Every publicly held corporation whose stock trades in the United States is required by the Securities and Exchange Commission to file a detailed annual report (Form 10-K) at the end of its fiscal year.
Call me weird, but I love reading 10-Ks. I especially love reading the parts that make corporate lawyers and executives squirm, because they’re required to divulge details they would never discuss with journalists. And although there’s a fair amount of boilerplate and yadda yadda, there’s also a lot of substance buried in these reports.
For example: Carefully reading last year’s 10-K from Microsoft (MSFT) allowed me to predict in August 2011 that Microsoft was going to get into the hardware business. They validated that prediction with the announcement in June of this year that they plan to enter the hardware business with a new line of devices under the Surface brand name.
But they missed the much bigger story: Microsoft is reimagining its entire business model, and they’ve laid out the details for anyone to inspect.
After carefully comparing last year’s 10-K with this year’s version, I’m comfortable making three predictions.
Services are the cornerstone of Microsoft’s strategy.
In the “Risk Factors” section of its 2011 10-K, Microsoft used the word services 44 times. In this year’s revision, the word appears 73 times.
This section is especially revealing. The underlined text is new this year:
Similar additions are sprinkled throughout the document.
Last year, Microsoft was still tentative about its efforts around cloud services. Despite the bravado of slogans like “We’re all in,” the 2011 10-K admitted that the process was not yet complete: “We are transitioning our strategy to a computing environment characterized by cloud-based services used with smart client devices.”
This year, those qualifiers are gone. The equivalent section has been rewritten and now refers to “our increasing focus on devices and services.” It concludes, “A growing part of our strategy involves cloud-based services used with smart client devices.”
Microsoft has thrown massive amounts of resources at the task of integrating cloud-based services into its flagship products. SkyDrive is a core part of Windows 8. Office 365 services are fundamental to Office 2013. Azure is moving entire server farms into the cloud.
The subscription-based offerings of Office 365 are just a hint of what’s to come.
Surface isn’t a bluff or a hobby.
Some of my ZDNet colleagues think that Surface is a bluff on Microsoft’s part, a way to jolt its hardware partners into delivering interesting products. If you believe that theory, then Microsoft will keep the price of its Surface products high so it doesn’t cannibalize sales from Lenovo and Dell and HP.
That’s not the Microsoft way. And the company telegraphs the importance of Surface by giving it marquee billing at the beginning of the “Risk Factors” section:
An important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions.
That’s boilerplate. But what comes next isn’t:
A well-established ecosystem creates beneficial network effects among users, application developers and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain competitive margins. The strategic importance of a vibrant ecosystem increases as we launch the Windows 8 operating system, Surface devices, and associated cloud-based services. We face significant competition from firms that provide competing platforms, applications and services. [emphasis added]
Those Surface devices get star billing, sandwiched between Windows (one of Microsoft's core businesses) and its cloud-based services. In that discussion of the ecosystem, there’s absolutely no mention of the hardware partners or their devices.
Later in the same section, there’s another new paragraph that hints that Surface is just the beginning:
We will also continue to invest in new software and hardware products, services, and technologies, such as the Surface line of Microsoft-designed and manufactured devices announced in June 2012.
Elsewhere in the same section, where last year’s report referred to the Xbox 360 console, this year’s report calls out “Surface devices and other hardware devices we design and market.”
The word devices appears 11 times in the “Risk Factors” section of the 2011 10-K. It appears 25 times in the equivalent section this year.
The word hardware appears 8 times in the same section of the 2011 10-K. You’ll find 15 references to hardware in this year’s report.
In the Sinofsky regime, Microsoft isn’t interested in hobbies or side projects. The company’s motto is “Go big or go home.” Earn a billion dollars. Get a billion users. Don't think small.
I expect a massive marketing push behind Surface, and I would be shocked if we don’t see more PC hardware from Microsoft in the next 12 months.
Deal with it, OEMs.
Microsoft plans to pick up the pace. Dramatically.
Microsoft has a reputation for being too slow to respond. This year’s 10-K contains a new section that suggests that’s all about to change:
Many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products that appeal to businesses and consumers. [emphasis added]
In recent years, Microsoft’s competitors have gotten fat (and maybe lazy) by counting on Redmond to be slow to respond to competitive threats. They just might have awakened a sleeping giant.
Last year, when I did this same exercise, I concluded:
One thing I’ve heard through the years from Microsoft employees is that the company does its very best work when its back is against the wall. Linux may be neutralized as a competitive threat, but Apple and Google are formidable, even existential competitors. The next 12 months promise to be very interesting indeed.
It has indeed been an interesting year. The next 12 months promise to be even more intriguing.
For more insights from the MSFT 10-K, along with some details on how I do this kind of analysis, see: