I do not think the puzzling conjunction of Microsoft’s rising profits and declining stock price reflect investor pessimism about its principal products—the Windows operating system, the Office Suite (Word, Power Point, and Excel), and servers for large users. There will continue to be a heavy worldwide demand for them. The laptop and desk computer are not going away; they will continue to be indispensable in enterprises of all sort, public and private, individual and corporate, all over the world. And there is no compelling objective reason why Microsoft should lag in improving these products sufficiently to maintain its market share.
No reason, and yet the decline in its stock price suggests that investors are dubious. The problem is not that Microsoft has failed to achieve success in the hot new areas of mobile devices and of search, but that the failure strikes many investors as symptomatic of a more general problem, identified by organization economists such as Clayton Christensen of Harvard. And that is the difficulty that large, established, successful enterprises have in adapting to rapid changes in their markets. The number of large successful computer companies that have failed or (like Hewlett Packard) are struggling is quite
markable. The list includes (among the better known) Atari, Burroughs, Compaq, Control Data, Data General, DEC, NBI, Netscape, Prime Computer, Remington Rand, Sperry, and Wang.
What makes the computer industry so unstable from a producer standpoint is not only or even mainly the rapidity of technological change, which characterizes a number of other industries as well, but the rapidity with which a start-up can become a major producer because start-up costs in software and other computer-related business innovations are so cheap. Teenagers attuned more sharply to emerging tastes than adults, let alone middle-aged business leaders, can become formidable competitors of established businesses, seemingly in minutes. Smart teenagers become proficient in computer programming, are instinctively knowledgeable about the tastes and need of their contemporaries, and are able to raise the modest amount of money necessary to demonstrate the feasibility of their innovations.
What makes the young computer entrepreneurs so formidable is that established firms, especially successful established firms, such as Microsoft, which made Bill Gates the wealthiest person in the world, cannot adapt rapidly to market changes in the computer-Internet-social media world. It’s a bird in the hand, two birds in the bush, problem. Microsoft is very successful with a certain type of product, namely software designed to meet the work needs of professionals and businesspersons. Microsoft’s corporate culture, organization, leadership, and personnel are all optimized to improving,
producing, marketing, price, and servicing that type of product. It a huge organization. It has 100,000 employees. What is it to do with them, who are the successful core of its successful business, if it tries to transform itself an Apple, a Google, a Facebook? Erect a new business beside it—a start-up staffed by brilliant unruly college drop-outs? Can one see a Bill Gates type or a Steve Jobs type as Microsoft employee number 100,001? What kind of fit would that kimd of employee make with the company’s existing staff?
Large firms are organized hierarchically; it is the only way top management can exercise effective control. New ideas move slowly up a ladder of successively more senior supervisors. Because they are senior, older, experienced, they resist change, espcially change that may diminish their value to the company, or provoke turf battles with other divisions of the firm. They suffer from bureaucracy.
Yet the problem of adaptation to change is not limited to large companies. Small companies are nimbler, but also more fragile, and so equally or more reluctant to cannibalize themselves in order to move into a more promising business. It is start-ups that are most likely to embrace new, disruptive technologies—they have little to lose.
The tendency in economics is to think of corporate costs in opportunity-cost terms. A forgone opportunity is a cost measured by the profit that the opportunity would have yielded. Failure to exploit a promising business opportunity is like failing to pick up a $10 bill that you see lying in the gutter. But the individuals who make up a large organization tend not to think in opportunity-cost terms. They are not worker ants. They are individuals with their own utility functions. And one of the arguments in their utility functions is risk aversion. They weight a loss more heavily than an equivalent gain. They’d rather go with the office consensus, even if they think it wrong, because if everyone is wrong no one is blamed, than go out on a limb. Not all business people are risk averse. Entrepreneurs are not. But middle managers in large, established, successful firms are risk. They are doing well. They don’t want to rock the boat. Bureaucracy and the bureaucratic mentality are not limited to government agencies.
It would take a remarkable person to change Microsoft’s business culture. Investors apparently think it unlikely that CEO Ballmer will be succeeded by such a person. And apparently they fear that Microsoft’s established products, profitable as they are, might someday soon be subject to the same wave of creative destruction that has challenged so many computer companies and destroyed not a few of them.