Will Microsoft’s Reorganization Pay Off?

Microsoft’s reorganization of its operating structure last week is a big move. CEO Steve Ballmer says he wants to make the company more nimble and collaborative and make it function as a single, cohesive entity rather than a collection of fragmented divisions. While Wharton experts acknowledge the need for this change, they note that it is not enough. For the reorganization to pay dividends, Microsoft needs to build market share in smartphones, tablets and gaming and reduce its dependence on the PC market. What is unclear is how the reorganization helps achieve that goal.

Clearly, a thorough overhaul was long overdue, in part because Microsoft faces a slew of external challenges. Declining PC sales have hurt the company’s Windows operating system software, which powers more than 90% of desktops worldwide. A day before Microsoft announced its reorganization, research firm Gartner reported an 11% decline in worldwide PC shipments — at 76 million units — in the quarter ending June. To make matters worse, Microsoft has been lagging behind in the smartphone and tablet markets that are eating into desktop PC sales. Its search engine, Bing, is dwarfed by rival Google.

Internally, Microsoft faces other problems. “Rivalries among the Microsoft divisions have built up over time, sometimes resulting in needless duplication of efforts,” noted a New York Times report last week. Microsoft’s finances mirror these challenges. Although revenues grew some 5% to $74 billion in its last-reported financial year ending June 2012, lower PC sales forced net income down more than 26% to less than $17 billion.

Given this reality, Ballmer seemed to have little choice but to change tack decisively. “We are rallying behind a single strategy as one company — not a collection of divisional strategies,” he wrote in a July 11 memo to employees announcing the changes. “To advance our strategy and execute more quickly, more efficiently, and with greater excellence we need to transform how we organize, how we plan and how we work.”

Ballmer hopes the reorganization will centralize technology decisions that were earlier made in separate silos. For example, all Windows operating systems for various devices are now under one business group headed by Terry Myerson. Similarly, the finance function has been centralized under Amy Hood, and Tami Reller will head all marketing, advertising and media functions.

In contrast, some old faces are expected to fade out. Kurt DelBene, president of the Microsoft Office division, is retiring. Chief research officer Craig Mundie — widely respected as a visionary, whom Knowledge@Wharton interviewed in 2008 — has been moved into a consulting role before a planned retirement at the end of 2014. Rick Rashid, who founded and ran Microsoft Research Labs for two decades, has been given a role in operating systems.

New Markets, New Structure

While declining PC sales pose a huge challenge for Microsoft, the company has been fighting that battle for a long time, notes Kevin Werbach, Wharton professor of legal studies and business ethics. “Pushing into new markets like mobile, cloud services, gaming, search and tablets is how Microsoft hopes to escape its dependence on the mature and now declining PC market,” he says. But Werbach adds that it is difficult to say whether reorganizations can help accelerate that process. In any event, Microsoft’s PC-based software businesses still generate huge revenues and profits, and so the company cannot abandon or ignore them, he states.

Kartik Hosanagar, a professor of operations and information management, expects Microsoft to deal with declining PC sales through its new “devices and studios engineering group.” Headed by Julie Larson-Green, the group will oversee all hardware development and supply chain aspects for the devices Microsoft builds. She will also be responsible for all offerings in games, music, video and other entertainment. “[That group] is being created in part to address hardware challenges with things like the Surface tablet,” Hosanagar says. “The tablet is certainly one piece of the puzzle in terms of addressing declining PC sales.” However, it is too early to speculate about the possible impact of the new division, he adds.

Shifting Power Centers

Power centers within Microsoft will shift as part of the reorganization. Ballmer has named 12 executives as heads of the new business groups. As he explained in an interview with the Seattle Times, Ballmer is optimistic that the new structure will enable greater internal collaboration through a four-pronged approach. First, the company will work on “a single strategy” and not divisional strategies. Second, effective its new financial year beginning July 1, Microsoft has “shared goals” instead of divisional goals. Third, each team is expected to take company-wide ownership of its responsibilities. “[For instance] the network team does networking, and they’re going to be the networking team for Microsoft, not that there’s going to be three or four networking teams…,” Ballmer told the newspaper. Lastly, the company will work on culture and focus among its employees. Ballmer listed five key attributes driving that effort: “Being nimble, communicative, collaborative, decisive and motivated — and collaborative and communicative are key parts of this.”

Following the reorganization, Microsoft has collapsed eight divisions into four, aligned around functions rather than products. “The underlying goal is to create software with tighter linkages to power an array of devices, making it easier for people to use their smartphones, tablets and game consoles as adjuncts to one another,” according to the New York Times report.

Rolling Out a New Microsoft

Despite the serious challenges that prompted the reshuffle, Microsoft has been making progress on several fronts. It seems set for a November launch of its much-anticipated Xbox One gaming console in North America. Microsoft is also working on the so-called Windows Phone Blue, the code name for an upgraded version of its Windows Phone mobile operating system. It recently struck a deal to open mini Windows Stores at 500 Best Buy locations across the country. The stores will aim to enhance customer experience with tryouts. “One of the keys to getting a new product to catch on is making it easy to try,” said Wharton marketing professor Jonah Berger, author of Contagious: Why Things Catch On,in a recent interview with Knowledge@Wharton Today on the arrangement with Best Buy.

The first major test for the new Microsoft may well be the tablet market. Last week, it slashed the price of the Surface RT tablet computer 30% from $499 to $350. The company had launched the Surface family of tablet computers last October and hoped to take on the mighty iPad, but that plan has not worked — at least so far. Surface RT sales are an estimated 1.5 million units since launch compared to the 19.5 million iPads sold in the first quarter of this year, according to a report from Business Insider.

Some media reports attribute the Surface RT price cut to the planned launch of an upgraded version. “With the news that that Microsoft is getting ready to release a Surface RT follow-up this fall, the massive price cut can only mean one thing: Microsoft and its retailers have a lot of stock that needs to be shifted quickly,” online magazine ExtremeTech reported. The price of the higher-end Surface Pro tablet stays unchanged at $900 and up.

Avoiding Pitfalls

The question uppermost in the minds of industry watchers is how successful Microsoft will be in reinventing the way it works. Wharton management professor Peter Cappelli notes that Microsoft will have to watch out for a few drawbacks of shifting decision-making power. “One is that decentralized decision makers take actions that are not what the central office would like,” he says. “A second is that it becomes difficult to get these decentralized actors to cooperate with each other or at least to know what the other is doing: It is very common to find that the company has several divisions contacting the same customer for similar things.” Microsoft would probably respond that that is precisely what the reorganization is intended to correct.

Hosanagar points to another challenge. “A key issue for Microsoft is the large size of the organization, which creates its own share of internal politics besides slowing down decision-making,” he says. “Reorganization alone won’t fix those issues.” A reorganization also “necessarily causes some chaos and confusion,” Werbach points out. “Employees need to understand the goals of the change, and they need to feel the company is not just shaking things up for its own sake. Also, the new structure has to be well aligned with external market demands, the corporate culture and the capabilities of the rearranged management team.”

The collaborative structure Microsoft desires has been compared to those that exist at Apple and Google. Both companies have brought hardware, software and services under a common umbrella in varying degrees. But the comparison ends there. Compared with these rivals, Microsoft is larger, more complex and has a wider product portfolio across which it must execute its reorganization. “Microsoft isn’t Google, and so Google’s structure wouldn’t be effective for it,” says Werbach.

Size is not necessarily the problem, though. “Even smaller, newer, more nimble technology companies often struggle to adapt to new platforms,” Werbach notes. “Look at how hard it has been for Facebook, and more recently Zynga, to adapt to the growing prevalence of mobile usage of social applications.”

Ballmer admitted in his memo that slipups are a necessary part of big changes. “In my own staff meetings, we are modeling these new characteristics, yet also find ourselves occasionally slipping back,” he wrote. “One strategy, united together, with great communication, decisiveness and positive energy is the only way to fly.”

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