Microsoft’s Hardware Gamble: Disrupting the Ecosystem
“What the hell, Microsoft?” PC makers are furious. The deal was always simple: Microsoft concentrates on its Windows software and they would focus on making better hardware. For over two decades, that’s the way it was done — a symbiotic relationship where everybody wins. It standardized platforms, drove down prices and expanded distribution — a procces that transformed Acer, HP and Dell into multi-billion dollar giants. But that was then. The game was now changed.
Microsoft, in unveiling its new Surface tablet and Windows 8 platform, announced its entrance into the hardware game — effectively becoming a competitor to partners it had once built empires with, and Microsoft’s OEMs are scrambling.
“We’ve said to Microsoft think it over — think twice. It’ll create a huge negative impact for the ecosystem ” Acer’s CEO JT Wang said to the Financial Times. “It’s not something you are good at — so please think twice.”
The shift is largely a reaction to the changing computing landscape. The once-lucrative PC business model has been upended by mobile devices. Apple, which develops its iOS platform, also designs its own hardware in the iPhone and iPad. Google, meanwhile, once a software-only company in Android, scooped up Motorola’s mobile division, sending Android partners like HTC and Samsung into a similar frenzy. In short, Microsoft realized becoming a player in software requires your own hardware. And the seemingly uneventful product announcement is creating shockwaves across the industry, as hardware makers scramble to ease their reliance upon a once loyal software partner.
“If Microsoft is going to do hardware business, what should we do?” said Campbell Kan, Acer’s president, echoing concerns other executives are asking themselves today. “Should we still rely on Microsoft, or should we find other alternatives?”
Inside Steve Ballmer’s Mind
To say Microsoft CEO Steve Ballmer is energetic would be an understatement. Known for his over-the-top enthusiasm, contorted facial expressions and a fanatical optimism for all things Microsoft, he’s a businessman first and foremost. And unlike Bill Gates, who immersed himself in code, Ballmer, who roomed down the hall from Gates at Harvard, ran the corporate side as the company’s first management hire.
Over the span of 20 years, he’s led several Microsoft divisions, including operations, sales and support, stepping in as CEO only when Gates left to run his foundation in 2001. Some critics say that’s when Microsoft stopped innovating, instead milking profits from its lucrative Windows and Office products. Over the last decade, Microsoft, once the pioneer of the smartphone and tablet, saw its market share slowly erode, as Apple and Google executed on mobile devices where it could not. So its shift to hardware comes as no surprise — just several years late to the game.
3 Screens and the Cloud
To understand Microsoft’s failure and shift in direction today, is to understand its basic strategy back then. As Ballmer saw it, a software play was the right strategy to dominate a super-high volume industry. That’s what worked with Windows and that’s how it dominated Apple in the PC wars decades ago. It made its software ubiquitous on technology everyone else made and bought. The problem now: it’s no longer the PC age. Ballmer was astute enough to understand this shift early on, actually, and knew that he had to maneuver Microsoft to get there.
“There’s this line in Woody Allen’s movie Annie Hall. Relationships are like sharks; they move forward or they die,” he said. “And I think tech companies are the same. You either move forward or you die. You become less relevant.” He is, of course, referring to PCs and the operating system.
“Moving forward doesn’t mean, ‘Hey we do operating systems and we do nothing but operating systems’,”he added. “Because the definition of what’s an operating system is constantly changing. We’ve got the right idea, which is to try to do software and hardware, and then put them together.”
It’s a good idea had it been said a few years ago. But actually, Ballmer did say it, back in 2009. Three years ago, Microsoft had foreseen the next big generational shift in the computing platform — the decline of the PC and the transition to mobile devices. Ballmer, in fact, had declared its battle plan — to push forward into online services, storing data in the cloud, accessible from remote devices like smartphones, PCs and even televisions.
“People will want applications that service them across different environments,” he said. “So when I’m away and I just have my phone with me, I may want to play games with somebody on the Xbox, or share a television show with a family member who’s traveling or in a hotel room — think of it as one integrated computing infrastructure.”
This was three years before Apple’s iCloud. In fact, Ballmer even had a catchy name for the vision: three screens and the cloud. “I like the alliteration to ‘Three Men and a Baby’,” Ballmer said. “Every time I say it, I think the movie.”
Failure to Execute
The vision of the future proved accurate — computing began its transition to the cloud. But what Microsoft lacked wasn’t direction, it was execution. The basic mistake: it misread a fundamental change in the market. At the time, Ballmer didn’t want to dominate a “niche” market, like tablets. It wanted to dominate major markets. It was going to go big — very big.
“Let’s break hardware devices into two broad categories,” he said back in 2009. “Niche and super-high volume. Anything that’s under about 50 million units sold a year is niche, and anything north of 300 million a year is super-high volume.”
PCs were a super-high volume industry, according to Ballmer. So were televisions and phones. And the reason these industries grew to be so colossal was largely due to multiple companies manufacturing those products. When a single player controls a large percentage of the volume, he claimed, the industry stays niche — as was the case in Apple when it over 30 million iPods during its peak year. In another example, the entire video game market, including the PlayStation, Xbox and Wii, anong others, sold a mere 30 to 40 million units that year.
For Microsoft, that’s peanuts.
“When you get into categories that are around 300 million to 1.5 billion a year, then you’re going to want multiple points of manufacturing,” Ballmer added. “You’re going to want a lot of innovation around it, whether it’s for supply chain or geographic diversity.”
But what about Apple?
“Some of the guys with vertically-orientated solution may do just fine,” he said. “But when 1.3 billion phones a year are all smart, the software that’s going to be most popular is going to be sold by somebody who doesn’t make their own phone.” Of course, Ballmer said all this in 2009. Since then, smartphones have conquered the mobile challenge: Apple, a company that combines its own hardware and software in one immensely popular device.
Partners? What Partners?
October 2011. The numbers were released. According to research firm IDG, Microsoft’s Windows 7 mobile operating system had captured less than four percent share of the global shipments in the July-September period. Apple, meanwhile, posted the third-highest growth rate. Samsung, backed by Google’s Android platform, surged selling nearly one-in-four devices.
Something clearly wasn’t working.
Earlier that year, in February, Nokia had vowed its allegiance to Microsoft. The Finnish phone maker had floundered with a high-stakes gamble on its Symbian platform, and now agreed an exclusive deal to develop Windows products. Nokia said it still had a fat distribution pipe — it just needed a winning product to push through the channel. So a partnership out of necessity was formed. Microsoft agreed to invest heavily into Nokia, and in effect, tie its future survival to the handset maker’s ability to execute on its promise.
Over the next few months, the companies feverishly worked hand-in-hand to rush a new line of Windows phones to market for the lucrative holiday season. But when its first device, the Lumia 800 hit, it was met with lackluster demand. Ballmer knew by shackling Microsoft to Nokia’s ankle, any failure on Nokia’s part would torpedo its Windows platform. So, hedging his bets, Ballmer turned a complete 180, and Microsoft started to develop its own hardware — the Surface tablet — forgoing its super-high volume strategy of focusing on software, while partnering on hardware to dominate an industry.
If Microsoft didn’t move quickly, Apple and Google would take it. But more importantly, Microsoft had lost faith in its partners — to stake the future of a company in the hands of others would be too risky. Nokia and HTC haven’t produced a winning Windows smartphone in years. Acer and Dell tried to transition into mobile devices, but failed miserably too. It would be time to take control of its future and go it alone.
Windows 8 and RT
Windows 8 is a radical change from previous operating systems. Microsoft developed the new touch-based interface centered on the concept of “tiles.” Widgets launch apps and provide information — like incoming e-mail, breaking news alerts and updates from Facebook and Twitter — all from the home screen. The layout is streamlined for a clutter-free view that’s vital for the smaller displays on mobile devices. It also comes in two flavors — Windows 8 and RT. The difference boils down to the chipset the software runs on. The more-robust Windows 8 requires Intel’s popular x86-architecture, while RT is designed to run on ARM’s more power-efficient processors — ideal for smartphones and tablets.
Windows 8 lets Microsoft keep its dominant presence in the laptops and PC market, while spearheading an attack on the iPad and Android-based tablets. Of course, speculation is already mounting that Microsoft will release its own smartphone next, and that reality doesn’t seem that far-fetched.
Hard-liners are complaining about the confusing interface, claiming the changes in layout are too drastic. Others are scratching their heads, wondering if Microsoft has alienated its loyal PC base.
It doesn’t matter, really. When you understand the dire straits that Microsoft is in, from missteps in execution on three screens and the cloud, to botched partnerships with hardware vendors, the drastic changes suddenly become clear. It’s not out of choice. Microsoft doesn’t take risks, or rather, it hasn’t taken risks in nearly a decade.
Innovation is a critical ingredient in niche markets. But Microsoft doesn’t bother with niche. It uses its business prowess — through sheer might in partnerships and distribution — to dominate an industry. It’s only when these niche markets mature and disrupt its established business, does it change — not by choice, but rather by necessity.
Just like Pax Romana ushered in two centuries of peace under complete Roman rule, Microsoft ensured a peaceful ecosystem in the PC industry. But in one bold move, it changed the dynamics at play. Shockwaves are flowing through the industry, and collateral damage will hit vendors — many of whom will go bankrupt. They’re scrambling now, and looking for ways to lessen their dependence on Microsoft.
Ironically, Microsoft is trying to ease the same dependence on PCs. It’s facing similar struggles against Apple and Google after failing to keep pace with the transition to mobile devices. The Surface tablet is an effort to go it alone, and in effect telling its partners it can’t count on them. Years late, Microsoft has entered hardware. And now that the floodgates are open, it’s safe to say more devices will be introduced over the next year — self-branded tablets, and likely self-branded smartphones.
It’s a hedge for survival. Windows 8 and the Surface are mere skirmishes in the larger war. And the bigger question will be how the company now navigates the increasingly-complicated landscape where partners like Nokia, Acer and Dell, among others, are feeling threatened. Microsoft says it’s still a fiercely-loyal partner, but its actions are saying otherwise. There’s little doubt that Microsoft wouldn’t sacrifice its partners to regain market domination. It’s not personal, it’s just good business strategy, and what Ballmer knows best.
But what do you do when you realize you’ve been in bed with the Devil? Well, if you’re Acer, you ask, “What the hell, Microsoft?”
