charge on February 4, 2014. Nadella was a native of Hyderabad, India. In 1988, he received an engineering degree from the Manipal Institute of Technology. He then travelled to the United States and earned a Masters in computer science from the University of Wisconsin. Later, while working full time at Microsoft, he earned an Executive MBA from the University of Chicago. Nadella had worked at Microsoft since 1992. He was senior VP of R&D for the Online Service Division from March 2007 until February 2011, when he was appointed president of the Server and Tools Division. This division grew at a healthy pace under his leadership. Moreover, the Azure cloud-computing initiative was based within this division. Nadella was credited for his adept leadership of the nascent cloud-computing business. Nadella moved quickly to put his stamp on Microsoft. Emphasizing a break with the past, Microsoft, he said, was competing in a “mobile-first, cloud-first” world. In this world, said Nadella, Microsoft must empower people to get things done. By June 2014, he was talking about Microsoft being the premier “productivity and platform company for the mobile-first, cloud-first world.” In March 2014, Nadella announced that Microsoft would offer a version of Office 365 for the iPad. A version had been in the works for some time, but release had been delayed because of fears that it would boost demand for the iPad and hurt Microsoft’s Surface tablet. Nadella asserted that in a world where Android and iOS are widely used, Microsoft had to make its applications run on those platforms too. By Fall 2014, Office for the iPad had over 30 million downloads. Also in March 2014, Nadella announced that Windows would be free for devices smaller than 9 inches, meaning smartphones and tablets. Clearly this was an attempt to jump-start adoption of Windows on digital devices, and to match Google’s strategy of giving away Android for free. 01/10/15 6:03 PM Case 20 Microsoft: From Gates to Satya Nadella In June 2014, Nadella sent a long letter to employees stating that the company would be taking “important steps to visibly change our culture.” He talked about the need to obsess over customers, to streamline engineering processes and reduce the time and energy it takes to get things done, to limit the number of people involved in making decisions, to drive greater accountability, and to flatten the organization. In making these statements, Nadella was implicitly acknowledging that Microsoft’s culture had been too bureaucratic and political, and that there had not been sufficient accountability. He also announced that, as part of its efforts to streamline the organization, Microsoft would lay off 18,000 employees, 12,500 of them in the newly acquired Nokia unit. These were the most significant layoffs in Microsoft’s history. Coming at a time when the company was still making very healthy profits, they sent a clear signal that Nadella believed company needed to become more efficient to compete effectively going forward. In January 2015, Microsoft unveiled Windows 10, which would be available in late 2015 (Microsoft decided to skip the Windows 9 designation). Windows 10 represents a move away from the tile-based, Metro interface. The traditional start menu that was in Windows 7 is back. Windows 10 will run on all devices, from desktops and laptops to tablets and smartphones. Applications written to run on Windows 10 should run on any device, which promises to remove a major headache for app developers. Moreover, the ability to tap into the wider Windows ecosystem might create an incentive for developers to write more apps for Windows devices. In a bold departure from its prior strategy, Microsoft announced that Windows 10 would be free to any Windows 7 or 8 users that downloaded it for the first year after its release. Estimates suggest that this would result in $500 million in lost revenue for the first year Windows 10 is on the market. Also in January, Microsoft announced its earnings for the last quarter of 2014. Among the highlights on the consumer side of Microsoft’s business, sales of the Surface tablet were accelerating and hit $1.1 billion during the quarter. Search and advertising revenues jumped 23% over the same quarter a year ago. Bing’s U.S. market share increased and was up 150 basis points to 19.7%. Office 365 consumer subscribers also jumped 30% over the prior quarter, to 9.2 million. On the enterprise side of the business, cloud revenue 02277_Case20_rev02.indd 167 C-167 grew by 114%, driven by strong enterprise adoption of Office 365, Azure, and Dynamics CRM online. Microsoft’s cloud business was now generating annualized revenues of $5.5 billion and growing rapidly. On the other hand, sales of traditional Windows and Office products to consumers and businesses were either flat or down. Clearly, the shift to the cloud was rapidly gaining momentum, and Microsoft was starting to cannibalize its own businesses. NOTEs 1. A. Covert, “Will Google Docs Kill Off Microsoft Office,” CNN Money, November 13, 2013. 2. International Data Corporation press release, “Worldwide Server Market Revenues Declines 23.7% in the Third Quarter,” February 24, 2014. 3. K. Mackie, “Microsoft Admits Windows Use at 14%,” redmondmag.com, July 14, 2014. 4. International Data Corporation press release, “Smartphone OS Market Share, Q1 2014.” 5. E. Protalinski, “Strategy Analytics: Android Tablet Shipments Up to 65.8% in Q1 2014,” thenextweb.com, April 28, 2014, http://thenextweb.com /insider/2014/04/28/strategy-analytics-android -tablet-shipments-65-8-q4-2014-ios-fell-28 -4-windows-secured-5-8/. 6. International Data Corporation press release, “IDC Expects PC Shipments to Fall by 6% and Decline Through 2018,” March 4, 2014. 7. J. D’onfro, “Here’s a Reminder of How Massive Amazon’s Web Services Business Is,” Business Insider, June 16, 2014. 8. Comment made to the author. 9. S. Nadella, “Mobile First, Cloud First” press briefing, San Francisco, March 27, 2014. 10. Much of the material in this section is drawn from P. Freiberger and M. Swaine, Fire in the Valley: The Making of the Personal Computer (McGraw Hill, 2000); A. R. Harris, Microsoft: The Company and Its Founders (ABDO Publishing Company, 2013); J. Wallace and J. Erickson, Hard Drive: Bill Gates and the Making of the Microsoft Empire (New York: Harper Business, 1992); information gleaned by the author during nearly two decades of teaching in-house executive education courses at Microsoft. 01/10/15 6:03 PM C-168 Case 20 Microsoft: From Gates to Satya Nadella 11. The full Gates memo is archived at www.wired .com/2010/05/0526bill-gates-internet-memo/. 12. J. Bick, “The Microsoft Millionaires Come of Age,” New York Times, May 29, 2005. 13. B. Herbold, “Inside Microsoft: Balancing Creativity and Discipline,” Harvard Business Review, January 2002. 14. Ibid. 15. J. Brustein, “Microsoft Kills Its Hated Stack Rankings. Does Anyone do Employee Reviews Right?” Bloomberg Businessweek, November 13, 2013. 16. The best description of this process can be found in M. Cusumano and R. Selby, Microsoft Secrets: How the World’s Most Powerful Software Company Creates Technology, Shapes Markets and Manages People (New York: Free Press: Touchstone Edition, 1998). 17. Business Software Alliance, Ninth Annual BSA Global Software Piracy Study, May 2010. 18. K. Powers, “Showdown,” Forbes, August 11, 2003, pp. 86–87. 19. A. Wilhelm, “Inside Microsoft’s Earnings: Windows 8 and the Xbox Money Machine,” thenextweb.com, April 19, 2013, http://thenextweb .com/microsoft/2013/04/19/inside-microsofts 02277_Case20_rev02.indd 168 -earnings-windows-8-and-the-xbox-money -machine/. 20. P. Dekho, “Google Android Lords Over 85% of Smartphone OS Market Share,” Financial Express, September 1, 2014; C. Buckler, “Browser Trends September 2014,” Site Point, September 2, 2014. 21. R. Nieve, “Yahoo Gets 31% of Search Revenue from Microsoft Deal,” CBET, December 10, 2013. 22. T. B. Lee, “Here’s Why Microsoft is Buying Nokia’s Phone Business,” The Washington Post, September 3, 2013. 23. Cited at http://blogs.msdn.com/b/philipsu /archive/2006/06/14/631438.aspx. 24. J. Greene, “The Inside Story of how Microsoft Killed Its Courier Tablet,” CNET, November 1, 2011. 25. The Economics of the Cloud, Microsoft White Paper, November 2010. 26. The author was an observer at a Microsoft strategy conference when Ballmer made this comment in response to a presentation suggesting that Microsoft take a cautious approach to the cloud. “No,” said Ballmer, “this is wrong, we have to go all in on this one.” 01/10/15 6:03 PM Individual Case: Microsoft Wayne Timothy Meyers CMR495 2021/9/16 Microsoft Business Case Analysis Summary Nadella and Bill gates were the significant managers and CEOs of Microsoft. They both operated with the Microsoft being a monopoly business. Steve is also another individual that contributed to the growth of Microsoft. However, the three assisted in the growth of Microsoft; there was some stagnation during the era of Ballmer. It was a real struggle for Microsoft to maintain itself and ensure that it was progressing. The three leading managers helped it all through. Bill Gates and Allen were the ones who invented Microsoft in 1975. Later in 1980, Ballmer joined them to assist them in progress. This was the same year that IBM approached Microsoft for help. IBM was finally successful, and it gave birth to clone manufacturers (Microsoft n.d). That was when it moved from the hands of Gates to Nadella. In 1983 it expanded its products by offering the presence of MS-DOS, which was the first world’s word. Later in 1985, Microsoft introduced the word web version, which got able to run the apple machine. It also revealed its first excel version. 1990 it also introduced its first PowerPoint. By 1982 the business was on point. By the mid-1980s, it was the leading monopoly business. In 1986, Microsoft got popular within the public. Then Gates realized the potential for GUI and its great future. And that is how Microsoft diffused from Gates to Nadella. It got straightforward for the third parties, which assisted Microsoft grew quickly and easily (Microsoft n.d). The first version of windows got introduced in the year 1985. It was the first that got displayed on the screens allowing multitasking. IBM also took advantage of the GUI. In 1992 Microsoft got to combine word, PowerPoint, and excel and called it the office. In the late 1980s, Microsoft began system operations to target the servers of the office. They later moved to server OS, symbolizing the importance of the growth of the servers to the big companies. To gain more market, Microsoft also added email to their office. Then windows XP and windows 95 were also incorporated. Windows 95 also enhanced the use of graphics in the same period. After Gates was challenged by being taken to court, he later took a step to hire people who had the same passion as his. He was lucky enough to get somebody like Charles, who was among the first to develop excel and word. And that is how Microsoft has grown over the years through various windows up-to-date. However, there is a shift to clouding, and its currently gaining momentum. Question 1 There are various factors that lead to the early success of IBMPC. IBM was the first available personal computer in the 1970s. It initially started as doing it yourself kit and then moved to off-shelf products. Therefore the first to allow the opening of architecture or opensource software. Thus it allowed the creation of external parts for the IBM PC very quickly and easily. It was the only innovation of the day and therefore allowed every company to assist in making parts for the computers (Baldwin n.d). Thus the IBM PC success was driven by elements such as massive marketing campaign and high brand recognition that supported the PC launch. Later joined became greatly widespread and adopted by many companies and therefore its growth. Question 2 Microsoft as well as Bill Gates played a big role in the early success of the IBM PC. First, Microsoft started as a tiny company with only twenty-five employers in it. However, Bill Gates, who was very interested in technology from his young age of 13, ensured that the company’s products were advertised as the first class in those times. He seemed very determined that he confirmed and checked every code that got shipped by the company and corrected them if he saw any problem with the code (Bill 2019). As time went by, many computers started to look for software to help them operate computers. IBM was one of the companies that operated the upcoming PCs, and they, therefore, decided to seek the help of Microsoft. Bill gates thus convinced them that he had a company that could meet their requirements. Unfortunately, they had not yet created the critical operating system to help them run the IBMs PCs. And that's how Bill Gates assisted them in creating an operating system that would play the role of running the computers similar to the PC. That is how he made a great deal with the software developers enabling Microsoft to be the licensing agent and later the complete owner of the system. Therefore making the PC efficient and able to get used by many companies. In addition in 1994, gates also hired Herbold, who was made the chief operating officer in progress. Bob Herbold was a graduate with a Ph.D. in computer science (Microsoft n.d). When he arrived, he described the working as a chaotic base for one people were not getting paid on time. Plus, the company did not have any strategies to follow too. He made and arranged everything that he felt needed change in the organization, which got to a very good outcome. The programmers developed codes that got tested and worked well. When Gates handed over his CEO role to Ballmer in 2000, the company was at its best. During the Ballmer, the revenue increased by 280%. However, Ballmer had to deal with a low growth rate of both the office and windows. Later, Xbox gets revealed in 2001, which got upgraded in 2005 (Microsoft n.d). The product diversification was at its highest point in the year 2007. However, the introduction of the android phone and iPhone lowered the marketing place of Microsoft. And that is how the early IBM PC has out grown up to date. Question 3 Various factors eased the surfacing of the PC clone industry. First, clone aspect was supposed to make it quick for all other entities to design software applications and peripherals to operate the IBM PC. In addition, applications and peripherals seemed to add value to the IBM PC. The 16bit operating system provided great utility compared to the 8bit operating system that was proposed at first. It is the development of other programs running on the MS-DOS that increased the supply of the implementation leading to the adoption of IBM PC. The element advanced factors of increased efficiency and production for the companies (Langlois 2021). Interestingly, the organization handled more information and tasks, and the storage and efficiency inclined. It was an expansion opportunity for Microsoft as Gates arranged a selfevident license with IBM. However this provisioned Microsoft control over IBM and OS, which were denied the right to question the same. Unfortunately, the license DOS allowed Microsoft to control over all other companies except IBM. However, the move made by IBM was a great mistake as it was realized that the operating system was the most valuable factor of the production in the equation of development. Question 4 Eventually Microsoft translated into great success in the 1990s with MS-DOD domination in the PC software. The prior version of windows came around 1995 after the release of Windows 95. This was the most significant product launch up to date. This is because, for the first time, windows and MS-DOS environments could be used simultaneously to run a machine by use of a similar GUI. Windows and the bridging DOS were a remarkable move that was implemented and given to the users in preference for a GUI-based system. However, it gets also designed to forestall the apple market that was significantly growing (Langlois 2021). The mid- 1990s was the time that Microsoft started to take the internet seriously. After the Netscape Navigator Internet browser launch, Microsoft brought to light its internet explorer and browser. Moreover, by this time, Microsoft was not bold content enough to decide who would win the browsers war. In return, nets cape accused Microsoft of engaging in monopoly marketing. This was to show that Microsoft had already started to take dominance in the PC software industry. Question 5 The World Wide Web was a severe threat to Microsoft. Tim Berners founded it in 1994, who also founded the World Wide Web consortium that's is the web's leading body in France. It was a one networked information system among many others (Microsoft n.d). By 1995 the web was quickly growing, and therefore Microsoft had to switch its course to compete with the web. Microsoft did not try to compete with other companies but took this threat as an opportunity. It built its product by failing and trying to improve upon it. It was then that Microsoft took the opportunity to get known by the internet. Microsoft dramatically got to expand its publishing electronic division and created a notable success in the late 1990s. In addition it joined entertainment industries and information services with a large wide services and products. Meanwhile it also became the most profitable and powerful company in the American history (Microsoft n.d). This shows the work smart for Microsoft not to be like other entities but to stand and its own and provide the best. The significant rapid growth was very evident then and rivals were not happy about it. However, Microsoft did not settle on its enemies but rather on the quality of its product, the price and its usefulness. This shows that Microsoft was a hardworking, efficient and quality company in that time. References Baldwin, C. Y. Design Rules, Volume 2: How Technology Shapes Organizations Chapter 15 The IBM PC. Bill, G. (2019). Bill Gates Biography. Langlois, R. N. (2021). Disintermediation: the Rise of the Personal Computer and the Internet in the Late Twentieth Century (No. 2021-12). Microsoft: From Gates to Satya Nadella. Retrieved 16 September https://www.homeworkmarket.com/files/microsoft-pdf-5167099. 2021, from
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