(An earlier version of this story ran online.)
When Microsoft (MSFT) said it would buy Yammer for $1.2 billion last June, many in Silicon Valley scoffed that the deal was a costly disaster in the making. Microsoft wanted to join forces with a hip maker of social networking tools for businesses that delivers its product as an evolving Web service. The culture clash was expected to result in Yammer’s employees being overburdened with bureaucracy. The prediction was they would flee in droves. “We were quite concerned about this coming together of two worlds,” says Adam Pisoni, Yammer’s co-founder and chief technology officer.
As the companies worked to close the deal, Pisoni flew to Microsoft’s Redmond (Wash.) headquarters to seek reassurance from Chief Executive Officer Steve Ballmer and Kurt DelBene, head of the Office business. Pisoni was taken aback by what he found: Microsoft had spent the last couple of years revamping its engineering teams’ processes to be more like Web startups. “We have to remember our roots and go back to building what’s good for the consumer,” Pisoni says Ballmer told him.
On Jan. 29, Microsoft began selling this new image of the company to the public with the release of Office 2013. This version, the first major overhaul of the franchise in three years, is Office for the cloud. The applications—Word, Excel, PowerPoint, Outlook, and others—have a much cleaner design, work with touch interfaces, and can save files directly to SkyDrive, Microsoft’s online storage service. Users can run Office as an app and share files across PCs, Macs, Windows tablets, and Windows phones, and they can tap into an online-only version of Office on almost any device. In the coming months, Office will be linked with Yammer’s service, which looks similar to Facebook (FB), so users can open documents and presentations and work on projects together.
In an interview, Ballmer stresses that Office 2013 should be viewed as a service. Microsoft will add features to the software as they’re developed, instead of going years between updates. Microsoft will also sell Office to consumers on a subscription basis: $100 per year will get a family five licenses for Office, 20 gigabytes of storage on SkyDrive, and 60 minutes of free calls per month on Skype, which Microsoft acquired in 2011. “It embraces the notion of social,” Ballmer says. “You stay connected and share information with the people you care about.”
While Microsoft was working to get Office right, its nimbler rivals charged forward. Dropbox recently passed the 100 million-user mark, making it one of the leading services for storing and sharing files across devices. Another cloud application, Box, has gained popularity with corporations that want to store and edit internal files and collaborate with other companies on projects. And Google (GOOG) sells low-cost rivals to Office products, including Quickoffice, an application that can run on iPads.
Last year, Microsoft’s business software division generated $24 billion, about one-third of Microsoft’s $73.7 billion revenue. It’s the company’s biggest, most profitable division and accounts for a handful of Microsoft’s fastest-growing products. Ballmer refers to Dropbox as “a fine little startup,” adding, “you have to remember that 100 million users sounds like a pretty small number to me.”
Microsoft plans to update Office every three months with features intended to keep the product’s 1 billion users happy. Its software engineers have moved from upgrading their test version of Office every month to working on a new copy of the software every day. The company has invested in automated systems that can spot errors in code and help engineers keep programming at pace. “It’s turned all our engineering systems on their head,” says Jeff Teper, a Microsoft vice president.
Yammer was mined for some data-analytics techniques, including algorithms to figure out which features were favored by testers of early versions of Office 2013. Yammer has been sending teams to Microsoft to teach engineers how to test new tools and designs and then measure precisely how they change users’ behavior. “It forces you to build software that is good for the user,” says Pisoni. Microsoft and Yammer are building toward a day when most business files are Web-connected and interactive. “Is every Office document a website? It’s possible,” says Ballmer.
In Microsoft’s ideal world, Office 2013 customers would be like Mike Kaminsky, a 32-year-old band manager from Los Angeles. He’s been testing the software for months and has a Windows smartphone. On a recent trip to Asia, he kept a complex itinerary saved as a Word document in SkyDrive and gave his assistants access to the file so they could update it. “I was in strange countries with a client but knew I always had the most up-to-date information of where we were supposed to be,” he says. “It usually takes Microsoft two or three versions to get something right, and I feel like they are starting to nail this.”
Aaron Levie, CEO of Box, which made one of the first applications to be available on Windows 8, counts Microsoft as both a competitor and a partner. He gives Microsoft credit for updating something as massive and critical to businesses as Office, even if it took a long time. “They simply have a longer list of stuff they have to build and more dimensions to the problem,” he says.
Levie says Microsoft will have to work harder to stay in the game. Because of Apple’s (AAPL) and Google’s strength with mobile devices, Microsoft can no longer rely on Windows, which is still viewed as a PC-based platform, to keep people attached to its other products. Microsoft is facing off against clever, low-cost rivals in many areas of business software. “Customers are just going to use a more diverse set of products,” Levie says.
Microsoft still lacks an Office application for iPad—“I have nothing to say on that topic,” Ballmer says—although the now-defunct Daily reported in 2011 that an iPad version was in the works. And SkyDrive, an important cloud feature, is not a well-recognized brand. Analysts expect Microsoft will be able to use its size and reputation to overcome these deficiencies for a while longer. “Office does a really good job, and it’s kind of like the U.S. dollar,” says Wes Miller, an analyst with market-research firm Directions on Microsoft. “I don’t think anybody is successfully poking at it.” That said, Microsoft will have to live up to the culture change it’s been touting if Office, Yammer, and other properties are to keep its coffers full in the years to come.