Microsoft and Cool

Growing up in the 1990's and the early 2000's, I recall Microsoft being the omnipresent company making Windows and thriving off its enterprise business. There was nothing remotely sexy about it. Even at a young age, I found the design of Microsoft's software to be stale and unimaginative, catering solely to function. Being raised in an immigrant family with little discretionary income, all I had to play with were old Windows PC's that were hand-me-downs from various friends and family members. My fascination with tech started with Windows NT, followed by Windows 95, Windows 98, and finally my last version, Windows XP. It was shortly before the release of Windows Vista that I had all but abandoned the Microsoft ecosystem, and turned to Apple.

There wasn't anything in particular that made me switch to Mac OS; it was a combination of many small deal-breakers that together made for a very frustrating Windows experience. First there was the bloatware that came preinstalled with practically every PC. Then there was the general disregard Microsoft had for aesthetic. Before I bought my first Mac, I never used OS X before, but I always found it to be more appealing from the screenshots I had seen. Moreover, Windows was never playful, and it always felt like it was made primarily to please enterprise. That's because it was.

Things began to improve with Windows 7, but it was the Windows 8 design language that finally made Microsoft value design and appeal. Although Windows 8 was a colossal failure, in my eyes it was what solidified the shift of Microsoft. I still do not know exactly where Microsoft is shifting, but it feels like the right direction.

If you've followed me on Twitter these last few weeks, you would know I called Microsoft out for its purchase of Accompli Mail and Sunrise Calendar. I have since changed my thinking. My mistake was in assuming that the goal of both purchases was to eventually turn a profit from these apps. This line of reasoning was reinforced by the constraints of my business school education: a company buys another company when it believes the return on that investment will exceed the return of the next best investment. You already know I'm a big fan of examples, so let me illustrate my previously faulty logic.

Let's say you own a company and have $1B of unused cash lying around. It would be foolish to keep it locked down at a bank, since the interest rate you would be earning would be negligible. Instead, you can invest it in the stock market and earn roughly a 10% return every year, or $100M. Alternatively, you can invest the $1B in the R&D of a potentially new product, which by your estimates will earn $500M in year 1, $800M in year 2, $1B in year 3, and $1.2B in perpetuity. Financial analysts would discount the cash flows of this potential project in year 1, 2, 3, and so forth, in order to calculate the total return of this product. If the return is greater than the original $1B investment, it may make sense to invest in this project. But what you really want is for the total return of this product to exceed the return of the next best investment, which is the $100M you would earn from the stock market. Of course, this example is a simplification of reality, but hopefully the point is made.

Using this logic, I assumed that the rumored price of $200M that Microsoft paid for Accompli, and the $100M they paid for Sunrise, that they would expect to earn a greater return than the cost of the investment. In other words, I implied that Microsoft believed that the $300M they spent on these acquisitions would provide a greater return than the cost. This thinking was largely incorrect.

It was incorrect because my assumptions were all wrong. I assumed that the goal of these acquisitions was for Microsoft to make money on them over the future years. After all, why would you spend millions of dollars on something that won't actually make you any money? Given this assumption, I reasoned that Microsoft will not actually make money on these products, since few people would be willing to spend money on an email or calendar app. Microsoft was paying millions of dollars for two apps that won't actually bring them any profit in!

For as much writing I do about the inability of spreadsheets to calculate the complete financial ramifications of a business, I still made the same mistake that many analysts do. In reality, Microsoft was investing not in the profitability of Accompli and Sunrise, but it was investing in the future of Microsoft.

Goodwill is what accountants and financial analysts use as a plug-in variable for everything they can't measure. It is fairly easy to asses how much the laptops, desks, and other equipment of the business are worth. The same goes for the liabilities of a business. But the worth of intangibles such as patents, logos, employees, brand recognition, and customer data is as close to the definition of guesswork as can be. We simply don't know how to put a concrete value on such touchy-feels things. There is no Craigslist for intangibles, and so we do not know their exact worth. What we do know is how much we are willing to pay for them. Accounting students spend a whole semester learning how to calculate goodwill on an acquisition, but in general terms the calculation is very basic. Goodwill = what you paid - what something is worth. If you paid more for the business than it is worth, you have goodwill. Congratulations - you now know more about goodwill than 99.99% of the population (and probably more than most accountants)!

Understanding the concept of goodwill, we can return back to Microsoft and its latest two acquisitions.

As I have alluded to earlier in this post, Microsoft was actually purchasing the intangible element of coolness when it acquired Accompli and Sunrise. Microsoft was also purchasing relevance, social, and trendy. Although it may seem insane for a company to spend hundreds of millions of dollars on such vague and immeasurable terms, these are actually investments that aim to convert Microsoft from being an enterprise dinosaur to a modern creature. Most of Microsoft's success in the past came from what its users did at work: Outlook for email, Microsoft Office for documents, SharePoint for collaboration, and Windows for the ecosystem. But when these users came home, they used consumer-grade products from Apple and Google since the user experience was better, and many features were free. As a result, Microsoft's blinding focus on enterprise lost many consumers to non-enterprise software.

Accompli and Sunrise are acquisitions to win back these non-enterprise users. Although Accompli is heavily geared toward productivity and scheduling, it is a well designed (but by no means perfect) app that also caters heavily to non-business users. By purchasing it, Microsoft was able to please enterprise users by offering them a great iOS mail application and please consumers by providing them with a great general email application.

Sunrise, a calendar app with social integration (Facebook, Foursquare, etc), is Microsoft's attempt to please consumers even further. Before the acquisition, Sunrise had millions of users. Now they belong to Microsoft. It is possible, of course, that Microsoft will lose these users through bad updates to the app, but I remain confident this will not occur.

So where exactly is Microsoft shifting - to consumers, enterprise, or both? My bet is on both, judging from the recent acquisitions. But what is most promising to see is the newfound focus on design and cool by Microsoft. For a company that never prioritized these two attributes, it is impressive to see them pivot so quickly. With both acquisitions, Microsoft purchased a huge cohort of younger users (like me) who have previously abandoned Microsoft products or have never used them before. If they don't mess up, there could be another generation of Microsoft users.