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Corporate Diversification Strategy of Microsoft

Corporate Diversification Strategy of Microsoft

April 6, 2014 8:35 pm8 comments

Hi Everyone,
    Microsoft has been in the news for a lot of different reasons lately. Whether it was the naming of the new CEO, Satya Nadella, the release of the new Xbox, their purchase of Nokia, or, most recently, their move to put Office on the iPad, Microsoft has to make a lot of very important decisions, but how do that do that? Major decisions like the ones described in the news recently need context. Why should Microsoft buy Nokia? What do they gain? Should they go into the handset market? All of these questions depend on how the company sets up its corporate diversity strategy. Below is my corporate diversification strategy analysis of Microsoft. Note it was written prior to the release of Office on iPad.

Analysis:
Microsoft is a software, services, and solutions provider based in Redmond, Washington. They are a $77 billion company with almost 100,000 employees (Microsoft, 2014). Microsoft is mostly known for its Windows operating system and Office products featuring Word, Excel, and PowerPoint. Microsoft has five major strategic business units: Windows Division, Server and Tools, Online Services Division, Microsoft Business Division, and Entertainment and Devices Division. Appendix A lists principle products for each segment.

Corporate-level activities for Microsoft include broad-based sales and marketing, product support services, human resources, legal, finance, information technology (IT), corporate development and procurement activities, research and development (R&D), costs of operating retail stores, and legal settlements and contingencies. The total cost of corporate-level activities in 2013 was $6,665 million (U.S. Securities and Exchange Commission, 2014). While there is no public information regarding allocation of these costs, many of the activities are apparently not allocated specifically to segments (e.g. broad-based sales and marketing, human resources, legal, costs of operating retail stores, and legal settlements and contingencies). For example, legal settlements and contingencies would arise unexpectedly and then be billed at the corporate-level. For activities like information technology and research and development, it is assumed that the segments would need to request these funds during their corporate budgeting cycle. The general amount spent towards R&D, for example, is most likely determined prior to the start of the fiscal year by taking into account previous spending, upcoming projects, R&D emphasis changes, and available funds. From the amount allocated to each activity, there would be a process for each segment to obtain resources.

In order to understand the interplay of Microsoft’s business segments, the operating incomes of all segments were plotted for the previous four years (Figure 1).

Figure 1: Microsoft Business Segment’s Operating Income
Screen Shot 2014-04-06 at 9.27.39 PM

Based on the products described in Appendix A and the incomes from each segment in Figure 1, an understanding of where each segment belongs on Boston Consulting Group’s unrelated diversification matrix (Appendix B) can be arrived at. The matrix applied specifically to Microsoft is shown in Figure 2.

The Microsoft Business Division and the Windows Division are cows. These segments have high income for Microsoft that they can milk. Additionally, they operate in industries that have low market growth and the products in these segments have high market share with the exception of a few products.

Currently there are no stars for Microsoft, but they are investing in certain products like OneDrive, the Surface tablets, and entertainment devices in hopes of finding a star. The sub-segment diversifcation strategy should be noted. Xbox is within the Entertainment and Devices Division, another cow type product, that is most likely being used to fund more questionable products like the Windows phone. A similar sub-segment diversification strategy is the Windows operating system supporting the OneDrive and tablet products. Unfortunately, there are no public figures regarding each specific segment, which would allow for a deeper analysis to be done.

In terms of the dogs, the Online Services Division and the Server Tools Division are great examples. Both of these divisions have low market share (e.g. Bing(1/3) vs Google(2/3) (MadWire Media, 2013) or Windows server(14%) vs Linux(65%) (Netcraft, 2014)) and have low market growth as both industries have matured.

Figure 2: BCG Matrix Applied To Microsoft*
Screen Shot 2014-04-06 at 9.27.54 PM
*Bold=Business segments
non-bold=notable exception products (i.e. their segment is categorized differently)

Based on the the BCG matrix, Microsoft is correctly taking from cows and investing in question marks. They are not following the BCG principles by allowing the dogs to continue to survive. The ownership test provides some insight as to why this may be. If the Server and Tools segment was an independent company, it would not perform near as well because of the synergies with the Windows Division. Additionally, this demonstrates a good example of the better off test for the Server and Tools segment. They are better off under the Microsoft umbrella for the same synergies. Neither test would pass for the Online Services Division. How does having Bing or MSN help Microsoft? The potential answer to this question is discussed in more detail later in the paper.

Company wide there is a lot of collaboration. For example, all of the software is designed to work together. The Windows operating system lets clients work with Microsoft servers, but the Windows operating system also lets clients collaborate together through the Office suite. The Xbox is the most independent product because it doesn’t integrate with the Windows operating system for most users, although it can be used to stream media from a Windows operating system. All of these segments use the corporate-level functions described previously. Each segment can use corporate-level resources like legal, human resources, IT, and R&D, but how much they use each function varies. Overall, Microsoft’s diversification strategy is related.

The major result of this collaboration amongst segments is a synergy. Imagine a large corporation that uses all Windows PCs. As an IT purchaser, there is a push to also purchase Windows servers, because they are designed to work flawlessly with each of those PCs. This same synergistic principle can be applied to all of the business division products (e.g. Office). This has a huge synergistic value when 91% of PCs run windows (NetMarketShare, 2014). Another example is OneDrive’s (i.e. like Dropbox) recent integration with Office to allow documents to be stored in the cloud for enhanced collaboration with teams.

The integration of Microsoft products can also have negative synergies. A great example is related to OneDrive and Office. By Microsoft forcing only the integration of OneDrive for corporate reasons, they are not allowing Office to integrate Dropbox’s 200 million users (Constine, 2013). This hurts Office’s ability to grow, but helps the company form a corporate ecosystem.

Microsoft is a very vertically integrated software company. It does all of its design in house, because that is its intellectual property–the code. Other services are outsourced like internal IT (Thibodeau, 2010) and commoditized legal services (Mintzer, 2013). These services are not core competencies for Microsoft. Microsoft should stay with the same level of vertical integration. They should only outsource elements of the business that are not a core competency for them, because this will ensure no other company can imitate them.

One of the major advantages that comes with massive vertical integration is a parenting advantage for Microsoft. An example of the parenting advantage is their R&D department. In 2012, Microsoft spent more than Oracle, Google, IBM, Apple, and HP on R&D to the tune of $8.7 billion (Banerjee, 2012). This large R&D department can be utilized by any Microsoft segment and gives each segment an advantage. Another parenting advantage for Microsoft is the brand. Being such a well-known name in the technology industry places any of Microsoft’s products at an advantage. A third parenting advantage is the bundle. Currently Microsoft has a very large Rolodex of companies that it does business with. If Microsoft releases a new product, it can bundle the product in with others to gain market share. They did this so impressively with Internet Explorer that it got them deemed as a monopolist by a federal judge (Wilcox, 1999).

Ultimately, Microsoft creates value at the corporate-level for most segments. The Online Services Division is the only mystery. Bing only has 33% of the search engine market share (MadWire Media, 2013) and MSN.com is ranked 33rd globally behind Google.com (1st) and Yahoo.com (3rd) (Alexa, 2014). This lack of market share and losses shown in Figure 1 would lead anyone to believe the segment should be sold. With that said, having knowledge of what your customers are doing online through searches and how they configure their personal MSN.com homepage is valuable information that is difficult to acknowledge without inside information. These intangibles seem to be the only business case for the Online Services Division. If there is no insider information that would demonstrate value otherwise, my first recommendation would be to divest the Online Services Division.

Additionally, I think the Surface tablet should be moved under the Entertainment and Devices Division. While the tablets run versions of Windows, I feel these products are questions like the other Windows phones and there would be many synergies of having the mobile phone developers work with the Surface developers. The problem trying to be solved by Microsoft is that people want to be productive on the go. The Windows phone and Surface tablet are Microsoft’s answer to that question and therefore should be developed together under the same division. Having the Surface tablet under the Windows Division does not add any apparent synergistic value.

Thirdly, a current major issue for Microsoft is the lack of stars. Microsoft does not have any products that have high market growth with relatively high market share. This is a major concern, because that means there is nothing to become the next cow. What happens when the Windows Division or the Microsoft Business Division stops producing cash to invest into question marks? While this may not be relatively soon with Windows still holding a lions share of the PC market, the executives at Microsoft must plan for that now. This problem could be solved with acquisition, but I would recommend heavier investment into Microsoft Ventures, the venture capital (VC) group within Microsoft. Investment in this group with continued high investment in R&D will give Microsoft the best chance to come up with the next star. I do not recommend using acquisition and not just because 1 in 5 M & As fail. I recommend it mostly because Microsoft has the human capital that should know a star when they see it through either R&D or VC. This will allow them to grow the idea from an early stage to fit it into the Microsoft ecosystem that provides the many synergies already discussed.

Finally, I recommend that Microsoft not move into the hardware arena. In September of 2013, Microsoft purchased Nokia’s devices and services business, license Nokia’s patents, and license and use of Nokia’s mapping services (Microsoft, 2013). This acquisition should be used to grow a star, but it may tempt Microsoft into entering the hardware business through Nokia devices. This would be an inferior idea, because Microsoft has always been a software company and they would have too much to learn to compete in hardware. Ultimately, Microsoft should sell off the Nokia devices business.

In conclusion, Microsoft is in a difficult situation now without any stars. Fortunately, they have cash cows that look healthy. In order to continue to be the worldwide leader in software, services, and solutions that help people and businesses realize their full potential they should make the four recommendations outlined in this analysis.


Appendix A: Principle Products For Each Segment

Segment

Examples

Windows Division Windows operating system, Windows Services suite of applications and web services, including Outlook.com and OneDrive, Surface RT and Pro devices, and PC accessories
Server and Tools Windows Server operating systems, Windows Azure, Microsoft SQL Server, Windows Intune, Windows Embedded, Visual Studio, System Center products, Microsoft Consulting Services, and Premier product support services
Online Services Division Bing, Bing Ads, and MSN
Microsoft Business Division Microsoft Office, Microsoft Exchange, Microsoft SharePoint, Microsoft Lync, Yammer, Microsoft Office Project and Office Visio, Microsoft Dynamics ERP and Dynamics CRM, Microsoft Office 365, which is an online services offering of Microsoft Office, Exchange, SharePoint, Lync, and Microsoft Office Web Apps, which are the online companions to Microsoft Word, Excel, PowerPoint, and OneNote.
Entertainment and Devices Division Xbox 360 gaming and entertainment console, Kinect for Xbox 360, Xbox 360 video games, Xbox 360 accessories, Xbox LIVE, Skype, and Windows Phone

* U.S. Securities and Exchange Commission, 2014.

 

Appendix B: BCG’s Matrix

Screen Shot 2014-04-06 at 9.29.16 PM

 


References

Alexa (2014). Msn.com Site Info. Retrieved March 23, 2014, from http://www.alexa.com/siteinfo/msn.com

Banerjee, U. (2012, September). Microsoft spends more on R&D than Google | Technology Trend Analysis. Retrieved from http://setandbma.wordpress.com/2011/07/22/1240/

Constine, J. (2013, November 13). Dropbox Hits 200M Users, Unveils New “For Business” Client Combining Work And Personal Files | TechCrunch. Retrieved from http://techcrunch.com/2013/11/13/dropbox-hits-200-million-users-and-announces-new-products-for-businesses/

MadWire Media (2013, April). Bing vs Google, Search Engine Market Share – How Many People Use Bing? Retrieved from http://www.madwiremedia.com/blog/bing-vs-google-search-engine-market-share-how-many-people-use-bing/

Microsoft (2014). Fast Facts About Microsoft. Retrieved March 23, 2014, from http://www.microsoft.com/en-us/news/inside_ms.aspx#About

Microsoft (2013, September 3). Microsoft to acquire Nokia’s devices & services business, license Nokia’s patents and mapping services. Retrieved from http://www.microsoft.com/en-us/news/press/2013/sep13/09-02announcementpr.aspx

Mintzer, R. (2013, October 29). Plan to Outsource Commoditized Legal Work Like Microsoft? | LDO Buzz. Retrieved from http://ldobuzz.com/2013/10/29/plan-to-outsource-commoditized-legal-work-like-microsoft/

Netcraft (2014). April 2012 Web Server Survey. Retrieved March 23, 2014, from http://news.netcraft.com/archives/2012/04/04/april-2012-web-server-survey.html

NetMarketShare (2014). Operating system market share. Retrieved March 23, 2014, from http://www.netmarketshare.com/operating-system-market-share.aspx?qprid=10&qpcustomd=0

Thibodeau, P. (2010, April 13). Microsoft signs outsourcing pact with Indian giant Infosys – Computerworld. Retrieved from http://www.computerworld.com/s/article/9175442/Microsoft_signs_outsourcing_pact_with_Indian_giant_Infosys

U.S. Securities and Exchange Commission. (2014). U.S. Securities and Exchange Commission Homepage. http://www.sec.gov

Wilcox, J. (1999, November 5). Judge calls Microsoft a “monopoly” – CNET News. Retrieved from http://news.cnet.com/2100-1040-232565.html

 

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