Microsoft in Transition

These are turbulent times for the software giant. The company is grappling with upheaval in the industry, in its leadership and in the way it deals with its partners. But one thing hasn't changed: Redmond and the channel still need each other to succeed.

Bill Gates gets all the attention. He always has, really. So, when Gates revealed two years ago that he would step down from his day-to-day responsibilities at Microsoft and passed his title of chief software architect to Ray Ozzie, the countdown was on.

Tributes to Gates, questions about Microsoft's future, predictions, treatises on the state of the company and the industry-they all trickled in slowly beginning in June 2006 and reached their peak in late June of this year, just before Gates officially walked away to concentrate on his charitable work with the Bill and Melinda Gates Foundation.

Gates' departure -- or partial departure, as he says that he'll still spend 20 percent of his time working with Microsoft -- represented the end of an era not only for Microsoft but also for the whole technology industry and perhaps even for the history of American capitalism. Gates' Microsoft stared down challenges from all comers, from established competitors such as IBM Corp. to antitrust regulators in both the United States and Europe, and bullied its way to the top of the software industry.

The monster Gates and his colleagues created is a beast that now employs nearly 80,000 people worldwide and has racked up more than $50 billion in revenue in the fiscal year that ended June 30, 2007. (Final figures for FY 2008, which ended on June 30, 2008, weren't yet available at press time.) The Windows operating system and the Office productivity suite enjoy market-share numbers in the 90-plus percent range. Microsoft has hundreds of thousands of partners -- officially, more than 400,000 at last count -- and millions of customers worldwide; Gates has been among the world's wealthiest human beings for years. For all those reasons, the end of his tenure as a full-time Microsoft employee is far from trivial.

However, Gates' departure might not be -- and probably isn't -- the biggest change or the most daunting challenge currently facing Microsoft. The IT industry as Microsoft has always known it is shifting -- although it's debatable as to how quickly -- from Microsoft's bread-and-butter client-based model to "cloud" computing and Software as a Service (SaaS) -- or, in Microsoft parlance, Software plus Services (S+S). New competitors, notably Google Inc., have staked Internet claims that Microsoft has found tough to challenge. And a combination of increasing industry acceptance of open source computing and European antitrust regulation has forced Microsoft to become less proprietary or face being a heavily regulated dinosaur.

With all that staring Microsoft in the face, the company now has to move forward with limited influence from its icon and a leadership team that includes plenty of faces that weren't around back when Gates and CEO Steve Ballmer were still trying to get a small company off the ground. And some of the decisions that Microsoft's leaders have made have put the company at odds with what is probably its greatest asset: its partner channel.

For the most part, partners like innovation, but they don't always react positively to change. Many of the changes happening at Microsoft have made the channel nervous; some partners question whether Microsoft is trying to distance itself from them. There's also no doubt that Microsoft is, or soon will be, competing with some partners. But the channel has been critical to Microsoft's massive success over the last few decades, and, although the industry is in transition, Microsoft and its partners are likely to remain important to each other for years to come.

Microsoft has officially played down Gates' departure, and at first blush it's easy to see Redmond's point of view. Gates has slowly -- over a period of two years -- transitioned away from life as a full-time Microsoft employee. Beyond that, he turned the CEO title over to Ballmer back in 2000. For some partners, Gates' departure has the air of a non-event.

"Big companies have a whole momentum of their own," says Michael McCarthy, CEO of ePartners Inc., a Gold Certified Partner and Dynamics VAR based in Irving, Texas. "Who the CEO is has an impact, but slowing down the Microsoft tanker in the middle of the harbor takes a whole lot of momentum shift. Clearly, Ballmer has been running the company for the last five to seven years."

McCarthy sees Gates' departure as being not unlike those of Lou Gerstner from IBM Corp. or Jack Welch from General Electric Co. Microsoft is "bigger than Bill Gates, just like GE was bigger than Jack Welch," he says. "When he left, GE went on. I come from the age of Welch and Gerstner and Gates, and they all move on. They go on the speaker's tour and write books and do what they do. [Gates] will stay very involved in technology as a statesman. I don't think Gates is Microsoft. Microsoft has an identity and a life of its own."

Others aren't so sure. Mary Jo Foley, a contributing editor to Redmond magazine, RCP's sister publication, is the editor of ZDNet's "All About Microsoft" blog and author of Microsoft 2.0: How Microsoft Plans to Stay Relevant in the Post-Gates Era (John Wiley & Sons Inc., 2008). She calls the transition more critical than Redmond lets on.

"Microsoft's message is that Gates' departure won't be a big deal -- 'nothing to see here; move along,'" she says via e-mail. "But I don't see Gates' departure as a non-event. I think Microsoft is going to struggle on the technology front without Gates. I realize Gates wasn't developing software for the past decade-plus. But he still was involved in many product meetings and served as a champion for a number of technologies that might never have seen the light of day without his guidance. Gates has been Microsoft's public face, in terms of laying out the company's technology strategy and vision."

Strategy and vision are now more important than ever before for Microsoft. Google's domination of Internet search and online advertising has Redmond chasing the enigmatic Silicon Valley outfit. This time, Microsoft can't build a competitive product into Windows and wrestle customers away from its competitor the way it did when it integrated Internet Explorer into the operating system in the '90s and buried the Netscape browser.

Still, observers say, Microsoft must broaden its vision if the company wants to grow. "Once you get that big, you've got to diversify," McCarthy says. "I think anytime you get as big as Microsoft and you have as much market share, I don't think you have a lot of choice. They need different ways of accessing the market, different lines of revenue. They're feeding such a big cow. If you want to continue to be thought of as innovative, you've got to keep branching."

But diversification doesn't necessarily translate to dominating just about every major market it enters, as Microsoft had been accustomed to doing until running up against Google in recent years, McCarthy adds. "Once you get to be $65 or $70 billion" in annual revenue, "being No. 3 can add a lot to your bottom line," he says.

And that's what Microsoft is in search -- No. 3, behind Google and Yahoo! Inc. So far, its Online Services business component has mostly not been profitable. But if competing with Google is a major challenge for Microsoft, it's really only the tip of a whole new technological iceberg for the enterprise: SaaS.

Increasingly, companies, especially small and midsize businesses, are turning to renting applications hosted by technology vendors rather than purchasing software in the traditional Microsoft licensing model. Inc.'s success in hosted customer relationship management applications and its ubiquitous "no software" slogan have become the harbingers of a new era in enterprise computing. And while it's hard to say just how much of an impact SaaS will have in the enterprise and how quickly, Microsoft is clearly making the approach a priority -- as it must, observers say.

"Now the big challenge is going to be that not only is technology being delivered differently, but customers are demanding technology to be delivered differently," says Tiffani Bova, research vice president for IT channel programs and sales strategies at analyst firm Gartner Inc. "[They're saying,] 'I just want to pay for what I use today, and I want something that will scale and fit my needs tomorrow. I want to start to acquire things differently.'"

Microsoft has responded with the S+S philosophy, which emphasizes combining "cloud computing," or a hosted model, with a more traditional client-server approach. But S+S doesn't yet make sense to some partners. Redmond's on-again, off-again bids to purchase Yahoo! for tens of billions of dollars -- speculation on the actual numbers varies wildly -- has led many commentators to suggest that Microsoft is desperate to catch Google and build a SaaS infrastructure, and Microsoft's somewhat dense explanations of S+S has some partners questioning Redmond's vision.

"I think Microsoft is still reacting more than it has a strategy in this space, quite frankly," says Keith McCall, CTO and founder of Azaleos Corp., a Seattle-based Gold Certified Partner that produces maintenance and management applications for Microsoft Exchange. "They're reacting to the threat of Google and not planning a strategy as they have in the past."

On that count, however, Foley says that Microsoft is better prepared than a lot of observers believe: "The hiring of Ray Ozzie said to me that Microsoft knows it needs to be looking at cloud/utility/SaaS more intently. To the company's credit, it has been fielding a lot of cloud/Web services that have oftentimes been flying under the radar," says Foley, citing Exchange Online, SharePoint Online,

SQL Server Data Services and BizTalk Services. "Also to Microsoft's credit, it's not pretending that all businesses are ready now to move all their data into the cloud," she continues. "The approach they're advocating is really what users want."

More and more, observers say, customers also want openness -- or at least a relaxation of the ultra-proprietary approach Microsoft has traditionally taken to software development and licensing. Redmond, responding largely to pressure from the European Commission's antitrust regulators, has begun publishing protocol documentation and has altered its licensing policies for intellectual property to make access to certain protocols less expensive-or free. It has also pledged to be more open and less proprietary.

It's hard to say how much Microsoft is really embracing openness, and open source in particular-company executives railed against open source for years, and Ballmer famously claimed last year that open source software violated hundreds of Microsoft patents. But some observers say that Gates' departure really will lead to more openness in Redmond.

"Bill is the guy that helped build Microsoft," says Rob Enderle, president and principal analyst, at Enderle Group, an IT advisory firm based in San Jose, Calif. "His combination of authority and vision built Microsoft into what it's become." But, he says, Gates could also be autocratic about his viewpoints and priorities. "The end result is that as the market moved to things like open source, Microsoft found itself out of step with the market," Enderle says. "The post-Gates Microsoft is one that's quite a bit more collaborative outside of Microsoft, quite a bit more cooperative and quite a bit less concerned about piracy. With [Gates] gone, you'll see Microsoft become more willing to share information at an earlier stage of the development cycle."

There are bound to be other changes post-Gates in Microsoft's new era, and opinions are split as to how positive those changes will

be. Paul DeGroot, a senior analyst with Kirkland, Wash.-based Directions on Microsoft and an RCP columnist, believes the upper-level management changes rumbling through Redmond will affect both the company's business culture and its technology approach.

"Maybe the important thing is that it seems inevitable that things will change. Don't assume that Microsoft even two or three years from now is going to be the same as it is today," DeGroot says. "A lot of the technical leadership is changing. Gates had a profound influence on the culture. It will take time for that influence to disappear, and it may not. Ozzie, who appeared to be the anointed successor in that space, doesn't seem to want it. He's not coming out and articulating a technical vision, and he's not very good at it either."

Enderle also describes the differences between Ozzie and Gates: "[Gates] leaves a team that is still a little bit unbalanced," Enderle says. "Steve Ballmer has a different skill set than Bill Gates. Together, they had a combination of vision and authority. With Bill out, they don't have that combination. Bill had a broad vision, but Ray is more focused. So there's a gap there."

Azaleos's McCall, on the other hand, expresses optimism about Ozzie: "Bringing him in really added to the intellectual firepower of the technical team at the top. I'd give them an A+ on that technology team."

Still, Matt Scherocman, vice president of sales and operations at PCMS IT Advisor Group, a Gold Certified Partner and solution provider in Cincinnati, Ohio, says that Microsoft's future lies in the hands of all its employees, not just in those of its executives. And that, he continues, could be a problem: "My biggest concern is that Microsoft used to pay below market for salary, but the benefits made up for it and the stock option grants made up for it. Today, they're still paying below market or at market, and the stock isn't worth anything." He says he's had outstanding experiences with individual employees and believes that turnover remains less of a problem at Microsoft than elsewhere partly because there's still prestige attached to working at Microsoft. His concerns relate primarily to the company's future hires: "Their ability to attract talent is declining at all levels," he says.

But how will Microsoft's new leadership deal with the company's ability to attract and work with partners? For many, that might be the foggiest part in the vision of the new Microsoft.

Redmond's SaaS strategy presents a strong example of why the new Microsoft makes some partners nervous. The company recently announced that it would host some of its own applications, such as Exchange and SharePoint servers, through the Microsoft Online program-a move putting Microsoft directly into competition with some of its hosting partners. Originally targeted at larger enterprises, Microsoft Online was later extended to smaller businesses.

"Microsoft has been warning folks in the hosting business for at least two years that providing nothing more than bare-bones hosting without value-add on top of it would put them in Microsoft's crosshairs," says Foley, the veteran IT industry journalist and author. Nevertheless, she adds, "Microsoft wasn't straight up about its intentions to sell its own hosted software to business users of all sizes; up until earlier this year, Microsoft was promising partners it would only sell Microsoft-hosted products to very large enterprises. I think that proves to partners that you are never completely safe from the Redmondian steamroller."

For McCall, who says his business isn't affected by the hosting strategy, Microsoft's decision to compete against its partners reflects a disturbing trend of desperation: "Microsoft was incredibly quick at going to market and painting a vision of how they're going to host these products on behalf of customers, and they have yet to deliver a model on how their existing hosting partners will be able to tie into that vision," McCall says. "They failed to create a marketing message that really weaves the partners in. You see those partners gearing up to go head-to-head with Microsoft, and that was unnecessary. It's Microsoft reacting to the Google threat and trying to provide a single-sourced competitor to Google rather than locking arms with its existing partner community and showing the strength of how that community can compete with Google."

McCall isn't the only observer who questions Microsoft's partner strategy. DeGroot says the company's direction on this issue is fuzzy-and not necessarily top-of-mind for new managers. "I can't say that I've run into anybody who had partners baked into the way they thought," he says. "I don't hear it from Ballmer. I don't hear it, from what I read, from [Kevin] Turner. You don't hear it from Ozzie."

Scherocman, who offers a similar sentiment, hopes that the transition will result in more guidance for the channel on the product side. "Ray Ozzie is a very big Software as a Service guy. I haven't seen him plugged into partner events. Truthfully, I haven't seen Gates plugged into partner events in awhile," Scherocman says. "Who takes the partner leadership from a product standpoint? I think that's a void today."

Still, the channel is Microsoft's sales force, and Bova, for one, believes that Turner's influence at Microsoft will be positive as far as the channel is concerned. "Kevin Turner is a large influence on that executive team," Bova says. "And I think he is in full support of what Allison Watson [corporate vice president of Microsoft's Worldwide Partner Group] and the country general managers are doing. He's very, very present at those partner conferences. Ballmer is there. So you've got the CEO and the COO really engaged at these partner summits."

In addition, "Microsoft's partner budget worldwide is probably equal to that of a small country," Bova says. "It's pervasive in every facet of their business, and it's driving the majority of their revenue."

Besides, Foley notes, outside of a few select markets, Microsoft can't go it alone without the channel: "Microsoft still needs the channel, in spite of the mixed messages it sends when it does something unexpected like start selling Microsoft-hosted software to all businesses," Foley says. "The company still doesn't have a very big direct sales force. And given how much money Microsoft is pouring into its red-inked Online Services business, I'd suggest there isn't going to be a whole lot left to hire a bunch of new direct sales guys. I think Microsoft -- the '2.0' version headed by Ballmer, Ozzie and company -- is going to have to re-instill faith among Microsoft's partners in order to continue to count on them to do business with Microsoft."

And partners will be counting on them to do just that as Microsoft and the channel enter the post-Gates era.