Microsoft (MSFT) looked like it was on the internet superhighway to becoming yesterday’s company. Its signature Windows software and other well-known features of the personal computer age faced dwindling sales as the tech action shifted to mobile devices and the cloud, and away from PCs.
But then Microsoft did something that few companies facing changing times have pulled off: a strategic pivot. The lessons from its reinvention are helpful to investors looking ahead for what will thrive and what will dive.
Microsoft, which turns 42 in April, now has solidified its position as the second-biggest force in cloud computing, behind Amazon (AMZN). In its most recent quarter, Microsoft’s cloud effort booked an 8 percent revenue increase, to $6.9 billion, as its Windows PC operating system shrank. Analysts like Mark Moerdler at Sanford C. Bernstein think the cloud business will continue its growth and steadily improve Microsoft’s profit margins. Over the past four years, the software colossus’ long-stagnant stock price has more than doubled.
Contrast that with what happened with GoPro (GPRO), which makes wearable cameras that people use during outdoor adventure experiences like skydiving or skiing. Recognizing that its fortunes were riding on one clever gadget, however popular, the company decided to branch into entertainment, assembling user footage into videos.
Well, that sounded like a good idea at the time. GoPro went public in 2014 at $24 per share, rocketed to $87 -- and now changes hands at a mere $8. The company just folded its entertainment division and laid off a lot of people as it dipped into the red. Lately, GoPro has vowed a return to profitability and reported that cameras sales were up. Where its future lies is anyone’s guess.
The difference between success and screwup can be tricky for executives to figure out. “Not a single sailing ship company made the transition to steam,” said Michael Jones, chairman of RiverFront Investment Group in Richmond, Virginia.
Certainly, giant Microsoft has a lot more flexibility than fledgling GoPro -- thanks to having 85 times as much in sales. And Microsoft has tried and failed to strike out into new territory before. Recall its epic pratfall buying the mobile devices arm of Finland’s Nokia (NOK), in a bid become a player in cell phones. Microsoft sold the Nokia business at a loss in 2016 after two years of struggling. While Microsoft still has cell phones, notably its Lumia devices, this is a small part of the company’s product portfolio, and not a growth engine.
Often, poorly planned pivots stem from management myopia. A classic 1999 Harvard Business Review piece, “Why Good Companies Go Bad,” described this tendency as “active inertia,” meaning a company’s leaders use the same approaches they followed in the past, despite changed conditions that required a radical rethinking.
The article’s author, Donald Sass, a senior lecture at the MIT Sloan School of Management, described the plight of Firestone, which for seven decades had dominated the U.S. tiremaking industry. But in the early 1970s, a new and more advanced design hit the American market from Europe, the radial tire. Firestone was slow to shift to the improved product and ended up in a financial pickle. Eventually Japan’s Bridgestone (BRDCY) bought it.
As GoPro demonstrates, foraying into areas outside a company’s “core competency” -- an inelegant corporate-speak term for an area of expertise -- too often is asking for trouble. The rationale for doing this is diversification, a highly popular concept in the conglomerate era of the 1960s and 1970s. Back then, disparate businesses were cobbled together on the theory that a weakness in one sector would be counterbalanced by strength in another.
The epitome of diversification was ITT, which at one time encompassed bread-baking, hotels, rental cars, TV manufacturing and telecommunications. But these hydra-headed creatures proved to be unwieldy, and the 1980s corporate raiders broke many apart in a quest to get better value from the pieces.
The temptation to stray into new areas remains, though. After all, sometimes it is a boon. Here’s a guide to what works and what doesn’t:
Sticking to a specialty: the same but different. The key is whether a company is extending its brand or striking off into unknown territory. Amazon (AMZN) started out as a bookseller. Today, its products range from clothing to jewelry to groceries. Plus, there’s its vaunted cloud service, in which other companies rent space at its enormous server farms.
That’s all because Amazon realized its specialties were much more than mailing you the latest bestselling James Patterson novel. Its core competency was selling and delivering consumer goods, and managing the data that supported the logistics.
“They plowed their money back into the business” to build out its cloud capability and its warehouses, noted Rajiv Jain, chairman of GQG Partners, a Fort Lauderdale, Florida, investment firm. “And now they’re even experimenting in drone delivery.”
Due to their size, the Microsofts and Amazons have more leeway to experiment than a GoPro does. But smaller businesses have done well altering their game. Orion Engineered Carbons (OEC), for instance, makes something called carbon black, a crucial ingredient for substances like rubber, binding them together and giving them color. The company decided that the future of rubber products, mainly tires, was limited.
So it’s moving strongly into other uses for carbon black, such as paint, ink and plastic. “This is substantially more profitable,” said Jack Clem, Orion’s chief executive. The newer offerings last year had a 31 percent profit margin, while the rubber division was 14 percent.
The art of knowing what a company can pivot to involves seeing the business’ essence, according to RiverFront’s Jones. Now, that sounds very Zen, but it’s practical. His prime example is Xerox (XRX), which a half-century ago made its mark with ubiquitous copier machines. “It thought that’s all it was, a copying machine maker,” Jones said. “But Xerox was a much broader tech company.”
The company’s Xerox Palo Alto Research Center, or PARC, invented many of the key features of modern technology, like the computer mouse and the graphical user interface -- windows, menus and icons used on computer screens. Others licensed these innovations and went on to glory. Apple (AAPL) co-founder Jobs is quoted as saying, “They just had no idea what they had.” Today Xerox is an also-ran.
Knowing when a company is boxed in. This means it likely lacks a big growth trajectory or even a reason to exist for very long. Department stores, once the rock-solid mainstays of shopping malls, appear to be in that category. Online competition and small, nimbler rivals like Stitch Fix and Bonobos are decimating them. During the last five years, Deloitte consultants estimate that the nation’s top 25 retailers have lost $200 billion to the smaller fry.
Department stores chains like Macy’s (M) and J.C. Penney (JCP) are closing outlets. Sears Holdings (SHLD) has said there’s “substantial doubt” about its survival, although Sears also said its latest turnaround plan should lower that risk.
The number of “distressed” retailers -- facing overwhelming competition, dwindling cash and lousy credit scores -- is at its worst since 2009, Moody’s Investor Service indicates. The department stores have tried everything, from hosting in-store sites for designer clothes makers to discount pricing to online sales. Nothing seems to click.
Making good predictions. Knowing the future is no easy task for mere mortals. Nostradamus doesn’t work in corporate planning departments.
Businesses spend millions on fancy consulting firms each year to spot trends, not always with goods results. What appears to be a genius move right now may prove to be anything but, once cruel Father Time delivers unexpected developments. Just ask department stores that rode the trend toward the mall-ifiction of America. Or Xerox, which looked on PARC’s inventions as interesting yet unprofitable curiosities.
What’s a fad and what isn’t? That’s the vital question. Snap (SNAP), parent of disappearing-messaging service Snapchat, recently went public amid mounting doubts that its popularity among the younger set can be maintained. If that turns out to be so, Snap would follow many other corporate pioneers into the ditch.
One-time giant Eastman Kodak (KODK) used to dominate the world of picture-taking. But the move from film to digital cameras and then to phones, body-slammed Kodak. After a tour through bankruptcy court, it’s a much smaller company. Meanwhile, video renter Blockbuster couldn’t prevent the shift of entertainment content online, and its once omnipresent stores are gone.
But one of Blockbuster’s nemeses, Netflix (NFLX), has prospered by avoiding the costly upkeep of physical stores like Blockbuster’s and mailing video discs to customers instead. Then, once more people moved onto the Web, Netflix rapidly jumped into streaming and now is very profitable, with its stock up 60 percent from a year ago.
“Some companies are not good at seeing the future,” said Terry Kramer, a former telecom executive who teaches at UCLA. “And that’s why they don’t survive.”