TMT: “Culture Eats Strategy for Breakfast!”

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May 21, 2014

TMT: “Culture Eats Strategy for Breakfast!

Culture matters. It biases a company’s world-view, it shapes institutional skill sets, and dictates management decisions. When it is aligned with a company’s strategy and the opportunities created by the market, it is a powerful competitive force, and when it is misaligned, it is an insurmountable obstacle to success. Each of the companies that have been the biggest drivers of the sea change underway in TMT carries the imprint of its founder(s) in strong, idiosyncratic cultures that are key to understanding their likely moves and their long-term potential performance in the face of major industry shifts. GOOG, driven to extend its towering leadership of cloud data center technology and leverage it via “moon shot” bets, and AMZN, relentless in pursuing its manifest destiny of global retail and wholesale distribution dominance, are aligned for success in the huge opportunities being created in TMT. FB’s culture is admirably agile in following its founder’s lead, a trait that is probably an enormous asset, but also, possibly a risk. MSFT, in the post-Gates era, was a poster child for culture/strategy/opportunity misalignment, but the 3rd generation CEO transition appears to have the company moving back to strategies that play to its cultural strengths. Finally, AAPL’s famously Jobs-ian culture has been absolutely critical to its rise to the top, but may be becoming a liability as the market opportunity shifts off of the device and into the cloud.

  • Corporate culture is critical to understanding TMT. The most influential tech companies tend to be young compared to leaders in other sectors, and typically, reflect the personalities of their founders, which guide their strategies for pursuing success in their particular vision of the future, shape their institutional capabilities and assets, and set their operating philosophies. When culture is well aligned to the real dictates of the evolving marketplace, it can be a powerful force driving success, and when it is not, it is a substantial limitation. As Peter Drucker famously said, “culture eats strategy for breakfast!”
  • Culture has many facets. There are many frameworks for evaluating culture, most of which touch on similar themes. The McKinsey 7S approach assesses organizations on 7 dimensions. Within the 7S, Systems, Structure and Strategy are viewed as “hard elements” that are easy to specify and change, and Staff, Skills, Style and Shared Values are “soft elements” that represent the personality or culture of an organization. To the extent that both hard and soft elements are well aligned to the company’s vision, and in turn, to the realities of the evolving market opportunities, a company can be successful. Misalignment is often badly punished in competition. This is particularly true in TMT, where personalities are strong and company lives are often short.
  • GOOG: Using computer science to solve big problems. CEO/founder Larry Page sets the tone for the company culture that we believe is best positioned for the cloud era. GOOG’s core strategy is to push the leading edge of software and data center design as far and as fast as possible, using its technology leadership to audaciously attack huge problems in business and society, and to find the best ways to monetize and protect its business investment. Its cloud data center skills are world best with very strong web application and advertising capabilities and growing design expertise. It is the employer of choice for top computer science talent, drawn by management that values ingenuity, big thinking, and risk taking, with a famous “work hard, play hard” meritocratic style that puts it near the top of “best company to work for” lists. We view GOOG’s culture and strategy/vision as tightly aligned to the biggest opportunities of the cloud era.
  • AMZN: Relentless pursuit of manifest destiny. AMZN plans to overwhelm incumbent merchants in segment after segment with its scale economies, efficiencies, convenience and selection, with the goal of rolling up as much of the $30T global retail and wholesale market as possible. AMZN’s institutional skill set is impressive, with the industry best e-tail logistics operation, world-class cloud data centers, and impressive product development capabilities. CEO/founder Bezos values customers above all (while disdainful of investors), and sets the tone for the company’s secretive, combative and Spartan style. The environment for employees is considered a bit harsh, and AMZN has more difficulty attracting and retaining staff than most of its rivals. While this may be a cultural soft spot, we see AMZN’s culture well suited to its aggressive strategy and to the e-commerce opportunity.
  • FB: In search of ubiquity. Mark Zuckerberg’s ambition is to connect every person on earth and to collect as much information about them as possible. FB culture is aligned to that goal, and reflects his “Hacker’s Way” manifesto of “move fast and break things”. FB values agility, shifting strategies on the fly, boosting things that work and killing things that don’t, and it values data, collecting as much of it as it can. It has strong data center, analytics and application software skills, with growing facility in advertising. FB has a fast paced, swashbuckling style that appeals to engineering talent, and attracts top notch staff with ease. FB’s culture and strategy are now well matched to opportunity, but Zuckerberg’s total control, relative inexperience, and distaste for financials, leaves the risk of a costly strategic misstep.
  • MSFT: Getting back on track. Under Bill Gates, MSFT was a vicious competitor that kept its strategic options open until it launched its withering attack, but also helped 3rd party developers prosper within its growing sphere. Gates stepped down in 2000, on the heels of a deal with the DoJ that neutered MSFT’s most aggressive tactics, and the company entered a lost decade of strong cash flows but slipping relevance. The recent elevation of Satya Nadella to CEO portends a move to strategies better aligned to the company’s cultural strengths and the opportunities of the emerging cloud era. MSFT has world-class cloud data centers, strong applications programming skills, and deep understanding of enterprise computing needs. It is still able to acquire strong talent, and is breaking the scleral bureaucracy that has plagued it.
  • AAPL: What would Steve do? During the 2nd Jobs era, AAPL is one of the greatest examples of the power of cultural alignment with strategy and opportunity. AAPL was and is creative, device driven, meticulous, and secretive, with world-best integrated device design, operations and marketing skill sets. Management style stresses accountability and winning, and rewards are status and responsibility rather than money or perks. However, as the cloud paradigm rises and high-end device sales decelerate, AAPL’s device-focused strategy and aligned culture, is limiting its opportunity set. The Beats by Dre acquisition may break with Jobs’ distaste for large acquisitions, but the assets being bought – brand, design, music industry experience – are all things that merely extend AAPL’s existing strengths. We are concerned that AAPL could be entering its own “lost decade”.

Culture – It’s Not Just for Breakfast Anymore

Analysts are shy about assessing the effect of corporate culture, perceiving it as subjective and squishy, vulnerable to criticism by their empirically minded clients. However, the impact of culture on the success or failure of companies is huge. Faced with market opportunities, a company starts with a vision of the future and sets its strategy to get there. Around that strategy, the company establishes an organizing structure and codifies systems for making progress. These formal elements of organization are supported by its evolving culture – its institutional skills, the style by which employees interact, its ability to attract and retain staff and its shared values around what is important and what is not.

The alpha dogs in tech have big differences in their strategies and their cultures, which often reflect the outsized influences of their ever present founders. The recipe for success, from Business School 101, is market opportunity, strategy and culture all aligned. Evaluating this alignment for the 5 companies that catalyzed the current TMT sector sea change against the opportunities being created is instructive. We believe those opportunities are huge, with mobile devices and wireless networks opening the door to applications run from powerful cloud-based data centers, attacking huge swaths of the traditional economy – 10s of trillions of dollars in traditional media, enterprise IT, advertising, retail, and wholesale.

GOOG leverages its world-best cloud data center capabilities to solve big problems with audacious “moon shots”. Its style is employee driven and data focused, and its shared values honor ingenuity and risk taking. In contrast, AMZN is customer and efficiency driven, while reflecting the ambition and secrecy of founder Jeff Bezos. It is also a prodigious infrastructure investor, funding a near obsession with shorter delivery lead times expected to open new categories and bring new customers. FB is following a “manifest destiny” to connect everyone on earth, collecting as much data as possible in the process. The organization is unusually agile, following the “work fast and break things” credo of its founder, and emulates GOOG in its skills and style. For these three, we see culture, strategy and opportunity in alignment, although the occasionally capricious leadership of FB founder Zuckerberg and AMZN’s disdain for investors, and to a lesser extent, its employees, does give us some pause.

MSFT spent more than a decade in limbo after its ferocious competitive approach was defanged by the DoJ and CEO/founder Gates stepped down. Opportunities were missed and the organization turned famously political. The 3rd generation passing of the CEO baton to former cloud head Satya Nadella appears to set the strategy firmly in alignment with opportunities, while structural moves to break up entrenched fiefdoms may soften the fierce infighting that plagued the Ballmer era. Meanwhile, the software engineering and enterprise sales skills remain extremely valuable, while its competitive style may be turned back outward toward rivals.

As MSFT alignment improves, AAPL’s may be going the other way. Its Jobs inspired culture – peerless device design, manufacturing logistics and marketing skills; a supremely confident and secretive style; talent drawn to the company’s mystique; and shared values honoring beautiful design and end user delight – was integral to its tour de force transformation of consumer electronics, and drove it to be the most valuable tech company in the world. However, this awesome, hermetically sealed linkage between culture and strategy may be a liability as market opportunities shift into the cloud. The pillars of AAPL’s strategy – supreme brand power, device focus, proprietary applications, high prices, small M&A just for tech or talent – need tweaking for the new era, and the deep roots of culture may make that very hard to accomplish.

The Cultural Revolution

In 1938, Chester Barnard, the president of the New Jersey Bell Telephone Company, published “The Functions of the Executive”, presenting his “theory of cooperation and organization” within a “study of the functions and the methods of operation of executives in formal organizations”. This book has been recognized as one of the most influential books on business ever published and was unique for its time in considering the social and psychological aspects of management. This was perhaps the seminal work on the importance of corporate culture. Since then, management gurus from Peter Drucker, to Peters and Waterman, to Edgar Schlein have emphasized the importance of a company’s culture on its ability to achieve its goals. As Drucker famously wrote – “Culture eats strategy for Breakfast”.

Analysts, however, shy away from including the influence of culture in their assessments of the companies they follow. Perhaps, this is because culture cannot be quantified. Evaluating it is necessarily subjective, and as such, difficult to defend from critics with a different perspective. Still, in TMT, where young companies often have idiosyncratic cultures that reflect the outsized personalities of their founders, understanding the ways in which those cultures support or undermine strategy can be crucial to forecasts of future competitive performance.

In this piece, we are asserting our understanding of the cultures of the five companies that we feel are at the center of the once-a-generation comprehensive paradigm shift underway across the TMT landscape. These companies, Amazon, Apple, Facebook, Google and Microsoft, all have distinctive cultures spawned from the personalities of their founders. Codifying the cultural facets for each of them, we also assess the alignments of those cultures to the dictates of their strategies and to the opportunities being created by the rising cloud era.

7S

There are a lot of frameworks for assessing the culture of an organization. We will use the one with which we are the most familiar, McKinsey’s 7S framework, popularized by Peters and Waterman in their best selling “In Search of Excellence” series. In this tool, three of the S’s – Strategy, Structure, and Systems – are termed “hard elements”, aspects of an organization that can be easily changed by executive decision. Structure is best understood as the boxes and reporting lines on an org chart. Systems refers to all of the processes that the organization uses to accomplish work – not just information systems, but all of the operational routines throughout the company. Strategy is straightforward – what vision does management have of the company’s future and what steps does it plan to get it there. For the purposes of our evaluation of corporate culture, we will set structure and systems aside, and consider strategy in the context of its juxtaposition between culture and the realities of the evolving market.

The “soft elements” of the 7S – Skills, Staff, Style and Shared values – are the real nuts and bolts of organizational culture, and are devilishly difficult for management to change. Skills are the capabilities of the company on an institutional level – human capital skill sets, unique technology, infrastructure, accumulated data, ecosystem relationships, etc.. Staff refers to the company’s ability to attract, motivate, develop and retain the employees ideal to its needs. Style is the norms by which employees communicate with one another and by which managers implement their directives. Finally, shared values are the priorities within the organization – What is important, what is cool and what is not.

Exh 1: McKinsey’s 7S Framework

Opportunity is Knocking

We believe that the TMT sector is in the midst of a massive transformation, the likes of which we have not seen in 25 years. This sea change was catalyzed by the contemporaneous rise of three major innovations – mobile device platforms, wireless broadband networks, and, most importantly, massively distributed cloud data processing architectures. Together, these innovations have eliminated constraints on user access to data and computing, spawning huge new businesses, bringing new leaders to the fore, and sounding a death knell for old paradigm business models. We have written about this once a generation phenomenon at length, most recently in our January piece (http://www.ssrllc.com/2014/01/january-6-2014-tmt-10-predictions-for-2014/).

The emerging “cloud era” arising from these new TMT paradigms has put huge swaths of the global economy in play for new players leveraging these innovations:

Devices: The smartphone, brought to its modern form by Apple, has already laid waste to the global cell phone market. About 967 million smartphones were sold in 2013, more than 54% of total mobile phone unit sales (Exhibit 2). We expect that penetration to approach 100% over time, with most growth now and in the future coming from lower priced units. The smartphone revolution has also spurred a rise in accessories, including audio headsets and other wearable extensions, such as e-watches and glasses. While this market is growing quickly, we do not believe that it has the potential to be more than a small fraction of the size of the smartphone industry given more limited added value to users and, likely, significantly lower prices (Exhibit 3). Tablets have also emerged as a major device category, again inspired by radical innovation by Apple. Global tablet unit sales were 219M in 2013, growing at 47.8% with most of the growth, again, coming from lower priced segments. This growth has come at the expense of consumer PC sales, which declined -9.8% last year and are now 31.3% smaller in units than the tablet market (Exhibit 4). We expect this trend to continue for the foreseeable future, and further, expect slow incursion into enterprise for laptop PCs as well. Many of these trends are addressed with more detail in our 2013 piece “The PC-ification of the Smartphone” (http://www.ssrllc.com/2013/08/august-1-2013-mobile-devices-the-pc-ification-of-the-smartphone/).

Exh 2: 2013 Smartphone and Feature Phone Sales, Top 5 Vendors

Exh 3: Quarterly Global Tablet Shipments, 2Q2011-1Q2014

Exh 4: Consumer PC versus Tablet Unit Sales, 2011-2013

Exh 5: e-Commerce in perspective, 2013

E-Commerce: Traditional retail stores and e-commerce companies moved more than $15T in merchandise in 2013 (Exhibit 5). Wholesale distributors – selling things from paper clips and medical supplies to industrial machine tools and construction materials – were even bigger, moving more than $20T last year. Potentially, all of this is better addressed by the new breed of cloud savvy players, able to use technology to better identify likely customers, better communicate their offerings, dramatically increase selection, provide better information and service to customers, improve the experience and convenience of buying, accelerate delivery to the customer, and greatly reduce the costs of doing business. Even with the notoriously thin profit margins of distribution businesses, E-commerce addresses well more than $1T in global profit contribution. We recently touched on this in our look at eBay (http://www.ssrllc.com/2014/05/may-8-2014-ebay-betting-big-on-the-future-of-retail/).

Exh 6: Global Measured Media Advertising Spend, 2013 vs. 2016

Advertising: Global “measured media” advertising, which in ad-speak refers to spending on forms of advertising that can be easily counted – essentially the traditional markets of TV, Radio, Magazines, Newspapers, and Outdoor, combined with the emerging category of online ads – was over $500B in 2013 (Exhibit 6). Much of this is addressable by cloud-based internet advertising – now 21% of this total – which offers dramatically superior targeting, measurement, and consumer tracking than the traditional categories. However, focusing only on “measured media” greatly understates the addressable market for cloud-based advertising. Spending in non-measured advertising and marketing categories – directories, flyers, direct mail, telemarketing, couponing, sponsorships, promotional events, in store ads, etc. – is thought to be as least as large as the measured spending, and is also addressable by cloud-based players, bringing the total opportunity to more than $750B. We reviewed the dynamics of this in our War On TV series last summer (http://www.ssrllc.com/2013/07/july-2-2013-the-war-on-tv-part-iii-reductio-ad-absurdum/).

Enterprise IT: Annual global enterprise information technology budgets top $3.6T, including hardware, software, services and the costs of maintaining an internal IT staff (Exhibit 7). Add in often ignored costs, such as real estate and power, and that figure could approach $4T. All of this is addressable by cloud software and data center providers, which offer dramatic cost savings and superior performance relative to traditional internal IT operations. We recently wrote about this in “SaaS: After the Levee Breaks – Competition in Software” (http://www.ssrllc.com/2014/03/mach-2-2014-saas-after-the-levee-breaks-competition-in-software/).

Exh 7: Gartner’s Aggregate IT Spending Forecast Revisions, 2Q11 – 4Q13

Other Addressable Markets: There are other traditional industries under threat by cloud-based attackers. The $250B global pay TV market is obviously threatened by streaming video (see our piece, “The War on TV Part IV: The Biggest Pipe Will NOT Win” http://www.ssrllc.com/2013/07/july-17-2013-war-on-tv-part-iv-the-biggest-pipe-will-not-win/) (Exhibit 8). Personal finance, including payments processing, savings account, consumer loans, etc. is protected by moats of regulation, but, ultimately, could also be vulnerable to cloud-based franchises. Consumer services – ranging from already decimated travel agencies, to future medical tele-consultations – will also be on the table for the cloud.

Exh 8: Global Consumer Internet Video Growth, 2012-2017

Amazon – Customer-driven, Efficient, Ambitious and Secretive

Amazon founder Jeff Bezos started the company with an insight. An online merchant with a centralized distribution center could economically keep a MUCH larger selection of products on hand for customers, and, without the real estate costs of brick-and-mortar stores, sell those products at a significant discount. Bezos chose books for his first market – broad selection was a huge advantage and book stores tended to be large with high costs – and the rest is history. Today, Amazon is positioning itself against as much of the multi-trillion dollar global retail and wholesale distribution market as it can, while simultaneously using its assets to address other related opportunities, such as cloud IT hosting and consumer electronic devices.

Amazon’s strategy is straightforward. Offer consumers (and, increasingly, businesses) an unmatched combination of convenience, selection and value for the products they want and need, investing in scale, efficiency and technological innovation to drive continual improvement along each of those vectors to widen its advantages against traditional stores and other e-commerce competitors. Its vision is nothing less than domination across wide swaths of both retail and wholesale distribution markets across the globe.

This strategy is well matched to the opportunities that we see in the market, and its culture is ideally aligned as well. Looking at the “soft element” S’s that we believe define corporate culture, this alignment is obvious (Exhibit 9):

Skills: Amazon’s expertise in efficiently managing logistics for an inventory of millions of products, sold to more than 200M customers, in more than 170 countries, often with less than 2 day delivery, is an extraordinary asset. Supporting this massive global operation is a world-class cloud data center operation, that is also the industry’s leading IaaS cloud hosting service. Amazon has also shown considerable consumer marketing prowess, and has delivered well designed e-readers and tablets to an appreciative market.

Style: Amazon’s management style reflects its founder Jeff Bezos. The company is efficient – decisions are clear cut, actions are bold, costs are low. Everyone is expected to work hard and perceived slackers are typically fired. Amazon is also secretive to the extreme, with information kept to close circles with a “need to know” and an ethos of “loose lips, sink ships”.

Staff: Perhaps because of its Spartan style – employee compensation and perks are not particularly generous, Amazon facilities are far from luxurious, and management is demanding – the company has more difficulty than many of its peers in attracting and retaining staff. Amazon has an unusual program that pays employees $5,000 to quit, feeling that it would rather part ways with disgruntled workers than to deal with poor productivity.

Shared Values: Amazon is extraordinarily customer focused. From the very top to the bottom, employees are expected to put customers first – working relentlessly to improve their experience and being responsive to their feedback. Customers come before employees, but they also come before investors. The company does not care about its quarter to quarter results, focusing instead on its long range goals. Bezos thinks big and expects his management team to follow his lead. Amazon also values information, about itself, its customers and its partners, and is loathe to share it with anyone outside the company, including its investors and partners.

Exh 9: Strategy and the Soft S’s: Amazon

We see Amazon’s culture as well suited to its “manifest destiny” strategy of relentless expansion against the massive global distribution opportunity. The biggest vulnerability is in its relatively low employee morale, which may make it difficult for it to attract and retain the caliber of technical talent that it needs to push its IT ambitions forward.

Facebook: In Pursuit of Everyone

Facebook’s origin story is mythic at this point. From Mark Zuckerberg’s Harvard dorm room, just over a decade ago, he launched the service that now connects more than 1.2B humans on earth. From the start, the central goal was to connect as much of the world, and to capture as much data about those relationships, as possible. Monetization came later. Zuckerberg was supposedly wary of advertizing – but after testing the waters in delivering a variety of paid services to Facebook users, it became clear that ads were the obvious best fit given the company’s huge and growing user list and the social graph of information beneath it. Now, Facebook unabashedly pursues ad dollars, and it is very good at it. Ad revenues were up an astonishing 82% YoY in the most recent quarter, with miles and miles of room for further growth.

Facebook’s strategy is driven by its obsession with the size of its user base, and with monopolizing the time that those users spend online (Exhibit 10). The details of the strategy are deliberately mutable – Zuckerberg’s “Hacker’s Way” mantra of “Work fast and break things” speaks to the iterative, no sacred cows, approach that permeates the company. To that end, when games and services weren’t enough to drive revenues, Facebook moved quickly to push ads. When the company’s “one app for all purposes” approach began to fail its users and its advertisers, Facebook executed an about face and began to break the services many functions into distinct, focused apps. M&A is also a major piece of Zuckerberg’s strategy, investing in potential new franchise services, like Instagram photo sharing or WhatsApp messaging, that bring and attract new users to the Facebook family.

Exh 10: Strategy and the Soft S’s: Facebook

Facebook’s culture is a clear reflection of its founder’s image:

Skills: Facebook has world class application programming skills and very strong data center operations as well. It has proven a fast learner on the intricacies of online advertising markets, and in selling itself to the adverting community.

Style: Facebook is virulently anti-bureaucratic, and the style is loose and creative, in many ways reminiscent of its bigger, older rival Google. The “Hacker’s Way” manifesto also values iteration – try things, test them, keep the things that work and jettison the things that don’t. Mistakes are okay at Facebook as long as you recognize them quickly, learn from them and fix them.

Staff: Facebook is generous to its employees and remains a “cool” place for top tech talent to work on cutting edge computer science, data analytic and application programming problems. As such, the company is rated near the top of “best places to work” lists and is considered an employer of choice for engineering graduates.

Shared Values: Users come first at Facebook, but employees are a close second. Advertisers, technical partners and investors receive significantly lower priority. Internally, Facebook values talent and adherence to the hard working, risk taking, iterative ethos inherent in Mark Zuckerberg’s Hacker’s Way manifesto. Above all, Facebook the company places its trust in its CEO, who has absolute say over any important strategic decision.

Currently, we see FB’s strategy of breaking its monolithic service into a collection of linked, focused apps as very well aligned to the needs of the advertising community, which remains its primary opportunity. Facebook’s culture, imbued with the agility inherent in its founder’s philosophy, is well suited to execute that strategy. Our only concern is that agility could work both ways, and iteration could become ambiguity, particularly if Zuckerberg’s capricious nature sees the company veer off course from the opportunities at hand.

Google: In Pursuit of Everything

Google famously started as a PhD research project by Stanford grad students Larry Page and Sergey Brin in 1996, before being incorporated in 1998 out of a Silicon Valley garage. Page and Brin have since then been on leave of absence from the doctoral programs and for good reason. Their algorithm changed the way internet search worked and the term “Google” has been part of the vernacular since the early 2000s as their site overwhelmingly became the search engine of choice for most of the world now serving some 100 billion searches a month. They built the internet’s leading advertising platform in the process. Both have continuously reiterated their company’s mission “to develop services that significantly improve the lives of as many people as possible” and branched out beyond search into other product areas. Though commonly viewed as an ad driven company given that more than 95% of its pre-2013 revenue came from advertising, the company’s tentacles reach into all things tech including software (Android, Chrome OS, Chrome browser, cloud based apps: Gmail, Picasa, etc), media (YouTube, Play), devices (Chromebook, Chromecast, Nexus), payments (Google Wallet), broadband (Google Fiber, Google WiFi), cloud computing (AppEngine, Compute Engine), and of course its moonshots (Google X, self driving cars, robotics, Calico, Project Loon). Google’s user numbers are staggering with over 1 billion Android devices activated in the last 6 years, 1B unique YouTube visitors consuming 6B hours of content every month, and over 750M users of its Chrome browser including the team here at SSR. Powering Google is the world’s biggest, cheapest, and most powerful computing platform that combined with its world leading data management, algorithm development and deep learning software expertise puts it in prime position to attack the nearly limitless number of traditional businesses ripe for disruption from the cloud.

Of all TMT companies, Google is the only one addressing every opportunity and sees the world as its oyster, and with that it may be addressing larger and more lucrative opportunities than any other TMT player. Google’s fundamental strategy is to think big, lever its extraordinary data processing prowess, and push the leading edge of technology as far and fast as possible. Revenue from moonshot projects like self driving cars, robotics, mitigating disease via its Calico venture, and offering universal internet access via Project Loon, is still well into the future, but these big dreams impact other work at Google like data analytics and deep learning, which have come a long way in the last decade. Google also realizes that sometimes it may not have the necessary skills to pursue an idea, and as a result, acquires companies like Nest earlier this year, which will position it for the smart home. It’s no surprise Google is the most acquisitive company in the world, buying out 6 firms this month alone.

Exh 11: Strategy and the Soft S’s: Google

Skills: Google has cutting edge technical skills around nearly aspect of computer science and encourages its researchers to push things forward by publishing in academic journals and open source forums. It boasts the world’s most sophisticated data center operations. It monetized its search business early, and is extremely adept at not only selling advertising, but innovating its advertising products and proving ROI to marketers. Its design and marketing skills have improved greatly over the past few years, closing a major gap vs. its perceived rivals Apple and Amazon. Where it has dreams but lacks skills, it’s willing to breakout the checkbook and buy companies.

Style: Google takes pride in its core principles around “doing cool things that matter” and change that is revolutionary rather than evolutionary. The company eschews processes typically found in most major companies, in favor of ideas. Innovation requires a hands on approach from everyone in the organization. Larry Page was once spotted speaking to a janitor about his methods for disposing trash. Despite this, it’s cracked down on the famous 20% time policy, issuing firmer guidelines on how to use it.

Staff: Google was ranked number 1 “Best Company to Work For” by Fortune for the last three years consecutively. The company spends on lavish perks like food, gourmet snacks, massages, and child care by design to keep employees in the office and productive. It also spends heavily to find and retain the best talent. Google will outbid for the best talent, but will often leave the employees it doesn’t want to retain. Not surprisingly it is a favorite employer of computer science graduates from Cal Tech, MIT, and Stanford.

Shared Values: It places emphasis on building, creating, learning, taking risk and having fun all the while doing no evil. The company values sexy advances in technology over the needs of individual users, prioritizing the developer. Advertisers typically come first at Google and have almost immediate access to reps, while consumer requests result in referrals to Google blogs that sometimes require an engineering background to digest as many products linger in beta status for years. Distribution of some devices like Glass has been limited to developers and sophisticated users it calls “Explorers.” Larry Page is now leading the day to day operations of the company while Sergey Brin leads special projects and moonshots.

Google’s culture and values have almost institutionalized innovation and are a core part of the company’s fabric. The company is attacking every front of TMT, but its primary source of revenue is still advertising. Longer term, we believe the company can build strong revenue streams from e-commerce, enterprise IT, pay media, and consumer services, while expanding its leadership of online advertising. Furthermore, we believe that some of the company’s more speculative investments – self-driving cars, Google Glass, anti-aging research, robotics, etc. will prove to be important new businesses. Still, Google is weakly positioned with enterprise customers, and faces regulatory and consumer watchdog scrutiny for its use of personal information.

Apple: Strong Culture, Excellent Strategy, Wrong Opportunity

Steve Jobs had an awesome vision – electronic devices, powerful yet intuitive, even simple, to use. Software and hardware melded into tight harmony to deliver a seamless experience to users. Beautiful, minimalist design that made Apple’s devices functional art, combined with smart, creative marketing, which burnished the brand into an aspiration for global consumers. A maniacal focus on manufacturing and global logistics, which ensured the highest levels of product quality at industry leading cost efficiency.

Apple first turned its vision toward the nascent market for personal music players, a market that had been previously led by Sony’s cassette tape walkman line, but that was threatened by the emerging technology of digital music downloads and the specter of copyright piracy. Apple exploited the record label’s fear of piracy, delivering the iPod, integrated with the proprietary (and copy protected) paid iTunes download service. Six years later, Apple followed the wild success of the iPod with the revolutionary iPhone, which followed the same awesome vision, delivering a new shortcut to accessing internet-based functionality via Apps, which Apple controlled with an iron fist through its App store, exacting a 30% slice of the app developer’s revenue. Five years after that came the iPad, which did to the consumer PC what the iPhone had done to traditional cell phones, and what the iPod had done to the Walkman so many years ago. From these extraordinary successes, Apple has grown to be the world’s most valuable tech company with annual sales of more than $175B. So far, so good.

The problem is that the opportunity for selling more consumer devices, particularly at the highest price points where Apple exclusively competes, is looking increasingly tapped out. After averaging 54.9% sales growth between 2010 and 2012, Apple’s sales growth for CY 2013 was just 5.7% (Exhibit 12). Total smartphone unit sales are still growing at a healthy 19.3%, but the average selling price slid 13.4% in 2013 and the iPhone’s global share slipped from 17.1% to 15.5% (Exhibit 13). The same story is playing out in tablets, where industry growth continues at 19.4%, but Apple’s share has slid from 40.2% to 32.5% in the past 12 months, while iPad revenues have begun to decline at a -12.9% pace. Other device categories, from TVs to connected e-watches have been posited as the next big thing for Apple, but the realities of those markets appear to obviate the potential for any of them to be big enough or profitable enough to move the needle for Apple. Meanwhile, the company has been slow and ineffective in addressing bigger opportunities outside of its traditional wheelhouse, such as e-commerce, advertising or enterprise IT.

Exh 12: Apple Key Metrics, FQ1 2012- FQ2 2014

Exh 13: Smartphone ASPs, 2012-2018

Addressing these larger, cloud-driven opportunities demands change from the Steve Jobs strategic playbook, and importantly, demands changes in Apple’s famously strong culture. These changes may be VERY difficult to execute (Exhibit 14).

Skills: Apple has unquestioned leadership in the design of consumer electronic devices, melding cutting edge hardware with its extraordinary software platform to deliver industry best integrated user experiences. It is also best at managing device manufacturing and global logistics. It is also world class in its marketing, advertising and retailing skills, supporting a brand that is one of the most valuable in the world. However, it is NOT strong at data center computer science, data center management, or cloud application development.

Style: To outsiders, Apple is paranoid, a reflection of its founder’s intense competitive instincts and his compulsion for secrecy. Inside, Apple employees yearn to be assigned to the highly secret product teams that drive new product development and the ongoing evolution of Apple’s user platforms. Management is firm, serious, and more hierarchical than many Silicon Valley firms. Above all, Apple’s style is confident, if not even arrogant, with a keen sense of the company’s past success and an overarching belief in its future.

Staff: Apple is still the employer of choice for top device engineers, decorated designers, manufacturing operations talent and retail experts. It is known to pay well, but does not offer the same array of perks provided by many of its bay area brethren. Stock options have made many employees rich, but recent performance has made it easier for would-be rivals to poach technical talent from Apple. Employee morale depends on the aura of success around the firm and the mystique of Steve Jobs. Should this fade, retention of talent may be more of an issue.

Shared Values: Even after his death, Steve Jobs sets the tone for Apple’s values. Beauty, simplicity, creativity, determination to perform the improbable, preference for the proprietary, a reluctance to look outside the firm for inspiration, disdain for competitors, and the confidence to stick to a vision even if some evidence points in another direction. The cool people in Cupertino are Jony Ivie and his hardware/software design team, new hire Angela Arendt’s retail organization, and the global operations group. The cloud application and data center operations teams have to sit at the nerd tables in the cafeteria.

Exh 14: Strategy and the Soft S’s: Apple

We believe that Apple’s strong culture may be a considerable obstacle for Tim Cook, should he look to move the company away from Steve Job’s strategic principals to move more resolutely to, say, advertising, payments or commerce driven cloud applications, or to a less proprietary platform strategy. It could also make it doubly difficult to integrate possible acquisitions that have their own established cultures. It is this misalignment of opportunity with Apple’s strategy and culture that leaves unenthused about its ability to continue its prosperous trajectory in the emerging cloud era.

Microsoft: Will the Third CEO be the Charm?

Microsoft obviously lost something in the transition from founder Bill Gates to 2nd generation CEO Steve Ballmer. Arguably, a big loss came in the wake of the consent decree with the DoJ, which mandated the separation of Internet Explorer from Windows and, essentially, neutered the company’s historic hardball competitive tactics. Gone was the fierce, merciless competitor with its fingers in everything, waiting for the market to reveal itself so it could pounce with overwhelming force. Early Microsoft is a fascinating case study – Gates was partnered with IBM on PC-DOS and OS1, while simultaneously developing Windows in secret, working with Apple on the applications that would become Office, and taking a 25% stake in the early Linux leader SCO. When Windows gained traction, Gates abandoned OS1, ported Office to Windows, and sold off its stake in SCO. In the process, IBM, Apple, WordPerfect, Lotus, and a few other early PC players were left holding the bag.

By 2000, that kind of no holds barred competitive behavior was off of the table, and Ballmer led the company toward a more cooperative role in the global software industry, driving adoption of broader APIs that could solidify Microsoft’s hold on key parts of the overall enterprise IT picture. Development focused on delivering major updates to Windows, Office and the company’s successful server and tools products every couple of years, with a tiger team process for executing the major update roadmaps. Meanwhile, Microsoft whiffed on many of its bigger initiatives during the first decade of the millennium, in particular, with repeated failures in the emerging smartphone market.

The elevation of cloud business head Satya Nadella to the CEO office may be the sign of a new Microsoft. Already, the company had committed its strategy and resources to the cloud, levering its data center hungry consumer businesses (Bing, Xbox Live, Skype, etc.) as anchor tenants on the world class Azure commercial cloud service. The extraordinarily lucrative Office franchise saw an early transition to the cloud as well, establishing Office 365 as the still dominant productivity franchise and thwarting would-be SaaS rivals at their start. Microsoft, which had been notably unsuccessful in the ERP applications that were cornerstone franchises for its fiercest software competitors SAP and Oracle, also used its cloud assets to attack with its own SaaS applications. This is the part of Microsoft that Nadella comes from, and we expect his strategy will be to continue to lever the company’s modern cloud infrastructure, its strong enterprise software development skills, and its comprehensive network of relationships with IT professionals all over the globe. This maps well to our view of the future of enterprise IT (Exhibit 15).

Exh 15: Strategy and the Soft S’s: Microsoft

Still, the question remains: can Microsoft’s culture rebound to show the same competitive aggression, decisiveness, and creative flair? We think it can, and Nadella’s actions to break up the ice cap of management fiefdoms at the top of his org chart is a great start:

Skills: With Amazon and Google, Microsoft is one of three scale players in commercial cloud hosting. We believe the company’s capabilities are strong, particularly when combined with its deep understanding of the enterprise computing market and the needs of IT professionals. Microsoft also leverages a deep and talented sales force and strong application development skills.

Style: Under Ballmer, Microsoft became less combative and more political. Things like forced scale employee ratings and multiyear upgrade cycle fire drills became central motivators for employees. Losing the infighting mentality will be difficult, but long time Microsoft employees seem confident that the old hypercompetitive Gates ethic is still deep in the company’s DNA.

Staff: Political infighting aside, Microsoft is still viewed as an attractive employer to engineering talent – it is generous with pay and perks, it offers work on big, fascinating projects, and has substantial resources to make it all work. The unambiguous emphasis on the cloud will only help.

Shared Values: Microsoft has an admirable focus on making all of its products work together, offering clear API’s for third parties to slot in to the integrated whole. It is also tightly focused on the needs of the enterprise customer and the individual knowledge worker. Nadella has suggested that he hopes to restore the entrepreneurial tradition of the company, which has been less than evident over the past 15 years.

Nadella certainly has a challenge in clearing the organizational plaque that is clogging Microsoft’s arteries. To its credit, the strategic shift toward the cloud has, thus far, been very successful, with Azure and Office 365 notable success for the company. We believe that the substantial opportunities in enterprise IT play greatly to Microsoft’s strengths, particularly since its traditional competitors in the subsector, like Oracle, HP, IBM and SAP, face far greater cultural and strategic challenges in coping with the industry paradigm shift.

Appendix 1: Known US Data Center Locations of Apple, Amazon, Facebook, Google, and Microsoft

Appendix 2: Highest paid software engineers, 2013

Appendix 3: Best Tech Companies to Work For, 2013

Appendix 4: Relative R&D Spend, 1Q 2004 – 1Q 2014

Appendix 5: Absolute R&D Spend, 1Q 2004 – 1Q 2014

Appendix 6: Relative CAPEX Spend, 1Q 2004 – 1Q 2014

Appendix 7: Absolute CAPEX Spend, 1Q 2004 – 1Q 2014

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