What is Microsoft becoming?
Twenty years ago, Bill Gates wrote The Road Ahead.
With so much asphalt behind us, some things he said were more obvious than others. Gates severely underestimated the impact of the Internet and overestimated the fate of the PC in the online era, an error reflected in the difference between the hardback and paperback editions of the book. Today, his shortsightedness is even more evident.
On the other hand, one of the most common quotes still cited from the book is this: “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next 10. Don't let yourself be lulled into inaction." He may not have known it, but Gates was predicting Microsoft's own future since then.
20 years on, Microsoft is such a different company that in the 1990s nobody could have foreseen what it would become. Even a decade ago, the company seemed sure to become roadkill on the Road Ahead, with the rise of software as a service, the smartphone and the long, slow demise of the PC all but inevitable. Those changes indeed came about, only more dramatically and quickly than most expected. And yet Microsoft isn't roadkill, but instead is looking much stronger today than it has been in many years. What happened?
To answer that, it helps to ask another question: What is Microsoft becoming? The company seems to have transformed into something entirely new since Nadella took over in February 2014. Nadella has steady repeated the mobile-first, cloud first motto since then, embracing an approach that ran counter to Gates' view of Microsoft at the center of a PC/Internet world and Steve Ballmer's subsequent dismissal of everything from Linux to Google.
For all the credit Nadella deserves, much of the success Microsoft is enjoying these days is also due to seeds planted by Ballmer as CEO – namely, a strong push into enterprise software and the focus on server tools that gave the company a footing in the cloud economy. Microsoft announced its Azure cloud platform in 2008 and released it in 2010, an early entry that has made Microsoft the biggest rival to Amazon in the growing market for cloud services. Office 365, the cloud counterpart to the packaged Office suite, was launched in 2010 as well.
Still, Microsoft's success didn't come to fruition until the company let completely go of its dream of dominating the software industry the way it did in the late 20th Century. And that seems to have made a big difference not just in what Microsoft does, but in how the company is perceived. Since Nadella took over, Microsoft's stock has risen 35 percent, more than doubling the Nasdaq Composite's 15 percent gain.
More recently, Microsoft has outperformed many tech stocks in the turbulent market of 2016, thanks to evidence its cloud-based businesses are growing. Azure and Office 365 may be cannibalizing older businesses but not as hungrily as the cloud is cannibalizing other giants like Oracle and IBM.
Office 365's subscription-based revenue, for example, is growing by 70 percent a year, driven largely by the enterprise market. That's enough to push Office's total revenue up 5 percent last quarter. Azure revenue, meanwhile, grew by 140 percent last quarter. And the two businesses are helping each other. “We see that Azure customers who also purchase Office 365 consume eight times more Azure than other customers,” Nadella said last month.
If that continues, it could mean a bright new era for Microsoft. “The enterprise cloud opportunity is massive, larger than any market we have ever participated in,” Nadella told investors. “Our commercial cloud run rate surpassed $9.4 billion, up over 70 percent year over year and almost halfway to our goal of $20 billion. We nearly doubled our cloud customers over the last 12 months.”
Microsoft still faces a huge threat in the decline of the traditional PC. Sales of laptops had been stabilizing in the past year or so, but that stability may be ending. Pacific Crest warned that the slowdown in laptop shipments may be accelerating, with early indications that they could fall 13 percent in the current quarter.
Microsoft's response has been to morph Windows into a cross-platform OS with Windows 10. The result is the usual litany of complaints whenever Microsoft makes a big change in Windows. But early indications are the move is working in terms of sales. Released last July, Windows 10 was running on more than 200 million devices six months later, 140 percent better than the adoption rate of Windows 7. The cross-platform design of Windows 10 is in essence a bridge from the collapsing PC market to new devices.
Windows was always the center of the Microsoft machine, driving most of its profits. Despite its recent evolution, it's become less and less relevant as a device OS. It lags Android by a long shot, and Gartner expects it to slip soon behind Apple's iOS/OS X combo. And so the cloud business becomes more important to Microsoft's future. And in doing so, it's chief rival will not be Apple or Google, but Amazon.
Amazon's early entry in cloud services has given it a dominant share of the market, but Microsoft is growing in popularity among enterprise clients, giving it a larger share than IBM and Google. The battle for the corporate cloud may not be a global phenomenon as much as one surrounding Lake Washington.
Cloud services is growing so quickly the market isn't likely to become a zero-sum game any time soon, so Amazon and Microsoft will see their cloud businesses expand. Still, Microsoft has one advantage over Amazon: A broader suite of offerings, including servers and tools to let customers build a hybrid cloud - that is, one that pairs Microsoft's cloud with a servers on a client's premises. Amazon has largely shunned the hybrid-cloud model so far.
The hybrid cloud isn't only growing in popularity among companies, it's a potential safeguard against Azure cannibalizing Microsoft's higher-margin server business. Analysts had expressed concern that Azure's rent-a-cloud model would hurt sales of server tools, but the hybrid cloud could be creating demand for both. Server product revenue rose 10 percent last quarter.
Microsoft still faces a lot of challenges. The old PC OS business that built the company's early success remains a drain on its overall growth. The company's decision to move away from it as quickly as possible is proving shrewd, even if it means a sharp break from the company's original DNA. Microsoft in 1996 would have tried to crush Microsoft of 2016. But this isn't 1996. And because of that, the new Microsoft is facing a brighter future than it has since the late 1990s.