Company culture and cloud-based services are fueling the next wave of Microsoft’s growth
In mid-July, Microsoft reported in its FY19 Q4 earnings that its cloud services revenue was largely driven by 64% revenue growth for Azure, the company’s Infrastructure as a Service (IaaS) solution. Although Azure’s growth fell over the fiscal year from 76% in Q1, the cloud services offering cemented Microsoft as a dominant player in the cloud infrastructure space, second only to AWS.
Last month alone, Microsoft reported $33.7 billion in revenue, placing it once again as the world’s most valuable listed company. This comes after a product pivot and thorough restructuring and stands in stark contrast with the Microsoft of twenty (or even five) years ago, which was hobbled by antitrust battles and a culture that failed to adapt to mobile and cloud-based developments.
Microsoft’s behavior in the 1990s led to growing calls for a break-up of the company, a solution some deemed as the only appropriate remedy to prevent further monopolization. Bill Gates, the company’s then chairman and CEO, stated that the eventual ruling against Microsoft was a challenge to “healthy competition in the software industry” and could impede innovation — an argument not unlike those made by tech giants under scrutiny today.
Monopoly.exe has stopped working
By the early 1990s, Microsoft was a dominant player in the personal computing space, helping to shape the modern working ecosystem by making its Office software and Windows OS vital to individual users and large enterprises. For some years previously, the Federal Trade Commission (FTC) had begun to investigate whether computing systems could facilitate monopolistic and anti-competitive practices.
Microsoft frequently collided with regulators over antitrust matters during this time. For instance, in 1989 the company was accused of limiting the effectiveness of its own Windows software to accelerate the adoption of the OS/2 system it had been developing jointly with IBM. Microsoft largely dismissed the concerns.
This back-and-forth with the FTC culminated with United States vs. Microsoft Corp, a lawsuit filed by the U.S. Justice Department and the Attorneys General of 20 states (and the District of Columbia) which alleged that Microsoft was illegally maintaining its monopoly position in the personal computing market by integrating once competitive products into its Windows software. According to Harry First, a Professor of Law at NYU, the core of the complaint was that Microsoft engaged in practices that stifled its then competitor Netscape; from Medium:
Netscape’s new “browser” software allowed desktop PC users to access goods, services, and information through the web. In 1995, Bill Gates saw that Netscape posed a challenge to the Windows operating system and predicted an “internet tidal wave” of competition that threatened to sideline Microsoft’s products. In response, Microsoft launched its Internet Explorer browser, triggering what became known as the browser wars and eventually attracting the lawsuit that ended Microsoft’s abusive practices and nearly resulted in the company’s breakup.
Many of the conclusions made in the 1990s Microsoft case came down to definitions. The DC Circuit made a questionable distinction between an upgrade and a product, arguing that technological integrations should be treated like a product “that combines functionalities […] in a way that offers advantages unavailable if the functionalities are bought separately and combined by the purchaser.” While intending to be consistent with antitrust laws, this definition would also set a low bar in identifying Microsoft products. All that would have to be proven is that the integration brings some advantages.
The 1990s Microsoft case shares many parallels with today’s federal antitrust investigations into Amazon, Google, Facebook, and Apple. These companies, like Microsoft in the 90s, grew through relentless acquisitions and a constant expansion of their core offering. Accusations of anti-competitive behavior (say, Google favoring its own properties in search engine results and Android devices) recall Microsoft’s competition-constraining contracts restricting OEMs from shipping computers with a different browser or OS.
Yet, with a strange twist, Microsoft today avoids the ire of federal agencies and antitrust investigations plaguing its counterparts. Much of this boils down to a changing culture and a product portfolio built to be compliant with regulation.
Microsoft’s return to prominence was brought on by a functional reorganization, spurred in turn by a shift in company culture. Other than the management style of former Microsoft CEO Steve Ballmer, his relentless focus on Windows and building a “services and devices” company (with too much emphasis on the latter) prevented Microsoft from fully taking advantage of the mobile and cloud transformations of the early 2010s. As Microsoft’s success at the time was often a byproduct of its Windows dominance, any downturn in the OS would lead to a comparable fall for Microsoft as a whole.
In his first company-wide memo after becoming CEO in 2014, Satya Nadella outlined a new vision of Microsoft’s future, breaking with Ballmer’s obsession with devices. He underscored that the previous focus was outdated and that efforts should instead be centered on delivering a “productivity and platform company for the mobile-first and cloud-first world.” Rejecting the notion that dominance could only be achieved by deploying assets across the widest possible range of devices (the exact mindset which got Microsoft in trouble in the 1990s), Nadella framed the company’s future around an obsession with customers:
To deliver the experiences our customers need for the mobile-first and cloud-first world, we will modernize our engineering processes to be customer-obsessed, data-driven, speed-oriented and quality-focused. We will be more effective in predicting and understanding what our customers need and more nimble in adjusting to information we get from the market. We will streamline the engineering process and reduce the amount of time and energy it takes to get things done.
What Nadella acknowledged, and Ballmer never understood, was that Microsoft could not keep leveraging its unmatched resources to produce devices en masse with the hope that they would improve with time. The deprioritization of Windows and subsequent focus on Azure (Microsoft’s cloud offering) was one of Nadella’s most important acts early on, and illustrated a willingness to allow interoperability across all devices, something that the company previously had been keen to avoid.
Nadella illustrated Microsoft’s embrace of a “cloud-first, mobile-first” approach by permitting the Linux operating system to be used on Azure and extensively rolling out Office to Android and iOS. The acquisitions made by Microsoft during this time also reflected a shift in culture, from last year’s $7.5 billion deal with GitHub (a leading software development platform) to this week’s announcement that it would be acquiring BlueTalon, a data privacy and governance startup, in an effort to bolster enterprise data governance at scale through Azure.
The great hybrid cloud enabler
Microsoft’s restructuring can be viewed through the lens of its three core revenue segments since FY Q1 2016: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The latter category captured the “services and devices” company Ballmer envisioned, including its Windows offering, devices like Surface and PC accessories, search, and gaming (right down to Xbox). The core engineering group could then be placed in Intelligent Cloud, Microsoft’s segment focusing on public, private, and hybrid server products comprising enterprise services and server products like SQL Server, GitHub, Azure, and more.
The Intelligent Cloud segment has primarily been driven by growth in Azure. Matthew Douglas, the Director of Cloud and Solutions Architecture at Smithfield Foods, referred to Azure a “great hybrid cloud enabler,” since it allows some applications to live in the public cloud, others on legacy on-prem servers, all while providing consistent authentication. In a blog post last year on Microsoft’s cloud offering, CTO Kevin Scott also emphasized the role of Intelligent Cloud in solving a wide array of challenges including diminishing global food supply, waste management, and energy inefficiency.
Microsoft’s value chain
Enterprise management has long been at the center of Microsoft’s focus. The company’s value chain encapsulates its distance from end-users: OEMs were largely building and selling devices to enterprise IT departments, leading to products that prioritized features over user experience. But this model didn’t lend itself to increased product innovation. Ben Thompson, a tech analyst and founder of online newsletter Stratechery, argues that any success Microsoft had in the consumer space largely resulted from its enterprise business; from Stratechery:
Products in the Microsoft value chain were typically feature rich and user experience poor, exactly what you would expect from a world run by top-down purchase order, not individual consumer choice. To the extent Microsoft did succeed in the consumer space, the reason was a spillover from their dominance in enterprise; by the time pure consumer markets like the web or mobile came along, Microsoft was woefully unprepared to compete. They were basically the opposite of Google.
This echoes many of the sentiments from Nadella’s memo, which argued that Microsoft needs to once again become a “customer-obsessed” company by streamlining engineering processes and improving its predicting abilities around customer needs. This would not necessarily entail taking away any resources from enterprise, but instead creating a more flexible back-end cloud infrastructure with the enablement of Windows on iOS and Android or allowing the integration of proprietary and third-party SaaS applications with legacy on-prem servers.
Intelligent Cloud nicely complements Microsoft’s enterprise value chain, from hybrid deployment to the company’s support of open source technology. Unlike the cloud-based offerings of other vendors, Azure allows workloads to be split across enterprises’ existing infrastructure and the public cloud. And beyond a partnership with Red Hat and release of its first Linux product (a third of virtual servers on Azure now run Linux), Microsoft is involved with hundreds of workgroups and community-driven projects aiming to promote open standards.
Up and to the right
It is also important to note is how Microsoft compares with other cloud vendors. Gartner, an advisory firm, recently published its latest Magic Quadrant IaaS market research report, where it evaluates cloud providers on a two-dimensional matrix according to the completeness of vision on the horizontal axis and ability to execute on the vertical axis; from Gartner:
The report positions legacy cloud providers like IBM and Oracle in the “niche player” category, noting issues ranging from late market entry to location-specific features, limited capabilities in MSP ecosystems, difficulties related to integrating third-party enterprise software, and poor user experience. Alibaba Cloud’s situation is both a blessing and a curse; while it has a compelling integrated IaaS offering and several strategic partnerships acting as a bridge into — and out of — China, the full capabilities of its China offering are not available internationally.
The “leaders” were not spared, with Gartner outlining reliability issues for Microsoft, AWS’ lack of cross-platform integrations, and the immaturity of certain processes within Google Cloud Platform. The advisory firm also points to customer frustration with tech support and runaway costs as detrimental to Microsoft’s IaaS growth. Yet, Microsoft’s outlook remains strong, particularly as it continues to identify future drivers of growth within Azure and benefits from the cost efficiencies of scaling its infrastructure across its own network (e.g. LinkedIn).
Culture is what allowed Microsoft to become a dominant player, cementing Windows as the only clear option for enterprise IT managers. But the same exact assumptions that allowed Microsoft to scale — that it would (with its unmatched resources) inevitably develop a superior solution, or continue leveraging its Windows dominance into the end of days — later constrained its ability to make a directional shift when required. By looking beyond their golden goose and betting instead on a cloud-based future, Nadella precipitated Microsoft’s revival.