Now that Steve Ballmer has announced that he will step down as CEO of Microsoft, the Board faces the tough decision of what to do next. Picking a new leader will not be easy; picking a new leader who will revitalize the company will be even harder.
The Board needs to resist the temptation to break up the company because that will destroy stockholder value. It should focus instead on carefully rationalizing the business around its core competencies and competitive advantages. Here it can learn from IBM’s experience in the 1990’s.
I was lucky enough to be a small part of the turnaround of IBM in the 1994-1995. In retrospect, the job looks easy – cut overhead, fix the accounting system, get out of lagging businesses, only invest in growing segments. However, at the time, it was much harder to see the forest from the trees.
IBM then had one advantage over Microsoft today; it was losing money and hemorrhaging cash. Running out of cash sharpens the mind and the pencil. Lou Gerstner was able to use the crisis to cut ½ of the workforce, shut down 100 isolated data centers, sell off campuses around the world and centralize core functions like branding, M&A and treasury. Microsoft does not have the luxury of a financial crisis. Its cash position is huge at $76B and its earnings are strong. That will make restructuring much harder.
All of these cost cutting moves were important but the most critical thing that Lou Gerstner did was get IBM out of businesses where it could not produce profit growth. He didn’t do this by breaking up the company but by slowly and carefully divesting businesses where others had a competitive advantage. He then used the free cash flow to invest in new segments and return cash to shareholders, especially through aggressive stock repurchase programs.
This is what Microsoft needs to do going forward. It needs to get focused on its core competency and revitalize its brand around consistent messaging. Right now the man on the street doesn’t know what Microsoft stands for. I don’t pretend to know which businesses it should sell and which businesses it should keep; that would require an insider’s access to the relevant market, technical and financial information.
Looking at IBM starting in 1994, during its restructuring, it exited a significant number of large and growing markets while focusing its resources on two new ones where it could compete and win: IT outsourcing and middleware. It exited data network equipment, consumer online services, PC operating systems, printers, application software, flat panel displays and its global data network. The combined market cap of the companies, including Microsoft, that filled the gaps vacated by IBM vacated is now in the trillions. That said, IBM’s market cap has grown since the turnaround from about $17B to $200B. Had it not focused on a few businesses where it had a competitive advantage, today its market cap would look more like Unisys at $1.1B or NCR at $6.4B.
The question for Microsoft is, “Does the Board have the stomach and foresight to figure out where to play and where to retreat?” Traditionally, Microsoft has tried to fight and win on all fronts at once. Until the 2000’s, this strategy worked because it was winning on all fronts like IBM was until the 1990’s.
Looking at the IBM turnaround in more detail, in 1994, it had a leading position in a number of market segments that it subsequently exited.
1. IBM led in data network equipment in 1994. It ceded this business to Cisco and others for a number of reasons. IBM’s token ring technology, though arguably better, had lost momentum to Ethernet. In addition, Cisco and others could buy start-ups with overvalued stock (with a price/earnings ratio of more than 50) and IBM could not (with its P/E ratio of 10). So Cisco could dominate the segment through acquisitions paying with overvalued stock while IBM could not.
2. IBM exited the online service business by selling Prodigy to Carlos Slim. IBM could not compete with AOL and others because the activities driving online service usage – sex, gambling and role playing games — were incompatible with IBM’s business brand image.
3. IBM exited the PC operating system segment and shutdown OS2. IBM did not have the user oriented, feature function culture of the personal computer industry to compete with Microsoft. IBM’s technical culture was focused at the high end and revolved around ‘speeds and feeds’, reliability, security, uptime, backup and fail-safe recovery, not around the coolest way to click through an app.
4. IBM exited two manufacturing areas where it was the world’s technology leader — printed circuit board fabrication and circuit board assembly. These steps in the manufacturing process were commoditizing and being outsourced to low labor cost economies. Plus the fixed investment required for these operations was high and resulted in negative operating leverage in a downturn. The proof point is Celestica, a IBM spin-off, that nearly went bankrupt in the recession of the 2002-2003.
5. IBM exited the printer business and spun off Lexmark. Its ink and imaging technology was better than HP’s but too expensive for the dominant consumer and SMB customer sets.
6. IBM exited industry software applications where it had 400 horizontal and industry offerings, many of which were leaders in their niche. IBM determined that its software R&D dollars were being defused over too many target and that they would be better spent if concentrated on a few middleware apps like database, security, systems management and collaboration. To affect the middleware strategy, my department involved in dozens of divestitures and the acquisitions of Lotus, Tivoli and many other smaller middleware start-ups.
7. IBM exited the flat panel display business that it invented. It determined that flat panel displays would be driven by the television industry, not the laptop industry, and that it could not compete with the economies of scale of the consumer TV segment.
8. IBM sold its Global Data Network to AT&T for $5B at the height of the datacom bubble. Microsoft actually financed this deal in the background and lost a significant amount of money on its AT&T stock position. When the data network market went from boom to bust in 2001, IBM avoided the pain.
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This kind of strategic thinking is what was really behind IBM’s turnaround in the 1990’s – plus a string of extraordinary CFO’s, i.e., Jerry York, John Joyce and Mark Loughridge, who executed the strategy and made sure that the resulting free cash flow was put into stock buyback programs. My sense is that Microsoft does not have the strategic planning and/or M&A teams to formulate such consistent and thoughtful plans. This is because it has been dominated by founder CEO’s who drove strategy and M&A, not the Deal Committee structure that worked so well at IBM.
Microsoft needs to hire a new CEO who can focus on improving the collective decision making processes at Microsoft. To maximize shareholder value, it needs to decide what segment it wants to dominate: consumer, SMB or Enterprise and concentrate all of its resources at that consumer set. IBM benefit in the 1990’s by getting out of the consumer segment where it could not earn an advantage return on capital. My recommendation from the outside – with incomplete information – is to focus on small and medium businesses, keep the enterprise business and get out of consumer, just like IBM. Cloud services companies like Salesforce.com, Workday, and Netsuite are the real threats to the Microsoft franchise.