How Microsoft Became Innovative Again

For years now, observers of tech have written off Microsoft as a 20th-century phenomenon, fat and happy from its Windows monopoly. The tech giant hadn’t had a breakthrough innovation in decades. It was rich enough to be a fast follower, but too big and bureaucratic to lead in any market. Jeff Bezos was known to gesture east and admonish his Amazon colleagues not to become complacent like their Seattle neighbor.

Yet on February 7, there was Microsoft CEO Satya Nadella telling reporters that artificial intelligence was creating a “new day in search.” Microsoft’s much-maligned Bing was integrating Open AI’s ChatGPT technology to generate information directly for users, not just links. And in doing so, it was directly challenging Google, the undisputed champion of search, by trying to out innovate Google on its home turf.

This wasn’t supposed to happen, especially not to Google. Already burned in 2014 by Amazon’s AI-enabled Alexa voice assistant, Google announced in 2016 that it would become an “AI-first” company.

Google’s problem certainly wasn’t engineering. The company had made fundamental advances in AI. Notwithstanding Google’s costly flawed demo earlier this month, its LaMDA chatbot was arguably just as good as the ChatGPT3 release that had taken the world by storm. And it had laid the groundwork for chatbot-powered search before last week.

We’ve known for a while that high-tech success and transformation is more about the culture than the technology, and the management decisions each company made here seem to have made the difference. Some say Google’s lead position forced it to move cautiously in order to minimize hate speech and misinformation. Others praise Kevin Scott, Microsoft’s chief technology officer since 2017, who joined with the LinkedIn acquisition, partnered with OpenAI a year later, and pushed hard for technology inside Microsoft.

Those explanations have some merit, but they don’t go deep enough. How did stodgy Microsoft, stuck in slow decline, ever muster the ability to leap ahead in the first place? As any corporate veteran will tell you, no single person, no matter how talented, can transform an organization. The culture has to change.

Microsoft’s Existential Moment

My team and I recently completed a multi-year research project to better understand perpetual innovation. We wanted to know what makes companies continue to innovate even after their initial success. To answer that question, we surveyed 6,873 global executives, academics, and consumers, and narrowed a corporate database to 26 firms, grouped into high, medium, and low degrees of agility and innovation. We explored how they performed on a long list of attributes, including interviews with dozens of managers, executives, and frontline and former employees, and coded the data.

From those efforts, we came up with several companies that seemed to have cracked the code of perpetual innovation. Some were expected: Apple, Amazon, and Tesla. But the list included some surprises: Namely, that Microsoft made the list, but Google/Alphabet did not.

I’ve been working in Silicon Valley since the 1990s, and Microsoft’s appearance was somewhat surprising. But, in taking a closer look, we found that something remarkable had happened there: a cultural shift to stop playing defense and go on offense.

This process began with Nadella taking the reins in 2014, when Microsoft’s board picked him to replace retiring CEO Steve Ballmer. At the time, he was the head of the company’s fast-growing cloud computing division, and his promotion seemed unlikely to change the lumbering giant’s trajectory. But Nadella, and the board, were tired of seeing the technology world pass by the one-time leader. He announced it was time to “rediscover the soul of Microsoft, our reason for being.”

This wasn’t just another exercise in corporate purpose — Nadella treated it as an existential moment. Having long accomplished its goal of “a PC on every desk and in every home, running Microsoft software,” the company needed a new goal to attract and inspire its many coders and engineers, and sustain its profitability. With his colleagues, he reoriented the company to “empowering every person and every organization on the planet to achieve more.”

This reorientation was accompanied by a strategic shift. Instead of protecting its assets, in a defensive posture, Microsoft went on offense, ceding big investments in existing tech and looking to jump into emerging opportunities.

The most noticeable change was external. For decades, the company had resisted partnerships. After all, insisting back in the 1980s on owning DOS and other software platforms had yielded big profits and cash cows. But to fulfill its new existential commitment, Microsoft needed to combine its enormous assets (cash and engineering talent) with those of other companies, by opening up to other platforms and by investing in partnerships.

This took two notable forms. First, Microsoft embraced rival operating systems such as Linux and iOS, and supported other companies’ virtual reality devices. Second, recognizing the entrepreneurial agility of startups, the company began investing in a series of small firms at the forefront of tech. Nadella also had the gall to elevate talented people from a series of acquisitions, including Kevin Scott. As I pointed out in HBR in 1999, sometimes the greatest value in high-tech acquisitions are the people.

Adopting a Startup Mindset

Despite the firm’s massive size, Microsoft’s cultural transformation involved several attributes of startups. One was an obsession with customers. The company sold a great many software products, most of them connected online in various ways. Rather than go by sales, a lagging indicator in fast-moving markets, or even what customers were saying, Nadella had product developers focus on what people were actually using. They set up dashboards to see usage over the previous month, to get an up-to-date sense of the market.

The company also freed up its engineering talent to explore new possibilities. As Nadella wrote in his account of the change, “They came to Microsoft with big dreams, but it felt like all they really did was deal with upper management, execute taxing processes, and bicker in meetings.” So the firm reduced hierarchies and freed engineers from most of the institutional controls — including rules on contacting people across levels to get answers to a specific problem. The engineers “became Microsoft’s mainstream, rather than fighting daily battles as renegades.” With them on board, the company could better address sudden opportunities and threats.

Microsoft even sponsored what it called the world’s largest private hackathonwhere company engineers worked together on all sorts of projects they dreamed up. The annual event regularly drew more than 10,000 people across hundreds of cities. Each one lasted only a few days, but it made connections across silos that continued for commercial projects — solving problems through fast-paced collaboration. In all these ways, Microsoft acted more like a startup, less likely a lumbering, protective giant.

Committing to the Change

Organizational transformation is messy in actual life, and Nadella and other leaders had to push it hard. Managers had become comfortable with their little fiefdoms: nice, orderly worlds with sufficient profits and technical challenges to engage all but the most ambitious talent. There was the notorious “stack ranking” system where managers graded people on a bell curve, each grade going to a fixed number of employees. The company had an arrogant culture of “us versus them” and “take no prisoners,” and this culture wasn’t serving its purpose anymore.

To regain the audacity of a younger company and commit to the new vision, Nadella announced Microsoft was doing the equivalent of burning its ships after landing on a new shore: The company would no longer update the once-central Windows operating system that had fallen out of favor. He also wrote off the $7 billion investment in Nokia’s me-too smartphone business, freeing up those engineers to work on new projects. Stack ranking also went away.

Then the company launched a series of market-opening acquisitions. Instead of the me-too deals such as Nokia’s smartphone, it bought category pioneers that it aimed to take to the next level: workplace social media platform LinkedIn for $26 billion, developer platform GitHub for $7 billion, and then the monster $68 deal for video-game developer Activision Blizzard.

These moves together made it clear the only option was moving forward. People realized they had to succeed in the new approach because they couldn’t fall back on the cash cows.

Game On

Meanwhile, Google was caught up in the opposite of boldness. Having become a tech giant in the public eye, it was leery of concerns about “feels AI” and antitrust attacks. (Microsoft, on the other hand, has gone on the offensepushing ahead with a deal to acquire Activision despite antitrust scrutiny.) Google’s leaders also worried about cannibalizing existing search revenues. They prioritized mobile, cloud computing, and hardware over search, which had become the company’s cash cow. Even as Google invested heavily in AI, it was risk-averse, playing defense.

All of that set the stage for Microsoft’s surprise upset earlier this month. Google could still prevail over time, but it has real competition now, and will need a cultural change similar to Microsoft’s.

Microsoft’s revival is an extreme case, but any company can carry out a similar shift to offense. Doing so depends on several steps, but the most important are to rally people around an existential vision, promote the openness and market focus of startups, and then move boldly to create organizational momentum.

You don’t need to be a tech company — we’ve seen similar shifts in industries such as retail and manufacturing. But you have to resolve to go on offense, with an existential commitment, a startup mindset, and bold action.