It’s possible, even likely, that Microsoft is about to enter the darkest period in the firm’s history. Darker, even, than July 2000, when it seemed the US government might dissolve the house that Bill built, and force the company to be split into two different companies.

Update: Part 2, The seven-point plan to save Microsoft

The revenue Microsoft earned in the quarter ending in March 2013, $20.5 billion, probably represents a high water mark for the company, at least for the foreseeable future. In the most recent quarter, the company’s revenue missed expectations, which Microsoft blamed on ongoing weakness in the market for PCs. There is no sign that demand for PCs is going to pick up again—even Intel is projecting sales will be flat, at best—and plenty that the world’s demand for PCs, or at least the kind that run Microsoft Windows, is in terminal decline (1).

Microsoft’s problem can be distilled to this: Computing is no longer confined to personal computers, where even now Microsoft maintains a near monopoly. More than ever, people are hiring other devices to do the jobs that PCs once did: communication, entertainment, and some portion of their work. For a host of reasons, Microsoft failed to compete effectively in the two markets that are disrupting its core business: first, the mobile devices that are supplanting PCs, and second, the cloud computing resources that are essential to making those mobile devices more useful, in many cases, than PCs.

Microsoft does produce a valuable good: its operating system (2). But with the decline of the PC and the rise of the web, mobile devices, and cloud services, the company failed to anticipate or effectively dominate these alternate—and in many cases superior—means of getting computing done. We have reached out to Microsoft for comment and are awaiting response.

Pulling back the curtain on the rot in Redmond

Everything that follows is, necessarily, from anonymous sources, all of them veterans of Microsoft. Synthesizing their feedback with other publicly reported accounts yielded some valuable insights about what ails the company and how to address it.

All the reasons Steve Ballmer never should have become CEO in the first place

The timing of the handover of Microsoft from founder and technical genius Bill Gates to employee no. 30 and MBA dropout Steve Ballmer could hardly have been worse for Ballmer. On December 29, 1999, Microsoft’s stock price was at an all time high, and Microsoft was the most valuable company on earth. Then the stock began to fall. Seventeen days later, Steve Ballmer took over, the stock market crashed soon after, and Microsoft has never returned to its pre-bubble valuation.

In 1999, when Microsoft was a blue-chip company wringing a steady stream of income from the Windows monopoly, it might have made sense to put Ballmer, who was initially the company’s first business manager, in charge. But Microsoft remained a technology company, and having a non-technical CEO meant that Ballmer was ill-equipped to oversee the increasingly large and unwieldy development project that Windows had become.

There is copious evidence of Microsoft’s broken product pipeline, which stretches back a decade, at least: In 2004, Steve Jobs unveiled a version of Mac OS X that incorporated many of the features that Microsoft had promised in its “Longhorn” reboot of Windows, a project that became so snarled that Ballmer eventually had to decide to throw out all the work his engineers had done and start again, delaying the release of Windows Vista (which succeeded Longhorn) by at least two years.

More recently, Microsoft’s disastrous attempt to copy the iPad, the Surface RT, led to a $900 million write-down, and the company’s cloud services simply aren’t functioning as the “glue” that should connect the company’s online software together, says one veteran. That contrasts sharply with Google, which has made inroads against Microsoft by offering a tightly-integrated suite of “Google Apps” that include replacements for Office and Microsoft’s email system, as well as cloud storage for data.

But perhaps the most concrete demonstration of Ballmer’s failure to be a “product guy” as a CEO is the way the company has pushed touch-screen PCs and a touch-centric Windows interface onto a public that has been trained for decades not to leave smudges on our PC screens (in contrast to tablets and phones) by touching them. (Granted, Google has made the same mistake with its Chromebook Pixel.) Touch screen PCs and “convertibles”—heavy laptop/tablet hybrids—have both failed to sell as manufacturers had hoped, contributing to the overall slump in the PC industry.



Low morale and a destructive internal culture

What was at the root of Microsoft’s broken product pipeline? As outlined by Vanity Fair’s expose on Microsoft’s lost decade, Ballmer was a tone-deaf manager. Microsoft’s “stack ranking” system of management, in which employees were graded on a curve that meant that one in 10 members of a team always had to receive a rating of “poor” even if everyone in a group was an A player, pitted employees against one another, discouraged collaboration between and even within teams, and slowed Microsoft’s development process to a crawl.



In 2012, Ballmer’s rating among his own employees was just 46%, compared to Google CEO Larry Page’s 94% approval rating and Mark Zuckerberg’s 99%. Morale at the company is at an all-time low, says one source, and Microsoft has for years been losing its best executives and engineers to competitors like Google. Even when Microsoft hires talented employees, the most talented ones leave more quickly than the less talented ones, degrading the overall quality of Microsoft’s workers.

Microsoft has also for many years paid sub-par wages. This policy was born at a time when Microsoft could compensate employees with stock, but the company’s stock price has been flat for a decade. Meanwhile, companies like Google are paying employees up to 23% more than the industry average.

Shareholder constraints on innovation at Microsoft

Microsoft is a blue-chip stock with huge institutional investors that expect a dividend—which doesn’t jibe with a culture of risk-taking and innovation. As a result, the company tends to be more conservative in its decision-making, says a source. As a result, Microsoft’s last decade has been almost entirely reactive. The company launched its competitor to the iPod, the Zune, just before Apple rolled out the fifth generation of the iPod (as well as the iPod Mini and Nano) and eventually discontinued the Zune. Bing and Office 365, reactions to Google’s search and Apps, respectively, came late enough that they seem destined to forever remain niche products. (Bing’s market share is about 18% to Google’s 67%.)



Perhaps the only area where Microsoft has competed successfully in the past decade is gaming, with the Xbox, but shareholders were never happy with the billions the company sunk into the project, and analysts are now calling for Microsoft to sell that business entirely.

Customer and organizational constraints on innovation at Microsoft

Imagine for a moment that Microsoft’s next CEO cleans house, and replaces almost the entirety of senior management (which in reality wouldn’t be possible given all the institutional knowledge that would be lost). But if it were possible, here’s the classic innovator’s dilemma Microsoft would face: Products that were sufficiently good copies of, say, competitors’ cloud services, would simply eradicate many of Microsoft’s core businesses all that much faster.

The software known as Microsoft Server is one example: Customers use it to run servers within their own data centers, whereas Amazon’s cloud services model is simply to sell you time on its servers. If Microsoft’s cloud services division were to copy Amazon Web Services, down to its hyper-competitive pricing, Microsoft’s sales force would revolt because Microsoft’s cloud services would cannibalize sales of Windows Server; middle men who resell Windows Server to businesses and make a living supporting it would be upset to lose those sales; and investors would be aghast at the hit Microsoft’s profits would take. That Amazon and Google might eventually eliminate this portion of Microsoft’s business in the absence of such a move hardly matters to shareholders whose focus is on the next quarter.

What’s a Microsoft to do?

Despite the myriad structural, historical and cultural constraints faced by Microsoft, there’s always an opportunity for a turnaround. That’s the subject of part two of this series, which will appear tomorrow: The seven-point plan to save Microsoft, as told by veterans who abandoned the company.

Footnotes

(1) There are many theories about why the world doesn’t want as many PCs as it once did: It’s the fault of Microsoft’s unfamiliar interface for Windows 8, or it’s simply that people are holding onto their PCs for longer. But the most compelling is this: Humans need access to computing, but increasingly, that access is provided by tablets, phones, and other mobile devices, and the computing itself is done in the cloud. Also, if a PC user accesses the internet as often for entertainment as for work, then the PC is competing with the increasing sophistication of set-top boxes, game consoles, hand-held gaming devices, and even e-book readers.

Even for businesses, which have long represented Microsoft’s primary cash cow, there are now more alternatives to the conventional PC than ever. Sales reps in the field are using iPads or tablets running Android, and Google’s email and productivity apps are luring large and small businesses into the primarily web browser-based Chrome OS. And the halo effect of a string of successful mobile devices has for years increased the market share of Apple’s OS X. Granted, businesses have invested enormous amounts of money and time into Microsoft’s products, and there are countless custom apps and services that will take decades to switch away from Windows. This momentum works in Microsoft’s favor, but it’s also possible that it has been masking weakness in demand for Microsoft’s products. That is, even business IT administrators who have wanted to shift away from Microsoft’s solutions have been unable to, shackled as they are to their own legacy systems. By necessity, large corporate IT infrastructures—and for different reasons, even those of small businesses—do not turn on a dime. [back]

(2) For years, there have been perfectly usable alternatives to Microsoft Windows that failed to gain any more than a niche market share, namely Linux-based desktop operating systems. It takes a sales infrastructure and a team of engineers dedicated to simplicity and ease of use to make an operating system successful. Arguably, open-source operating systems finally have that in Google, whose Android and Chrome OS are, after all, based on Linux. [back]