How Microsoft learned to love the outsiders

Date: 02-05-2012
Source: Fortune

A motley crew of struggling Internet companies have found an unlikely inspirational coach: Steve Ballmer.

FORTUNE — The Bad News Bears. Hoosiers. Remember the Titans. Moneyball. Friday Night Lights… It’s happened so many times in the movies — movies that often pledged they were based on a true story: A flawed but decent coach takes a bunch of ragtag misfits, turns them into champions and rekindles the passion in his heart.

So it’s got to happen in real life sometimes, right? Even in a part of the real world as surreal as the Internet industry. There has to be some great coach who can take a motley crew of misfits and turn them into a team of unlikely heroes with a Hollywood incantation like “Clear eyes, full hearts!”

Motley crew of the Internet, meet your inspirational coach: Steve Ballmer.
No, not the Ballmer who, in low-slung and lumpy slacks, played the sweaty ape as mad villain to Steve Jobs’ clinical yet charismatic hero. This is not the Ballmer who grunted, “Give it up to me!” This is the new Ballmer, the man who speaks — discreetly but forcefully — through his wallet. The man has $60 billion worth of kindling in his executive heart, just waiting for the right spark to set it afire.

This week, Microsoft invested $300 million in the digital book and college bookstore operations of the beleaguered Barnes & Noble. That comes nearly a year after Microsoft paid $8.5 billion for Skype, which had exited a rocky marriage with eBay and received a cold shoulder from the IPO market. A few months earlier, Microsoft announced a partnership with Nokia to make Windows Phone the primary platform for its smartphones. Nokia was once the global leader in mobile phones, but its market share had fallen to 31% from 37% in the year before its partnership with Microsoft (it’s fallen to 23% in the year since).

Like Nokia, Barnes & Noble, which has seen its stock lose more than 75% of its value since 2006, has fallen on hard times. And a pattern is emerging. While it’s made a few small acquisitions, like the $100 million purchase of video-search engine VideoSurf, and spent around 14% of revenue on research and development on new technology every year, Microsoft is slowly but steadily investing in building an alliance of web outsiders.

The Barnes & Noble deal brings into relief a web strategy that, for Microsoft, is peculiar. On the one hand, the company knows that if it’s going to be a force in the software industry, it needs to have a presence on the web. On the other hand, Microsoft has never gained traction there. Its online-services division has made a total of $6.9 billion in revenue in the past three fiscal years and posted an aggregate operating loss of $6.5 billion.

Abandoning the web isn’t really an option for Microsoft, so why not invest as little as possible in strengthening its hand? It’s almost as if Microsoft’s failed bid for Yahoo four years ago – an ill-conceived merger that Ballmer must be in some way relieved to have dodged – taught the CEO a lesson: cut-throat competition is for market leaders, and when you’re not a leader you need to band together with others on the periphery, even if they were once your enemies. But make friends as cheaply as possible.

There’s a historical irony to all this. In the 80’s and 90’s, when Microsoft dominated the software industry, Silicon Valley (led by the VC firm Kleiner Perkins) fostered a network of allied companies it called a keiretsu, a term loosely based on the Japanese practice of companies interconnected by both strategy and cross-shareholdings. One company that emerged from Kleiner’s so-called keiretsu was Google, which did more than any company to weaken Microsoft’s grip on the web.

But after Google came Facebook. And in the age of Facebook, Microsoft seems to be taking a page from Kleiner’s old keiretsu playbook. Microsoft is building a team of outsiders and unlikely heroes — bonded by strategy or shareholdings or both — to ensure it has a place at the table. If not to usurp the seat at the head of the table.

Whether the team of misfits that Ballmer is assembling proves to be the Bad News Bears or just bad, his strategic investments in the past few years will be studied in business schools.

They exemplify the art of the corporate tease. Microsoft approaches a company on the verge of being washed away into the ebb of Internet history, and offers them the vital flow of capital they crave. No full merger, just a friendly alliance with mutual benefits.

According to the Hollywood storyline of a team of misfits, there must be an underrated star, an ace that nobody saw coming. And Microsoft found its ace in 2007, when the company invested $240 million for a 1.6% stake of Facebook. At the time, no one — probably even Microsoft and Facebook — knew what to make of that move.

But five years on, it’s yielding unexpected benefits. Nevermind that that $240 million investment will be worth $1.6 billion if Facebook goes public at a $100 billion valuation. This alliance goes deeper. Microsoft can lend Facebook a presence in search that it lacks now, and enhance its presence to online advertising. And not just that. After Yahoo moved to sue Facebook for patent infringement, Facebook paid Microsoft $550 million for patents it recently bought from AOL. This is a keiretsu in action.

The question now is, whose keiretsu is it? Will Facebook be a big part of Microsoft’s developing keiretsu, or will it be the other way around? Yeah, it’s probably the other way around, but keep in mind that Microsoft now has one of the world’s premier VoIP apps, one of the world’s best e-reader apps, a potentially viable tablet OS and ready access to a mobile phone maker with a global reach. And Facebook has none of that.

The team of losers Microsoft is building may well, in the end, lose. But if you’ll allow me to stretch the sports metaphor a little further, all a team needs to do in a season is make the playoffs. Once it gets there, anything can happen. Microsoft knows its strategy is unlikely to make it a leader. It just wants to stay in the game at minimal cost. That’s not a bad strategy, and it just may get Microsoft its wish.

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