CEO Satya Nadella talks about innovation, disruption, and organizational change.

In 2014, Satya Nadella was appointed CEO of Microsoft,making him only the third leader in the software company’s 40-year history, following Bill Gates and Steve Ballmer. Since taking the top job, Nadella has doubled down on cloud computing, artificial intelligence (AI), and social networking while also pushing Microsoft to become more innovative, collaborative, and customer focused. In 2017, he published Hit Refresh: The Quest to Rediscover Microsoft’s Soul and Imagine a Better Future for Everyone, a book reflecting on his journey from a cricket-obsessed childhood in India to leadership of one of the world’s largest companies.

In this episode of the McKinsey Podcast, Nadella speaks to McKinsey Publishing’s Simon London about organizational change, the role of culture, the danger of silos, and how companies can confront digital disruption by reframing the business they are in.

Culture and innovation

Simon London: Well, Satya, thank you for doing this.

Satya Nadella: Thank you so much for having me.

Simon London: Let’s start with culture change, which is a big theme in the book. Clearly, you decided to make it a big theme for this first part of your tenure as CEO. Why culture change compared with other things you could have focused on?

Satya Nadella: One of the things that I’ve come to realize is that in companies that have been successful, one of the things that happens is the original idea or the concept that became a hit, the capability you built around it, and the culture that implicitly grew as you were growing the business all get into this beautiful, virtuous cycle. But there’s no such thing as a perpetual-motion machine. At some point, the concept or the idea that made you successful is going to run out of gas. So, you need new capability to go after new concepts. The only thing that’s going to enable you to keep building new capabilities and trying out new concepts long before they are conventional wisdom is culture.

I would argue that for a successful company, you will have to overemphasize [creating] the right culture so that you can continue to cultivate new capabilities and new concepts. When I became CEO, we were already a 40-year-old company, and I felt that it was very important for us to make culture a first-class, explicit conversation so that we could then reinvent ourselves and invent new things.

Business units versus capabilities

Simon London: You’ve got this wonderful trifecta of concept, capability, and culture. But can I introduce a fourth “c”—configuration? This is how a company is organized—the lines and boxes—and the business processes that underpin it. Have you made any process or organizational changes to support what you’re trying to do?

Satya Nadella: That’s actually a very good point. Configuration or structure is superimportant. One of the things that I’ve come to realize is structure can help and, in some sense, reinforce the first three c’s, but it should not get in the way of reinvention or coming up with new concepts. That’s the fundamental challenge.

For example, when the business is doing well, in the name of accountability, in the name of efficiency, in the name of lower transactional costs, you get organized by business unit or what have you. This reinforces the next level of productivity gains, efficiencies, and accountability. The issue is that then it becomes hard to reconflate [recombine] some of the capabilities across these divisions to build new products. This is always a challenge. In tech, it’s even worse because we don’t have long periods of stability. If anything, the periods of stability are short and getting shorter. So, you can use structure sometimes in order to reduce transaction costs and improve efficiency, but in the long run, we [in the technology sector] are much more capability driven. I want a silicon capability. I want a cloud-computing capability. I want an AI capability. I want great product aesthetics in devices. Then we want to be able to take [these capabilities] and apply them to different markets at different times. Without this strategic flexibility, it’s very, very hard.

And I would argue that in a world where every business now is a digital business, this is probably one of the bigger challenges. I see this when I talk to many customers who we partner with who have come from, say, an industrial conglomerate or an energy company. It’s very, very hard, because culturally they’re all about business units. But digital recognizes no digital business unit. You need to be able to bring things together. This is probably one of the more transformative changes that many CEOs will have to confront.

Simon London: The move toward functional capabilities at Microsoft was already in the train before you took over as CEO, wasn’t it? Is there anything you’ve done to accelerate that?

Satya Nadella: Yes, I think this was one of the biggest changes that Steve Ballmer made. It has been superbeneficial. Without it, I don’t think we would have been able to change as much as we have done, because it’s a necessary condition. This [functional] configuration allowed us to reconflate. Otherwise, we would have had a lot more institutional resistance to that just because of what people’s incentives and measurements were. So, it has helped us tremendously.

Of course, products and product truth ultimately matters. But to me, what matters is: What are we being hired for? Or customer-in ways of thinking about markets and categories. For example: How are we enabling the modern workplace? It’s not just about Office or Office 365 or Windows or EMS [Enterprise Mobility + Security]. These are all brands and tools and applications we love. But ultimately, we have to deliver to companies the ability to empower their employees so that modern work can happen, they can collaborate, they can communicate in new ways, and companies can get more out of their people. This is very important. We have really changed how we think about customer orientation because of this.

Metrics and compensation

Simon London: I’m guessing that you’ve made some changes related to performance management, for example, or compensation to reinforce this more cross-functional, cross-business unit customer orientation. Is there anything that you can or want to talk about there?

Satya Nadella: One of the big things that we have done at the leadership level is to focus on shared metrics. We make a distinction between what we call “performance metrics” and “power metrics.” Performance metrics are in-year revenue and profit and things of that nature. Power metrics are about future-year performance. They are leading indicators of future success and are more about usage and customer love or satisfaction. We have a blend of metrics that are few but shared. A large part of the compensation for me and my leadership team is fundamentally based on that.

Simon London: So, that scorecard has been reconfigured during your tenure?

Satya Nadella: Correct. In fact, a lot of our own tools have become instruments of changing culture. We track metrics such as monthly actives, monthly active versus daily active ratios, consumption, consumption growth. These are all the things that we measure as much as we measure any end-quarter revenue or profit by segment. And these are tied to compensation. Also, it’s not just the leadership team. In the field, our sales culture has changed a lot because we have put a lot of the sales-compensation levers to also go from just the one-time license or bookings to actual consumption, which means it aligns us much better with our customers and their success in using the products and getting benefits out of them.

I do believe that if you just talk about culture change and customer obsession without tying it to some of these core levers of how you measure performance, the entire program can come to a knot. In our case, we have been able to take action on all of those levers.

Empathy and purpose

Simon London: You’ve talked a lot about the need for a culture of greater empathy because it’s only through empathy that you can really understand the unmet needs of customers. Some of these forward-looking metrics feel almost like “empathy metrics.” Are products getting traction? Do customers love them? Are they using them?

Satya Nadella: That’s correct. All of us are human. However, when you think about culture as all about business and metrics and scorecards, you can get a lot but it just doesn’t invoke that real, innate capability that we all have. Work is a large part of what we do in life. If it was only about achieving some scorecard metrics, I don’t think that would be enough of a deep meaning.

The reason I talk about empathy is that I believe this is the leading indicator of success. Innovation comes only when you are able to meet unmet, unarticulated needs—and this comes from a deep sense of empathy we all have. But you can’t go to work and, say, “turn on the empathy button.” Your life’s experience will give you that passion and understanding for a particular customer, a particular use case. How you can connect [your life experience] to your work is what we want to invoke in the 100,000 people who work at Microsoft. All these metrics, which are real compensation drivers, do relate to this. But I don’t think we make decisions thinking that these two things are connected.

We as humans all have bounded rationalities, Herbert Simon would say. Therefore, it might, in theory, be correct, but in practice, none of us make decisions thinking of this as connected.

Simon London: Presumably, part of this is related to attracting and retaining talent as well. If you want to attract the very best people in highly competitive fields, they want to go to work feeling and knowing that they’re doing something for a purpose. It can’t just be about the extrinsic motivation of the paycheck because talented people could pick that up in any number of different places.

Satya Nadella: One of the key things, I feel, is that just like individuals, companies have an identity. I talk about it even as a soul. It’s that collective purpose that a company represents. In Microsoft, we talk about our mission as being empowering every person and every organization on the planet to achieve more. Every one of those words, for me, telegraphs that soul.

We think about people and the institutions people build that are going to outlast them as a first-class software construct. We think about this globally—in fact, I’m a product of that, if you will. We think not about the technology we create but about the technology others create using what we create—whether it’s a student writing a term paper, a small business becoming more productive, or a developer writing the next world-changing application.

We think about creating tools for other technologists. That’s why you join Microsoft. In fact, college kids might say, “Hey, I have a couple of different offers; why should I join Microsoft?” I say, “Look, simple. If you want to be cool, go join somebody else. If you want to make others cool, come join Microsoft.” That’s the test. What’s your self-image? What is it that you want to do?

And I’ll go one step further. Business models should be constructed so that they reinforce your core identity. Somebody once said that you can only trust people who think, say, and do the same thing. By the same token, I think you can only trust companies that are thinking, saying, and doing the same thing. That’s the consistency that you need.

Turning artificial intelligence into value

Simon London: Can we pivot and talk a little about AI? What advice do you give to executives that you talk to about how to leverage AI in their businesses?

Satya Nadella: I believe AI is one of the more defining technologies of our time. One of the things I am most excited about is AI technology helping with inclusivity. For example, in the latest release of Windows, we have something called Eye Gaze, which allows anybody who is suffering from ALS [amyotrophic lateral sclerosis] to be able to type just with their gaze. We have learning tools inside of Word and OneNote that allow anyone with dyslexia to improve their reading. It’s powerful stuff, and it’s a very practical way for executives to deploy some of these tools so that more people in their workforces can fully participate, which is important.

But there is no question that automation and the efficiencies of automation are tremendously important. For example, if you go to support.microsoft.com, it’s a bot. It uses some of the latest techniques of reinforcement learning to answer questions that customers may have. And of course, if it runs out of gas, it turns over to the customer-service representative, who is also using the bot to help answer the question.

So, we have the full gamut of technology that is getting deployed. We now really have human-level speech recognition. In January, there was a contest at Stanford University for machine reading and comprehension. Microsoft was number one. This means a machine can read a piece of text and start answering questions, like a reading-comprehension test, without necessarily being fed the answers that are indexed in the text.

The advances are enormous, and they will lead to productivity gains broadly. Therefore, every CEO—every executive—should be thinking about how to get more analytical power or predictive power inside his or her business process or organization. That’s ultimately what’s needed to translate AI capability into productivity.

Simon London: What types of IT configuration and IT capabilities do companies need to do this?

Satya Nadella: I would say there are two big considerations. One of the fundamental things is that there’s no way to create AI if you don’t have data. If the data inside your organization is siloed, it’s going to be a challenge to create AI. This goes back to your point around company configuration.

Take customer connection as an example. In order to be much better at omnichannel customer connection—and it doesn’t matter whether you’re a retailer, a CPG [consumer-packaged-goods] company, or a bank—everything from the log data from your website, to your mobile analytics, to your CRM [customer-relationship-management] system, to all the other data streams, it all has to come together in order to create the next best touchpoint action with the customer. This is both an AI problem and a data problem. One of the things that we like to stress is: how can we help our customers first get their data estate in many cases into the cloud? Then they can reason on top of it and create these transformative outcomes, whether it is connecting with customers, or operational efficiencies, or even changing the nature of their products. This is a super important thing.

I would also add that trust is going to be of paramount importance. Not just the security side of trust but also the trust of the business model. You need to pick partners who are going to help you with your capability building, whose interests are aligned with your interests in the long term.

Simon London: If you’re a senior executive at a big industrial company, for example, there are a lot of different potential use cases for AI. Do you have any generalizable advice about how to look across those use cases and what to go for first?

Satya Nadella: When I pattern match and look at some of the best and easy-to-get-started use cases, it would be anything related to customer experience. This is a good use case. Let’s say there’s omnichannel customer data. The ability to do the next best action, whether it be a sales force, or inside sales, or your website personalization, can come in a variety of different ways.

Connecting with your customers more deeply—using your data and your ability to reason over data—using the latest AI techniques is one use case. The second use case is supply-chain or operational efficiencies. The IoT [the Internet of Things] is a fascinating thing. If you think about it, most of these projects are where you have a good or a service, you’re collecting operational data from it, you’re doing preventive maintenance, and then you’re going to connect it to field service, because once you can predict something, you want to connect it to somebody coming and fixing it before it’s broken. That’s a thing that can drive both top-line and bottom-line efficiencies. That’s a great use case, and we see a lot of it, especially in industrial companies. We also see a lot of deployment of technology to empower people inside the organization. I’m fascinated to see how HoloLens is being used for doing oil-field inspections or training. So, AI can be deployed not just against traditional knowledge work but also in what I will call frontline work.

Sometimes organizations have this “cobbler’s children” problem. They talk about all these great things they’ll do for customers, for [business] partners. Except you also need to do fantastic things for your employees so that they can do all these great things for customers and partners.

Resolving the innovator’s dilemma

Simon London: Something I think you’ve done fantastically well is to bring Microsoft along in its embrace of cloud. In many ways, this was a classic innovator’s dilemma situation—a Clayton Christensen textbook case of a new technology coming along with, let’s be honest, probably a lower margin structure than older technology around servers. Do you have any advice for other executives in this situation? So many companies are facing this now as they are attacked by new digital players with new business models, probably at lower margins.

Satya Nadella: The only generalizable piece of advice is to reconceptualize your business to be non–zero sum. These shifts are tough if they are zero sum—in other words, if all I’m doing is jumping into this new paradigm to essentially regain the business I already have. Especially if [the new paradigm] comes with a lower net margin, then it’s sort of an impossible task. But just imagine a railroad company in the 1930s. If it had conceptualized itself as, “we’re in the transportation business” versus “we’re in the railroad business,” then it probably would have seen the ability to line extend or jump into new businesses.

That’s, I think, what companies have to do. They have to understand more broadly what category they are in, as opposed to defining themselves very narrowly by the technology they’re using today. That’s why I like to talk about a perpetual or a perennial category we are in: the modern workplace. My bet is that the workplace will always remain, and you will always need to be modern. We’re not trying to talk about one tool or one service. Our job is to build new technology for the modern workplace. That’s a better way to think about the future.

Simon London: That reminds me of the John Chambers phrase about having no “technology religion” and also maybe adding no “business-model religion.”

Satya Nadella: That’s right. No technology religion, no business model religion, and the ability to frame things with a broader lens versus a very narrow product definition or category definition based on what has happened in the past.

Simon London: Well, Satya Nadella, thanks so much for talking with us.

Satya Nadella: It’s my pleasure. Thank you so much.

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