Original URL: http://www.theregister.co.uk/2007/04/26/microsoft_needs_a_gerstner/

A modern-day Gerstner is needed to cure all of Microsoft’s ills

Time for Ballmer to move on...

By Faultline

Posted in Software, 26th April 2007 06:02 GMT

Analysis Later today (Thursday) Microsoft will release its figures for the past quarter, and there’s more than a good chance that financially speaking, things will be pretty much okay. But no better than that.

Increasingly there is an opinion forming that Microsoft is nearing an inflexion point in its success and that both success and share price have peaked, after which the company, its products, and all its attempts to invade all of its neighboring business areas, may be doomed to mediocrity, and a downward spiral, reminiscent of IBM when it reached the 1980s. IBM needed a change of management, which was affected by ousting John Akers and putting Louis Gerstner, ex-Nabisco in charge, to rethink its direction pull it out of the mire.

It’s hard to picture a glowing outlook for Microsoft in the near to medium term future while being run by Steve Ballmer, and when it has so many failures on its hands and when its strategy is fundamentally “knee jerk” and based on Windows.

It puts us in mind of that age old joke about travelers asking a local yokel how to get back to a town they recognize on the map. He replies “If I was going there I wouldn’t start from here.” Where Microsoft is right now is a lousy place to start and it seems to us it is looking less promising by the day.

Although Microsoft knocking copy has fuelled writers for many years, this is not knocking copy, just an observation that times have changed and the Microsoft needs to move on. Anti-Microsoft arguments have always been based on resentment at the company’s seemingly unending and perhaps in some cases, unjustified, successes. No longer. Today it is the evidence that points to a Microsoft that is moribund on the innovation front and which is a ragbag of separate and loosely tied together business units, each with the same operational formula, and only slightly varying missions. Loosely expressed that reads “Get Google, and Push Windows.”

Google leapfrog

We would argue that that Microsoft really has reached its inflexion point whereas for some commentators in the past it was just wishful thinking. One indicator this week is that Google just leaped over Microsoft, in the eyes of consumers, as the world’s most successful brand, as measured by US researcher Millward Brown, measuring brand value (rather than pure consumer recognition).

This has happened despite Microsoft spending hundreds of millions a year in advertising, while the Google brand spreads by word of mouth and internet usage. Microsoft’s brand value fell to third place and co-incidentally Nokia, Apple and Samsung now sit in 12th, 16th and 44th places, but significantly these brands are all moving up in value as Microsoft moves down. The conclusions were reached by interviewing people in all the major countries around the world, not just the US.

But on the face of it there is little wrong at Microsoft. That’s if you accept the Microsoft version of events. It remains dominant in the office and the enterprise, it has just shipped its most sophisticated operating system upgrade ever, and will soon ship the office suite to go with it. It has given billions to its shareholders and yet still has $29 billion in the bank.

And in the Faultline territories of digital media, Microsoft could argue that it’s doing a great job. It has the dominant media player, the dominant PC based Digital Rights Management software, it has finally brought its VC-1 codec to a point where it can be licensed and it remains the lead software supplier to the largest Telco in the US, AT&T in its IPTV roll-out, a rollout that is vital to the long term financial health of that company.

Microsoft has converted a third placed gaming console position to a market leading position, is growing market share among handsets and has made a recent shrewd acquisition in in-game advertising networks and is building out it AdCenter product line to position itself better against Google, and it has launched the Zune and its PlayReady handset DRM to better position itself against the iPod and the iPhone and others.

The Xbox Live network and the other Microsoft Live network offerings in instant messaging, VoIP and conferencing are all generating more and more revenues in some cases in partnership with some of the biggest operators in the world, in others, like Xbox and MSN, directly from consumers.

Costing a fortune

And if you are a Microsoft employee and you regularly drink your own Kool Aid, then read no further. Because it is starting to become apparent that the invasions of turfs in entertainment, networks and gaming are costing Microsoft a fortune and not getting it very far. Last quarter Microsoft revealed losses in all of these activities, just as it has for many of the last few years and just as it will when it launches its first calendar quarter (its third financial quarter) numbers again today.

Its losers are Online Services Business (OSB) which includes MSN and Windows Live and Hotmail, and the Entertainment and Devices Division (EDD) which includes the Xbox 360, mobile and IPTV and peculiarly Mac Office, which somewhat lifts the division. Last quarter the losses for OSB were around $155 million on revenues of $624 million while EDD was responsible for flat losses of around $290 million on revenues on $2.9 billion.

The only positive thing about these numbers was that EDD had risen its volumes considerably through the Xbox.

But if there was a division for law suits at Microsoft, then that would have lost the most money by far. The various anti-trust and patent actions that Microsoft is involved in is expected to use up between $1.5 and $1.8 billion of the poor shareholder’s money, and although much of that has been set aside, this is as a direct result to the knee jerk way Microsoft reaches for bundling and the way that it uses other companies’ intellectual property without asking, and that’s a management issue. And it’s worth reminding ourselves that if the intellectual property trial that went in Alcatel-Lucent’s favor over MP3 patents is upheld on appeal, Microsoft can double the amount it expects to lose in legal actions.

Forbes this week calculated that over the life of EDD it has lost something over $5 billion. But there is also an invisible cost here. While it is public knowledge that Microsoft paid Intertrust $440 million in settlement of its DRM intellectual property dispute, what we don’t know is what it costs to develop and keep current the Windows Media DRM. We also don’t know what kind of drain on management time this took.

The operational loss is perhaps included in the losses by EDD or disguised as R&D, but given that things like DRM, codecs and media players are given away for free, they can hardly be expected to bring in any revenue, except minimal licensing, and for the most part it turns out that Microsoft has too weak a control of the IPR asset to make that stick, as the VC-1 case bears out.

The continually successful divisions of Microsoft are the Client Division, Server and Tools, and the Microsoft Business Division which includes Microsoft Office, Access and various server pieces of software.

What we have at the moment at Microsoft is a business that was once visionary, where the visionaries have been supplanted by marketing men, and where someone with the operating and financial nous that Gerstner brought to IBM would almost certainly close or sell off the bulk of these lossmaking divisions, or better still, sell them to strategic partners so that the company can still benefit from their output without picking up their bills.

Over the years IBM sold of its printer division, which became Lexmark, its storage division was sold to Hitachi, as was its miniature hard drive business, it outsourced its low end manufacturing, it got out of PABX switches, and more recently sold off its PC manufacturing. What it bought was software, and services business, such as PWC consulting, Rational and Lotus.

What we have today at IBM is a money engine, which is dominant in services and which is plugged in to the IT departments of every one of the top 100 global accounts through vigorous accounts control. The aging mainframe technology business at the heart of IBM has flagged,but the IBM numbers have barely changed.

But similar to Microsoft, IBM’s share value rarely ever changes. It is usually worth around $150 to $160 billion, and in just the same way Microsoft has been valued at $270 to $290 billion for most of the last four to five years.

Share cropper

So from an investor point of view Microsoft has been static for a long time, rising and falling with the market, a place for investors to park their money while they sit and think about what investment stratagem to follow next.

If you look a little closer at what Microsoft is doing in its neighboring markets and take off the rose tinted spectacles, we see that perhaps it’s not doing quite so well.

Its media player dominance days are about to be over. It has been forced to unbundle software in both Europe and Korea, and yet at the same time its video technology has stood still. Adobe, which has never lost a major battle against Microsoft, is closing in on Windows Media Player with a full blown media player of its on built around the fantastic success of point and click video, delivered through its subsidiary Macromedia, and its Flash player. Funnily enough a few decades ago Microsoft fought tooth and claw to get Macromedia to switch from targeting its software at Apple environments first and Microsoft second. Perhaps it will now be regretting all the temptation it placed in the way of Macromedia.

And although Microsoft has a ten year license from Intertrust to use its DRM IPR, Microsoft has not got access to innovations that happened after the date of the deal. This includes DRM domain management, where more than one device can be allowed DRM licenses when they are part of the same home, or DRM interoperability, which Microsoft may or may not want anyway. Microsoft has had to reinvent these for itself and it is this type of problem that has led to first Zune having a separate DRM from Windows and from its PlayFor-Sure consumer electronics campaign, and once again with the launch of PlayReady, Microsoft has launched yet another incompatible DRM designed to target the handset.

All of this means that DRM is multi-flavored within Microsoft, and confusing for customers and consumers alike, opening the door for companies like Intertrust to fuel a new generation of PC DRM platforms through insightful licensing terms, clever partnerships and by bridging it to OMA, likely to become the dominant handset DRM.

This doesn’t only meant that a Microsoft media player and bundled DRM is unlikely to emerge on Symbian and Linux Smart phones and other handsets, it also means that its previously untouchable home turf of the Personal Computer, is vulnerable to invasion. This perhaps could all be avoided if Microsoft’s answer to everything stopped being to put the familiar look and feel of Windows on everything, and if it came to understand that there are many ways of building a software platform without it requiring a change of operating system allegiance.

Recently the MPEG LA patent pool issued terms for licensing the Microsoft VC-1 codec, which is the standard based on the Microsoft codec bundled in its Media Player. Out of 125 patents that are licensed by going to this pool, Microsoft only has two essential patents.

Financially it has to pay back-payments, perhaps as high as $80 million, to the patent pool, and a further $8 million a year to license technology which it allegedly invented. Instead of market dominance, what Microsoft achieved was a tax on being Microsoft imposed by intellectual property of rivals. Again it was a problem of management.

But during the 3 to 4 years that it has taken this technology to become standard, it has lost ground both in the market and in performance terms against the H.264 codec which is now standard throughout much of digital media.

The VC-1 effort has cost Microsoft both credibility and time, and today, within Flash video, the proprietary codec of On2 Technologies resides. This means that Microsoft is being beaten out of internet video by a small company with just 37 employees, despite over 200 patents that it claims in this area.

Which brings us to AT&T in its IPTV roll-out. All the major tier 1 telcos need help redefining their services, in a manner that doesn’t force them to spend too much money re-building their networks but which staves of fixed voice price erosion. If the same telephone line can be used not for one service, but for three or more services, the huge losses of fixed phone lines, due mostly to mobile fixed line replacement and VoIP, can be averted. So everything that can help is worth buying into, and IPTV and the triple play are vital.

But this hasn’t progressed as Microsoft had expected. Despite signing up 15 or so tier one accounts around the world there are three major issues, firstly that the AT&T requirements are over and above any other in IPTV, and Microsoft is reported having trouble scaling its systems to these requirements. Even if this is not the case, AT&T has major problems targeting a system that has at least two concurrent HD screens at once, a requirement that Europe, where Microsoft has the rest of its IPTV customers, won’t reach for years to come.

Hey, where did that roll-out go?

The second issue is that the US is the only place where cable operators are dynamic and well funded enough to have built out digital cable, and this has created a particularly tough environment for companies like AT&T, and Microsoft has got the brunt of this. But at the same time, the original contract with Microsoft was only for $400 million from AT&T and while this may have been renegotiated to take in Bellsouth and other acquisitions, precious few homes have yet been switched on. This means that Microsoft is almost in the position of having to force the pace on software development purely for a single customer. A Microsoft IPTV division which did NOT have AT&T as a customer, would be a very different, and rather better, proposition from the one that does.

But the third reason in that in Europe where Microsoft can argue that it has done a better job, the prospect of DVB-T terrestrial TV, well in advance of US broadcast digital TV transition, has limited the requirement for pay TV services. Add to this the fact that the European Union legal position on unbundling the local loop means that all of the Microsoft customers in those territories enjoy rivals that also have access to the incumbent telco’s lines and we have a scenario which inhibits IPTV take up at incumbents, because there is wide choice, which in turn delays any real success that Microsoft might enjoy in IPTV in dollar terms.

Of course once tier 1 telecommunications operators engage with any company, that engagement becomes an exercise in strategic account control, and that never was the Microsoft way of conducting business, it’s far more an IBM style approach. Microsoft needs the IPTV account at Deutsche Telekom so that it can launch other services with DT, not just for the revenue it can get from IPTV. So if IPTV is paying it nothing, Microsoft is forced to remain attendant and helpful for the sake of the rest of the business. This pulls Microsoft towards the IBM way of doing things, with sales and project led account control.

This in turn lowers margins and make for a far less exciting income statement. Perhaps it’s worth all that trouble, but then Microsoft becomes tied to the operator and cannot offer services which take a free ride over operator networks.

So any way you look at it IPTV is going to remain an on-going cost for Microsoft for years to come, and internal pressure to make it profitable would be far more palatable if this IPTV team was working at say Alcatel-Lucent or Cisco, where it could help shift more and more router equipment. With the arrival of someone in the Microsoft leadership ranks with views like those of Gerstner of old, MSTV would find itself on the block and sold off to one of the major telecommunications equipment suppliers, probably Alcatel-Lucent.

In gaming we see much the same thing. The Xbox loses money and only a big increase in the attach rate of games and an outright win in this generation of gaming devices would change that. Being in first place, where Microsoft is still in a price sandwich with the Nintendo Wii below it and the Sony PlayStation above it, is still an uncomfortable place to be. This is made worse by having virtually no Japanese gaming penetration, and by backing the wrong horse on High Definition DVD players.

By going with HD DVD, Microsoft took an emotional anti-Sony decision. And by bundling the Blu-ray player in the PS3 Sony has managed to rapidly overtake the Toshiba based HD DVD format and very soon Microsoft could be forced into an unpalatable climb down by allowing OEM version of the Blu-ray drives into the Xbox 360, in fact we’d say that this is pretty inevitable within a year.

So a market leading gaming console position is perhaps not to be envied quite so much, and perhaps the only consolation is just how badly Sony managed the entire PS3 launch. But it’s doing better now, and that spells even more bad news for Xbox. Actually the Xbox has a shining light in that the Xbox Live network, although under pressure from Sony now, is an outright success and this is perhaps the only area where Microsoft has learned (from iTunes) how to move into services.

Until recently Microsoft had been growing market share in mobile handsets, but it still has virtually no chance to move towards dominance from a purely software defined architecture. It is here that the lesson about an operating system not being a platform needs to be best absorbed.

Java is a platform. MobiTV is a platform, DVB-H and MediaFLO are platforms, Brew and Series 60 are platforms, but none of them are operating systems, none of them offer the Windows look and feel and they can all sit on virtually ANY handset, be it Windows Mobile, Symbian, Linux or a proprietary chipset BIOS.

Linux is picking up speed as a consumer electronics operating system and particularly on the handset. Motorola could have fully embraced Microsoft, instead it has pushed Linux on handsets. Palm could have doubled the Windows Mobile reach, instead it will now revert back, in part at least, to Linux.

Similarly on the Ultra Mobile PC Intel could have solely embraced some form of Windows, but instead it has just decided to use Linux as well and hedge its bets. This amounts to a major split with its original partner and one which could leak back into the enterprise and PC domains, and begin to erode Microsoft’s appearance of an unassailable lead.

In fact Intel here seems to have more in common with Nokia than with IBM (see elsewhere in this issue) and the convergence of devices from the PC down to the handset and from the handset up to the palm sized and tablet PCs, will push Linux more and more and make it more acceptable in the enterprise.

Following the leader

The advertising obsession of Microsoft, due to the need it has to cover every move that Google makes, is sending mixed messages to the world. IBM, during its recovery stopped trying to be Microsoft, and in the same way Microsoft has to stop trying to be Google and find its own new paradigm.

In the world of networks Microsoft is also trying to invade the operator’s turf by using Connected Services Framework, sitting it between .Net applications and IMS. This could lead to millions of services across the world’s networks, in many cases doing the jobs that Cisco’s product line used to do. But it could equally lead to an all out war between Cisco and Microsoft in networking, and that will be both distracting and unprofitable.

We could go on. The abject and predictable failure of Zune, setbacks in the browser wars with Opera, Safari and Firefox on the PC, and on handsets, all making Internet Explorer less and less a household name, the failure to penetrate handsets with a decent downloadable DRM, the failure to lure advertising network DoubleClick into a merger (it went to Google), and the countless lawsuits, are all symptoms that Microsoft management isn’t losing its way, it has lost it sometime ago.

Microsoft needs leadership that can innovate, not bully and it can go one of two ways. It can find itself a new visionary, like Gates himself, or it can opt for someone who’s skills are corporate management and accounting based, as Gerstner’s were.

The one thing it cannot continue to do is let itself be run by marketing and continue to repeat the bundling tricks of previous technology generations.

Ballmer needs to call it a day, preferable graciously, and in his place someone is needed who can change Microsoft’s reputation from a playground bully to a company that can be sensibly invited onto the handset, and onto IPTV set tops and onto Linux and Apple platforms, with its own next generation of platforms, none of which are operating systems.

Copyright © 2007, Faultline

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