Microsoft's dilemma

I m Dan Farber, editor-in-chief of ZDNet and I m here today to talk about what I m calling Microsoft s dilemma. I put a question mark there because to some people it may not look like a dilemma when you go over the numbers and I pre-loaded this session and put up seven business units that Microsoft has and some numbers to go along with it so that we could talk about what s a dilemma and what s not. Let me start with the big business, the client software Windows OS. It s a $12.2 billion business for its fiscal year which ended June of 2005 and an operating income of $9.45 billion.

Nothing wrong with that business. However, it does have a dilemma. The desktop is not going away but all of the energy and interesting activity seems to be going on more on the web. Now Microsoft has Vista coming out in 06 which should pump up the sales again but I think if you look out over time, the client OS is going to be much, much less important than it is today.

Now moving on, servers and tools, very important business infrastructure. Infrastructure sells because it powers businesses so SQL Server, Exchange Server and all the development tools and obviously, it is important to have developers. They build the applications that keep Microsoft printing money. I don t think the server business is in big trouble at all. In fact, I think it is going to continue to grow at a good rate because they just came out with SQL Server 2005. That s a hot product. They are reviving Exchange, they just came out with a new development tool with their visual studio so that s on its way up but as long as you re in the so called Microsoft mono culture, it s going to work. But just as we re seeing, there is Linux coming in on the other end from here and obviously, on the database side where you have SQL Server, there is Oracle so it is not that simple of an equation but it is definitely an area where Microsoft is going to have a lot of growth.

The big ticket item, look at this, $11 billion in revenue, almost $8 billion in operating income and that s a really good business and that is Office. Now again, Office 12 is coming out next year with great new interface features, much more integration with the web and this set of products which are the Microsoft business solutions which has not been a great business. As you can see, it lost money. It has been losing money every year but it seems to be getting a little bit better but there is a ton of competition out here. You ve got Salesforce.com and SAP and everybody else and it s just not an area where Microsoft has a lot of strength. I think they ll do some acquisitions to try to really double down in this space over time because they really need to print more revenue.

This is a company with $40 billion in revenue for its fiscal 05. It expects to do $44 billion next year. Now how do you keep that growth going? How do you keep shareholders happy especially when you have a stock that has been pretty much flat? So they have to have growth and it is going to be tough to get growth without acquisition here. This area is going to be hit a lot by the software as a service as I was speaking about where people are saying, Where s Office for the web where you don t need a huge download and we have competitors like Openoffice.org and StarOffice and lots of little players coming on with word processors that are web owned.

Moving on here s a growth business although embedded, Windows Mobile then Auto Play as well. It s losing money but again, it s going to be a growth area because there is so much moving into mobile and having a mobile operating system. They ve got a bunch of deals with the phone companies. They have a new Motorola phone coming out that s pretty cool so I think there will be growth in that area.

Home entertainment, big area and they ve invested billions and billions over the last few years. The big deal now is Xbox and we use a different color here, 360 which just came out. It s a really super hot product. This is a business where they have a product called Halo, a game, a $300 million business so it s just printing money. Now they lost money here. They lose money on every Xbox that they sell or Xbox 360, at least according to some people who unpacked it and found that they lose about $126 a unit, but they re investing a loss now so that they expect to be profitable in the next year or two in this space. Are they in a dilemma in this space? A little bit, there are a lot of competitors but they are certainly investing and this is a company with $37 billion in cash to invest so I don t think that they have a problem investing in this space either.

The area where it is really getting most interesting is here. This is Microsoft Live, MSN, where they have their services orientation. They brought in Ray Ozzie who used to have a company called Groove and he was at Lotus and IBM where he founded Lotus Notes. He s a real leader for the company now in turning it into a services organization where services drives through everything. That s a hard transition for a company that has been focused for all these years on client server, the difference being that on the services end everything kind of goes on the web infrastructure and lives on the web and that s quite different from where you have the fat, rich clients like you have with Windows and Office.

So we re going to see Microsoft investing very heavily in this space to compete with you know who, Google, Yahoo, etc. And already, they have something new. They have an ad center to compete with Ad Sense from Google and Yahoo s offering. They re trying to get a deal with AOL so they can get that business for their new ad center. They ve launched Live and also a live office for small businesses so I think this is just the beginning of Microsoft s attempt to overcome this dilemma of being the legacy player in a world we have lots of companies like a Google or Yahoo, where they grew up on the web and they don t have to support all this legacy stuff going forward and can just focus on what the future is going to be.