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Welcome to Microsoft Pri0: That's Microspeak for top priority, and that's the news and observations you'll find here from Seattle Times reporter Sharon Chan.

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February 24, 2009 6:15 AM

Microsoft Strategic Update: Ballmer tells Wall Street more dramatic cost cutting would be 'imprudent'

Posted by Benjamin J. Romano

With Microsoft's Redmond campus largely emptied out for the winter holidays, CEO Steve Ballmer crunched the numbers on the proper level of spending for his company against the current economic climate, which he has repeatedly referred to as a "reset" rather than just a recession. Ballmer said his own estimates for the weakness and duration of the downturn tend to be more severe than those of other business leaders he meets.

With that in mind, he settled on $27.5 billion of operating expenses -- a level the company aims to hold relatively steady through the current fiscal year, which ends June 30, and during its 2010 fiscal year. Ballmer made clear to financial analysts meeting in New York this morning for the company's annual strategic update that cutting back even more significantly -- say to $20 billion -- would be "imprudent."

"I think this is right," Ballmer said.

That should give some comfort to those wondering if the modest layoffs Microsoft announced last month were the beginning of a more significant reduction. Wall Street analysts and investors are pressuring companies in every industry to continue cutting costs as sales and profits slow dramatically.

The strategic update call just came to an end. Ballmer gave a detailed look at seven major business areas for the company. Check back here later this morning for more details.

Update, 7:50 a.m.: As he told Congressional Democrats earlier this month, Ballmer said Microsoft's corporate strategists have been evaluating past downturns -- particularly those driven by "deleveraging." The team read company annual reports from 1927 to 1938 to determine who did a good job managing through the Great Depression. "RCA, God rest them in peace, became our role model," Ballmer said. The company was able to dominate the television business because it continued to invest during bad times, he said.

Then he broke down how Microsoft plans to invest.

The $27.5 billion in operating expenses breaks down like this:


  • Research and development, $9.5 billion.

  • Sales and marketing, $14 billion.

  • General and administrative, $4 billion.

To further put those expenses in context, Ballmer separated Microsoft into seven big businesses in which he plans to continue investing. He also lumped several smaller businesses into an "other" category. He described the profitability, allocation of operating expense, impact of the economy, competition and strategy for each one. (Note: He was referring to a PowerPoint slide deck used during the presentation that wasn't visible to those following via Web cast. I'll update this post with more details when I get hands on the slides. This summary also contains information from CFO Chris Liddell's presentation during the update. 9:47 a.m.: Microsoft has posted links to both the Web cast and the PowerPoint at this page. I've also added Microsoft's R&D employment in each of these businesses, as reported in the PowerPoint.)

Windows

Very profitable
Operating expense allocation: 16 percent, $4.4 billion. Investment has increased in the past several years, particularly marketing expenses in the last year with the launch of a major Windows advertising campaign.
Employment: 8,200
Economic impact: PC sales to both consumers and businesses are getting hit hard. "We cannot control it and it will impact revenue," Ballmer said. In this market, the healthiest segments -- netbooks and emerging-market sales -- also represent the lowest revenue to Microsoft and the biggest challenge from piracy, respectively.
Competition: Windows is still the market-share leader. Ballmer said the closest competitor is pirated versions of Windows. Apple has increased its market share by "a point or more" in the past year, he said, calling it an interesting development but not necessarily as dramatic as it's often portrayed. Open source Linux is also still on the radar, particularly as Google pushes its Android mobile operating system on to low-powered PCs. "We'll see Google more as a competitor in the desktop operating system business than we ever have before," Ballmer said. Microsoft is investing more in R&D here than any of its competitors, though some of that is shared with the company's servers group.
Strategy: Microsoft set out a year ago to have high market share on netbooks, new, low-cost, low-powered portables for lightweight tasks such as browsing the Internet. Ballmer said Windows now has an attach rate of more than 90 percent. Windows 7 will be available on netbooks. Ballmer said Microsoft is working on ways to entice consumers to trade up from lower-price versions of Windows, such as XP Home Basic, to higher-priced offerings.

Windows Mobile

Somewhat unprofitable
Operating expense allocation: 4 percent, $1.1 billion. Investment has increased.
Employment: 2,000
Economic impact: The economy may cause the phone market to contract, but more important to Microsoft is the move from feature phones to smartphones. Those in the best position to benefit will be companies with low-cost smartphones.
Competition: "All of the consumer market mojo is with Apple" and to a lesser extent, Research in Motion, Ballmer said. But with the device makers and mobile network operators, Windows Mobile and Google Android have the momentum. In terms of smartphone operating system market share, Symbian is the current leader.
Strategy: Microsoft is competing with Apple and RIM, which offer end-to-end hardware, software and services offerings. It's not Microsoft's strategy to build a phone, Ballmer said. He seemed more focused on the market for software sold independent of hardware, which has the potential to reach a broader base of devices. This is where Google is playing.

Ballmer noted that Windows and Windows Mobile are becoming closer in many ways. There's still a distinction between the phone and PC hardware that Microsoft's software runs on, but an increasing amount of technology is shared across the two.

Desktop productivity (mainly Microsoft Office)

Very profitable
Operating expense allocation: 28 percent, $7.7 billion. Investment has increased as Microsoft aims to earn more from the enterprise market by attaching more features to its main product offerings.
Employment: 6,700
Economic impact: This business takes a hit with slower PC sales and enterprise IT spending.
Competition: Microsoft Office is the market leader and again, second place belongs to pirated Office. OpenOffice is still in the market and challenges Microsoft particularly in the education market.
Strategy: Decreased prices on consumer versions of Office in the past year have been more than made up for by increased sales. Office 14 will not be released in 2009. Microsoft makes more selling Office to enterprises than consumers and small businesses because it's able to sell more add ons, Ballmer said. New technologies yet to be sold to enterprises include security and identity management, next-generation collaboration and portal software and conferencing tools. Microsoft's new online services for enterprises, in which large businesses run their e-mail and collaboration software on servers Microsoft operates, is seeing "rapid uptake," he said, but added it's still early and the company is still figuring out how to make it a better source of revenue.

Servers

Very profitable
Operating expense allocation: 8 percent, $2.2 billion. Investment relatively flat.
Employment: 1,600
Economic impact: Two-thirds of server sales are on an annuity basis, so they're less susceptible to the deteriorating economy than products linked to desktop software, but they are suffering as well.
Competition: Microsoft has the biggest share over all, Ballmer said, with particular strength in desktop infrastructure and IT. Linux is a big competitor, dominating Web servers and scientific computing workloads.
Strategy: A new release of Windows Server 2008 is due in conjunction with Windows 7. Windows Azure, Microsoft's platform for hosting third-party online applications and services, should make significant progress and be able to go to market by the end of the year, Ballmer said. The company is also rolling out a new Foundation Edition of Windows Server, a low-cost, low-price, low-functionality version to match falling hardware prices. More details should come out in a month or two, he said.

Enterprise software

Very profitable
Operating expense allocation: 10 percent, $2.75 billion. Investment relatively flat.
Employment: 5,900
Economic impact: IT budgets are tight, making it difficult to increase sales.
Competition: Ballmer sees an opportunity to take market share from Oracle, which dramatically outspends Microsoft on R&D and sales and marketing, he said.
Strategy: Microsoft has a host of new software for databases, online transaction processing, business intelligence and Web hosting. Ballmer said Microsoft is looking at Oracle's licensing model for ways to break into some of its customers.

Internet search and advertising

Very unprofitable
Operating expense allocation: 7 percent, $1.925 billion. Investment has increased.
Employment: 3,800
Economic impact: Advertising sales are down with the economy and are likely to stay that way at least for the next six months.
Competition: Google is the dominant player by a longshot. Ballmer looked at global market share, where Microsoft has about 3 to 4 percent, as opposed to the more commonly reviewed U.S. market, which is actually one of Google's weaker areas. "We are up against incredible odds," he said.
Strategy: Sticking with it. "You give up, you can't get back in the game," Ballmer said. Microsoft continues to take talent from Yahoo. In addition to Qi Lu, Ballmer said Microsoft has hired about 10 other key technologists from Yahoo. Ballmer still wants to explore some arrangement with Yahoo to provide more competition to Google. On its own, Microsoft will continue to release updates to its search engine every six to nine months; work on improving the relevancy of search results and associated advertising; try to change the search business model by focusing on improving commercial search and sharing more value with advertisers and retailers; and invest in search distribution deals.

Entertainment and TV

Somewhat profitable
Operating expense allocation: 6 percent, $1.65 billion. Investment relatively flat.
Employment: 2,300
Economic impact: Reduced consumer spending hits this business.
Competition: Microsoft, of course, looks at Nintendo and Sony in the game console business, but Ballmer didn't detail the competitive landscape for this broader TV and entertainment business.
Strategy: The real opportunity, Ballmer said, is to have a device connected to the television, whether it's a set-top box, a Media Center PC or an Xbox 360. Microsoft is bringing its Zune music service -- not the hardware -- to the the TV, phone and PC. In the short-term, Microsoft will try to improve its margins by continuing to reduce the cost of producing the Xbox hardware and getting more people to subscribe to Xbox Live.

The rest of the company's operating expenses go to other minor businesses (10 percent, $2.75 billion); research (1 percent, $275 million); new business incubation (2 percent, $550 million); and business functions such as human resources, IT and legal (8 percent, $2.2 billion).

Ballmer said Microsoft's cost-management efforts have focused on giving the company flexibility to shift spending from one part of the business to another. It can be difficult when spending really means employees. You can't easily take video game designers and put them to work on SQL Server, Ballmer said.

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