Will there be a third?
A recent quote by Steve Ballmer in an article by analyst Stephen O'Grady caught my eye: "We’ve had the two most successful software products in history: what makes you think there will be a third?"
It isn't clear if this is a direct quote, but it does point to the fundamental problem that not only Microsoft, but all mature technology businesses face. Once you succeed in building a meaningful business, how do you sustain and continue to grow? The technology industry is littered with the corpses of companies that had great success followed by great failure.
We have some photography buffs in the office and Kodak has come up as an example of a business that was not able to cope with changing technology trends. It is easy to criticize Kodak for missing out on the digital market, but the digital market couldn't easily replicate the billions of dollars in high margin reccurring revenue that the traditional film business generated. In 1999 Kodak earned $14B in annual revenue, almost all of which came from traditional film products. Inflation adjusted, just to maintain their business, Kodak would have needed to generate over $16B in revenue in 2009. To put that into perspective Google generated $23B in revenue in 2009, and following their merger with Macromedia, Adobe, which could be considered one of the leaders in digital imaging, generated total revenues less than $4B.
So for Kodak to fully bridge the gap from film to digital, they would have needed to create a digital business 2/3 the size of Google or 4 times the size of Adobe, while their core business was withering away. Even if Kodak had succeeded in generating billions of dollars in digital revenue, more than likely it would have come in a much lower margin business.
It isn't impossible, but the chances of rebuilding the entire company's revenue stream in 10 years are slim. Having attended RIT, often referred to as Kodak U, Kodak is a company that is near and dear. They knew digital was coming. They released the first Digital SLR system in 1991, and were pioneers in commercializing CCD technology. But when trying to replace billions of dollars in revenue, every opportunity looks comparatively small. A business as strong and profitable as Kodak's traditional film business isn't something you stumble into everyday.
I think Microsoft will soon be in the same position as Kodak. As the market moves away from desktop productivity apps to hosted services, they too will be faced with having to replace billions of dollars in revenue with a massive new business opportunity, that they've yet to tap.
In 2009, Henry Blodget, had this to say about Google's application business, as it relates to Mircrosoft:
Google Apps are a classic disruptive technology. They meet the needs of casual users (whereas Microsoft Office is vastly over-featured). They are simple and convenient (we use them almost exclusively). Their price, free, can't be beat.
Google Apps could end up being a lousy, puny business for Google and still steal a huge chunk of revenue and profit from Redmond.
So, Ballmer is asking the right question. Will Microsoft be able produce another product with the massive revenue generating opportunities the size of Windows and Office? And if not, how does the company manage out of their current situation? I think the same questions could be asked of Google. Will their mobile and application businesses ever reach the size of their advertising businesses?
When considering the types of investments that Warren Buffet makes, he looks for the business like Kodak with massive recurring revenue streams, but one's that can't easily be replaced by new, cheaper, technology. That's why a portfolio company like Coke is such strong business. Their recurring revenue is not easily effected by advances in technology.