Microsoft And Its Legacy Problem

May. 1.14 | About: Microsoft Corporation (MSFT)


Every time there is a change in chief executive officers, there is a "legacy" problem that the new CEO has to deal with.

For Microsoft, one of the major "legacy" issues Satya Nadella, Microsoft's new CEO, has to deal with is the newly-acquired Nokia handset division.

How Mr. Nadella deals with his legacy problems will go a long way to determining his success.

Steve Ballmer, the former president and chief executive officer of Microsoft Corp. (NASDAQ:MSFT), left his successor three major legacies.

First, he left Microsoft with the culture and vision he had promoted for thirteen years. Second, he just reorganized the company. And, third, he announced just before he left the acquisition of the Nokia (NYSE:NOK) handset division.

Two things have happened since Mr. Ballmer resigned. First, the price of Microsoft stock has gone up. Not much, but in the 14 percent to 16 percent range.

Second, the price of Nokia stock has gone up approximately 85 percent since the deal for the handset division was first announced last September.

No chief executive officer likes to see results like this.

The first result basically came after Microsoft stock price flatlined around the mid-$30s during Mr. Ballmer's tenure as CEO.

The second result apparently comes from the fact that the handset market for Nokia was diving. In the first quarter, handset sales at Nokia fell dramatically, and the net loss for the division was in the neighborhood of €350 million (around $475 million).

The handset business had been declining for some time, and Nokia, like some other companies, like Google (GOOG, GOOGL) who sold off the handset business it had acquired from Motorola to Lenovo (OTCPK:LNVGF), and Ericsson (NASDAQ:ERIC) of Sweden who sold off its handset business to Huawei of China, decided to sell. Investors, obviously, liked the decision.

Now, Microsoft has a handset division. The question is… what is Microsoft going to do with it?

Mr. Ballmer had his sights set on "devices and services."

Satya Nadella, Microsoft's new president and CEO, has voiced a different view: "mobile and cloud." He has recently voiced his different view.

"I see a world where computing is more ubiquitous and all experiences are powered by ambient intelligence."

He continued,

"In a world of ubiquitous computing, we want Windows to be ubiquitous. We think about users and their experiences spanning a variety of devices."

One argument for having a handset division is that Microsoft has no alternative. As presented by Richard Waters in the Financial Times:

"As the producer of around 90 percent of the handsets carrying Windows Phone software, Nokia was too important to Microsoft to risk losing: had it followed other handset makers into the Android camp, it might have dealt a fatal blow to Microsoft's hopes of becoming a force in smartphones, the dominant computing platform of the day."

And, if Nadella wants to "think about users and their experiences spanning a variety of devices," Microsoft may have to have some kind of presence in the handset business.

But Mr. Nadella must make sure that the vision of Microsoft stays focused, and must make sure that his decisions clearly support this vision. He cannot afford to hedge his bets at this time.

This is why it is was a little disconcerting to hear Stephen Elop, who comes back to Microsoft as a part of the acquisition, was quoted in another article in the Financial Times as saying that,

"Microsoft is developing a brand for forthcoming smartphone products...." This effort "will not use Nokia or Microsoft Mobile as had been speculated for the next stage in its attempt to crack the smartphone market."

Mr. Elop is the vice president of Microsoft's Devices & Services business unit. Sounds like this is a throwback to the Ballmer re-organization.

Mr. Nadella, in order to be consistent with his vision stated above, must use the handset division to support the "mobile and cloud" model and not let the acquisition divert him from what he needs to do. Computing must become ubiquitous.

Google, for example, is spending more than anyone else on this vision. Dan Gallagher writes in the Wall Street Journal that Google's rising spending "reflects what the tech business has become: a platform game. This involves the provision of mobile and cloud-based services backed by large networks of data centers." The business now is not a devices play.

Richard Waters, in the first Financial Times article mentioned above, lays out only two choices for Mr. Nadella. The first is for the handset business to "stand on its own two feet." That is, it must build a bigger niche for itself in a market that is dominated by the Android operating system, which controls 80 percent of the market, and the iPhone system that holds 14 percent of the market.

We saw what the handset division did as a part of Nokia, and investors cheered the departure of this division by dramatically pushing up the price of Nokia's stock. The feeling I get is Microsoft investors at not that enamored with the handset division, now at Microsoft, going on its own.

This brings up the second option, where the choice is to have Nokia handsets "become an important part of the broader mobile ecosystem that Microsoft has been building." Here, Microsoft would "present a single, unified Windows across all devices" so that customers would bet a unique, consistent experience across all devices.

But, Waters closes, Mr. Nadella has an even broader vision: "His sights are set on creating software-enabled services that can find an audience no matter what the platform." This thrust was signaled by last month's announcement of a touch-based Office for Apple's (NASDAQ:AAPL) iPad.

This is the battle for the future within Microsoft. New CEOs always have to deal with the "legacies" of their predecessors. How the new CEO handles these "legacies" and moves on into the future is an important thing to keep your eye on.

Mr. Ballmer took over a dynamic structure from a legendary predecessor. He just could not live up to the legend.

Now, Mr. Nadella has to deal with the legacy Ballmer has left him, and even though the company is earning 15 percent or more on its equity, Microsoft is now dealing from "behind the curve." Continuing to focus on devices, like handsets, or on services, like the Bing search engine and the XBox, is not going to get the company into the future.

But, firm decisions to get the "legacies" behind him are going to define the tenure of Mr. Nadella at the top. I have just written another post about a CEO that has had a very difficult time "putting the past behind him."

For the new CEO, if you do not act decisively to put the "legacies" behind you, you end up struggling for a long time. And, with each passing year, it becomes harder and harder to move forward and catch up... or get ahead... of the curve. So, we need to watch Mr. Nadella closely.

Disclosure: I am long MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.