Steering a Tech Giant Towards the Cloud

Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Microsoft Corp (NASDAQ: MSFT) is currently going through a paradigm shift. The changes made this year will, according to a recent interview with CEO Steve Ballmer, remake the Redmond giant into a “devices-and-services company” rather than just a software developer.

Since the beginning of the mobile computing revolution Microsoft has witnessed a portion of its primary customers completely abandoning PCs and laptops. The change is even more evident in IT professionals, who are generally the trend setters in adopting new gadgets and devices. According to IDG as many as 16% IT professionals in the U.S., 23% in Europe and 27% in Latin America have now stopped using personal computers completely. This change is going to continue. Therefore Microsoft has had to take a huge gamble in shifting its core revenue centers, Windows and Office, towards this new environment. 

One could make the argument, and rightly so, that if Ballmer were a competent CEO he would have seen this shift 18 months earlier and have already made the transition.   Since most of these ideas were gestated under Bill Gates’ regime, all Ballmer had to do was align the company’s organization with these goals and their positions in both the tablet and smartphone segments would not be nearly so tenuous today. 

But that didn’t happen.  The good news is that Microsoft gets the shift towards “cloud” in a fundamental way and is aligning its institutional and enterprise offerings completely towards this.  In this Cloud Services arena, Microsoft is a small player in a huge market which is expected to touch $109 billion in 2012. The biggest segment here is the BPaaS (Business Processing as a Service) which includes cloud advertising, accounts for 77% of the total cloud service market. BPaaS is followed by SaaS (Software as a Service) with 13% and IaaS (Infrastructure as a Service) with 5.6%.  Companies such as Salesforce.com, SAP, Amazon (NASDAQ: AMZN), Rackspace (NYSE: RAX) and Oracle are the major players and mostly operate in a “Microsoft-free environment.”  Amazon, Rackspace and Salesforce are using Linux, no Windows or SQL Servers. Even Google uses its own customized version of Linux.

Outside of Office and Windows, Microsoft’s other divisions have yet to yield any profit.  In 10 years their online services, i.e. MSN and Bing, have piled up $16 billion in losses.  But Ballmer is not worried, yet.  He believes that Windows 8 will “propel” PC sales and with 400 million PCs still being sold globally, the market for its core product will remain strong in the near term.  It is this window of opportunity that exists for Microsoft to re-brand the company’s image as a more full-service provider of end-user products; creating the much hoped-for ecosystem for the practical business person, especially the small entrepreneur that will dominate emerging markets.

The failure to this point of Windows Phone to capture market share has been well documented as that space is dominated by Apple (NASDAQ: AAPL), Google (NASDAQ: GOOG) and Samsung. Globally, Windows Phone has a huge hill to climb but the latest numbers, still before the release of Windows Phone 8 are encouraging.  European market share is rising rapidly according to the latest reports from Kantar, pulling in much of the market share lost by Research in Motion; market share which is growing.   

But Apple has sold 85 million iPads.  Android on the tablet has been a disaster until recent moves by Google to stop the disintegration of the brand.  The strategy Microsoft is employing is to slip the tablet up the value chain and provide a better device than the failed netbook and the current iPad for the business professional; attempting to hit the iPad where it is currently living large.  The Surface and other OEM designs like those from Dell and Lenovo are focused on this market segment to migrate those people quickly to the latest hardware without having to change their working environment.

By bundling Office into the Windows license for all tablets, Microsoft is creating a very enticing option to keep professionals from leaking away to Apple and Google.  Office is the driver of Windows revenue, not the other way around.  And competition to it at the low end is eating away at its dominance.  Almost 5 million organizations around the world now use Google’s apps for their office requirements. Through September 15th, more than 16 million people had downloaded Open Office 3.4 which was launched just a few months ago.  The Linux crowd uses Libre Office.  But none of these is MS Office and Microsoft is on the right track with offering Office as a subscription service, though the pricing may need to be tweaked lower.

Microsoft is a cash cow that will continue to attract investors, at least in the short term. Ballmer has rightly pointed that PC sales are still, and will remain, in the hundreds of millions.  The tablet threat is real and Ballmer knows that 5 years from now computing will look completely different, but the principles are still the same.  Provide a better environment to develop ideas into tangible products and people will use your stuff.  That’s the value added.

What Microsoft knows is that eventually the hardware margins will shrink back to commodity levels.  We’re already seeing this in smart phones.  Market share comes from low barrier to entry, especially in a global economy struggling for growth.  Fully integrating Microsoft’s entire disparate product lines under one common User Interface connected through the cloud is the only potential way forward for them to maximize their revenue potential.

Contrary to popular opinion, the launch of Windows 8 is not a make or break moment for a company this big and powerful.  Inertia will carry them a long way, especially as Apple seems to be making small mistakes regularly now.  The latest strategic moves indicate a company that realizes that even though it has come a long way in the past 18 months, it is still behind its chief rivals, and has a lot of work ahead of them.

Windows and Office became chains of Microsoft’s own devising.  It got too big and too bureaucratic for its own good, protecting internal fiefdoms and not utilizing the innovations happening within the company.  However, that attitude is changing and Ballmer may finally realize that technology matters and moving “innovative engineers” to executive positions is what his company needs now.  If these changes don’t go far enough it will likely be the last set Ballmer is in charge of.

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PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Amazon.com, Google, and Microsoft. Motley Fool newsletter services recommend Amazon.com, Apple, Google, and Rackspace Hosting. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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