When you look at the portion of your portfolio that’s devoted to tech companies, what do you see there? If you’re holding onto shares of Microsoft , you need to rethink that part of your portfolio. During the last 12 years or so, the tech giants such as Google , Amazon and undisputed champion Apple have had an amazing run, delivering astonishing returns. Microsoft, on the other hand, hasn’t done much of anything. Here are some things to consider when it comes to determining why Microsoft’s performance has been so lackluster of late.
Perhaps the biggest problem at Microsoft is that it no longer innovates the way a tech company must in order to thrive. Think about the revolutionary products that have come out of Apple in recent years – the iPhone and the iPad being the most notable. And Google continues to come up with disruptive technologies that turn the tech industry upside down and inside out – including its developing driverless car and its augmented reality glasses. Microsoft, by contrast, seems to settle for producing knockoff products and technologies. It’s simply not ahead of the curve. What position it does have is based largely on the widespread adoption and use of its OS in the vast majority of computers worldwide.
What doesn’t make sense is that Microsoft obviously has a huge bank account – more than enough to fund plenty of R&D, along with opportunistic acquisitions. As a total percentage of revenue, it even outspends its competitors on R&D. What it can’t seem to do is match the great returns on investment in its steep research and development spendings that companies like Google and Apple achieve.
Lately, Apple’s R&D expenditures as a percentage of total sales have dropped significantly in the last few years to its current level of under 3%, but its product launches nearly always hit the mark in spades. Amazon is another company that has managed to do very well on the innovation front while spending only 8% on R&D. Google is spending more like 13% of its sales on R&D, while Microsoft leads the pack at nearly 14%. But what does it have to show for that? Very little, I’m afraid.
A tired strategy
On another level, Microsoft’s lack of first-time innovation is an intentional strategy. It means rather than making an effort to become the first one to launch a new product, it intends to be the first to actually make good profits on its proprietary versions of a technology or product developed by its competitors. It’s a strategy that made sense when Microsoft had a huge size and strength position relative to its peers.
Take the case of what was once the very new technology of web browsers. It quickly became a competition between Netscape and Internet Explorer. Netscape was the first on the scene, but it lost the battle because Microsoft had its operating system in nearly every computer, and could bundle IE with it, which meant automatic ubiquity for the IE browser. But Microsoft simply does not have that same strong position these days. The strategy hasn’t changed with the times, which is why Microsoft cannot make much headway in the mobile phone industry against Apple’s iPhone, Google’s Android, and Amazon’s Kindle devices, all of which have much stronger operating platforms.
On the brighter side
In spite of its lackluster performance on the innovation front, Microsoft is still a strong company in many respects. No other company is going to suddenly eclipse its performance on the operating system front, or unseat the popularity of the Microsoft Office software suite. These core parts of its business are what fuel some surprisingly good numbers for Microsoft, such as gross profit, net profit and operating profit margins higher than industry averages, all of which results in an ROE in excess of 30%. It also has a strong liquidity position, with current and quick ratios above industry standards.
The bottom line
Part of Microsoft’s problem is one of perception. The basic view out there in the trenches is that the company is in a pattern of slow decline. What it really needs is something that will re-excite investors about the company. Unfortunately, that’s hard to do with its strategy of always lagging behind the exciting developments coming from other companies. On the smartphone front, Microsoft is in fourth place (3% market share), lagging behind even Blackberry (6%) and very far behind Apple (38%) and Google's Android (52%).