Did Microsoft experience a lost decade?

The company developed a flawed culture that may constrain its ability to compete with its more innovative rivals in the future

Over the past decade,¬†Microsoft‘s (Nasdaq:¬†MSFT) share price has stagnated, while¬†Apple¬†(Nasdaq:¬†AAPL) shares are up approximately 20-fold. In the quarter ending in March 2012, we learned that sales of¬†Apple’s iPhone¬†now exceed¬†all¬†of Microsoft’s sales. It seems clear that Microsoft has been surpassed by Apple on multiple fronts over the past 10 years.

In “Microsoft’s Lost Decade” — a widely read piece that appears in the July issue of¬†Vanity Fair¬†— Kurt Eichenwald shows how Microsoft has become technology’s version of Sears over the past 10 years. Since 2000, Microsoft has performed poorly in a variety of areas, including music, search, and social networking. The formerly revolutionary company, according to Eichenwald, has “become the thing they despised.”

E-readers will never amount to anything                     
Eichenwald’s case for a lost decade is very compelling. While Apple,¬†Google¬†(Nasdaq:¬†GOOG), and¬†Facebook¬†(Nasdaq:¬†FB) were introducing dramatic innovations, Microsoft was concentrating on “Old Faithfuls” like Windows, Office, and servers. Since 2000, Eichenwald notes that Microsoft’s market cap declined from US$510 billion to US$249 billion (as of June 2012).

Eichenwald believes that Microsoft’s concentration on Office, for example, made it unable to introduce new products like e-readers, despite the fact that it was an early pioneer in this area. Ultimately, it was¬†Amazon.com¬†(Nasdaq:¬†AMZN) and Apple that benefited tremendously from this innovative new product. And debacles like the Zune and Bing only reinforced the notion that Microsoft was losing its edge when it came to technology. Eichenwald even quotes a senior member of Microsoft’s leadership team who wondered in 2004 why¬†Apple’s technology¬†was “so much better than Microsoft’s.”

Ballmer strikes back
Not surprisingly, Microsoft’s CEO¬†Steve Ballmer¬†firmly rejects the notion that his company experienced a lost decade. In a recent interview with¬†Forbes, he said, “It’s not been a lost decade for me!” He notes that there are now 1.3 billion people using PCs today, and that there will be 375 million of them sold just this year. He adds, “So, is it a lost decade?”

Ballmer also wonders whether the stock market might not be the best barometer of how well a company is doing. And he thinks the company is creating excellent products like Surface, Windows 8, and Office 15, and that those products will ultimately result in rewards for shareholders.

The demise of a company culture
So who is correct on the matter of the lost decade? Ballmer’s defence is somewhat compelling. It’s true that the stock market may not always recognise the true value of a company, particularly a¬†tech giant¬†like Microsoft. And there are many customers out there who praise the technology behind the Xbox and Windows Phone 7. Finally, Microsoft is the fifth largest company in the world by market cap. Clearly, it still has the ability to generate considerable profits for its shareholders.

Eichenwald’s criticisms should not be ignored, however, even if the notion of a lost decade is perhaps overstating the problem. Microsoft certainly missed a huge opportunity in smart devices, and it clearly saw Apple surpass it as a leader in developing new products.

Eichenwald offers a persuasive explanation as to why Microsoft fell behind more innovative companies over the past decade. Based on dozens of interviews with current and former executives, he identified “stack ranking” as the most destructive process within the company.

Stack ranking is defined as a process where “every unit is forced to declare a certain percentage of employees as top performers, then average, then below average, then poor.” According to many of the executive interviews, this process led employees to compete fiercely with each other versus external competitors on whom they should have been focused. One executive believes that stack ranking explains why Apple’s technology surpassed Microsoft’s.

Time for new leadership
Regardless of how we characterise Microsoft’s most recent decade, it seems to me that the company developed a flawed culture that may constrain its ability to compete with its more innovative rivals in the future. Eichenwald concludes his piece with a quote from¬†Steve Jobs, who said before his death, “I don’t think anything will change at Microsoft as long as Ballmer is running it.”

The big takeaway from Eichenwald’s piece is that somehow Microsoft’s culture went off the rails over the past 10 years. It seems to me that new leadership will be required to get the company back on track.

While Microsoft was having a disappointing decade, Apple was experiencing one of the most amazing decades in American business history. That may sound like hyperbole, but Apple’s extraordinary performance backs up that statement.

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The Motley Fool‚Äės¬†purpose is to help the world invest, better.¬†Take Stock¬†is The Motley Fool‚Äôs¬†free¬†investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.¬†Click here now¬†to request¬†your free subscription, whilst it‚Äôs still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

A version of this article, written by John Reeves, originally appeared on fool.com

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