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It's Official: Microsoft Wants to Be Apple

By Evan Niu, CFA - Oct 10, 2012 at 7:35PM

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A tad overzealous, are we?

There have been plenty of hints this year that Microsoft ( MSFT 2.68% ) truly does want to pursue a monumental shift in its overall strategy after nearly 40 years and be more like longtime rival Apple ( AAPL 3.55% ). Everything from the introduction of its first-party Surface tablet, hinting at an eventual Surface Phone in the pipeline, to recent words that the Microsoft of the future would focus on devices and services.

Steve Ballmer has just penned his annual letter to shareholders, outlining his visions of where the iconic company is headed and how it will get there, and the clear takeaway is that path looks an awful lot like one that Cupertino went down many years ago. Of course, Ballmer's unmasked hatred of Apple would never permit him to admit to such strategic idolization of his archenemy, but investors can read between the lines.

Devices and services
Those are the two primary businesses that Microsoft wants to be in, though software will always be the heart of the company. Here's his summary of where the company's business is heading, straight from Ballmer's letter:

Last year in this letter I said that over time, the full value of our software will be seen and felt in how people use devices and services at work and in their personal lives. This is a significant shift, both in what we do and how we see ourselves -- as a devices and services company. It impacts how we run the company, how we develop new experiences, and how we take products to market for both consumers and businesses. The work we have accomplished in the past year and the roadmap in front of us brings this to life.

He's quick to point out that there will always be a place in the value chain for Microsoft's wide stable of hardware partners to help offer "great choices" in the marketplace, and one company can't build all the gadgets to serve the base of 1.3 billion Windows users throughout the world. However, he says there "will be times when we build specific devices for specific purposes," such as with the Xbox and Surface.

That level of hardware and software integration has proven wildly successful for the Mac maker, and Mr. Softy has taken note. Over the past decade, a segmented value chain full of commoditized OEMs racing to the bottom to compete on price and cost has led to consistently lower-quality hardware designs. That's a trend that Apple has bucked by focusing on the whole package and raising the bar with industrial design, and Microsoft wants to follow suit and set an example for its OEMs, even if that means competing directly with them.

Ballmer's words carry a strong implication that Microsoft is indeed working on a Surface Phone. With the importance of smartphones in the future of mobile computing, this is surely one of those "times."

Come one, come all
Cloud services is another area where Microsoft needs to invest heavily, especially if it ever hopes to become profitable there. We're talking about a realm currently dominated by Google (Nasdaq: GOOG), whose plethora of services keep its users engaged. (Nasdaq: AMZN) is also a heavyweight when it comes to content services that Microsoft is challenging by focusing on Xbox music and video services. Apple maintains a presence in cloud and content services, but its iDevice businesses pay the bills.

Microsoft retains top-dog status in enterprise services with its arsenal that includes Office, Exchange, Sharepoint, and Lync, among others, but Google is now starting to encroach more there by undercutting with its Google Apps suite. The company is looking to transition Office into a subscription service model with Office 365, but that shift has just begun.

A tad overzealous, are we?
The real question for investors is whether or not Microsoft can pull off such a "significant shift," and do it profitably. Transitioning its focus away from software and broadening its role as a devices and services company carries a lot of risk, considering that Microsoft simply isn't good at those things. If we categorize each of its operating segments into one of three categories (devices, services, or software), here's how I'd break down revenue last fiscal year:

Source: 10-K.

That's just the top line. If we look at operating income, the picture becomes even clearer:

Source: 10-K.

The three primary software segments provide substantially all of the positive operating income, while devices is now run near breakeven (after many years of cumulative losses), and services is just plain a stinker. Microsoft has bled billions of dollars trying to compete with Google in online advertising and cloud services, culminating recently in its $6.2 billion goodwill impairment.

This is the future that Ballmer wants for Microsoft. It's an ambitious shift, but investors need to be aware of what they're getting into because devices and services are not Microsoft's fortes. With Microsoft wanting to replicate Apple's success, with a pinch of Google tossed in there, perhaps Ballmer's being a bit overzealous.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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