The two sides of Satya Nadella.

Photographer: Photographer: Graham Crouch/Bloomberg

Year One at Nadella's Microsoft

Katie Benner is a Bloomberg View columnist who writes about technology, innovation, and the cult and culture of Silicon Valley. She lives in San Francisco.
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Satya Nadella is celebrating his first anniversary as Microsoft’s chief executive officer, and the last year has offered a tale of two companies.

The first is an institution that Nadella has encouraged to be more open and collaborative, less siloed and fiercely competitive. The second is a legacy powerhouse that’s flatlining and saddled with a turnaround plan that won’t generate meaningful growth for a long, long time.

Since Microsoft will inevitably march along, more or less profitable for many quarters to come, that Dickensian analogy might be too harsh. So here’s another, very techie, way to look at Nadella’s first year: He vastly improved Microsoft’s user interface, but he hasn’t found a way to optimize its corporate hard drive.

It should come as no surprise that Nadella generated a lot of goodwill inside and outside of Microsoft when he ascended. Thanks to his ministrations, the software giant has a friendlier halo around it. It now plays nice with everyone from Salesforce.com to Oracle and with startups like Dropbox and GitHub. Nadella also speaks on the company’s quarterly calls with analysts, a practice that his predecessor as CEO, Steve Ballmer, eschewed.

Nadella wants to be a good partner to employees too. He has embraced issues such as diversity and unconscious bias against women and minorities in the workplace. He did so after apologizing for a callous public comment he made late last year about women and pay raises that caused a big dust-up.

When he fumbles, Nadella appears to learn from his mistakes and tries to do better. He is thought to be genuinely kind. For employees, shareholders and partners, he’s been a much-appreciated change from Ballmer’s brash, sales guy persona.

But Nadella still hasn't figured out how to fix Microsoft’s core business conundrum: How can the company be less dependent on PC sales -- which the mobile market and smartphones are undermining -- without getting a lot smaller overall?

Microsoft’s most recent financial results showed that corporate technology sales grew by a sluggish 5 percent last quarter, and the company said that overall revenue growth would be slower than expected in the first half of this year. Investors were more interested in the trouble at Microsoft's core than they were in Nadella’s myriad cultural improvements. Microsoft's stock fell 10 percent when that earnings news landed and has yet to fully recover from that swan dive.

As growth slows, Nadella is putting a lot of resources behind Azure, Microsoft's cloud computing platform that rents data center space and other infrastructure to customers like GE Healthcare. He’s also pushing Office 365, a cloud version of the company’s Office software that customers essentially rent, to adapt to new storage and software trends. In addition, Nadella also decided to give versions of Windows away for free to connected-device developers and for use on devices with screens smaller than 9 inches.

These initiatives keep Microsoft relevant in a world dominated by Amazon Web Services in cloud computing, Apple iOS and Google Android in operating systems, and Google’s office software suite for consumer and small business software. But Microsoft's newer offerings are less profitable than the traditional Windows and Office products that once made Microsoft such a dominant force. As cloud-based and free products make up more of Microsoft's sales mix by volume, revenue and margins will probably shrink.

The free version of Windows is a particularly tricky offering because of how quickly pricing power could collapse over time. The distinction between devices with large and small screens will become more and more arbitrary as businesses use more mobile devices and ever-smaller laptops. All of this will make it harder to draw a line in the sand between free and premium products.

Nadella has done a lot of positive and exciting things for Microsoft. He’s breathed new life into the place, cut costs and revealed some projects that made the startup-dominated tech world take notice (such as the HoloLens). This is all very important stuff, but none of it has yet to truly address Microsoft's larger financial and business challenges.

A lot of Nadella's supporters note that the stock went up when the company announced last year that he would be its new CEO. What they forget, however, is that the stock move wasn’t just about Nadella. Some of that was due to the fact that Wall Street assumed no one could spend (and waste) as much money as Ballmer.

Yet when it comes to Microsoft's core business, Nadella is in some ways executing on initiatives that Ballmer had already put in place -- such as Azure, a corporate reorganization and even the HoloLens project. In that regard, Nadella is acting more as a steward than as an innovator.

Nadella has a better relationship with Wall Street than Ballmer did, but it’s not a perfect one. Value Act, the activist hedge fund that forced Ballmer out, wanted eBay chief John Donahoe for the CEO job at Microsoft and was disappointed when he wouldn’t consider the position, three people with knowledge of the search have told Bloomberg View.

Investors are happier with Nadella than they were with Ballmer, but they’re carefully watching to see how he manages Microsoft as its core business shrinks.

Nadella spent his first year making Microsoft genuinely exciting and interesting again. In year two he’ll have to show that he can offer more than buzz and kindness. He'll have to prove that he can make Microsoft grow.

(Corrects example of Azure customer in ninth paragraph.)

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the editor on this story:
Timothy L. O'Brien at tobrien46@bloomberg.net