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The newly integrated company

During the first quarter of fiscal year 2014, we changed our organizational structure as part of our transformation to a devices and services company. As a result of these changes, information that our chief operating decision maker regularly reviews for purposes of allocating resources and assessing performance changed. Therefore, beginning in fiscal year 2014, we are reporting our financial performance based on our new segments; Devices and Consumer (“D&C”) Licensing, D&C Hardware, D&C Other, Commercial Licensing, and Commercial Other.

The previous reporting segments were:

  • Windows & Windows Live
  • Server and Tools
  • Online Services
  • Microsoft Business
  • Entertainment and Devices
  • Unallocated and other

The new are:

  • D&C Licensing: Windows OEM licensing, Consumer Windows, Consumer Office, Windows Phone (including related patent licensing)
  • D&C Hardware:  Xbox 360, second-party and third-party video games, and Xbox LIVE subscriptions; Surface; PC accessories
  • D&C Other: Resale, including Windows Store, Xbox LIVE transactions, Windows Phone Marketplace; search advertising; display advertising; Subscriptions including Office 365 Home Premium; Studios including first-party video games; retail stores.
  • Commercial Licensing: Windows Server, Microsoft SQL Server, Visual Studio, System Center; Windows Embedded; volume licensing of Windows; Microsoft Office for business (Office, Exchange, SharePoint, and Lync); Client Access Licenses;  Dynamics, Skype.
  • Commercial Other: Enterprise Services, including Premier product support services and Microsoft Consulting Services; Cloud Services, comprising O365, other Microsoft Office online offerings, Dynamics CRM Online, and Windows Azure.

From Microsoft’s FY14 Q1 10Q via Microsoft Investor Relations – Press Releases

The mapping between the old and new is not straight forward. There is overlap between D&C Licensing and the old Windows and perhaps between Entertainment and Devices and D&C Hardware but there are many gaps. There is also some overlap between the old “Business”/”Server” segments and the new “Commercial” but, again, they cannot be matched.

I show the difference between the two structures in the way revenues are allocated below, using color to try to show similarities.

Screen Shot 2013-10-25 at 10-25-11.25.07 AM

Given the re-stated quarters it’s possible to compare one year’s historic performance at a segment level. For example, the company states that “Devices and Consumer revenue grew 4% to $7.46 billion” while “Commercial revenue grew 10% to $11.20 billion”.

Since we don’t have data older than one year, our ability to assess the company over longer time periods will be drastically reduced and a new picture will take a long time to emerge.

There is however one aspect of the new structure that needs to be appreciated right away: the allocation of costs has changed fundamentally. The company explains:

Cost of revenue is directly charged to the D&C Hardware segment. For the remaining segments, cost of revenue is directly charged in most cases and allocated in certain cases, generally using a relative revenue methodology.

We do not allocate operating expenses to our segments. Rather, we allocate them to our two segment groups, Devices and Consumer and Commercial. Due to the integrated structure of our business, allocations of expenses are made in certain cases to incent[sic] cross-collaboration among our segment groups so that a segment group is not solely burdened by the cost of a mutually beneficial activity as we seek to deliver seamless experiences across devices, whether on premise or in the cloud.

[my emphasis]

In that brief paragraph Microsoft has formally and in a financially binding way declared itself to being a functional organization.[1]

The mechanism seems banal: operating costs are no longer assigned to product divisions but to two large buckets. In practice this means that profitability (P/L) cannot be assessed or assigned to individual managers. The lack of P/L responsibility means that incentives from top to bottom have to be re-engineered. If this goes wrong, the Assets[2] of the company could evaporate.

If the assets go, then processes and priorities are for naught.

In other words, what the company is undertaking is a priority shift (to a  functional structure to create integrated experiences) which requires a process change (whereby employees work according to new incentives) while preserving the fragile assets the company depends on (a motivated and skilled base of employees.)

This makeover is as ambitious as a re-org gets and the context, scope and target are as difficult as they can be. This is, after all, the largest software company operating the the most dynamic industry whose multi-sided markets are notoriously volatile due to disruptive forces.

The challenge also suggests why Ballmer left and who should replace him. A priority transplant operation requires a different set of skills than those held by the manager who created the processes for the previous set of priorities. That’s the manager’s dilemma: even if you foresee the changes needed and push for them to be enacted, your reward might be to be replaced by someone who can make the changes happen.

Those who envision and persuade for change are rarely allowed to enact it.

Notes:
  1. Welcome to the club. []
  2. read: people []
  • Accent_Sweden

    So over the coming 2-3 years, we will actually get to see how nimble Microsoft as an organisation can be. It should be very interesting regardless of how it turns out. The number of people who have to change motivations and focus could be significant. This is a major attack on Microsoft’s long-engrained culture as much as its accounting procedures. Could this portend the mass cleaning out of upper and middle managers who can’t or won’t adapt? Will the right people be put into place who can remove the intransigents and saboteurs protecting long- and well-defended turfs? Will this unleash creative dynamics that have long been held in check or create new ones? Will life-sustaining assets be drained before the task is complete? Lots of questions.

  • 程肯

    Given that the negative $2B or so of “unallocated” is now being allocated, I wonder how that will go down with the troops when it comes to bonus time.

  • poke

    This is going to be tough. Apple isn’t just functional, it’s virtue-oriented. The incentive structure is about personal excellence. Functional organisation is essential to that: a functional org has well-defined roles, making it easier to understand what excellence means for both those striving to achieve it and those assessing it (among other benefits). But you need to cultivate a culture of craftsmanship, where the job is its own reward, and people don’t expect to climb the corporate ladder, etc. That’s going to be very difficult to achieve in a company that isn’t in financial distress. The fact that Microsoft’s business is mostly B2B isn’t going to help either.

    In terms of a CEO, they need someone “at the intersection of technology and liberal arts,” of course! That’s going to be hard to find.

    • Shameer Mulji

      “In terms of a CEO, they need someone “at the intersection of technology and liberal arts,” of course! ”

      I hear Scott Forstall is looking for a job.

      • Daniel Lu

        Forstall was notoriously hard to work with and rather competitive with the other groups internally. That sounds more like the old Microsoft than the new ‘One Microsoft’

      • Shameer Mulji

        Before Steve Jobs was kicked out of Apple in the early days, he was also notoriously hard to work with. After being kicked out, starting NeXT, and owning Pixar, he gained a lot more wisdom. He brought that with him to Apple the second to build Apple to where it is today.

        Point being, people can learn and change.

      • Daniel Lu

        I think Forstall, like Jobs, would need time and room to make those self-improvements. Jobs spent over 10 years at NeXT

        This is also aside from the non-compete he probably signed.

      • Tatil_S

        AFAIK, non-compete agreements are not enforceable in CA, so he may not have actually signed one.

        He may have been competitive with other internal groups, but if he is the top dog, his competitors would be other companies, so his personality may suit the CEO position.

      • Daniel Lu

        Supposedly, it went so far that other executives would not meet with him unless Tim Cook was also there. I find it difficult to imagine that him transitioning so quickly from instigator to moderator.

        If Microsoft is going to be more like Apple, and Apple has a huge head start in regards to the workflow, procedure and culture of a functional company, and Forstall became detrimental to Apple’s well refined machinery… then I don’t see how Forstall would help Microsoft become a well run functional organization.

        I concede that Scott Forstall is like Steve Jobs, but I disagree with the jump from there to ‘Scott Forstall could save Microsoft.’

      • rogifan

        What qualifications does he have to run a complex company like a Microsoft? He didn’t have CEO like responsibilities at Apple. And if Steve Jobs didn’t think he was CEO material and Tim Cook fired him why on earth would Microsoft make him their CEO a year later?

      • Jacob Willliams

        Cook saw Forstall as a threat. That qualifies him.

    • JohnDoey

      That is an abandoned dream. Even at Apple, today they are just speeds, feeds, and designers wagging their tails in our faces. The last 2 or 3 Apple Events should have just been TechCrunch posts. I’m getting support calls from friends like iOS 7 is a version of Windows, so I don’t think Microsoft has it so bad.

      • berult

        The mythical glories of the Medieval English Longbows…

        The more resistance one encountered from pulling as far back as one’s ‘power-base’ let one, the farther afield one could aim one’s target…

  • Mercutio

    Why the [sic] before incent? While incentivize is the word in common parlance these days, incent means the same thing and is less of a mouthful.

    • Walt French

      Some dictionaries don’t show it; others show it as an Americanism.

    • http://www.asymco.com Horace Dediu

      Neologism. http://www.economist.com/blogs/johnson/2011/06/neologisms

      In any case, I flagged it [sic] since my spell checker identified it as an error. It seems not to be.

  • Tatil_S

    The reporting categories may not reflect the actual organization, but it is still odd that Skype is listed under Commercial Licensing. I wonder if that means Skype team is being merged with Live Meeting/Lync teams and the income from the real Skype is effectively declared negligible.

    It is also curious that they list Xbox Live subscriptions under one group, but Xbox Live transactions under another. By the way, what the heck is second party games?

    • obarthelemy

      This. The reorg still feels a bit half-baked, many products seem caught in a tug of war between Pro and Consumer.

      • Ian Ollmann

        It will go away when the same team becomes responsible for both.

  • Daniel Lu

    With their longstanding tradition of internal competition, the hardest aspect of this reorg will be moving from a extremely territorial, to superbly collaborative. And as Mr. Cook says, you have to be A+ at collaboration.

    I think the hardest part will be letting go of superstars who don’t fit into the new culture. Shame that their most recent exec departure was Sinofsky. In fact, I would say that if we don’t see a high level departure in the next 6 months, then the reorg hasn’t changed enough at Microsoft.

    • sranzha

      I think a argument can be made, people are now remaining and reporting to CEO directly are all kind of new faces at that level. Previous guys have all been pushed out or pushed aside.

      So the change has begun and I guess only time will tell how collaborative they are. I think one thing that happens in business conglomerates is who has a bigger revenue/profit center will get to decide overall direction and drive everyone based on their needed.

      I think that doesn’t anymore at MSFT – as clearly WP team is doing a better job than Win team. So question will be how will the leaders learn to follow?

    • DaMarico Fowler

      Most of the new faces do not have Sinofsky’s reputation and most of their superstars are much quieter types who collaborate.

  • menon

    Interesting Fact-Not Many people know that Scott Forstall has a Brother who works at Microsoft :)

  • DaMarico Fowler

    Kind of like Moses not entering the Promise land

  • handleym

    To me what leaps out from these graphs is that in MS it is enterprise that wears the pants. Which means Windows 9 and Windows 10 are going to suffer from the same split personalities as Windows 8.

    Enterprise is unwilling to let go of the baggage of the past; but that same baggage is what makes MS unable to compete successfully in consumer. Changing labels, and claiming the company is now “functional”, are not going to resolve this fundamental tension.