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Brad PowerRic Merrifield
What defines success for a business? For most of the last century, it was
profits. The leading enterprises of the world were ones that fashioned a
profitable business model and leveraged it over time. Profitability as the key
measure of business success was akin to a law of physics like gravity a
foundational assumption which we all take as given: you have to deliver profits
to create long term shareholder value. But what was once a natural feature of
the competitive landscape has now become a trap for people and companies who
are not able to adapt to a new landscape and change their focus.
Two big, well-known tech companies neatly illustrate this shift. Consider
Microsoft under Steve Ballmer. The former CEO believes that delivering profits
is the main measure of a company, and he s justly proud of the $250 billion of
profits Microsoft generated during his tenure over 14 years. Then consider
Amazon, the first big company to deliver long term stock growth for the better
part of two decades with essentially no profit to show for it. The contrast
could not be clearer: Amazon fearlessly making big, risky bets like a serial
entrepreneur; and Microsoft, eschewing disruptive innovation in favor of
remaining the fast follower it has always been, wringing profit from
previously proven technologies.
Coming from a profitability-focused paradigm, it is not surprising that Ballmer
was critical of Amazon, Microsoft s Seattle neighbor, and its focus on growing
and expanding its range of services instead of profits. From the old paradigm
perspective, it was as if Amazon was attempting to defy gravity. But the
contrast has come to favor Amazon. Many people in Silicon Valley see Microsoft
as irrelevant today, while Amazon investors focus on its future growth. Profits
appear more and more as a lagging indicator of yesterday s innovations. Around
three-quarters of Microsoft s profits come from two extremely successful
products that the company introduced in the 1980s and 1990s: the Windows
operating system and Office productivity suite. As Paul Graham, co-founder of Y
Combinator wrote, Microsoft cast a shadow over the software world for almost
20 years starting in the late 80s But it s gone now. I can sense that. No one
is even afraid of Microsoft anymore. They still make a lot of money But they
re not dangerous. And that was in 2007.
Amazon keeps margins razor thin, as part of its mission to become the best
place to buy just about everything. As CEO Jeff Bezos has said, Your margin is
my opportunity. Amazon is maniacally cost-focused, but rather than letting
benefits flow to profit, they pass them along to their customers. Also, Amazon
needs to spend a lot as it grows its existing and new businesses. For example,
as part of its same-day delivery service, it is dramatically expanding its
distribution centers and hiring thousands of people in California and other
states. It spends its earnings on creating and expanding new products (mobile
phones, tablets) and continuing to build out Amazon Web Services (AWS). In
2006, AWS began offering IT infrastructure services to businesses in the form
of web services now commonly known as cloud computing. Today, AWS powers a
growing universe of more than a million active customers in 190 countries
around the world.
This can be very hard to do given the incredible pull of profitability in
driving strategy. And therein lies the trap : a company s success at
generating profits can prevent the investment in innovation it needs.
Profit-focused companies focus on scaling efficiency and cutting costs, and
miss new opportunities. While Ballmer was focusing key resources on a new
version of Windows ( Longhorn ) to defend Microsoft s core product line, he
missed big opportunities in search, social media, and phones. (Both the Bing
search engine and the Windows Phone were just too late to mount serious
challenges to Google, on the one hand, and the iPhone and Android, on the
other.) Microsoft seemed to become rigid and bloated, and had difficulty with
mergers and acquisitions. A friend of ours said recently, In its early days
Microsoft took more risks than a pirate; now they take less risk than an
insurance company.
A New Model for Growth
What lessons can we learn from Microsoft s and Amazon s differing emphasis on
profits? How do you know when to focus your attention on defending a cash cow,
and when to worry about winning in the future?
Despite its scale, Amazon still thinks and acts like a startup. It has
maintained its openness to invention that was characteristic of its beginnings.
It is focused on growth and continues to create new things. It is expanding its
core business by increasing selection (the range of products it sells) and
improving the customer experience (for example, Amazon Prime and next day and
same day service). Here s a rough illustration of this new model compared to
Microsoft s.
[profit_vs_growth]
Microsoft s model, which reflects its definition of success, revolves around
profits. As our friend said, it wasn t always this way earlier in its
corporate life, the Microsoft model no doubt looked very much like the Amazon
one. But Amazon has found a way to sustain its more entrepreneurial model,
growing its business at the edge, with services like AWS, and products like the
Kindle and Fire. Amazon still has the founding phase zeal for creating and
building. It measures its success by revenue growth and satisfied customers,
not big profits.
High tech companies provide a useful laboratory to explore the tension between
profit and innovation since high tech product lifecycles are short and
shrinking. As companies like Microsoft succeed and grow to be very big, they
tend to become stewards of the formulas that got them their success, and they
focus on profitability. They milk their cash cows. But an excessive focus on
profits can compete away investments that could lead to creating the next big
thing.
Can Microsoft escape from the profit trap, recapture its founding spirit, and
start taking more risks? Or does it feel there is no benefit to reducing margin
on many of their products, as Amazon does, since it will not increase share?
There are some interesting recent developments. The traditional shrink wrapped
software business model surrounding Microsoft s core Windows and Office
products has been breached. Current CEO Satya Nadella seems to be inching
forward by introducing more reasonably priced Software-as-a-Service (cloud)
versions of Windows and Office, at the expense of profit. And it appears that
Nadella has a renewed interest in taking risks and making big bets, such as the
virtual reality HoloLens. Might Microsoft be willing to concede their
traditional profit margins to win in this new category, effectively taking a
page from the Bezos playbook? Time will tell.
Brad Power has consulted and conducted research on process innovation and
business transformation for the last 30 years. His latest research focuses on
how top management creates breakthrough business models enabling today s
performance and tomorrow s innovation, building on work with the Lean
Enterprise Institute, Hammer and Company, and FCB Partners.
Ric Merrifield is an expert on innovating through technology and has worked at
Accenture, Microsoft, and boutique consulting firms. He has recently been
involved in Internet of Things projects at Disney, Starbucks, and other
companies and is the author of the book Rethink.