Ballmer just opened the Second Envelope

You know the business lore joke. The departing CEO meets his successor and hands him three envelopes to be opened in the prescribed order when trouble strikes. First crisis, the message in envelope #1 says: Blame your predecessor. Easy enough. Another storm, the the CEO opens the second envelope: Reorganize. Good idea. And when calamity strikes yet again, he reaches for the third: Get three envelopes…

This past Tuesday, Steve Ballmer reorganized Microsoft’s Entertainment & Devices division, let go of its execs, Robbie Bach and J Allard, and moved a few more pieces around. All wrapped in the most mellifluous, Orwellian language we’ve seen from Microsoft in awhile. The full memo is here. We’re treated to encomiums to great work, friendship, spending more time with one’s family, leaving on a high note…under the guise of decency, this is indecent.
Ballmer’s view of executive leadership doesn’t admit standing up and taking responsibility. He can’t say ‘I screwed up’ and then explain what he’ll do to rectify the situation. No. Instead, two gents are fingered while they pretend they aren’t being blamed. In a surreal, a cappella farewell memo, J Allard writes to his soon former troops:
No one can touch our talent, our impact or our ambition. We’re the only high-tech company with the track record and self-confidence to reinvent ourselves as we have. If you want to change the world with technology, this is still the best tribe out there.

Robbie Bach dutifully plays his part in the down-is-actually-up corporate farce. He gives a long exit interview to the Microsoft-friendly blog TechFlash where he claims the dual departures are coincidental, that everything is fine. What does he have to say about tablets? Nothing much:
Well, tablet is an area that will evolve going forward. Certainly it’s a focus for what we’re doing in the Windows space, and how they’re thinking that space. We’re going to have a bunch of netbooks and tablet stuff that’s in the works there. We’ll just see how that evolves. I don’t think there’s anything earth-shattering about that. It’s just another set of devices, and we’ll figure out how we make sure we bring a good offering to consumers.’
And, regarding the now defunct Courier tablet:
Courier, first of all, wasn’t a device. The project and the incubation and the exploration we did on Courier I view as super important. The “device” people saw in the video isn’t going to ship, but that doesn’t mean we didn’t learn a bunch and innovate a bunch in the process. And I’m sure a bunch of that innovation will show up in Microsoft products, absolutely confident of it.
Serves us right for not reading the small print on the screen during the demo. These guys obviously think we’re idiots. That’s their privilege, but they ought to be a little more discrete about their low regard for us.

Not everyone buys this BS. One blogger, Horace Dediu, offers what many believe is the right explanation: Robbie Bach was fired because he lost the HP account. As the largest PC maker, HP is a hugely important Microsoft customer. A few weeks ago, HP acquired Palm for its WebOS smartphone software platform. The slap in Microsoft’s face still resonates; it’s a verdict on the failed Windows Mobile offering and a negative prognosis on its upcoming Windows Phone 7 Series operating system for smartphones. Days after the acquisition, Mark Hurd, HP’s CEO, let it be known that WebOS will be used in connected printers. As a final blow, HP’s (future) Slate Tablet, once held high as a Windows 7 device, will also use Palm’s WebOS.

Steve Ballmer has always been Microsoft’s most powerful salesman. That he lost the HP mobile devices account—and it was Ballmer who lost it, not Robbie Bach—is yet one more reason why Microsoft shareholders are troubled. Their unhappiness can be charted by comparing two stock price graphs, spanning the January 2000 – May 2010 period. Microsoft’s stock dropped from $56 to $25.80…

…while Apple shares rose from $25 to $256.88:

The morning after Steve Ballmer opened the proverbial Second Envelope, Apple’s market cap, the total value of its shares, surpassed Microsoft’s. In Wall Street terms, Apple is now the largest high-tech company, worth about $230B, a few percentage points ahead of Microsoft. Across all industries, Steve Jobs’ company is now second only to an oil company, Exxon, at $285B. When questioned about Apple overtaking Microsoft, Ballmer had this to say:
It is a long game. We have good competitors but we too are very good competitors,’ he said. ‘I will make more profit and certainly there is no technology company on the planet that is as profitable as we are.

When it comes to profits, Ballmer is willing to take credit.

Over the last decade, Wall Street has declined to reward Microsoft for its superior profit. The explanation is simple: Professional investors don’t believe Ballmer, and they don’t see bigger profits in Microsoft’s future. Conversely, they bid up Apple’s shares precisely because they think the company will keep growing revenue and profits. Apple has managed to enter new, growing markets, a feat Ballmer has repeatedly failed to accomplish.

January 2000 was when Steve Ballmer was made CEO of Microsoft. Yes, we can discount the year 2000, that’s when the Internet Bubble burst causing most high-tech shares to collapse. Still, since the end of 2000, Microsoft stock has stagnated, hovering between $25 and $30.
This never appeared to faze Ballmer. While we joke about the Steve Jobs Reality Distortion Field, Microsoft shareholders ought to worry about Steve Ballmer’s own distortion, and about the self-inflicted effects of such a strong field.
We all remember Vista, it was a godsend for Apple. Did Ballmer acknowledge that there were problems? What about the Xbox 360 reliability nightmare? The apologies were left to underlings. Then Google comes out of nowhere to take 65% of the Search market, leaving Microsoft with an Apple-like market share (I’m referring to Macs, not iPods). In MP3 players, Microsoft failed again and again in its attempts to unseat the dominant (65% market share) iPod/iTunes combo. Social networks? A tiny investment (1.6%) in Facebook. And where is Microsoft in the Microblogging world, a.k.a Twitter? Nowhere, the old Microsoft Messenger is fading away.

Now we have the most recent Microsoft failure: Smartphones. When the iPhone came out in 2007, Ballmer pronounced it a “passing fad’’. Then, in 2008, he promised that Windows Mobile would have 40% market share by 2012. To be fair, he did recognize the failure in October 2009: ‘[We] screwed up with Windows Mobile.’ The platform was effectively dead. Earlier this year in Barcelona, Ballmer introduced his new smartphone OS, Windows Phone 7 Series, available in time for the Holidays. Two months after the Barcelona event, two Kin phones emerge to a lukewarm reception…and neither of them run on the old generation software, nor the next one, orphaned at birth.

Undeterred, Ballmer now predicts there will be 30 million Windows Phone 7 smartphones sold in 2011. Ballmer has proudly proclaimed there will be no iPod or iPhone in his household, so that’s a few Windows 7 Phones sold right there. As for the rest of the 30 million… has he heard of Android? At last week’s Google I-O, the company announced there were over 100,000 Android phones activated every day, more than 35 million Android phones this year. Given the enthusiasm of handset makers for Google’s OS, they’ll probably sell twice as many next year. Ballmer’s Reality Distortion Field is overheating.

There’s no dearth of advice for Ballmer to right the ship. You can find Galen Gruman’s at Infoworld and Anders Bylund’s at the Motley Fool. But I’m afraid none of it will work. The same leadership will cause the same effects. Ballmer is running out of envelopes.

One of Microsoft’s problems, paradoxically, is that it makes a lot of money. It can spend 15% of revenue in R&D—about $9B a year—with no market breakthrough to show for it. Great concept demos and prototypes… and then nothing. (How many new Googles, Facebooks, and Twitters could we VCs fund with that kind of money?…)

A bigger problem is Microsoft’s Board of Directors. Ten women and men with distinguished backgrounds ranging from banking to pharma, from university president to venture capitalist. (There’s a lonely entrepreneur there, Reed Hastings, CEO of Netflix. He’s a math whiz, which could explain the NetFlix prize.)
Three out of the ten members are old-time friends, connected through Harvard (Gates and Ballmer) and Stanford (Ballmer and Marquardt). Such closeness makes it difficult to make painful decisions. Furthermore, it’s not obvious how a research mathematician, the President of Harvey Mudd College—a terrific place for gifted kids—an auto executive, and a banker can parse the finer but essential points of a mobile software strategy. The PowerPoint slides look professional, the occasional demo looks good… but what can a “generalist’’ director do?

In theory, the directors’ most important function is to hire and fire the CEO. But how independent are the Microsoft directors? How could they get the CEO to open the third envelope?

Microsoft didn’t have Apple’s stroke of luck. Fire one if its founders who goes on to start two companies, Pixar and NeXT, and then comes back twelve years later, tempered by the experiences, good and bad, ready to lead the company to an amazingly successful second act. Except for Ballmer’s two-year stint at Procter & Gamble, all he and Gates have ever known is Microsoft.

So, there we are. An immensely successful company, still making large amounts of money but unable to go beyond its original Windows + Office + Exchange franchise, left behind by a combination of newcomers such as Google and Facebook with the old frenemy, Apple.

Someday, a large institutional holder will get tired of waiting, tired of watching yet another rah-rah, ‘the future will be great’ speech from Ballmer, and they’ll dump their shares. That might shock the Board into taking the required drastic action. Take a look at the institutional ownership of Microsoft stock. Many have already started selling portions of their holdings.

Next week in Los Angeles we have the Wall Street Journal’s D8 conference (the speaker line-up is here). Steve #1 and Steve #2 will be interviewed on stage by Walt Mossberg, the newspaper’s high-tech guru. We’ll see how Walt broaches the Second Envelope question with Steve #2. Will he pose hard questions or toss softballs, allowing Ballmer to give one more of his now tired and tiring ‘We’ll win…eventually’ speeches?

Come to think of it, Steve Numero Uno might very well heap praise on Microsoft’s CEO, he likes him just the way he is: with enemies like Ballmer, who needs friends?

I’ll be in attendance, and will report back next week.

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