MICROSOFT’S PROFIT MARGINS: Have you noticed that Microsoft has fallen
out of the spotlight?
Compared to their tech peers, Microsoft is rarely on the news and not many people have
a strong opinion about the company.
In fact, I’d argue that Micorsoft is the prominent tech company that people don’t
have a strong opinion about.
With Apple, there’s the whole controversy about their premium pricing and their anti
user policies.
With Facebook and Google, you’ve got the entire privacy argument.
With Amazon, you’ve got the bald slave driver controversy.
And with Netflix, well a lot of people are happy that they’re getting crushed.
This isn’t to say that we aren’t dependent on Microsoft though.
The vast majority of the world still uses windows and even if you’re a mac user, you
probably still use microsoft office.
Yet, despite their popularity, we rarely talk about Microsoft as a company.
I mean, they’re literally not even part of FAANG and their public interest is virtually
non existent in comparison to FAANG.
Despite this, Microsoft’s business as a whole is doing better than ever.
In fact, their gross margins are nearly 70% and their net margins are nearly 40%.
If Apple had these margins, people would be shredding them to pieces, but because it’s
Microsoft, no one cares or even knows other than shareholders.
Last year, Microsoft even overtook Apple and became the world’s most valuable company
for a hot minute.
If this same thing happened with Amazon instead of Microsoft, we would’ve seen social media
erupt with outrage and toxicity, yet no one cares because it was Microsoft.
Somehow, they’ve essentially become the VISA of the tech space.
Everyone knows about them and uses them on a regular basis, but no one cares about them
much more than that.
Honestly, this is probably the ideal situation given that spotlight the hasn’t exactly
been forgiving historically.
But, how has the company that essentially created the modern computer experience been
able to avoid the spotlight so effectively.
Well, it’s definitely not by accident.
So, here’s how Microsoft became the world’s largest background company.
THE PUBLIC MONOPOLY: Taking a look back, Microsoft wasn’t always
such a discrete business.
In the 80s and 90s, Microsoft was very much a consumer business and that’s why we all
know about them today.
As a front facing company, they faced much of the same criticism that today’s top tech
companies are subject to.
Many thought that Microsoft was a gross monopoly and that Bill Gates was an ruthless businessman.
Bill’s social image at the time could be compared to that of Mark Zuckerberg’s today.
But, Bill didn’t really care.
He was the richest man in the world and Microsoft was more profitable than ever, so he wasn’t
going to let a bit of public criticism get to his head.
But, maybe, he should’ve paid more attention to the criticism because pretty soon regulators
got involved.
In 1992, the Federal Trade Commision would began an inquiry into Microsoft’s monopoly.
This quickly escalated into a DOJ investigation, and in 1994, the DOJ would order that Microsoft
was no longer allowed to package other Microsoft products with the sale of Windows.
However, one nuance to these decree was that Microsoft could continue packaging in additional
features with Windows.
It probably would’ve been in Microsoft’s best interest to play this safe and avoid
testing the regulators.
But, Microsoft had different plans.
The internet was starting to explode in popularity, and it was clear to Microsoft that the internet
was the next big thing.
So, what better way to capitalize on the internet than to launch a browser, and this lead to
the creation of Internet Explorer in 1995.
If Microsoft stopped right there, it wouldn’t have been that bad.
Sure, they were still pushing the boundaries of being a computer software monopoly, but
they weren’t violating any court decrees right?
Well, this was true at the beginning, but this didn’t last long.
It was clear to Microsoft that if they really wanted to make Internet Explorer popular,
they had to package in with Windows.
So, they would call Internet Explorer a feature and throw it in with Windows.
As you would guess, regulators weren’t exactly a fan of this classification.
Internet Explorer was obviously a product and Microsoft was simply calling it a feature
to try to get around the DOJ settlement.
At first, the regulators turned a blind eye to this, but Microsoft kept pushing the envelope.
Remember the controversy about Apple slowing down older iPhones, well, Microsoft had their
own version of this with Internet Explorer.
They told users and the court that if the browser was uninstalled, Windows would run
slower and have more malfunctions.
This was obviously completely false, and if Windows did slow down, it was because Microsoft
programmed it to slow down, not because Internet Explorer actually made Windows run better.
Eventually, regulators had enough, and in 1998, they would put their foot down.
The DOJ and the Attorny Generals of 20 US states and the District of Columbia would
sue Microsoft for “illegally thwarting competition in order to protect and extend its software
monopoly.”
SAVING THE MONOPOLY: Usually, it takes forever for regulators to
get involved, but once they’re involved, you know they mean business.
Two perfect examples of this were Standard Oil and AT&T.
In 1911, Standard Oil was broken up into 34 different companies.
And in 1984, AT&T was split up into 8 different companies.
A break up like this would’ve devastated Microsoft and Bill knew it.
Fortunately for Microsoft though, Bill had already been preparing to fight such a lawsuit.
You see, several months before the lawsuit, Microsoft had actually bailed out Apple.
If you’re familiar with Apple’s history, you know that they were getting destroyed
in the late 1990s and the company was on the brink of bankruptcy.
Even though Microsoft could’ve easily watched from the sidelines as Apple went bankrupt,
Bill decided to strike a deal with Steve instead.
Steve agreed to drop Apple’s copyright lawsuit against Microsoft and Bill agreed to invest
$150 million into Apple.
Through this deal, not only was Bill able to knock out Apple’s lawsuit against them,
but he was able to create some plausible deniability for himself.
If regulators questioned him about his monopolistic practices, Bill could point to how he saved
Apple and how he’s actually pro competition.
Unfortunately though, regulators didn’t quite buy Bill’s master plan and on June
7, 2000, they ordered that Microsoft be broken up into two separate units.
One unit would produce operating systems while the other would produce additional software.
Honestly, this ruling wasn’t even that bad given that AT&T was broken up into 8 parts
and Standard oil was broken up into 34 parts.
But, that doesn’t mean that Microsoft was happy with the verdict.
They weren’t gonna go down without a fight, so they filed an appeal.
The appeal was instantly escalated to the Supreme Court, and the justices would suprisingly
all side with Microsoft but not for the reason that you would think.
The supreme court unanimously agreed that Microsoft was absolutely a monopoly; however,
they invalidated the break up order because the judge who issued the order did not follow
the correct protocols.
He had failed to hold hearings on the remedy and he had also been having secret interviews
with reporters while the case was ongoing.
The supreme court did not rule out the possibility of properly issuing another breakup order,
but after being so publicly humiliated, it’s no wonder why prosecutors didn’t pursue
another breakup order.
Instead, they would order that Microsoft share their application programming interface with
third party companies and that a panel be setup to ensure Microsoft’s compliance.
Microsoft had basically just won the lottery.
They were able to avoid a gamechanging breakup all thanks to a few semantics.
Playing ball as a brash public monopoly had nearly devastated Microsoft, and Microsoft
had escaped with the skin of their teeth.
There was no way that Steve Ballmer or Bill were gong let this happen to Microsoft again.
And this marked the beginning of Microsoft's life in a shell.
TRANSITION TO B2B: There was no question that Microsoft needed
to stop attracting all of this public interest if they wanted to avoid future lawsuits and
regulations.
But, how does such a massive company fade from the spotlight?
Well, the answer is switching customers.
Microsoft has always had an extremely lose policy when it comes to people pirating their
software.
In fact, Bill has publicly admitted that Microsoft would rather you use a pirated version of
their software than a pirated or paid version of someone else’s software.
As you can see, Bill was very much ok with people pirating their software if it meant
Microsoft would get more marketshare.
As Bill touched on, the idea was that they could eventually figure out some sort of method
of monetization whether that be ads or data collection.
By the mid 2000s, Windows and Office had basically reached market saturation, so it was finally
time to collect.
But, they couldn’t deploy something as public as ads or data collection.
Regulators were literally waiting for the next moment that Microsoft would trip up so
that they could persue more severe legal action.
So, directly monetizing customers was off the table, but it was time to look at monetization
differently.
Instead of trying to monetize the end user directly, maybe it was smarter to monetize
businesses.
They had already gotten people used to and addicted to Microsoft products, so they could
force businesses, institutions, and computer manufacturers to pay for Windows and Office.
They also went ahead and basically made Windows free for end users.
So, no one could really complain.
Everyday people weren’t directly paying Microsoft at all.
And, institutions had better things to do than complain about Microsoft leveraging their
monopoly and charging insane markups.
I gotta say, there was legitimate reason to complain if they wanted to though.
Back in 2010, Microsoft literally had gross margins above 80%.
Meanwhile, the regulators didn’t really care because they only care about protecting
the public not institutions.
They figure that institutions have the resources and capital to protect themselves if they
wanted to.
And given that the public wasn’t being harmed, regulators turned a blind eye once again.
Not to mention, they had bigger fish to fry like Facebook, Google, and Amazon who were
even more obvious monopolies.
So, Microsoft has been more or less left to do as the please when it comes to the computer
OS market.
THE NEW MICROSOFT: Overtime, Microsoft has further leaned into
this B2B model and they’ve started to offer these businesses other products like servers
and cloud computing.
Since then, this side business has grown so much that it’s actually started to outshine
Windows and Office.
In fact, intelligent cloud is now Microsoft’s largest revenue driver having pulled in $20.9
billion last quarter.
This includes all of their server products and cloud services.
Second place goes to the productivity and business processes category which pulled in
$16.6 billion.
This includes Microsoft Office, LinkedIn, and other commercial products.
And in last place, we have the personal computing category which pulled in $14.4 billion and
this is what includes Windows, the XBox, Bing, and other consumer products.
This means that Microsoft could completely ditch the consumer market, and their business
would only shrink 30% if that.
In other words, they could ditch the consumer business and they’d likely still be a trillion
dollar company.
And that right there is why Microsoft has completely avoided the spotlight.
In the 80s and 90s, Microsoft was one of the most well known consumer businesses in the
world, but after nearly being broken up, they made a 180.
They pivoted to being an institutional business which allowed them to maintain their monopoly
with little public criticism and legal ramifcations.
And now that they’ve made the switch, they no longer need or want public attention.
For them, it’s better if the media keeps grilling on Facebook and Google while Microsoft
continues making just as much from the shadows.
And that's why Microsoft has been avoiding the spotlight.
Did you realize what game Microsoft was playing?
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