By: Peter Cohan
Back in January 2014 when Satya Nadella took over as CEO, I expressed skepticism that Microsoft stock would rise as a result. I was very wrong—since then its shares have soared 143% from about $37 to $90—way above its previous 2000 high under CEO Bill Gates.
Microsoft’s financial results have been solid, if not spectacular. Over the last five years, its revenues have grown at a 4.1% annual rate to about $90 billion in 2017 while net income has increased at a nearly 4.6% annual rate to $21.2 billion — yielding a whopping 23.6% net profit margin.
What’s more, Microsoft seems to be accelerating. In its second quarter report — announced January 31, Microsoft reported a 12% increase in revenue, according to CNBC. Unlike IBM, Microsoft seems to be turning the corner when it comes to replacing its old money-maker, PCs, with new ones.
How so? Despite tepid 2% growth to $12.2 billion in its More Personal Computing unit — which includes Windows, devices, gaming and search advertising — Microsoft was able to report faster growth in its Gaming (up 8%); Productivity and Business Processes segment— including Office, Dynamics and LinkedIn — (up 25%); and Intelligent Cloud — Windows Server and SQL Server — (up 15%), CNBC noted.
Before taking over as CEO, Nadella created Microsoft’s cloud service, Azure, which reported 98% growth in the second quarter.
But what underlies those results? Last month, I spoke with a long-time Microsoft executive who shared a surprising force propelling Microsoft’s growth — a fundamental change in culture.
This deeply-rooted change could be a good reason to buy its shares. (I have no financial interest in Microsoft securities).
Before getting into that, let’s discuss what culture is and how it can affect a company’s growth. As I wrote in Disciplined Growth Strategies, culture is turning specific values into criteria for hiring, promoting, and firing people.
Some cultures — those that attract and motivate the most talented people to create world-beating products and deliver excellent customer service — promote growth. A case in point is information security provider, SailPoint, which went public in November and has since seen its stock rise 54%.
Other cultures — for example, those that encourage people to extract the most possible revenue from current customers — damage the company’s growth potential.
On March 21 I met with Nir Tenzer, now CEO of cybersecurity firm, nsKnox Technologies, who worked for Microsoft from 2006 to 2017. Tenzer — who spent the last four years of his Microsoft career as chief operating officer of its South Africa operations — explained that before Nadella became CEO, customers did not trust Microsoft so they were not eager to buy.
Nadella changed Microsoft’s culture in a way that made current and potential customers feel that Microsoft cared about their success. As Tenzer said, “Nadella created a North Star to motivate millennials and unite its 170 subsidiaries. The new culture answered for everyone in the company — of different ages and from different countries — ‘Why are we here?'”
Nadella made that change in the face of significant challenges at Microsoft. Microsoft not only had to improve the way it interacted with customers but also how it created “new products and services to existing customers. The main challenge, given the new markets and new products and business model, was how to grow and to scale and how to transform while [continuing to] perform,” he said.
Overcoming these challenges required Microsoft to change the way it developed products, earned its revenues, and managed its people. As he explained,
We had to introduce and to promote new products and business models ([software as a service] vs. perpetual [licenses]). We had to drive our employees to interact with new corporate decision-makers – business vs. the original technical ones. We had to scale our employees to master new advanced products. In order to be successful, new skills were needed. We had to promote and to support learning.
Nadella’s solution was a new culture dubbed the “growth mindset.” The new culture, encourages “learning, trying and even failing. The new concept made employees enthusiastic about learning and [tackling] areas outside of their comfort zones. That of course boosted sales while also helping partners and customers. The new products and services also opened new opportunities with new groups of customers,” said Tenzer.
Indeed Nadella cited the growth mindset — which in his book, “Hit Refresh,” he defined as “take nothing for granted and always be willing to check your assumptions as new data comes in,” — as a key to Microsoft’s success.
But as Business Insider reported, there were plenty of people at Microsoft who used growth mindset as an excuse to complain. To tackle this problem, Nadella issued an ultimatum at a meeting of his 150 top executives, saying:
Once you become a vice president, a partner in this endeavor, the whining is over. You can’t say the coffee around here is bad, or there aren’t enough good people, or I didn’t get the bonus. To be a leader in this company, your job is to find the rose petals in a pile of shit. You are the champions of overcoming constraints.
I think the new culture bodes well for Microsoft’s ability to keep growing faster than investors expect.
So with its shares trading 7% below their March 2018 high of $97, I think Nadella’s growth mindset is taking hold enough to be confident that now is a buying opportunity.