Solving the Innovator's Dilemma

By Reuters  |  Posted 2010-10-28 Email Print this article Print
 
 
 
 
 
 
 

Microsoft is entrenched in business and consumer consciousness as the company that owns the Windows OS and the Office productivity suite. But Apple has made serious inroads recently, capturing the imagination of both business and consumers with its iPad tablet device. Is Microsoft's efforts to protect its core markets hampering innovation? Some say yes.



Muglia says the shift to providing cloud services -- which involves investment in hardware and a new way of selling to customers -- will likely shrink Microsoft's profit margins, but he hopes that the new sources of revenue will make up for that, as more computing is done via the cloud.

This is how Microsoft is answering the innovator's dilemma, insiders say, by moving lucrative services like Exchange e-mail and Office applications into a web-delivery format, and betting that customers will end up spending more with Microsoft rather than less in the long run, as Microsoft looks after more of the back-end systems.

Microsoft talked a lot about the cloud at the gathering with analysts in July, but it stressed how it was moving existing businesses in that direction -- especially creating a 'personal cloud' to link up all kinds of data and services -- rather than billing it as a huge new and separate avenue of growth.

This was a quiet but significant step, said Matt Rosoff, an analyst and journalist who has covered Microsoft for more than a decade. "The investment community seems to have missed it, but Microsoft's pitch about the cloud was an admission that it's no longer trying to recapture the go-go growth of its early years," wrote Rosoff in a recent piece for the Silicon Alley Insider blog. He recalled that at past meetings, Microsoft would throw out lofty estimates on how much money it could make in grand new business areas, none of which quite panned out.

The company's recent fiscal behavior backs up the theory that it no longer sees itself as a fast-growth company, but a steady achiever. In September Microsoft hiked its quarterly dividend 23 percent to 16 cents per share. That will give it a dividend yield of about 2.5 percent, putting it in the top third of the S&P 500. Why stop there, asks Friar at Goldman, who thinks the dividend yield should be twice as much to make the shares more attractive.

All told, Microsoft has returned nearly $170 billion to shareholders through dividends and share repurchases over the past 10 years. The company started paying a dividend in 2003, and surprised the market with a special dividend of $3 per share the year after, dispersing more than $30 billion to investors in one go.

The Next Stage

The company is quietly closing businesses and unpromising projects. This year it killed off the Kin phone, the Vine emergency social networking tool and video-game ad operation Massive. Last year it closed digital encyclopedia Encarta. A "slow and unannounced" pullback from other non-core businesses could be ahead, said Rosoff.

There is always the possibility that Microsoft will attempt to buy its way to growth, as software rival Oracle Corp has successfully done. The company tends to make dozens of small deals each year, generally under $250 million, but has slowed significantly this year. Although Microsoft is mentioned as a potential buyer in almost every tech M&A situation, CFO Peter Klein told Reuters earlier this year that it is unlikely to go for a "mega-acquisition."

Its largest deal to date, the $6 billion purchase of web ad firm aQuantive in 2007, has not been a great success. And shareholders are generally relieved that its $47.5 billion offer for Yahoo Inc in 2008 was rebuffed, paving the way for a web-search agreement which gives Microsoft most of what it wanted anyway. Its most important deal may yet turn out to be the $240 million it paid for a 1.6 percent share in Facebook in 2007.

Microsoft has made moves to tighten its belt financially, another sign of a cost-conscious culture rather than a growth-at-any-price approach. Last year it had its first ever job cuts, getting rid of 5,800 people, or 6 percent of its staff. In October it announced that workers would have to start paying a portion of their health insurance for the first time in 2013.

That may be common practice at other companies, but it could be a stinging financial penalty to Microsoft workers, who no longer get rich on stock options and have seen no real increase in the value of any stock they hold.

"There's zero tolerance now for major money screw-ups like Kin and Massive," wrote Mini-Microsoft, an anonymous inside blogger. "The bumbling flushing away of millions or billions of dollars is going to be compared directly to the reduction in benefits."

As for those iPad killers, industry-watchers expect to see manufacturers like Acer, Dell and Toshiba to bring out devices after Intel's low-power 'Oak Trail' chip is available next year. Although there is some concern that they will merely be small PCs with touch screens, there is hope they will grab a slice of the burgeoning tablet market, which technology research firm Gartner forecasts will almost treble to 55 million units next year.

If Microsoft can do that, while maintaining focus and cost discipline, then maybe the company and its investors will have a clearer understanding of each other.

"Microsoft has grown up. It's a mature, entrenched, leading provider of technology," said Hanson at BlackRock. "It's not what it was 15 years ago. It's not what Apple is today in terms of a high-growth trajectory. But I don't know if the stock market has graduated to that maturity of perspective."

(Editing by Jim Impoco and Claudia Parsons)

 

 
 
 
 
 
 
 
 
 
























 
 
 
 
 
 

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