Microsoft (MSFT, Financial) never officially announced any structural changes to its business, but the way the company has been re-aligning its focus areas and shedding unwanted business units it looks like there is, in fact, a major restructuring effort in progress.
Let me elaborate.
Recently, their legacy Windows business was pushed to the sidelines while cloud and Office 365 have become the main focus. After buying Nokia (NOK, Financial) for more than $7 billion, the company has now wriggled out of the feature-phone business. And they have spent nearly $26 billion to bring a social network into the mix.
The Nokia story itself is an interesting one because it happened just three months after Nadella took over as CEO. As such, it was one of former CEO Steve Ballmer’s legacy moves. But for all his good intentions, hardware-software marriages are only made in Apple heaven it seems. Even Google (GOOG) failed spectacularly in its efforts when it tried to enter the mobile manufacturing world with the Motorola (MSI, Financial) acquisition, and Microsoft followed suit.
Nearly a year after the acquisition, Microsoft wrote off its Nokia investment and sold off parts of the mobile business to other players. The impairment charges on the deal alone was $7.6 billion, almost the entire amount that it paid for the Finnish company’s business units and patents the year before.
The Mobile Manufacturing Segment
Mobile phone manufacturing is a cut-throat, low-margin business. It is an innovation-intensive industry where you have to keep up with the competition, constantly coming out with new products and keep investing big money for small returns. Except for Apple (AAPL, Financial), which boasts operating margins in the 30% range, there is no other mobile phone manufacturing company that comes close to that number. It is also worth noting that Apple’s products sit in the luxury category of smartphones and electronic devices, and if they can make only 30% then you can imagine where other players might be.
Take a look at the not-so-small Samsung (SSNLF, Financial), for example.
During the period between 2012 and 2014, Samsung was only making between 15% and 20% as their profit margin. That suddenly plummeted to slightly over 7% before showing incremental gains. Since then, Samsung has released several premium models with higher margins on them, but the bulk of their sales come from budget and mid-range smartphones.
What Is Microsoft Doing Now?
After shedding their feature-phone business, Microsoft still retained device manufacturing so they would not have to depend on OEMs to build devices that will eventually run on Windows 10 Mobile. With Surface devices, the company is now trying to do what Apple has been very successful at for decades - company-made devices that run on company-made operating systems.
The launch of the Surface brand in 2012 has more to it than merely allowing Microsoft to compete in the tablet market. That market is already very crowded, with everyone from Apple to Samsung to Lenovo (HKSE:00992, Financial) in the fray, so Microsoft is not just looking to be a device manufacturer. There is more to it than that.
To understand Microsoft’s direction with devices and their need to be in the segment, we need to look at what Nadella told ZDNet’s Mary Jo Foley in July of 2015:
"If there are a lot of OEMs, we'll have one strategy. If there are no OEMs, we'll have one strategy. We are committed to having the phones in these three segments. And I think the operational details will become clear to people as they see it."
And the section that makes it clear for all:
"Because all of this comes down to how are you going to get developers to come to Windows. If you come to Windows, you are going to be on the phone, too. Even if you want to come to Windows because of HoloLens, you want to come to it because of Xbox, you want to come to the desktop, all those get you to the phone. It's not about let's do head-on competition. That will never work. You have to have a differentiated point of view." - Windowscentral
So Microsoft wants to do all these things: make their own tablets and phones, work with OEMs (third-party manufacturers) and create an environment that is organically interlinked to its other products and services. But in the end it all leads to mobile first, which is the first part of his ‘mobile first, cloud first’ mandate as CEO.
But now that makes a full circle back to Windows. But, the Windows of today is vastly different from the Windows of PCs past. Microsoft wants to sit at the edge of the device market, not in the middle of it because there is not much money for non-premium devices. But they need their own devices to push their Windows 10 agenda forward.
So in the end the company is still be about Windows, but with a significant twist to the plot. They are looking at building an ecosystem of hardware and software so developers will come. When the developers come, the consumers will automatically make a beeline for their products, which also carry their software.
As such, Microsoft is not going to give up its device business any time soon. They need it as part of the ecosystem they are building. The upcoming Surface Pro 5, Surface Phone and Surface Cardinal are all part of that ecosystem, as is the Xbox or HoloLens.
The company is not looking to become another Apple Inc. It is merely trying to become a better, stronger Microsoft Corporation. Nothing more, but certainly nothing less.
Disclosure: I have no positions in any of the stocks mentioned above and no intention to initiate a position in the next 72 hours.
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