Podcasts: Exponent Episode 010 – Clap on Three; This Week in Tech – Netflix Thinks I’m a Bronie

On the newest episode of Exponent, the podcast I co-host with James Allworth:

In this episode we discuss feedback about Uber and pricing, then talk about Ben’s recent articles on Microsoft and Apple/IBM.

  • Ben Thompson: It’s Time to Split Up Microsoft – Stratechery
  • Ben Thompson: Big Blue and Apple’s Soul – Stratechery (Note: We recorded this show before this piece was written)

Show Link

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I was also a guest on This Week in Tech with Leo Laporte, where we discussed Microsoft, Apple-IBM, Comcast, Kindle Unlimited, and more.

You can check it out here.

Big Blue and Apple’s Soul

I hope you’ll forgive my writing about week-old news,1 but I find it striking to compare the paucity of words written about Apple’s partnership with IBM, at least relative to what was written when Apple acquired Beats. After all, the IBM partnership is a much bigger deal.

It certainly seems that Tim Cook feels the same. On yesterday’s earnings call Cook spent, by my count, five times the amount of time talking about IBM than he did Beats2, much of it unprompted by questions. The key paragraph was this one:

We also are in the — virtually all Fortune 500 companies, we are in 99% of them to be exact and 93% of the Global 500…[but] the penetration in business is low. It’s only 20%. And to put that in some kind of context, if you looked at penetration of notebooks in business, it would be over 60%. And so we think that there is a substantial upside in business. And this was one of the thinkings behind the partnership with IBM that we announced last week. We think that the core thing that unleashes this is a better go to market, which IBM clearly brings to the table

In other words, lots of enterprises have dabbled with iOS, but Apple doesn’t have an effective way to sell more.

Apple is in a fascinating position when it comes to the enterprise: it turns out that iOS is the best choice for enterprise from a product perspective.3 Blackberry has the integration, but everything else is obsolete; Android has less-effective device management built in and suffers from the usual Android fragmentation issues (which are improving),4 while Windows Phone, shockingly, has only in the last update added basics such as VPN support.5

However, especially in the enterprise, product is not enough; in fact, very few devices are sold to enterprises as-is. Rather, they are delivered as part of “solutions”, the total cost of which is multiples greater than the underlying device. These “solutions” include things like custom software, implementation, training, consulting, and service contracts. Each of these pieces is fully customizable and negotiable for each enterprise customer, and it is for this you need a massive sales force. Ultimately, no matter how good of a product the iPhone may be, without the sales force and willingness to build “solutions” – the right go-to-market, in Cook’s words – Apple was never going to fully realize the enterprise opportunity.

The problem is that building said sales force is massively expensive, and not just in dollars: it has a big impact on a company’s culture.6 As Jobs wrote in his biography:

The company starts valuing the great salesmen, because they’re the ones who can move the needle on revenues, not the product engineers and designers. So the salespeople end up running the company. John Akers at IBM was a smart, eloquent, fantastic salesperson, but he didn’t know anything about product. The same thing happened at Xerox. When the sales guys run the company, the product guys don’t matter as much, and a lot of them just turn off. It happened at Apple when Sculley came in, which was my fault, and it happened when [Steve] Ballmer took over at Microsoft. Apple was lucky and it rebounded, but I don’t think anything will change at Microsoft as long as Ballmer is running it.

To Jobs this was anathema. If Jobs was adamant about anything it was that Apple always focus on creating the best possible product. If that meant forgoing a massively lucrative enterprise market, then so be it.

That, though, is what makes this partnership so brilliant for Apple. By offloading everything onto IBM – who is playing the role of whats called a “Value-added reseller” (VAR) – Apple can now sell into the enterprise without building the sales capability that in the long run would be poisonous to the product-centric mindset that is their ultimate differentiator.

To be clear, while I’ve been writing from Apple’s perspective, this is an even bigger deal for IBM. As I just noted, the total cost of a VAR “solution” is usually multiples greater than the cost of the underlying device or software; fully integrating a device into an enterprise is a messy business, but dealing with messiness is not only worth a lot of money, it also entails building deep and ongoing relationships with the company you are servicing. In other words, when it comes to the sort of enterprise deals that IBM is going to put together, iOS devices are much closer to commodities; it is IBM that will provide the most value from the enterprise’s perspective. This is a risk for Apple: it’s certainly possible to envision a scenario where IBM switches out iOS for another platform, and there will be nothing Apple can really do about that.

I’m sure, though, that Apple is well aware of this and counts it as a price they are willing to pay7 (in addition to the commission they’ll likely pay IBM on each iPhone or iPad, in case it’s not clear who will be the lead in this partnership). Apple is getting access to a massive market that had long been off-limits, and they are doing so without giving up their product-centric soul.

  1. I was on vacation at the time
  2. 777 words versus 174
  3. It’s hard to overstate what a change this is; Apple has always prioritized the user experience over features, but in a market where the buyer is not the user, a user experience advantage is worthless. That’s what Steve Jobs was driving at in this classic clip
  4. Note: I originally said Android lacked device management completely, which was not right. I apologize for the error
  5. There is no greater example of Microsoft’s misplaced hubris than in launching Windows Phone without any enterprise features in the belief they could knock the iPhone off in the consumer market. Remember this?
  6. To be clear, I have no problem with sales forces or their effect on culture – they are critical for enterprise businesses. The issue is when you try to do both enterprise and consumer
  7. This is also an interesting contrast to Apple and Google Maps; in this case, Apple is prioritizing their culture over control. When it came to maps Apple prioritized control over the product

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It’s Time to Split Up Microsoft

To understand why so many serious Microsoft observers were encouraged by Satya Nadella’s week-ago memo Bold Ambition and Our Core,1 it’s useful to go back 10 years and read Steve Ballmer’s 2004 memo Our Path Forward. It was around this time that cracks were first starting to appear in the Microsoft machine: the stock had been stagnant for going on four years, Windows XP was besieged by a security crisis, and Microsoft was about to announce the reboot of Windows Vista née Longhorn. Meanwhile, the iPod was exploding, and Google’s stock price had quadrupled since its IPO earlier that year on the back of its 85% share of search.

In response, Ballmer said that Microsoft needed to innovate:

The key to our growth is innovation. Microsoft was built on innovation, has thrived on innovation, and its future depends on innovation. We are filing for over 2,000 patents a year for new technologies, and we see that number increasing. We lead in innovation in most areas where we compete, and where we do lag – like search and online music distribution – rest assured that the race to innovate has just begun and we will pull ahead. Our innovation pipeline is strong, and these innovations will lead to revenue growth from market expansion, share growth, new scenarios, value-add through services (alone and in partnership with network operators), and using software to open up new areas. Our focus areas are:

Ballmer then listed 10 different areas of “focus”, the vast majority of which were themselves so broad as to be meaningless. More disturbing than Ballmer’s abuse of the word focus, though was the fact that mobile barely figured in those ten areas. Here is the one mention:

Non-PC Consumer Electronics: The opportunity is virtually unlimited to integrate the richness and intelligence of the PC world with everyday devices such as mobile phones, handheld devices, home entertainment and TV. At the center of our efforts are products such as Pocket PC and Smartphone, Portable Media Center, MSTV, MSN TV, Windows Automotive, the Windows Media Center Extender, and other electronic devices built on Windows CE and Windows XP Embedded.

Even here, mobile phones are only useful insomuch as they “integrate the richness and intelligence of the PC world.” Ballmer and Microsoft simply could not break free of their Windows-first mindset, and while it would be another 3 years before the iPhone arrived, it was this memo and what it represented that marked the beginning of Microsoft’s decline.

The Power of Monopoly

It’s easy to dump on Microsoft now, but even easier to forget just how impressive and seemingly impregnable their core business once was.2 I have written multiple times that tech companies ought to be either vertically/platform focused, with software and services that differentiate hardware (like Apple), or horizontally/service focused, with the goal of offering superior software and services on all devices (like Google and Facebook). To try and do both, as Ballmer explicitly did with his “Devices and Services” strategy, is to do neither well: differentiating your devices by definition means offering an inferior service on other platforms; offering superior services everywhere means commoditizing your own devices. “Devices and Services” was nonsense.

Still, it’s understandable why Ballmer thought differently: Microsoft in the 90s managed to do exactly what I just said was impossible. Because Windows was a monopoly, making their software and services work everywhere meant making them work on Windows. There was no choice between horizontal and vertical, and the company profited fabulously. Over time Microsoft added a server component to this virtuous cycle: people depended on Office, which ran on Windows, and was enhanced by services like Exchange Server, Sharepoint Server, SQL Server, etc. It didn’t matter that Office for Mac kind of stunk; that product mostly existed because of a (failed) attempt to fend off antitrust watchdogs, and it made a ton of money to boot.

This cycle is why breaking up Microsoft, as Thomas Penfield Jackson originally ruled in 2000, would have been truly destructive to shareholder value. The company was strong because its products built on each other, and at the root of that strength was the Windows monopoly.

Microsoft’s Opportunity

Fast forward to last Monday, and the opening of Microsoft’s Worldwide Partner Conference. COO Kevin Turner put up this slide:

Kevin Turner's slide at WPC. Curiously, and in contrast to the rest of WPC, Microsoft has not made Turner's keynote available publicly.

Kevin Turner’s slide at WPC. Curiously, and in contrast to the rest of WPC, Microsoft has not made Turner’s keynote available publicly.

A monopoly that is not.

My first reaction to this slide was quite positive, but the more I’ve thought about it, the more I think the slide represents Microsoft’s biggest issue moving forward. It’s not that their devices share is at 14% – that’s just a fact, and I applaud the honesty; rather, I’m bothered by the phrase “We have a big opportunity.” For Turner, the opportunity is in growing that 14%. As quoted by Gregg Keizer:

We want to go from 14% to 18%, from 18% to 25%, from 25% to 30%. That’s the beauty of this model … [the opportunity] is much bigger than anything we’ve had in the past.

Turner is still talking about devices, and it’s really too bad, because the real opportunity is in the 86%. Microsoft already has software and services like Skype, Bing, and OneDrive that work right now on 100% of that pie; it’s only a matter of time until the same can be said for Office. That is the opportunity; to even think about the share of devices, particularly at the executive level, is to handicap Microsoft’s greatest chance for growth before it even truly gets started. It’s not just that Windows is no longer Office’s only market that matters; it’s that Windows and Microsoft’s devices focus is actively damaging Office’s prospects.

Nadella’s Memo

And so we are back to Nadella’s memo. In contrast to Ballmer’s anything-but-“focus,” Nadella was quite specific:

More recently, we have described ourselves as a “devices and services” company. While the devices and services description was helpful in starting our transformation, we now need to hone in on our unique strategy.

At our core, Microsoft is the productivity and platform company for the mobile-first and cloud-first world. We will reinvent productivity to empower every person and every organization on the planet to do more and achieve more.

Nadella was clear that focusing on “every person” meant focusing on every device as well:

[Microsoft’s productivity apps] will be built for other ecosystems so as people move from device to device, so will their content and the richness of their services – it’s one way we keep people, not devices, at the center.

This is exactly right. Nadella is making a choice here: productivity as a single unifying principle, and by extension, services based on people, not differentiation based on devices. Moreover, it’s a far more difficult and brave choice – obvious though it may be – than outside observers could likely understand. It was only a little over a year ago that Ballmer declared, “Nothing is more important at Microsoft than Windows.”

Last week, Nadella said “No.”

The Power of Culture

The problem, though, was elucidated by Nadella himself in an interview with The Verge:

At the end of the day, look, any strategy gets eaten for lunch if you don’t have a culture that’s also changing.

Nadella is referencing the famous Peter Drucker3 quote “Culture eats strategy over breakfast”; unfortunately, as we have already seen with Kevin Turner’s presentation, that is almost certainly what will happen at Microsoft. For all the talk of moving beyond Windows (and Windows Phone), I am deeply skeptical that Microsoft can truly pursue its potential as a software and services company as long as Windows is around. Culture is developed over years, and for decades everything at Microsoft was about Windows. Read again Ballmer’s statement:

Nothing is more important at Microsoft than Windows

The problem for Nadella and Microsoft is that ultimately this wasn’t a declaration of strategy; it was a declaration of fact, and facts don’t change by fiat.

Understanding Nokia

This is how one can really understand why Ballmer – over the objection of Nadella, among others – made the disastrously stupid decision to buy Nokia. We now know for a fact that my speculation at the time that Nokia was about to introduce Android phones was spot-on, and the terms of the deal suggest that Nokia was having financial difficulties as well; if Microsoft would have lost Nokia, they would have lost Windows Phone, and Ballmer saw that as a mortal threat. Never mind that Windows Phone is for all-intents-and-purposes already dead; the thing about culture is that it not only eats strategy, it washes it down with a potent mixture of selective facts and undue optimism.

In so doing, though, Ballmer dramatically compounded his 2004 error. When Nadella took over earlier this year Microsoft had not only missed the mobile boat, he was now saddled with a $7.2 billion dollar anchor and 34,000 new employees. That’s the thing about last week’s layoffs: even after shedding 18,000 employees Microsoft will still be about 16% bigger than they were before the acquisition, and still tightly bound to a devices group that is working at diametrically opposed goals from the software and services businesses that are Microsoft’s future.

The Solution

It was just about year ago that I wrote in Services, Not Devices:

The truth is that Microsoft is wrapping itself around an axle of it’s own creation. The solution to the secular collapse of the PC market is not to seek to prop up Windows and force an integrated solution that no one is asking for; rather, the goal should be the exact opposite. Maximum effort should be focused on making Office, Server, and all the other products less subservient to Windows and more in line with consumer needs and the reality of computing in 2013…

As for Windows, let it focus on solidifying Microsoft’s hold on the enterprise (it’s here the need to fight the iPad is most acute), with a nice spillover into Home PCs and gaming, and accept the fact Windows was only ever relevant in the consumer market because nobody got fired for buying IBM.

In other words, keep Windows as a cash cow, but be explicit that the future was in cross-platform services. Unfortunately, this was before the Nokia deal. The effects of that deal – and understanding why it was made – have convinced me that Microsoft cannot truly reach its potential as a services company as long as Windows and the entire devices business is in tow.

In short, it’s time to break Microsoft up.

In 2000, Windows, Office, and Server were a virtuous cycle. Today, Windows and the entire devices business is nothing but a tax. Microsoft is a company that is meant to serve the entire market, and the way to do that is through services on every device. It’s all fine and well to say that you will treat devices equally, but given Microsoft’s history – and the power of culture – I just don’t believe it’s possible.

I would create two companies: the devices side, which includes Windows, Windows Phone, and Xbox, and let them do the best they can to grow that 14%. Heck, make Kevin Turner the CEO. Windows profits will keep the company going for quite a while, and who knows, maybe they’ll nail what is next.4

The other company, the interesting company, is the services side – the productivity side, to use Nadella’s descriptor. This company would be built around Office, Azure, and Microsoft’s consumer web services including Bing5, Skype and OneDrive.6 These products don’t need Windows; they need permission to be the best regardless of device.

Of course, the Windows company does need Office, and Azure, and all the other Microsoft growth engines, and this cleavage would likely hasten Windows’ decline. But that’s exactly why a split needs to happen: anything Office or Azure or Microsoft’s other services do to prop up Windows – that focuses on that 14% – by definition limits Microsoft’s opportunity to address the far bigger part of the pie that ought to be the future.

  1. I’m very puzzled by the URL here: It is “”, which means this email is the de facto home page for Satya Nadella. I presume that won’t be the case forever, but how then will you find this note?
  2. To be clear, from a revenue and profit perspective, the business still is incredibly impressive. Microsoft still makes more revenue and profits than Google. Revenue in particular, though, is trending in the wrong direction, and Microsoft’s decline in relevancy, particularly in the consumer market, is large
  3. Supposedly
  4. One more thing: this devices company would not have killed Nokia’s feature phone business. The “tax” works in both directions
  5. Don’t laugh; the thing with search is that when you reach the tipping point, it can become very profitable very quickly, and Bing is getting closer
  6. Probably the toughest division to split would be the on-premise server groups. On one hand, they make Office go; on the other hand, their incentives and sales patterns aren’t perfectly aligned with Azure and Office 365. I could see arguments on both sides, but would tend towards leaving them with the new Services Microsoft

Site Note: Vacation and the Daily Update

Just a quick note that I am on vacation this week and do not plan on posting an article (although I certainly picked quite the week to be gone!).

The Daily Update will continue but instead of analysis of recent news, I have written brief overviews of the Strengths, Weaknesses, Opportunities, and Threats (SWOT) of five of the most important companies in tech (all links members-only):

These will be delivered to members as usual by email, private RSS, or via links on the right side of this page (bottom on mobile).

To become a member of Stratechery go here; to read through the archive of past Daily Updates, go here (members-only).

My thanks to all of Stratechery’s readers and especially members for your support. Look for new content starting on Monday, July 21.

Podcast: Exponent 009 – The Societal Perspective

On the newest episode of Exponent, the podcast I co-host with James Allworth:

In this episode we first defend surge pricing before continuing our debate from last week: is society better off when corporations try to innovate, or would we be better off if we left the innovation to startups? Your answer to this question may change your opinion of Silicon Valley.

Note: In the podcast I talk about owning Microsoft stock; to be clear that was while I was an employee. As a matter of policy I do not currently hold any individual stocks. Also, this podcast was recorded before Satya Nadella’s recent strategy memo, which I analyzed in today’s Daily Update (members only)

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