Break it up Bill

This morning’s Wall Street Journal [subscription required] advocates that Bill Gates should consider a breakup of Microsoft. I couldn’t agree more. In fact, I expressed my views on this last September on The Informed Observer, last October in Red Herring, and yesterday during my interview on CNBC.

Microsoft’s stock is down roughly 60% since its 1999 peak. While its revenues and profits are way up since then, I think the stock dropped because it missed two huge technology changes:

• Open Source. The emergence of free operating systems, such as Linux, which enable companies to replace expensive servers running proprietary operating systems with so-called blade servers -- much less expensive servers that run this open source software.
• Advertising-based software. Google has demonstrated that it can profit from giving away free software, such as that used to conduct searches, and generating revenue through advertising keyed to the search.

The two reasons Microsoft missed these changes spring from the management practices that led to its previous successes.

First, Microsoft’s traditional approach to getting into new businesses was to outexecute a successful innovator. During the 1980s and 1990s, for example, Microsoft was able to develop

• Excel, a more widely purchased spreadsheet –-- after Lotus Development popularized 1-2-3;
• Word, a word processing package, after Novell bought and promoted WordPerfect; and
• Internet Explorer, the dominant web browser, after Netscape pioneered the browser.

Through subsequent versions of these programs, Microsoft came from behind, caught up and ultimately exceeded the incumbent’s market share – while linking these programs with its dominant PC operating system. In all these cases, Microsoft was able to charge money for its versions of the new products.

However, in the case of the two recent technology trends mentioned above, Microsoft could not use the outexecute strategy without cutting its own throat. In these cases, Microsoft’s competitors were smarter. They recognized that if Microsoft pursued its traditional approach to competition, it would cannibalize its core revenue streams. For example, if Microsoft competed with Linux by delivering customers a free operating system, it would rapidly lose its operating system revenues, which constituted 12% of its $40 billion (2005 fiscal year end) in revenue and 65% of its $14.5 billion in operating income. And if it gave away free applications software, as Google does, it would wipe out a portion of the $11.5 billion in revenue and $8.6 billion in operating income that it earns from applications software.

A second reason that Microsoft missed these new technology trends is that it makes decisions more slowly than its more focused competitors. As I commented last December in the Washington Post, Microsoft’s OODA loop -- its ability to observe, orient, decide and act -- is slower than that of its competitors because it needs to integrate its new products with each other and with its earlier versions. As a result, decisions are made in long committee meetings which consume a lot of time and reduce the value that Microsoft’s products can generate for customers.

If Gates wishes to get Microsoft’s stock price back up, he should break up the company into autonomous units that can react quickly to industry changes because they are untethered from these creativity-sapping committees.