Why LinkedIn is worth $26 billion to Microsoft

In one of the year's biggest technology deals, Microsoft is buying LinkedIn for $26 billion.

If you’re in a profession that makes heavy use of LinkedIn, this deal may make perfect sense to you. But if you're in a profession that doesn't use LinkedIn much, you might be surprised to learn that LinkedIn is not only still in business but is worth $26 billion.

But this is no blunder. LinkedIn isn’t a very cool company, but neither is Microsoft, and LinkedIn has a thriving business focused on helping professionals find jobs and companies find workers.

Beyond the dollars changing hands, the acquisition of LinkedIn cements a broader shift in Microsoft’s corporate strategy that many consumers still haven’t noticed. Microsoft's early success came from dominating the market for PC software, followed by a period of struggle in which it tried to basically copy that business over to the mobile world and failed.

But under the leadership of relatively new CEO Satya Nadella, Microsoft is shifting to become a company that primarily sells online services to business customers. LinkedIn fits this new strategy perfectly, and it will help Microsoft both broaden the set of business customers it can serve and deepen the relationship with those it already serves.

LinkedIn has a thriving business

I remember the surprise I felt a couple of years ago when I learned that LinkedIn has been enjoying robust growth. I joined LinkedIn about a decade ago, but I didn’t find it very useful. I gradually became more annoyed by the deluge of emails from distant acquaintances asking to "add you to my professional network on LinkedIn," so I eventually deleted my account, hoping that would make the emails stop. (It didn’t.)

But my experience is not universal. While journalists like me do most of their professional networking on Twitter, there are lots of professions where LinkedIn is considered an essential networking tool. Today the site has more than 100 million monthly active users.

LinkedIn is most valuable in professions where a bulging Rolodex was once a prized professional asset. If you are a sales professional, for example, LinkedIn is both an indispensable way to learn about potential clients and an essential way to find out about new job opportunities.

And while LinkedIn’s audience isn't as big as mainstream social networks like Facebook, Twitter, or Instagram, it's a highly lucrative audience. Companies are willing to spend considerable sums of money to find the best employees, and LinkedIn effectively has the world’s largest Rolodex of skilled professionals. LinkedIn's "talent solutions" business — charging businesses to post job ads and provide other recruiting services — accounted for almost two-thirds of LinkedIn’s $3 billion in revenue.

LinkedIn also makes money selling premium subscriptions to LinkedIn users and helping users in sales occupations find other users who may be interested in buying their products.

And depending on how you measure it, LinkedIn is already profitable. According to generally accepted accounting principles, LinkedIn took a modest $46 million loss in the most recent quarter. But like many technology companies, LinkedIn prefers an alternative method of computing profits that excludes the value of employees’ stock-based compensation. This measure shows the company earning a hefty $99 million in profits.

Microsoft is reinventing itself as a business services company

Buying LinkedIn makes good sense for Microsoft too. It represents one of the most significant steps in Nadella’s effort to reinvent Microsoft from the leading PC software maker to a company that sells business technology services more generally.

Microsoft’s initial success came from selling software for PCs — most notably the Windows operating system and Office productivity suite. During the 1990s and 2000s, Microsoft built on its dominance of the PC market by selling a growing portfolio of licensed software that runs on corporate servers — like the Exchange email server, SQL Server database, and IIS web server.

But over the past decade, Microsoft has faced two big disruptive threats. First was the online app revolution led by Google. People increasingly used online products like Gmail and Google Docs instead of desktop software like Microsoft Outlook and Microsoft Office.

Next came the mobile revolution, led by Apple. People increasingly used smartphones and tablets running Apple’s iOS — or Google’s Android — instead of Microsoft software.

In the waning years of CEO Steve Ballmer’s tenure, Microsoft made a series of increasingly desperate attempts to meet these threats head on. Microsoft responded directly to Google with products like the Bing search engine and Bing maps. It responded directly to Apple with the Windows Phone. But these products didn't catch on, and the efforts cost Microsoft hundreds of millions of dollars in losses.

Under Nadella, Microsoft's new CEO, the company finally seems to be accepting that it’s not going to play the kind of dominant role in the consumer technology market that it did in the 1990s. People are mostly going to perform Google searches on their iPhones, not Bing searches on their Windows Phones.

But while Microsoft has been bleeding market share among consumers, the company continues to be popular with business customers. So Nadella has focused on expanding and modernizing the company’s business products.

Because companies often invest millions in large, multiyear technology projects, they tend to be less fickle than consumers. If your corporate IT system is built on Microsoft software today, you’re going to be very interested in buying additional Microsoft software tomorrow. So Microsoft has been very successful at upselling existing customers on additional software products that work within the Microsoft software ecosystem.

At the moment, one of Microsoft’s fastest-growing products is its Azure cloud computing platform. This is a subscription-based service that allows businesses to run software in Microsoft’s data centers instead of on servers they run themselves. Microsoft has also been shifting customers to Office 365, an online, subscription-based version of its productivity suite.

In short, there are two big themes to Microsoft’s reinvention. First, Microsoft is deemphasizing the consumer market and focusing on business customers. Second, Microsoft is shifting from selling individual copies of software to run on customer-owned hardware to selling online services supported by subscription fees and advertising.

LinkedIn complements Microsoft’s shifting business model

It’s obvious how Microsoft’s acquisition of LinkedIn dovetails with Microsoft’s shifting business strategy. There’s a lot of overlap between LinkedIn’s user base — corporate professionals — and Microsoft’s customers. And LinkedIn is already providing online services rather than selling software.

There are also some specific ways Microsoft and LInkedIn hope to strengthen each other’s products. For example, LinkedIn offers a Facebook-style newsfeed to its users. Microsoft plans to integrate this newsfeed into the Office 365 user interface, allowing users to keep track of developments in their professional network while they’re working on a spreadsheet or presentation.

Microsoft also hopes to integrate data from LinkedIn into Cortana, the personal assistant that is Microsoft's answer to Siri and Google Now. So a future version of Cortana may be able to look up the phone number of a LinkedIn contact or tell you about mutual friends.

Access to LinkedIn's data will be especially useful for Dynamics, Microsoft’s customer relationship management software. You probably haven't heard of CRM software, but it’s considered an essential software tool for any company that maintains long-term relationships with customers. Microsoft hopes to use data from LinkedIn to enhance Dynamics, giving customers access to more data about their customers and helping them find new ones.