I met Satya Nadella, the newish CEO of Microsoft a couple of weeks ago. I say “met” because we shook hands and exchanged a few pleasantries. However, given the conga line to greet him at the party held by Keith Krach, CEO of DocuSign, in his sumptuous house in Pacific Heights, San Francisco, I’d be surprised if he has any memory of the encounter. The accompanying pic is the best evidence that it did take place.
So, of course, I have no idea who Nadella really is and have no sense of what drives him. All I have is what you have: published reports. And in my case, a few asides from people in the industry who do business with him. Thus, I remain baffled by the direction he is taking Microsoft with respect to its partners. I will do my best to construct a logic flow that explains what is going on up in Redmond.
Let’s start with the basic business model. Microsoft has traditionally sold software to users through various channels. That has been its main business for many years. In contrast, Google sells user eyeballs to advertisers, and Apple sells high-margin hardware to end users.
Recently, it has become more difficult for Microsoft to sell software because both Google and Apple tend to give it away. So, toward the end of the Steve Ballmer era and carrying into the Nadella era, Microsoft has been pushing into new areas, notably services and hardware.
Microsoft has always had a hardware division. Originally, it made mice and keyboards to help grease the skids for Windows systems. It also created prototype systems for the software development teams to work with as well as reference designs for hardware partners to use.
Now, however, the company has begun to compete directly with its own channel, particularly the hardware OEMs. When the company announced its latest foray into hardware Oct. 6, it not only refreshed its phones and tablets, but for the first time brought out a so-called 2in1 notebook as well. A 2in1 is a notebook can serve as a tablet, too, when the keyboard is detached.
In the Wall Street Journal article covering the announcement, Dell put on a game face and said something about coopetition, but neither Lenovo, the world’s #1 PC maker, nor Hewlett-Packard, the #2, had any comment. Which is what companies say when they are spitting mad.
Microsoft is stepping on its biggest channel’s toes. Most of its software goes out to the market on PCs built by these three companies. Why would it do such a thing? This is the part that perplexes me. The Surface Book, as the 2in1 notebook is called, is positioned at the high end with a starting price of $1,499. While volumes at that price point are relatively low, profits on those units are usually better. And since the PC hardware OEMs sell a lot of hardware at lower prices and profits, they need the high end to help even things out.
Why is Microsoft sailing upwind of its own partners?
Well, for one thing, it thinks it can. Where are they going to go if not to Microsoft? Apple won’t have them. I’ve heard Dell executives say that they would license Mac OS in a heartbeat. But Steve Jobs cut off that avenue when he retook over Apple in 1997. Apple’s hardware partners at the time were skimming the cream off Apple’s efforts, and Jobs didn’t like it. Google represents an alternative, and the OEMs are availing themselves of it where they can. All of them have Chromebooks in their lineups, and Lenovo has Android phones. But Microsoft software is sticky in the companies’ main commercial markets. So, as channels, they have nowhere to turn.
For another, it thinks it has to. As software sales become more of an uphill slog, Microsoft needs to make money other ways. And hardware is one of the chosen ways. The company has said there’s plenty of room for its partners, it is just setting the bar high for new systems, and it has to demonstrate how hardware can accommodate some of the new features of Windows 10. But some of its partners have been pushing the envelope on these types of systems for years already.
In fact, Lenovo invented the 2in1 when it brought one out under the brand name Yoga four years ago. The company reports that the 2in1 has been its fastest-growing category. Its Yoga consumer models range from $299 to $1,599. It also recently brought Yoga features to its commercial ThinkPad line. The “watchband hinge” on the high-end models is a work of art.
So, Microsoft isn’t doing its partners any favor here. It’s just trying to skim their high end. What can possibly go wrong?
The conclusion is that Microsoft is not just an unthinking parasite, sucking on its hosts’ blood until they expire. It must believe that it can establish its own hardware business before they either die or abandon the software maker as a supplier. It’s a calculated gamble, which may — or may not — pay off.