Microsoft Surface: What's the Strategy?

Microsoft's decision to build its own tablet computer (called Surface) has raised some interesting questions about the firm's strategic intent.   Has the firm finally acknowledged that Steve Jobs was correct when he said that you had to be vertically integrated to produce something as terrific as the iPad?  In other words, did the same firm have to make the hardware and the software, because complex integration was needed to deliver a exceptional customer experience?   Jobs, of course, believed that Android devices could not match the iPad experience because they lacked such sophisticated integration (since the hardware makers were simply licensing the Android system). 

A recent New York Times story suggests an alternative hypothesis:  Has Microsoft decided to move temporarily into the tablet hardware business so as to drive the type of innovation that could lead to lucrative tablet operating system and software sales down the road?   Toward the end this New York Times article, MIT Professor Michael Cusumano offers his take on Microsoft's latest move.  Here is the excerpt from the article:

Some who study the technology industry still believe Microsoft will get out of the business of selling its own tablet computer as soon as it can persuade other hardware companies to build compelling devices of their own. “I think once they jump-start it, they plan to make money the way they always have — from licensing software,” said Michael A. Cusumano, a management professor at M.I.T. 

I found this hypothesis quite intriguing.  I can think of at least one other example of a company choosing to vertically integrate on a "temporary" basis.   Coke and Pepsi both chose to forward integrate into bottling and distribution some years ago, and then they divested those units.  Why the back-and-forth?  Some (including HBS Prof. David Yoffie) would argue that Coke and Pepsi forward integrated  so that they could acquire and consolidate their distribution network, driving economies of scale throughout the channel.  They also wanted control of the channel at times as their product strategies shifted.   However, the firms didn't want to have all those assets on their books for the long haul, given the returns in bottling and distribution are much lower than in concentrate production.   Of course, both chose to forward integrate once again more recently, and now we hear rumblings (particularly at Pepsi) of the possibility of another divestiture down the road.  Again, forward integration may have served a distinct strategic purpose, but the firms may find themselves questioning the returns on the distribution businesses. 

Similarly, Microsoft may not want to be in the hardware business long term, as the returns are likely to be lower than in the software business (at least if the tablet market operates in a manner consistent with returns in the personal computer market).   However, "temporary" vertical integration may be their way of shaping the industry in the way that will be positive for them in the long term.   We'll see which hypothesis turns out to be correct.  It should be fascinating, and of course, it will depend on how well customers receive the Surface product. 

Should Coke Acquire Monster?

The Wall Street Journal reports that Coca-Cola explored a possible acquisition of Monster, the energy drink company.   Coca-Cola apparently backed away due to the hefty price tag.  Some investors reportedly balked at the premium that would be paid for Monster, and they made their concerns known to management.

I found one particular note in the story quite interesting.  It reads: "Coca-Cola already has an agreement with Monster to distribute some of its drinks, and that could diminish the potential synergies from any deal—and thus Coke's willingness to pay a large premium."   When I teach strategy, I always reinforce the idea that companies need to consider whether a merger is actually required to achieve the benefits of cooperation.  I draw on Williamson's transaction cost theory, and I argue that we have this "markets vs. firms" choice to make.  Do we organize the activity inside the firm (merger), or do we transact with another party through the market (with a contract or alliance)?   In this case, Coke has been working quite effectively with Monster through the market for some time.  The question is:  What additional synergistic benefits will come if they move from this relationship to a merger?   What can they NOT accomplish through their current relationship?  That's the key question in this case.

Beyond that, though, we also have to consider the following:  What are the costs of inaction?  Will Pepsi acquire Monster, and therefore, Coke would lose its current relationship altogether with this leading energy drink firm?  We have seen that story before, in fact.  Coke once considered acquiring Gatorade, and investors (specifically Warren Buffett) balked at the price tag.  Pepsi swooped in and acquired Gatorade instead.  Coke has been a laggard in the sports drink business ever since that time.  So, Coke must consider the question about whether additional synergies exist above and beyond their current relationship, but they also must consider whether that relationship could get disrupted by a rival's purchase of Monster.