24 April 2006

Why Microsoft really loves Apple

In the previous post, I argued that Apple is in essence no longer competing with Microsoft. But how does Microsoft see Apple? Do Bill and Steve wake up each day wondering how they're going to kick Cupertino's ass that day?

I took a look at their Microsoft's most recent filing on quarterly performance to get an idea about where MS makes its money.
Their revenues are reported broken out along the following lines:
Client (ie desktop OS): 29%
Server/tools (MS Server OS, SQLServer etc): 24.5%
Info Worker (ie. MS Office): 25%
MS Business Solutions: 2%
MSN: 5%
Mobile: 0.85%
Home and Entertainment (eg XBox): 13%

The most profitable parts are the Client and the Info worker parts of the business in which gross margins are greater than 70% (nice if you can get it!). But just who are Microsoft's biggest competitors, and where are the challenges? When you're in all those businesses, then in fact, you're competing with just about everyone. In servers/tools, it's people like Sun, IBM, Oracle. In the traditional core businesses of Client and Info Worker, the danger isn't from existing competitors which essentially have been marginalised, it's about facing up to the replacement of that business model by something else. The biggest challenges there are from open source which changes the landscape significantly, and from someone like Google - moving processing, software and data off the desktop to the internet for instance. Other challenges come from technologies such as virtualisation - and it's effect on licensing models.

In these mature business lines, the strategy is to defend the status quo of the current business model. This will hopefully (but not necessarily) come from innovation. In the other business lines, MS doesn't yet have a completely dominant position but is using its financial strength to muscle into these areas. It sees mobile as a key market as well as Home and Entertainment where the XBox is a key product for it. In services, MSN is it's primary offering, competing against people like AOL, Yahoo and of course Google. Where is Apple then on the Microsoft radar? I think if we're honest we can say it's not very visible at all. I'm sure MS will take every opportunity to take pot shots at OS X and the iPod for instance - but it is not worried about Apple taking over the OS crown because Apple is not trying to do that, and nor would it succeed. Yes, MS would like it's own music store (in conjunction with MTV), but it is only doing that after seeing how Apple has succeeded at creating this market and deciding it should not ignore it. And, in home entertainment, Apple could become a competitor too as convergence happens. But for now, MS has enough to do in that market fending off Sony and to a lesser extent, Nintendo.

So, while Apple fans like to think there's a David vs Goliath struggle going on, the reality is that David isn't going after Goliath, and Goliath has his hands full elsewhere. And, in fact, I think Goliath actually wants a bit of David's help too. Why do I say that? Well, look at the other challenges they face.

For every Linux computer sold, MS makes precisely zero. For every Mac sold, MS has a chance of selling an MS Office license. And, as of last week, it also has a chance of selling an XP (and later, Vista) license. Not only that, but Mac licenses are pretty profitable as they tend to be at higher prices due to retail purchases of the full product. I've never seen the statistics, but I'd take a bet that as many business Macs have a legal copy of MS Office as business PCs and that as many home Macs do too (in percentage terms). It has oft been stated that the Mac Business Unit at MS is one of the most profitable divisions. Every MacWorld Expo, there is always a presentation by the Senior VP of the Microsoft Mac Business Unit (Roz Ho, I think?) - and it's more than just a charade (incidentally, there's also a great blog entry doing the rounds from David Weiss, a member of the Mac BU giving a tour of the facilities at Redmond - these guys are REALLY committed to the Mac platform) So, MS can in fact make as much from a Mac as they can from a PC. Microsoft has the skills to develop Mac software, and it could in fact make more of its products available for Mac (eg Visio, Project etc). So, financially, MS has little to lose by Macs taking market share from it's traditional PC allies. And, if it had a choice between a Mac sale and a Linux sale, there is no doubt what it would prefer.

But I think MS needs Apple even more than this. I think that Apple has been a constant source of ideas for Redmond, and that it has benefited from taking those ideas in the past and will continue to do so in the future (sure Apple learns from Microsoft too, but I think one direction is more prevalent!). Whatever Apple does in the living room, MS will surely copy, refine and exploit. And, as Paul Thurrott notes in his recent article which I linked to last week, much of Vista is indeed a copy of what's best about Mac OS X Tiger. MS needs these ideas not to fight Apple but to fight Linux, and to fight Google. Apple's business model comes from the same vintage as MS - hardware sales with commercial software licenses etc. Apple's success in that way shows that model is still essentially valid. Cupertino is Redmond's R&D facility. It has used this very effectively in the past to profit at a level Apple could never achieve. It has (had?) cross-licensing agreements with Apple that allow it to use many of these technologies. It's own internal innovation has become crippled because of its own management failings, the need for constant legal overview (see below) and the sheer difficulty of supporting the vast numbers of platforms sold by it's partners.

But, there's even another level on which Microsoft needs Apple. It showed this when Apple was on the ropes and needed cash. It injected $150m and agreed to continue to develop MS Office for the platform. Sure, it has made money from the Mac BU as discussed above (and as it turned out, it made a lot of money when it cashed in that investment). But in my opinion that investment was always about Microsoft preferring a weak competitor around than no competitor at all. That's because, even back then, it knew it's biggest problems were not from it's (weak) competitors (esp Apple) but from the competition authorities. And today, that is an even bigger problem. Every product feature that MS would like to introduce is probably endlessly debated by lawyers internally as it will no doubt be challenged somewhere as anti-competitive. Add an MS version of iLife? There'll be some companies (eg Adobe) that will be upset by it and cry foul. For heaven's sake, they can't make the OS more secure without upsetting the antivirus and anti-spyware companies that make their living off MS' insecurities. But if Apple has 10% of the market for OS, wouldn't it be a lot easier for MS to argue that it needs to be free to innovate as that proves that the free market is working? The client OS is still a growing business, so this does not imply a loss of revenue - just a slowing down of that growth. The trade-off for Microsoft in its other areas of ambition is potentially huge.

That's why I think Microsoft would actually welcome Apple's success - at least for the next few years.

Read the final part of this series with what this means Apple will and won't do as a consequence of this strategy.

(Edited to add links between Articles)

No comments: