Microsoft's Blown Quarter: Reflecting on the Aftermath

Now it's easier to understand why CEO Steve Ballmer looked dyspepsic announcing Microsoft's latest reorganization: he knew that a guano-tinged quarter was coming down the pike. In the post about the reorganization, we noted that "this company is its own worst enemy."  

The company took a $900 million inventory write-down for its Surface RT units, parts and accessories.  Beyond the obvious financial impact, it's hard to see the way forward coming into the Christmas selling season. Those hardy souls who opted for Surface won't come back, and their friends with Apple or Android tablets have their decisions re-affirmed. 

Even though we believe that Microsoft engineers and partners did a nice job of designing a form factor for Surface with decent durability and features, it was not ready for the burden of Windows 8.  Worse, users of tablets don't use them to deploy Office applications and do their work-related projects on the tablet.

Apple got it 100 percent spot on: tablets are used to browse the web, check emails, read e-books, take videos and photos,watch videos and television, and update their social media sites.  It may have sounded like a rational step for consumers to do their Powerpoint on Surface, but it's not what they wanted.  Microsoft executives don't understand their retail customers at all, whether for tablets or for gaming.

Whereas Office 365 might make some sense for very large corporations, it's not because of the savings of subscription versus licensing, but for the potential to economize on IT resources to make sure applications are always up, desktop users are being supported, application security, and upgrades. For the retail consumer, at the prices being announced, a subscription seems like anathema. 

Where Bing has made real progress (Credit Suisse reports its 18% market share is up 230 basis points year-over-year), Online Services is still a peanut in the corporate structure. 

Entertainment and Devices continues to lose money, despite the strong brand equity of Xbox among gamers. The company alienated younger gamers with the announcement of the requirement to be online to play and for the ban on reselling the consumer's own games.  Windows Phone seems too little and too late given that the consumer mobile market itself is hitting a wall, just as the number of makes, models, and plans has grown too expensive and too confusing.  For your first smartphone, who would take a flyer on a Nokia Windows phone? This division lost $110 million, down from last year, but its future seems uncertain. 

The Business Division is the other strong performer, and somehow, it seems to keep growing and performing well, despite competition from other large players. It's almost as if there are two Microsofts: the dumb consumer folks and the smarter business division folks.  Or, maybe it's the executives who direct the smart engineers to do stupid things in the consumer businesses.

Jeff Ubben of ValueAct Capital is apparently now a shareholder of Microsoft.  Mr. Ubben knows the company well from his Fidelity Value Fund days.  A press release said that independent directors have already had a conversation with him.  As we wrote in our last post, 

"A better question for the board is this one: should Microsoft continue to exist in its current corporate form, given how badly it has consistently missed industry waves like the Web, tablets and mobile devices?  Can any executive lead such a bipolar organization effectively?  Now that there is one corporate CFO, you better believe that the investment bankers are asking themselves this same question and will be coming up with some ideas."

Apart from these short-term pressures, it's clear to me that Microsoft cannot deliver value with the culture that produced the venture portfolio strategy, acquisitions in online advertising, Windows 8, Windows Phone, the debacle with Surface, and a reorganization that fails to address any of the cultural issues.  This is rearranging deck chairs again. Steve Jobs cracked Apple's engineering culture by sheer force of personality and will. No one person can perform this job within Microsoft.  It really needs to be shaken up beyond org charts.