By David Zeiler
There are monopolies. And then there's Microsoft Corp. (Nasdaq: MSFT).
With its Windows operating system installed on virtually all of the world's PCs - the market share peaked at about 95% - Microsoft became synonymous with the personal computer revolution.
And it didn't stop there. After locking up the operating-system market, Microsoft did nearly the same thing in the applications market with its Office suite of productivity software.
The breathtaking margins - 85% for Windows and 79% for Office - combined with the explosive growth of the PC market sent Microsoft shares on a 9,000% ride during the 1990s. So dominant was Microsoft that it drew the attention of government anti-trust watchdogs in both the United States and the European Union [EU]. The lawsuits, designed to curb the Redmond, WA-based tech giant from bullying smaller rivals, did little to slow down the Microsoft juggernaut.
But Microsoft's mastery of its markets and the slowing growth rate in the PC market that followed the "dot-bomb" implosion of 2000 ended the years of eye-popping increases. The decade that followed taught Microsoft investors a very hard lesson: The market doesn't reward companies that rake in profits but show only modest rates of growth.
From 2001 to 2011, while the tech-heavy Nasdaq Composite Index has gained 34%, Microsoft shares have plunged 25%. In just the past year, while the Nasdaq has surged 20%, Microsoft shares have declined some 16%.
"Microsoft got huge and failed to deal with the consequences," Paul Allen, a company co-founder, wrote in his recent book "Idea Man."
From PC Potentate to Mobile Misfit
Microsoft has also failed to deal with two major market changes that directly affect both its business and its market position. We're talking, of course, about the slowdown in the PC market - and the shift toward the mobile Internet.
The stalling PC market has a direct impact on the sales of Windows and Office, the dynamic duo that powers Microsoft's profits and share price. According to stock-analysis firm Trefis, Windows accounts for 39.6% of the stock price, and Office 35.3%.
When Microsoft revealed last month that Windows sales had slumped 4% in the most recent quarter, the stock slid another 3% despite a 19% rise in profits (excluding a one-time benefit from a settlement with the Internal Revenue Service).
Even though they had good earnings, the PC market is under scrutiny and there continues to be uncertainty on whether or not Microsoft can compete with the growing tablet and handheld devices from the likes of Samsung and Motorola.
Researcher Gartner Inc. (NYSE: IT) said that first-quarter PC sales were down 1.1% from the same period last year. The shift toward mobile computing - driven by the growing consumer adoptions of smartphones and "tablets" such as the Apple Inc. (Nasdaq: AAPL) iPad - is blunting the demand for PCs.Mikako Kitagawa, a principal analyst at Gartner, said in a statement:
Weak demand for consumer PCs was the biggest inhibitor of growth. Low prices for consumer PCs, which had long stimulated growth, no longer attracted buyers. Instead, consumers turned their attention tomedia tabletsand other consumer electronics.
Even those who disagreed tablets were responsible for the decline - The NPD Group Inc. says PC sales seem to have dropped because of unusually strong sales in the year-ago period - acknowledge the looming mobile-computing threat.
The big challenge for [PC manufacturers] going forward with the iPad is for that second or third computer in the house," NPD analyst Stephen Baker told Computerworld. "In the next six to 12 to 18 months, as consumers think about replacing the rest of their installed base of older PCs, people are going to start asking, 'What's right for me, another PC or a tablet?' That should give anyone in the PC business cause for concern.'
And that's just the half of it. Consumers also are increasingly using their smartphones for such low-level-computing tasks such as e-mail, social networking and Web browsing.
Mobile computing is clearly the new mother lode of high-tech-sector profits, but Microsoft has been unable to stake its claim.
Windows runs fewer than 5% of smartphones and almost no tablets. Operating systems from such Microsoft rivals as Apple (NASDAQ:AAPL) (with its iOS operating system) and Google Inc. (Nasdaq: GOOG) (which markets the Android OS) are currently dominating the mobile OS market.
The shift toward mobile devices already has reached a tipping point. Consulting firm Deloitte LLP has projected that 2011 will be the first year that the combined sales of tablets and smartphones will exceed those of laptops, desktops and notebooks.
And the trend could well spread beyond the consumer realm and into the enterprise market - Microsoft's most cherished turf. Last year, Apple reported that in excess of 80% of Fortune 500 companies were deploying or testing the iPhone; more than 65% were deploying or testing the iPad.
It's called the "consumerization" of IT: Workers are bringing the devices that they use at home into the workplace, and then are asking to have those devices incorporated into the company network. If companies adopt non-Windows-powered tablets in significant numbers, Microsoft will have to waste resources defending a core market.
Cloud computing adds to the threat, as companies also may decide that the free, available-from-anywhere Google Apps can replace Microsoft Office. That's no small worry - particularly since companies are beginning to use large numbers of mobile devices.
One Misfire Follows AnotherThe inability to deal with the mobile threat to its key franchises is actually symptomatic of a more basic - but critical - problem facing Microsoft.
Microsoft management has tried - and failed - for years to answer a single question: How can we grow the company past its Windows-Office profit machine?
Just about every attempt to answer that question has ended in failure. For instance:
- Its best effort, the Xbox gaming division, does make money - but not enough to move the growth needle inside a company that generates more than $5 billion in revenue per quarter. Microsoft's Entertainment Division, which includes the Xbox, made a $225 million profit for the March quarter.
- In 1997, Microsoft bought WebTV, a set-top box that provided Internet access via a user's TV. The product struggled for years; sales of the hardware were finally halted in 2009.
- The online division, which includes the MSN portal site, aQuantive Web advertising and Bing search engine, perennially loses money - including a loss of $726 million in the most recent quarter alone.
- The Zune MP3 player - despite being a very good product - struggled against Apple's iPod, and never got more than 3% of the market. Reports earlier this year claimed Microsoft will produce no more new versions of the Zune. And Microsoft found once again that "me too" products won't clear the bar in a discriminating market.
It had a tablet PC as far back as 2001, but their swivel keyboards and stylus-based interfaces were awkward to use. That, and the general unavailability of Wi-fi back then, doomed the early Windows tablets to niche status.
Manufacturers of the more recent iPad-style media tablets have preferred Google's Android over Windows 7. The Honeycomb version of Android has a better touch interface than Windows. Besides, it's free. Even in smartphones, the story is similar - years of effort with scant results to show for it. Microsoft developed its first phone-specific operating system, Windows CE, 15 years ago and collaborated with HTC Corp. on an early Windows smartphone, the Orange SPV, in 2002. But market share for Windows among phones peaked at about 23% in 2004, and has fallen every year since. Last year, it dropped to 4.2%.
Microsoft also tried to buy its way to smartphone success by acquiring the mobile-computing software-and-services company Danger Inc. in 2008. The fruit of that acquisition, the Kin phone, debuted in May 2010, but was discontinued less than two months later due to poor sales.
Although partner Verizon Communications Inc. (NYSE: VZ) revived the Kin as a low-cost "feature phone" in November, Microsoft refocused its energies on Windows Phone 7. Released last fall, Windows Phone 7 was supposed to revive Microsoft's smartphone fortunes, but hasn't made much of a dent in the market.
Three Moves Aimed at a Mobile-Market Victory
Microsoft leaders still hope to pull off a win in the mobile-computing market. In the near-term, Microsoft is banking on a deal with Nokia Corp. (NYSE ADR:NOK), announced in March, that will put Windows Phone 7 on Nokia smartphones. Gartner and IDC both predicted last month that the Nokia deal would deliver about 20% of the smartphone OS market to Microsoft by 2016, but even 20% is nowhere near the 95% Microsoft once enjoyed in the PC market. And some say Microsoft will be hard-pressed to get even 20% of the market.
Windows Phone 7... which shipped in two million handsets in Q4 2010, will have to find incredible success through its Nokia channel to take more than 7% of the market by 2016.
Microsoft also has made some dramatic acquisitions, most notably its recent $8.5 billion purchase of Skype, to somehow get traction in mobile computing by integrating well-regarded technology invented elsewhere into its Windows products.
It's too soon to tell if adding the Web-calling capabilities of Skype will make any measurable difference, but previous acquisitions haven't had the desired results.
However, there is hope for some for success in the mobile-computing success with Microsoft's Windows 8, which the company says will be optimized for tablets. A recent Forrester Research Inc. (Nasdaq: FORR) survey showed 46% of the U.S. consumers queried wanted Windows on a tablet. Only 9% of the U.S. consumers queried said they wanted Android, and 16% preferred Apple.
Microsoft could be a force in the tablet market if it gets Windows 8 right, but that OS upgrade won't be released until the latter part of 2012 - more than a year from now.
Given the likelihood of a gradual erosion of the PC market, Microsoft needs to come up with an effective mobile strategy soon, or it could face the only thing worse than stagnation - contraction.
The biggest overhang on the stock is they're losing share to tablets and they don't have an answer to that. They're trying to survive in an new era where it's a post-PC era.