For Microsoft's Nadella, signs of leadership potential

February 4, 2014: 3:09 PM ET

Before Microsoft selected him as its third-ever chief executive, Satya Nadella showed traits that would catapult him into the company's leading role.

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FORTUNE -- The first thing a visitor from Silicon Valley notices in Building 35 on the Microsoft campus in Redmond, Wash. -- until today the domain of new CEO Satya Nadella -- is the silence. This is the stodgy, old Microsoft (MSFT), a warren of offices with doors that close, with hallway walls devoid of the colorful graffiti that splotches the workplaces of competitors like Facebook (FB) and Google (GOOG). Nary a sound emits from these offices. One imagines more voluble insurance agencies.

There is a calmness to Nadella that fits his surroundings. A rail-thin 46-year-old who joined Microsoft in 1992, he speaks slowly, clearly, and confidently. We are talking on the Monday before the Thanksgiving holiday in a conference room near his office. It's a clear and crisp Pacific Northwest morning. He discusses the success of the businesses he heads, the stalwart enterprise software line and the rapidly growing upstart "cloud" service, Azure. Clad in a navy sweater vest, a blue-striped dress shirt, jeans and brown loafers, Nadella's calm doesn't mask his passion for his business. The search for Microsoft's next CEO has gone on for three months, and Nadella knows he's in the running, though he doesn't remotely touch the subject.

Yet over the course of an hour spent mostly discussing Azure, Nadella manages to show precisely why Microsoft's board selected him as the company's third CEO, placing his name on the roster that includes only Bill Gates and Steve Ballmer. He displays a rare trait for a top Microsoft leader, humility, by matter-of-factly owning up to Microsoft's mistakes. Yet he also pugnaciously attacks his competitors, Google and Amazon (AMZN) included, while defending Microsoft's strategy of simultaneously serving businesses and consumers with software and hardware products. "Being captive to old category definitions is really a death sentence in this business," he says, by way of explaining Azure's commitment to working with platforms invented by entities other than Microsoft. "Being caught in the old metaphors is just hard."

MORE: Inside the Microsoft CEO search

Nadella's challenge will be to create new metaphors for Microsoft. Yet his first hurdle will be to play the hand he was dealt, namely the new corporate structure Ballmer put into place weeks before his resignation in August. Nadella also must contend with Ballmer's subsequent agreement to buy Nokia, a deal that is pending. By all appearances, Nadella completely accepts this reality. Asked to explain the re-org -- dubbed by Ballmer the "One Microsoft" strategy -- Nadella walks through the four engineering groups (hardware, operating software, applications, and infrastructure software) plus marketing and business development that constitute the company's new structure. It is telling that he lists his group, the infrastructure unit, last. To the outside world, things like mobile phones, Windows, Office, and Bing are far sexier, or at least better known, then cloud services, and it takes a humble executive to recognize this.

Yet the new CEO owes his promotion to his success beginning to transform the blood-and-guts-type business that also happens to be Microsoft's most defensible product line. At the heart of his strategy for enterprise software, Nadella says, is a commitment to work with the non-Microsoft world where appropriate. Because Microsoft products and services like Office 365 and Bing use all the services required by a cloud-computing platform, Nadella says Microsoft had a leg up at building it correctly.

Azure competes directly with Amazon Web Services, the leader in providing online applications to small businesses so that they don't have to own their own software. Nadella contends that Microsoft has designed the flexibility of Amazon's service with the industrial-grade attributes of Microsoft's legacy software. "Azure is an honest-to-God public cloud service with multiple data centers -- in our case, close to 20 data centers now -- with lots of additional service endpoints across geographies."

MORE: Microsoft's reorganization is only step one

Nadella acknowledges Microsoft's failure in an important industry shift toward virtualization, a software category lead by VMware (VMW) that allows corporate IT users to make more efficient use of their server computers. "One trend we missed early on was virtualization," he says. "Big mistake." The solution was to catch up by offering virtualization as a service on Azure and for Microsoft's own products to use the service. "Now people are saying, 'Hey, where did you come from? You guys were getting your ass kicked by VMware.' We started using it at scale ourselves. And now we're grabbing share like crazy. We now have 30 points of worldwide share. We were stuck in the teens forever."

Nadella matches his humility with plenty of the traditional Microsoft swagger. He claims that Microsoft is one of the few companies that can match -- and exceed -- Amazon's cloud offerings. "My thesis is there will be a couple of big mega-cloud providers, and quite frankly, if you're not already spending around close to $5 billion of capital expenditures on building that out -- that's around $2 billion, or $2.5 billion per year --" you are not going to be player. "That's the kind of muscle you need to kind of get into this business." For all the value of public cloud services, certain sensitive customers, like the Egyptian bank that buys from Microsoft, require the security of a private cloud service, something Amazon Web Services cannot provide, he says.

One of Nadella's biggest challenges will be addressing Microsoft's culture. He says Azure has been a good test case for cultural change because of the requirement that a public cloud service work with all kinds of platforms. "One of the things that I tried to orchestrate is the concept that capability and culture all needed to change," he says. It's a sentiment he echoed Tuesday after the announcement of his historic appointment. "We have picked a set of high-value activities as part of our One Microsoft strategy," he wrote in his first memo to employees as CEO. "And with every service and device launch going forward we need to bring more innovation to bear around these scenarios ... [E]very one of us needs to do our best work, lead and help drive cultural change. We sometimes underestimate what we each can do to make things happen and overestimate what others need to do to move us forward. We must change this."

As a first-time CEO, Nadella's challenges will be daunting. Raising the noise levels of Microsoft's placid environment to the same degree he has embraced change outside its halls might be a great place to start.

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About This Author
Adam Lashinsky
Adam Lashinsky
Senior Editor at Large, Fortune

Adam Lashinsky is a San Francisco-based editor-at-large for FORTUNE, covering Wall Street and Silicon Valley. Lashinsky joined FORTUNE in 2001, after two years as a contributing columnist. Prior to joining FORTUNE, Lashinsky covered Silicon Valley for TheStreet.com and The San Jose Mercury News. A Chicago native, Lashinsky holds a B.A. in history and political science from the University of Illinois at Urbana-Champaign.

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