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Microsoft is one of the world’s largest and most
successful computer software enterprises. It’s
strength is based upon two businesses: Windows,
the operating system which resides upon more
than 90% of the world’s personal computers; and
Office, the most widely used suite of office productivity software in the world. These two monopolies generate much of the $22 billion in free cash
flow that Microsoft generated in 2010, and are the
major reason for the company’s stellar 2010 return
on invested capital of 38.57%. Both monopolies
are also under threat from the rise of a new computing paradigm know as “cloud computing.”
For the last 20 years, individuals and enterprises
have stored their data and run their applications
on their own computer hardware. Individuals have
stored data and installed applications onto their
own machines. Enterprises have stored data and
installed applications onto their own networks
of servers and clients. The vast majority of clients
(desktops and laptops) have run Windows. A large
proportion of servers have also used the Windows
server operating system by Microsoft.
However, with the rise of high bandwidth (very
fast) Internet connections, it is becoming increasingly attractive to store data and run applications
remotely “in the cloud” on server farms that are
owned by other enterprises. The largest owners
of server farms today are Amazon, Google, and
Microsoft. Server farms are vast collections of
thousands of computer servers. Each server farm
can cost $500 million to construct. Data can be
stored and applications “hosted” on server farms.
Individuals and enterprises can access these server
farms to run their applications from anyplace, anytime, so long as they have an Internet connection.
The applications no longer need to reside on their
own machines. In fact, all that is needed to run
applications is a Web browser. In other words, you
may no longer need Windows on your machine
to run applications that are “hosted” on a server
farm. The Windows monopoly is therefore under
threat. In the future, an individual using a laptop
that is running a non-Windows operating system,
such as Apple’s OS X, Google’s Android, or Linux,
could conceivably run applications hosted on
server farms through their Web browser.
There are compelling economic reasons why
enterprises might want to move their applications
to the cloud. First, they no longer need to purchase
their own servers and maintain them, which reduces
information technology hardware costs. Second,
they no longer need to pay for applications upfront;
instead they can adopt a pay-as-you-go approach,
in the same way that you pay for electricity from a
utility company. This is very attractive, since there is
good evidence that corporations overspend on applications, purchasing excess software that is rarely
used. Third, server farms can balance workloads
very efficiently, spreading out application runtime
Planning for Rise of Cloud Computing at Microsoft

from numerous customers, thereby optimizing capacity utilization (in contrast, most enterprises must
have enough servers for peak load periods, meaning that most of the time they have excess capacity).
This means that server farms can run applications
at lower costs, and some of those cost savings can be
passed onto customers in the form of lower prices.
Microsoft first recognized the potential importance of cloud computing in 2006–2007. At that
time, the business was tiny. However, through its
environmental scanning, Microsoft quickly realized that over time, the economics of cloud computing would become increasingly attractive. The
company’s strategic managers also understood
the negative implications for their Windows business. The introduction of Google apps in 2008
underlined this. Google apps is a collection of
Office-like software, including Word Processing,
spreadsheets, and presentation software, that is
hosted on Google’s server farms, and that enterprises and individuals can access and run through
a Web browser. You don’t need Windows to run
Google apps, and moreover, Google apps represent a direct threat to Microsoft’s lucrative Office
business.
Microsoft saw the rise of cloud computing as
both a threat to their existing business, and an opportunity to grow a new business. The company
decided that it had little choice but to aggressively
invest in cloud computing. Moreover, the company
realized that it had several strengths that it could
draw upon in order to build a cloud computing
business. It already had built server farms to run
its search, X-Box live, and Hotmail businesses,
so it knew how to do that. Many enterprises that
used Microsoft applications would likely want to
continue using them on the cloud, which gave the
company an inherent advantage. The company
had a significant cash horde that could be used to
finance investments in cloud computing, and, had
a wealth of software talent that could be used to
write applications for cloud computing.
Beginning in 2008, Microsoft charted out a
strategy for cloud computing. First, the company
made heavy investments in large-scale server
farms. Second, the company developed a new operating system to run applications on the cloud.
Know as “Azure,” this operating system is specifically designed to distribute workloads across
large numbers of servers in order to optimize
capacity utilization. Third, the company started
to rewrite many of its own applications to run in
Azure and moved them to the cloud. For example, enterprises can now sign up for Office Live,
which is a cloud based version of Office that is
run through a Web browser and hosted on Microsoft server farms. Fourth, the company embraced
a change in its business model. The traditional
business model for most Microsoft applications
has required enterprises to pay an annual licensing fee for the number of copies of an application
that they install on machines. The new business
model is a pay-as-you-go structure for applications like Office Live that are hosted on Microsoft’s server farms.
Fifth, Microsoft realized that one of the impediments that corporations face when moving
their own customized applications to the cloud is
the cost of rewriting the applications to run on a
cloud based operating system, such as Azure. To
manage this, the company invested in the development of “tools” that would help programmers
complete the transition in a cost efficient manner.
Finally, Microsoft understood that for security
reasons, some enterprises had to maintain control
over data on de dicated servers (e.g., regulations
require banks to do this). In such cases, Microsoft
decided to offer its enterprise customers a “private
cloud,” which is a collection of servers packed into
a container, running Azure, and hosting applications that are dedicated to just that enterprise.
Private clouds enable enterprises to gain many
of the economic advantages of cloud computing,
without moving all data and applications to a
“public cloud.”
By 2011, the cloud was starting to gain attention. Although it only represented about 5% of
the $1.5 trillion in global information technology spending in 2010, numerous companies were
starting to announce their investment in cloud
services. In the first quarter of 2011 alone, IBM,
Hewlett-Packard, and Dell Inc. all announced their
intentions to increase their investments in cloud
computing infrastructure and applications. This is
an emerging market that is posed for rapid growth
in the years ahead. Microsoft hopes that through
proactive strategic planning, it has positioned the
company to do well in this new environment.50

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implications of this new business model for Microsoft’s future financial performance?
4. To develop its cloud computing business, Microsoft implemented a self-contained unit within its
organization dedicated to that task. Why do you
think that it did this?
5. Cloud computing is still in its infancy. If business
history teaches us anything, it is that events often
do not turn out the way that planners thought
they would. Given this, might it have been better
for Microsoft do adopt a “wait and see” attitude?
What would have been the benefits of delaying
investments? What would have been the costs?
1. If Microsoft does not build a cloud computing
business, what might happen to the company
over the next decade? Why did the company decide that it had little choice but to invest in cloud
computing?
2. The case talks about Microsoft’s strengths, which
might help it to build a cloud computing business. It does not talk about weaknesses. Can you
think of any weaknesses that the company might
have?
3. How does the business model for cloud computing differ from the traditional business model used
by companies such as Microsoft? What are the
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