The early mainstream successes of personal computing were products like the Commodore 64 and the Apple II. They ran apps from third parties, and supported third party peripherals, but the devices themselves were designed, engineered, manufactured and distributed by a single company. In other words, the suppliers of these computers were vertically integrated.

When the IBM PC was born, the relationship between Microsoft (operating system software vendor) and IBM (hardware vendor) ushered in a new, horizontal model. With hindsight, IBM made a blunder when they allowed their contractor, Microsoft, to retain ownership of the operating system (OS), but this was only one part of the equation. Crucially, a layer of software decoupled the OS software from the electronics hardware, and the PC’s brain was a micro-processor that was available from Intel, a 3rd party silicon vendor. These factors and others enabled the industry of PC clones that followed when Phoenix cloned the key interface layer between hardware and software (the Basic Input / Output System, or BIOS).

Lawsuits followed, but when the dust settled the industry was horizontal. And Microsoft owned the most important piece of the value chain — the OS. The OS was the key because it defined the app platform, and apps, in turn, are what created the network effect that exploded into 95% market share. Hardware, on the other hand, was “commoditized” because virtually anyone could make a PC from components. In fact, college students like Michael Dell started doing just that from their dorm rooms and grew companies that later eclipsed IBM in the PC market.

So in the PC value chain, there was intense competition in the hardware part, and little to no competition in the OS part. The rule is that value flows to the part of the value chain that is most “concentrated” (fewest competitors) because that is where companies aren’t pressured to lower their prices, and nowhere is this more apparent than PCs. Microsoft with the biggest profit margins we’ll ever see, and the PC manufacturers struggling to make a few points of margin.

Mobile Computing and the First Signs of a Cycle

In the late ’90s and early ’00s three precursors to mobile computing devices started to go mainstream, the phone, the personal data assistant (PDA) and the portable media player. Initially these were all vertical plays, but Microsoft saw the potential of mobile computing and got in early with a compact version of its Windows operating system, Windows CE.

The problem was that the market for mobile computing was nascent. Only the earliest of early adopters were prepared to do things like edit documents on a device, or send email from one, or download music to one. At a time where the thing people needed most of all to convince them to buy one of these devices was simplicity, Microsoft’s horizontal approach led to confusing products. Not only did they have too many features, they were confusing in that multiple companies were collaborating to bring them to you. It is a Compaq piece of hardware with Microsoft software and… what does it do again? Who do I call when I’m confused?

The devices that did take off were different. Simpler. Palm Pilots acted as an extension of your PC address book and calendar. Blackberrys delivered only your email. iPods were walkmans that could store all your music. The successful products were focused on one single value proposition.

This might have represented the beginnings of a pattern that we will see repeated whenever there is a fundamental shift in user experience, or a new computing modality. In the early stages, simple, vertically integrated products that minimize complexity are successful. I don’t only mean user interface complexity, I mean everything about the user experience. “What does it do?”, “Who makes it?”, “Where can I buy it?” and “Who will help me use it?” must all have simple answers.

How simple? Much, much simpler than you think. Very few people in technology understand the level of simplicity required to create a new category, so the odds are that you aren’t one of them.

Steve Jobs was one of these people and he hired a lot of the others. They made the iPhone, which catalyzed the mainstream smartphone market. Even Jobs’ description of the iPhone during his launch keynote reflects the need for simplicity. He teases the crowd by describing three separate dedicated devices, a new iPod, a phone and an Internet communications device.

“An iPod, a phone and an Internet communicator. An iPod, a phone… Are you getting it? These are not three separate devices. This is one device. And we are calling it, iPhone. Today Apple is going to reinvent the phone.”

Beautiful simplicity that launches Smartphones across the chasm.

Steve Jobs and the Horizontal Storm

With the iPhone, Apple is in its vertical element. The capability to design and execute on all aspects of the product is their home turf. This gives them the edge in the new mobile computing cycle. It represents their emergence from a long period where their model was not suited to the dominant horizontal model in the computing industry.

But how did they weather the horizontal storm that Jobs inherited when he returned to Apple in 1996?

1. They hit bottom. When Steve returned, he could cancel products left, right and center without sacrificing much profitability. There was little to lose by trying a new direction.
2. They focused their vertical chops on a profitable niche. A beautiful, differentiated iMac that had high appeal with a smallish subset of the PC market created a profitable base to start the return.
3. They found and dominated an adjacent vertical opportunity. Who knows whether Apple or Jobs knew the potential of the iPod at first, but when it became evident they executed flawlessly doing what they do best: an end to end offering that took a technology based value proposition mainstream.

By 2006 they had the brand, the capability, and the resources to introduce a product that led the world into the era of mobile computing. And also, back to an industry where the dominant player is vertically integrated. I don’t think they sat around the boardroom plotting the overthrow of the horizontal model. They were probably just playing to their strengths and passionate in a belief that “if you love software you have to build your own hardware”. Their specific motivations are irrelevant though. The outcome is that their own product changed the industry rules and brought the game back to their home field.

Once Horizontal, Always Horizontal

Apple didn’t make a big wrenching change when Steve Jobs returned in 1996. It stopped trying to change and it returned to its roots — making profitable end-to-end products. Prior to that the company had bowed to the pressure of a conventional wisdom that Microsoft’s horizontal platform strategy was better, but their attempts to make a business out of licensing their platform wasn’t going well at all. There were any number of reasons, but most of them derive from the simple truth that making platforms wasn’t Apple’s bag. They hadn’t hired the kind of people that were good at it. Passionate Apple employees didn’t have their heart in it. It wasn’t in their DNA.

And here is a fundamental truth that so few people acknowledge. Building a business on a horizontal platform and building a business on a vertical product are completely different things. So although Apple and Microsoft have many superficial similarities — they both build operating systems, write application software and design user experiences — their differences run far more deep.

The horizontal platform is all about strategic collaboration with partners. This is a technical challenge and a business challenge. Technical, because you need to support all of your hardware partners all the time. Not only their current products, but their previous generation hardware too. And a business challenge because your economics are completely dependent on extracting profits from the value chain at your partners’ expense, while keeping them happy enough not to flee your platform.

Try to imagine the mind-bending complexity of building something as sophisticated as Windows for the thousands of distinct products that use it as their OS. Then imagine the constant negotiations with your big partners, and the massive programs you need to set up to manage the thousands of small hardware partners that you can’t deal with directly.

Apple deals with orders of magnitude less complexity when it comes to hardware supported and partnerships with other companies. Windows engineers can only test a new OS on a tiny fraction of the actual PCs that will run it. Apple can test a new OS on every machine that will run it. Apple has few partnerships, and when it does partner it does so when it has a lot of power in the relationship. It doesn’t have partners that are also customers. It doesn’t have any confusion about who’s more important. It’s you, the consumer. Microsoft, on the other hand, tries very, very hard to do what you want, but it also has to answer to Michael Dell.

What Apple does have is the ability to execute almost all aspects of the end-to-end product. And they can afford to have an undiluted, single minded focus on the people that purchase their product. Unlike Microsoft, it has no confusion about who the customer is. Engineers, designers and managers spend all of their time think about products, the problems they solve, and the people that use them.

All of this is to say that when people talk of Microsoft becoming like more Apple and adopting a vertical strategy — or back in the day, Apple becoming more like Microsoft and licensing their OS — they completely miss the massive, wrenching change that this would represent. Microsoft will have product successes, like Xbox, but it is, and probably always will be, a platforms company.

The Platforms Guy

If Apple is made in Steve Jobs’ Image, then Steve Ballmer is made in Microsoft’s image. The large, blustering, bumbling exterior belies a very smart, capable core that is struggling to weather two storms: (1) the shift in power from from client to cloud and (2) the return to dominance of a vertical industry structure in the fastest growth area of computing: mobile.

Steve Ballmer can’t take many lessons from the way Steve Jobs weathered the horizontal storm. Microsoft’s remarkable profitability means that it will not hit bottom for a long, long time. It can’t easily do the iMac trick and retreat into a niche, because horizontal platforms need market share and scale in order to succeed. And it can’t do the iPod trick of finding a nascent category to dominate, because horizontal platforms don’t do well in the early stages of a market when consumers need clarity and simplicity more than anything else about the value proposition.

Microsoft has to do something different. It has to find the next important horizontal platform, accelerate us towards it, and then dominate it completely. Is it in the living room? Maybe, so let’s build the leading entertainment platform that connects to the TV. Is it the preeminent starting point on the web? Maybe, so lets make MSN the most important portal. Is it the communications network? Maybe, so let’s buy Hotmail (then) and Skype (now). Is it the index of the web? Maybe, so we better not cede that to Google. Can we make it the mobile OS? Maybe, so let’s get in early, build one and try to replicate the PC licensing model. Is it the platform for web applications? Maybe, so we’ll create a platform for the cloud called Azure.

Is this hard? Yes. It might be impossible. Is it crazy? No. If you are a platform company and you plan to stay true to your nature, then this is a completely rational strategy. It does, however, take its toll.

First, Microsoft can’t go anywhere quietly. As soon as the giant appears at the door of any category, every journalist, pundit and competitor knows exactly what Microsoft has in mind. There is very little scope for subtlety. Gulliver can only make a frontal assault, because the front moves to Gulliver.

Second, anything but domination will be considered a failure. Both internally at Microsoft and by the press.

And third, there will be many failures along the way. Some of them successes by any other standard, and others hopeless failures by any standard. Either way, they will represent opportunity after opportunity for gloating pundits to ridicule Microsoft. And to ridicule the personification of Microsoft, Steve Ballmer.

Opportunity in Obscurity

Ironically, all the ridicule does have a silver lining. Although Microsoft is still making money hand over fist on Windows and Office, it has all but left the industry consciousness. Mary Meeker’s “Internet Trends” presentation at the Web 2.0 summit in 2010 mentioned Microsoft precisely once, more than 30 slides in, as one of three companies introducing innovative gaming input methods. Notably, it isn’t listed in the Global Public Internet Companies about 5 slides earlier. The surprise isn’t so much that Meeker reinforced perception rather than reality, but rather that almost no-one pointed it out. In an even more striking contradiction, Meeker’s 2011 presentation omits Microsoft in her list of “mega-leaders”, but acknowledges that they are behind only Google in global monthly unique visitors in the very next slide.

More recently, Tod Hixon’s Forbes article, “The Post-PC Era Starts to Make Sense”, doesn’t mention Microsoft at all. Even if you don’t believe that Windows Phone 7 and XBox warrant inclusion, surely Microsoft at least deserves a mention for representing the PC-oriented incumbent. Hell, even IBM makes it into Hixon’s piece.

The silver lining is that competitors will underestimate Microsoft’s ability to return to relevance. It is looking less and less like Gulliver. At the same time, it is continuing to adapt to the new realities of cloud and mobile computing.

In the cloud, Microsoft has its Azure platform. Here are two interesting things about Azure. First, it is apparently one of two 3rd party cloud platforms providing infrastructure for Apple’s iCloud (the other is Amazon’s AWS). The cloud is the area where Apple’s DNA is weak, and that is one thing to draw from this. It also brings into focus the extent to which Google has replaced Microsoft as Apple’s nemesis.

The second interesting tidbit about Azure is that it has recently released support for Node.js, a bleeding edge open sourced technology for building code that runs on servers. This is a different Microsoft.

In mobile, Microsoft has Windows Phone 7, widely acknowledged to be an excellent user experience, but struggling with market share percentage in the low single digits. Microsoft has partnered with Nokia, another powerful company that pundits have already counted out. The result of their collaboration, the Lumia 700 and Lumia 800 phones, are receiving extremely positive reviews from everyone who sees one, and initial market response in Europe is good. Lumia 900 is eagerly anticipated in the US, and tech bloggers are raving about it. Having a good product is definitely the first step, and Microsoft has achieved that.

In a Mirror, Darkly

With competitors looking the other way, Microsoft’s biggest obstacle is itself. The cash cow businesses will not cede the throne at Microsoft easily. My knowledge of internal Microsoft politics is more than two years stale, but I would guess that even today, Windows, not Windows Phone or Windows Azure, is the more powerful internal group.

Perhaps an even more difficult challenge for Microsoft is switching to the mindset of the underdog. Microsoft was so dominant for so long, that hubris is part of its DNA. In the quest to find a market for Windows Phone that is “Microsoft large”, executives are likely to favor a massively broad approach that maximizes addressable market and distribution reach. In the process they will smash themselves on the battlements of iOS and Android.

If, on the other hand, they have the humility to focus on a few key market segments that they can dominate completely, then they might gain a solid foothold that positions them for a comeback. Microsoft is more focused on user experience than Google, and it is more experienced in the cloud than Apple. That powerful combination may end up weathering the vertical storm.

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Disclosure: I was a Microsoft employee and I still own Microsoft stock.