Microsoft acquiring GitHub — Understanding the business principles behind it!
We belong to a generation which was lucky to observe the evolving era of digitization through close quarters — from simple and basic personal computers to the high profile GPU’s, from simple analog-ish Nokia phones to value for money One Plus 6’s. Technology has simplified our lives to a huge extent and even continues to do so at an enviable pace. It is all possible because of one particular region of the world known as the Silicon Valley.
The companies coming out of the valley have been disrupting our lives at a maniacal pace. Their business models function pretty much in a similar way. With five Valley-based companies being worth over $ 500 billion today, Silicon Valley has become the undisputed hub for innovations. Pretty much all the innovations happening in the technology world happens in the valley or has a valley based company associated with it.
I guess this is enough hindsight about the business of the valley. Now the valley might boast of the highest number of innovations but the business model of most of the biggies is pretty much along the same lines. Most of the companies earn their primary revenue through ads, renting cloud computing, hardware etc. Here is the catch. Since most of the companies aim to tap into the similar avenues, the competition is surreal. Thus the metrics used to value the products and services of the companies are very different from those used by the Wall Street bankers for the other industries.
The way stakeholder value is created in the valley falls into two categories — strategic and financial. The financial value is what B-School grads master during their MBA programs. It is more about the ability of the business to keep on growing and functioning independently yet prosperously. It involves all the old school math excel based valuation methods.
For a service based company it is governed by the number of customers you have, the expenditures and the medium of the expenses, cost of acquiring new customers and how much do we spend. For a product based company it is determined by the number of users of the product, the market size of the product and the weights these two factors have on driving the share prices.
When it comes to the strategic value, it has little to do with all these B school fundamentals and more to do with the ability of a company’s product or market position to help/hinder the chances of success of another company (usually a bigger one). Strategic value is not realized by the ability of a business to make profits but by its ability to generate/protect profits for someone else.
This is the primary reason why a company with a few gifted founders and no revenue (WhatsApp) can sell for tens of billion dollars while an age-old company making over $ 100 million in revenue will not even be worth a fraction of that(Whole Foods). Most of the smart venture builders are not driven by building a company capable of an IPO embarking on a journey of continued growth (immensely difficult these days), rather they are after creating value for someone else. This might sound contrary to some of the most popular success stories of building profitable companies like Google, Apple and Facebook but the slew of acquisitions of companies like WhatsApp, Instagram, YouTube, Siri etc just prove my point.
Being an astute football fan, I wonder if this is the reason behind the inhuman transfer fees of certain young players!!
A few case studies will include the $ 20 billion acquisition of WhatsApp and the $ 1 billion acquisition of Instagram. The stars of both these acquisitions include two of the shrewdest business brains in the tech industry in Sheryl Sandberg and Mark Zuckerberg. Both WhatsApp and Instagram had tremendous potential to hinder the growth plans of Facebook and thus were acquired, not because they were hugely profitable but because they created enormous strategic value for Facebook. These acquisitions of yesteryear left many of the IBs scratching their heads and pulling their hair but now Facebook owns 3 out of the top 4 apps where people spend the maximum time on. In an increasingly data-driven world, this provides them enough leverage to keep the duopoly (of Facebook and Google) in the ad industry going.
Another exciting example is that of Eric Schmidt leading the acquisition of YouTube while he was the CEO of Google. YouTube was barely a profitable business. In fact, it is still unclear if it makes any profits today despite its enormous potential to turn into a cash-cow. Google paid a whopping $ 1.6 billion for it. It made little to no sense for people then but then it is now considered to be one of the best deals in the history of mankind because of the immense strategic value it has for Google.
In both the aforementioned cases, it was the ability of the companies acquiring to prevent their smaller competitors from encroaching their very profitable ad business driven by data.
Another lesser known example is that of Apple acquiring Siri. Apple in an attempt to enter into the search industry wanted to cut its ties with Google and paid over $ 200 million to acquire a virtual personal assistant making company. The deal was in an attempt to load their future their products with specs to drive their most profitable arm — smartphones. These are a few select examples and in no ways exhaustive. The history of the valley is filled with many such examples.
Now coming to the main point — Microsoft is paying $ 7.5 billion to acquire a company which generates extremely minimal revenue (close to 30x) times. A change in leadership has brought in a fresh set of changes in the way Microsoft functions. Satya Nadella (what a man) has made 3 really spectacular acquisitions in Minecraft, LinkedIn and now Github. While the entire world is going gaga on how Github fits into the Azure system and will help them compete with AWS, the subtle detail that they have been missing is the vision of their CEO. Microsoft has always been a developer first company and this certainly helps them wrap it up with the developer community.
Nadella has been pin focused on building businesses which are core to their heart. They have certainly learned their lessons from tinkering with their previous acquisitions like Cortana and Skype and have done a great deal giving independent operation rights to brilliant platforms like LinkedIn and Minecraft. The vestiges of his predecessor also were developer focused who built world-class tools for Windows because Steve Balmer was hell-bent on making the everything run on Windows. Now with the passing of the baton, Nadella has streamlined Microsoft to function as a closely knit community of developers but with focus on making everything run with Windows. With about just $ 1 billion Windows users left, Nadella had well understood that the success of being a developer-driven business which focuses on empowering their customers, it was imperative to go open source. Integrations with multiple platforms will make it much more loved.
In simpler words, Nadella isn’t shelling out $ 7.5 billion for Github’s ability to make money or its financial value. It is valuing it for getting the access to the legions of developers who use the Github repositories on a daily (sometimes hourly) basis — funneling them into the Microsoft’s developer environment. The other funnel is the enterprises. Microsoft is arguably the world’s largest enterprise based software provider. It is certainly the most trusted too. I cannot imagine any other company in the world having such exciting prospects. There are enormous possibilities of trying out different permutations and combinations with developers’ code on one side and an opportunity to streamline into a business opportunity for an enterprise on the other. This is where the real money is made and the Azure cloud will only make it simpler.
While Microsoft still faces the challenge to take a small business in Github and transform it into a profit making machine, big enough to justify the $ 7.5 billion price tag, Nadella has already cleaned up the mess left behind by Steve Ballmer and has successfully managed to get back the developers into the ecosystem. He understands that they aren’t a company that makes money by trading data for ads or based on transaction and the only way they can be successful is by empowering their customers. He humbly quotes — “We need to have a real position that we can contribute something unique to that market. In this case, being a developer-first company from the very start gives us confidence that we can bring real value to the developer community.”
On a concluding note, while the entire world has comments like “wow, ridiculous, amazing, humongous” for the recent M&A activity in the valley, the smart ones are beginning to recognize the drivers behind such huge sums. Building a self-sustaining behemoth is an exception and not the rule. Strategic, not financial, the value is what determines the success of such measures. The primary value of most successful high-tech startups doesn’t lie in their ability to transform into a future Goliath but the potential strategically important value it can create for much bigger companies despite being David. To understand what goes on in the minds of the people in the strategic division of the valley, we have to direct our thinking along these lines.
