MSFTextrememakeover

Tuesday, August 21, 2007

Home runs, base hits, virtual aspirations and actual failure

As shareholders we all want MSFT's "investments" to pay off. The company obviously can't live on just its legacy cash cows forever. New accretive investments offer the potential for not just keeping the company strong, but also [finally] accelerating earnings.

Unfortunately, as per my last post, most haven't over the past decade. Sure, they've taken the up-front cash required by most investments - way more than most in fact. It's that niggling little thing called profit, or shareholder value created, that's proven elusive for the current leadership team. Which is why we now get CFO Liddell belatedly telling us that we shouldn't look for normal internal rates of return from these efforts like at other companies. MSFT "investments", you see, are special. They don't follow normal convention. Instead, they are "winners-take-all" events. MSFT is swinging for the fences; They're not interested in mere base hits. And all those apparent strikeouts so far? Well, they're hoping the game goes into extra innings.

Let's examine how this has worked out in just one area - virtualization. Back in 2003, in a uncharacteristically non-laggard move, MSFT bought the virtualization guts from Connectix. Since that time, they've done what they often do after making an acquisition: buried it in bureaucracy, forced it to be a cog in some massive overall strategic architecture plan, and continued pouring cash into it. The result? According to Trip Chowdhry, senior software analyst at Global Equities Research:

The Redmond, Wash.-based software giant has 'been a total failure when it comes to virtualization'.

Tell us what you really think, Trip. Sadly, that's accurate.

Meanwhile, EMC was busy buying a small software company. When asked about it now, they indicate that their go-in expectations were rather modest; They were just looking for a base hit. That company was VMware, acquired by EMC back in 2004 for $625M. On August 14th, 2007, following an IPO for VMware, EMC's remaining 85.6% stake was worth $16B (even more now btw, with total marketcap approaching $27B). And that's after already receiving $218.5M and $150M from INTC and CSCO respectively for a piece of the action.

In other words, for just $625M, EMC (primarily a hardware vendor) managed to buy a software company - a year after MSFT's entry into the segment - and still generate more shareholder value in just three years than MSFT (the world's largest software company) has generated from all of its investments combined over the last decade, with the possible exception of Server and Tools (although that's predates a decade). Oh, and did I mention that along the way VMware has been profitable (something this and other equivalent MSFT efforts almost never are) AND is the category leader despite MSFT's best efforts to unseat them in what even senior management concede is an increasing strategic area?

BTW, for more on VMware see here:

MSFT is a large company and it's reasonable to assume that some opportunities are too small to be pursued because they won't "move the needle" in a meaningful way. However, the current strategy of eschewing base hits for home runs clearly hasn't worked either. The latter have mostly turned into strikeouts, either clearly or soon-to-be. Meanwhile, a few decent base hits like VMware in MSFT supposed core area of expertise (software) -and a strategic one at that - could have put up numbers meaningful even to a company of its size. And in this case it's not like MSFT wasn't there early and spending equivalent amounts of money to succeed. They simply failed to focus, prioritize and win the game. Apparently it was more important to dream about other possible match-ups in different leagues entirely, and spend $20B+ to field new teams like Xbox, for example, only to now risk "becoming a distant third in the battle for market share in the video game business".

The real shame - and waste - is that the internal virtualization team at MSFT probably contains many members who are just as pissed off and embarrassed by this lackluster performance. It's likely not lost on them that just up the road in Washington State, Parallels is generating more buzz vs VMware than MSFT. But they're likely hamstrung by the stifling bureaucracy that's telling us everything will be better if the game goes into extra innings. Server 2008 will come in to relieve, and brings new virtualization/hypervisor functionality. Well, not right away when Server ships mind you - whenever that ends up being. But 180 days later - or thereabouts. Because...well, you know. And "it'll be great" - or maybe just okay. Because...well, you know. That's what Ballmer said about Vista too and look what happened.

Meanwhile the stock continues to under perform. If you're keeping track, that's now under performance versus all three major indexes on an intraday, 5 day, 10 day, 1 month, 3 month, YTD, 1 year, 3 year, 5 year, and decade to date basis. Go figure.

Update: (Related)

As an aside, at what point can we hope for a management team that rather than cite their ability to come from behind as a badge of honor, will deal with the underlying reasons why they're always late to market - or at least slow out of the gate - and need three generations minimum before being competitive?

Update #2: (Related)

Excerpt:

Microsoft is far behind and everybody else, including XenSource, is a speck on the horizon.

Update #3: Some actual good news on the VM front:

9 Comments:

  • or, to your point, what exactly did MSFT do with the technology it acquired alongside Ray Ozzie - Groove Networks ?

    By Anonymous Anonymous, at 1:31 PM  

  • wow; great insight! so what do you do as a shareholder? management doesn't sweat the "small stuff" that you have so aptly described...

    By Anonymous Anonymous, at 6:16 PM  

  • Since that time, they've done what they often do after making an acquisition: buried it in bureaucracy, forced it to be a cog in some massive overall strategic architecture plan, and continued pouring cash into it.

    They may also be slowly coming to the realization that a full function high performance implementation of OS virtualization requires changes that the Windows architecture and infrastructure is too convoluted and monolithic to readily accommodate, without breaking everything else.

    Also, given the MS tendancy to tie/lock applications into the OS, implementing application virtualization may impact application layers presently embedded in the OS.

    So, mismanged, yes, but the complexity for a Windows implementation may be proving a bit daunting technically as well.

    By Anonymous Charles, at 7:45 PM  

  • Dude chill out. You seem to be unnecesarily bothered by MSFT's performance. Nobody cares. Neither the executive team, the employees or the shareholders. The stock has died long ago.

    By Anonymous Anonymous, at 8:06 PM  

  • I'll leave my comment to Dilbert (think he must read your blog) @ http://www.dilbert.com/comics/dilbert/archive/dilbert-20070822.html

    By Anonymous Anonymous, at 3:47 AM  

  • Didn't Microsoft acquire Connectix in order to kill it, to further try to drive a stake into Apple's penetration into the business market?

    By Anonymous Anonymous, at 4:53 AM  

  • "Didn't Microsoft acquire Connectix in order to kill it, to further try to drive a stake into Apple's penetration into the business market?"

    Not that I recall. I don't think they were that worried about AAPL back in 2003, and especially not in the business market.

    By Blogger MSFTextrememakeover, at 9:23 AM  

  • MSFT needs to have a "winner-takes-all" approach because they only know how to be profitable in a market that they have monopoly control over. They've never been adept at being profitable in a market where they are competing with other companies.

    As for virtualization, MSFT correctly recognized it as an emerging market. They didn't want to spend a lot of money so went after Connectix rather than VMware, but it really didn't matter which they chose: either company would have been destroyed in the assimilation process and have the drive and creativity hammered out of it. It isn't clear whether they ever intended to use virtualization to generate profit, rather than to simply better control the platform that props up the Windows monopoly.

    By Anonymous Anonymous, at 9:58 AM  

  • The swing for the fences habit is born from MSFT's internal evaluation and promotion mechanism. Over on Mini, they're talking about review scores. For anyone with more than five years experience, doing a steady, solid job, hitting a single, gets you ranked in the middle of the pack at review time. That earns you a 2% raise, a 7% bonus, a smattering of stock that vests over 5 years, and almost certainly no promotion. Do that for two or three years in a row, and instead of being ranked in the middle of the pack, hitting that same single will get you dropped down to the bottom 10%, and given the message that your future career at Microsoft is limited because your promotion velocity is too low. In a couple more years, you'll be managed out.

    Getting promoted requires swinging for the fences. It's been that way for years. But during the 90's, stock options paid well enough that having your career fizzle out still paid extremely well, so there were plenty of people who focused on getting their job's done.

    Since 2000, those people have been getting steadily more and more disenchanted with the company and leaving. The company meanwhile, has been stocking it's management ranks with swing-for-the-fences types for so long that's all they know how to do.

    It's one of the great ironies that Microsoft's struggles are because it got exactly what it wanted out of it's internal personell evaluation system.

    By Anonymous Anonymous, at 9:21 AM  

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