Microsoft's (NASDAQ:MSFT) Windows and Office cash cows once made it the top dog of the tech world. But that heyday, which lasted through most of the 1990s and early 2000s, ended when it missed the market shift toward mobile devices. That's why analysts expect its revenue and earnings to respectively rise just 2% and 4% this year.
But under CEO Satya Nadella, who succeeded Steve Ballmer in early 2014, Microsoft made sweeping changes to counter its biggest headwinds -- sluggish PC sales, OS fragmentation, a poor mobile presence, and weakness in its cloud ecosystems. Let's discuss Microsoft's latest strategies to overcome each of these challenges.
Weak PC sales and OS fragmentation
In the past, Microsoft relied heavily on sales of Windows and Office licenses for PC users. However, sales of PCs have fallen year-over-year for seven consecutive quarters, according to Gartner, due to longer-lasting hardware and an increasing dependence on mobile devices.
Meanwhile, Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google and Apple (NASDAQ:AAPL) popularized free operating systems. Google and Apple both take a cut of app store sales within their free operating systems -- which generates more stable long-term revenue than a one-time license fee.
Since a new license was required for every Windows upgrade, many users simply stuck with older, "good enough" versions. That's why Windows 7 remains the most popular PC OS with a 48% share of the market, compared to a 23% share for Windows 10. That fragmentation means that Microsoft must keep supporting outdated operating systems, and that newer features (like Cortana) might only reach a fraction of its users.
Microsoft addressed these headwinds by making Windows 10 a free year-long upgrade for most users, and tethered PCs, mobile devices, and Xbox Ones to a universal app store. The Windows Store remains much smaller than Google Play and the App Store, but it's an encouraging step toward generating revenue from apps instead of paid OS licenses.
To counter similar problems with Office licenses, Microsoft pivoted toward Office 365, which runs on a cloud-based subscription model. Earlier this year, Gartner reported that Office 365 was more popular than Google Apps among large enterprise customers.
Weakness in mobile and cloud ecosystems
If Microsoft had a viable mobile OS, the slowdown in PC sales wouldn't be as challenging. Unfortunately, Windows Phone controlled just 0.4% of the global smartphone market in the second quarter, according to IDC. Android and iOS respectively controlled 87.6% and 11.7% of the market.
The lack of a mobile platform makes it hard for Microsoft to expand cloud-based features like Bing Search and Cortana. Without users feeding data to those services, the overall usefulness of its cloud platform Azure as an analytics tool declined. In response, Microsoft reduced the number of smartphones it would launch every year, and pivoted toward launching major apps like Office 365, OneDrive, Bing, and Cortana on iOS and Android. It even forged partnerships with numerous Android OEMs to pre-install those apps on their devices.
Microsoft is also trying to blur the lines between mobile devices and PCs with new Surface 2-in-1 devices and Continuum, a Windows 10 feature which converts Windows 10 Mobile devices into full desktop PCs. By doing so, Microsoft is leveraging its strength in PCs (particularly among larger enterprise customers) to promote the idea of an "all in one" device to replace the smartphone, tablet, and PC.
Microsoft is also gathering more data from its users than before with Windows 10. That practice was criticized by privacy advocates, but it's arguably necessary to get the OS, Cortana, Bing, Azure, and other Microsoft platforms onto the same cloud-based page. To do so, it recently merged the Microsoft Research and Information Platform Groups with the Bing, Cortana, robotics, and ambient computing teams to create the new AI and Research Group.
That team will infuse Microsoft's apps with AI features (like Skype translate), develop new features with facial recognition and machine analytics, and expand the company's cloud infrastructure to "build the world's most powerful supercomputer with Azure." In other words, Microsoft wants to expand its cloud ecosystem to counter Google's, while helping Azure close the gap with Amazon's market-leading AWS (Amazon Web Services).
But will these strategies pay off?
Microsoft still has a long way to go before it can catch up to Google, Apple, and Amazon in the mobile and cloud platform markets. Nonetheless, Nadella's forward-thinking strategies are arguably superior to the complacent tactics that came before, and could gradually offset Microsoft's outdated dependence on PC sales and licensing fees.