Microsoft Strategic Update: IT Matters, Big Time

Last week, during an annual Strategic Update meeting with Wall Street financial analysts in New York, Microsoft CEO Steve Ballmer laid out his assessment of the coming year and Microsoft's plans for coping with what is clearly an historic economic downturn. Ballmer's talk was hopeful at times, but more tellingly it offered a pretty brutal overview of the problems facing the software giant as some of its traditional core products are beginning to flat-line for the first time. Looking at the state of Microsoft's businesses and ahead to the coming year, however, one thing becomes clear: IT is more important than ever.

In his talk Ballmer described Microsoft's seven core businesses: Windows, Windows Mobile, Desktop Productivity, Server, Enterprise Software, Search and Advertising, and Entertainment and TV. Of those seven, five are directly related to IT. And when you consider the eighth "other businesses" category, you see that two of the four emerging Microsoft businesses, Dynamics and Enterprise Services, are also IT related.

Although Microsoft is clearly in the midst of an enormous push into consumer software solutions, its business sales remain the company’s primary source of revenue. And from a mile-high view, all of Microsoft's IT-related businesses are profitable or highly profitable, with the exception of Windows Mobile, which Ballmer described as "somewhat unprofitable."

For Windows, Microsoft is ramping up operating expenses and marketing this year, both to stem the tide of bad publicity about Windows Vista and, in the future, to promote Windows 7. The Windows business has been hit hard by the economic depression. What's odd is that sales are still strong. It's just that a higher percentage of them are going to low-cost netbook computers that include a low-end version of Windows XP for which Microsoft receives a much lower licensing fee. Microsoft also sees a slowdown in IT spending for 2009, which makes sense given the economy. From a competition space, however, Windows has no real competitors today beyond pirated copies of Windows. Even on netbooks, over 90 percent of installs are Windows. But Microsoft sees Linux being more competitive on the PC desktop going forward because the company believes that Google will port its Android mobile OS to the PC. (An increasing synergy between phone and PC is a theme of Microsoft's planning going forward.)

Windows Mobile is a bit of an enigma. Microsoft is number three in the smartphone market worldwide, following Symbian and RIM, but ahead of Apple. But that's a temporary condition, and we can expect Apple's iPhone to surpass Windows Mobile this year, thanks to its consumer-heavy sales. Ballmer says that Microsoft will not build its phone, suggesting that the company is ready to concede the consumer market to Apple. But the company is strongly positioned in the business world and should remain a RIM contender. Ballmer says that the smart phone market will continue to grow despite the economy and that the low price of some Windows Mobile phone offers will help.

Desktop productivity is now Microsoft's strongest business by far, and it accounts for the largest slice of operating expense as well. Here the software giant's long-term customer licensing agreements will help Microsoft offset some of the more damaging aspects of the economic downturn. But this business isn't immune to challenges, Ballmer notes, and the low-priced Home and Student version of Office 2007, for example, is already the best seller. That said, Microsoft derives far more revenue from its enterprise Office users that it does from consumers, so once again the company's dedication to IT is paying off. Looking ahead, Office 14 will ship in 2010, not this year, and will be accompanied by web-based versions of popular Office applications. This can't happen quickly enough for me, and I’d like to see these Office web apps appear sooner rather than later.

Microsoft's Server business is going gangbusters thanks to a strong product lineup with an incredible range of functionality and manageability. Linux remains a key competitor in web and scientific computing workloads, but Microsoft owns desktop infrastructure and IT infrastructure workloads. Looking ahead, Ballmer can point to an amazing set of releases coming in the next year, including the Windows Azure cloud computing platform, Windows Server 2008 R2, new versions of System Center, SQL Server, and other servers, and of course Microsoft's hosted online services (Microsoft Online Services--MOS). To address the financial needs of emerging markets and cash-strapped smaller businesses, the company will release a Foundation Edition of Server 2008 R2 as well. Ballmer called it a netbook-type release for servers.

What's interesting about Microsoft's business-oriented offerings is that the company typically dominates most of the markets in which it competes, from a market-share perspective. But the company is light on the revenue side because of its low prices. Microsoft accounts for only 16 percent of revenue in the enterprise, for example, but has a higher market share than companies that earn higher amounts (such as Oracle). Ballmer called this a double-edged sword, suggesting that the worsening economy might actually help Microsoft pick up some new accounts from customers tired of competitors' higher prices.

For those who have already opted for Microsoft's IT solutions, it looks like you've made a good decision. The issue here, of course, is whether your existing infrastructure can be stretched for a few more years. Microsoft isn't the only company that will be riding out this storm.

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