Office slips again - along with MSFT's credibility

I hadn't even gotten around to trying out the newly announced Office 2007 test drive preview, when lo and behold MSFT announces that Office 2007 will slip once again. See coverage here:

• Microsoft delays Office release, again

Difficult to comment on this news. On the one hand, developing software of this sophistication for millions of users is tough - no doubt about it. Similarly, the last thing I want MSFT to do is ship something before it's ready. On the other hand, MSFT is meant to be in the business of developing complex software for the masses. So against that backdrop, these continued delays and failures to adequately scope development timeframes, suggests a deeply flawed internal process. I fully expect that the next shoe to drop will be Vista getting delayed until March of next year - along with Office. Meanwhile, MSFT executives will shortly be splitting a ridiculous amount of money in performance bonuses for the supposedly great job they've done over the past 3 years. Ironic huh?

Stop it...my stitches!

One of the unfortunate benefits of owning MSFT - besides the horrific stock performance, of course - is that nearly every day you're treated to a new negative article about the company. Worse still, there's often an unsettling amount of truth to them, albeit that many originate from angry competitors or the Government bodies they've whined to. However, once in a while you get one where you just have to laugh. For me, that was this piece from Alex Eckelberry, President of security vendor Sunbelt Software:

• Microsoft practices predatory pricing
  

Here's the essence of his argument:

It's bad enough that Microsoft is getting in to all aspects of security. But now they are going to kill their competition through predatory pricing.

For those who may not be familiar with the term, he provides this handy dandy definition which includes:

Predatory pricing is the practice of a dominant firm selling a product at a loss in order to drive some or all competitors out of the market, or create a barrier to entry into the market for potential new competitors.

He goes on to say that "But now we see that Microsoft is endangering the entire security ecosystem with ruthless, Standard Oil-style pricing."

Having successfully chummed the waters, the feeding frenzy begins and we get Joe Wilcox from the Microsoft Monitor Weblog chiming in with this:

Alex contends--and I would agree--"that Microsoft is endangering the entire security ecosystem."

Hmmm...predatory pricing, selling a product at a loss, endangering the entire security ecosystem no less? Those are some pretty serious charges. In fact, if true, they'd be grounds for an anti-trust complaint. So Alex must have some killer evidence to offer up, right? I mean, no one would be ignorant enough to make those accusations without compelling proof, right? Well here it is: MSFT is apparently pricing themselves 50% below the market leader. That's it. That's the sum total of the evidence offered. How, pray tell, does Alex know that this is below MSFT's cost? In a word, he doesn't. And if we look at Symantec and McAfee, the two publicly traded leaders in this space, we see that both currently enjoy gross margins even higher than that of MSFT (87.8% and 88.10% vs 85.9 respectively). Almost 90% gross margins for what effectively is a utility piece of software for most users?

Bottom line, sorry Alex, but I'm not buying into your argument. There's plenty of room for security vendors to drop their prices on the standard offerings and still make very attractive, albeit more normal, margins. And you've provided no evidence to support your implicit claim that MSFT is selling their products at a loss - in violation of the law. While I'm normally against MSFT competiting against its partners, in this case security vendors seem to have been only too happy to price people off a demand curve even as the problem of viruses, worms and other malware spiraled out of control, harming consumers and threatening MSFT's bottom line. MSFT needed to act and they did. As a result, consumers will likely benefit via lower prices generally. Isn't competition great?

Ballmer ain't going nowhere!

I'm not normally a fan of [Fortune senior editor] David Kirkpatricks's MSFT reporting, but amidst all the "MSFT is doomed" media hype today in the aftermath of Gates' announcement and continued Ballmer concerns/speculation (my own included), he penned the following article that takes an alternative view and makes some reasonable points and counter arguments:

• Ballmer ain't goin' nowhere!

There's also some truth to this comment, although I personally think MSFT could do far more to influence its own stock fortunes:

Microsoft is just one of a bunch of giant large-cap companies that have been delivering stellar financial results but have elicited nothing but yawns from Wall Street. This is hardly Ballmer's fault. IBM, Time Warner, and Home Depot are other examples. Profit growth seems not to matter.

In any event, kudos to Kirkpatrick for going against the general media tide and consider it my contribution to a balanced debate regarding Ballmer!

By the numbers

As mentioned in a previous post, during the transition announcement yesterday, Gates said of Ballmer that as CEO "he's done a fantastic job by every measure". I took specific issue with that in the post, because it ignores the massive multi-year underperformance of the stock. However, whether it's even true on just a pure financial basis is worthy of debate.

Here's some data from MorningStar which may be difficult to read and can be found here:



This first table details overall profitability. Reviewing the numbers and in particular comparing the period '00 (the year Ballmer took over as CEO) to '05, things that jump out include a good job keeping gross margins stratospheric (83.7% vs 86.9%), but a whopping 44% increase in SG&A which has contributed to a 24% decrease in operating margin . The trend in both did improve materially in '05 vs '04, but the net result is a company that is far less profitable today on a net basis that it was in '00. This is key, and completely at odds with Gates' further statement yesterday that MSFT "had doubled sales and profits" during that period. Sales, yes. Profit, at least on a net basis, not even close.



This second table details growth rates. In addition to the massive slowdown in revenue growth that we're all aware of, note the lack of consistency in either operating income and - critical to the stock - EPS. Once again, '05 brought some promising improvement in raw numbers, but based on next year's surprise spending plans, we'll once again see a huge variable move down in EPS growth.

If you're wondering how this compares to MSFT's peers, here's the first one I pulled - SAP:



Looking at the period '00 - '05, we have gross margin up 8.5%, and operating margin up a whopping 53%. I guess their CEO must have done a "super fantastic" job.

Ummm... could I have what's behind door #2 instead?

Okay, I'll admit it, if there was going to be a senior leadership change, this isn't the one I would have opted for first. I feel a bit like the guy on Let's Make a Deal who just got the elephant instead of the trip to Europe. Wall Street seems to have been thinking the same way since the stock was up on the rumor but down on the news. If you somehow missed it, Gates announced today that he'll be stepping down from his current full-time role at MSFT effective July of 2008 to focus on his charitable foundation. He will continue on as Chairman. You can listen to the webcast or read the press release here.

In the webcast, Gates made it very clear that he has 100% confidence in Ballmer as CEO. In his words, Ballmer has done a:

...fantastic job on every measure.

On every measure Bill? What about the only one that ultimately matters to shareholders - the stock price? Comments like this are unfortunate because they reinforce the perception of a management team that doesn't place any importance on the stock. A reporter did ask Ballmer about the apparent "disconnect" between results and share price in the Q&A that followed - judge for yourself if you find the answer compelling.

On a brighter note, I'm encouraged to see Ray Ozzie take over the role of chief software architect. Ray seems to have a good handle on where computing is going and what MSFT needs to do to successfully manage the transition. His elevated role may also keep him from succumbing to the 2-3 year maximum career expectancy that has typified most other senior-level transplants to Redmond.

Various media reactions:

• Bill Gates' Departure is Good News - Gates wasn't focused anymore, Ozzie will be, Ballmer should stick to sales.
  
• Why Ballmer should leave Microsoft - the alternative view of Ballmer's track record as well as handicapping potential replacements from current in-house candidates.

Media Potpourri

A selection of articles that caught my attention this week:

• Microsoft watch keeps up with the times - $7B of annual R&D and we get the new and improved SPOT watch. If Ballmer still wants input on where to start cutbacks, I have one suggestion...
• Ballmer Talks Up "Big Bold Bets In Wake of Big Stock Drop - reasonably balanced overview with something for both detractors and supporters of current management.
• Microsoft: Vista Most Secure OS Ever - Apparently Bob Muglia was either misquoted or, like most MSFT senior executives, never heard of underpromising and overdelivering.
• 10 to Rebuild with in Tech - RealMoney.com contributor Richard Suttmeier's list of 10 undervalued techs - MSFT makes the list.

Repeat after me, "We're on the cusp of..."

Is it just me, or is that the new corporate tag line for MSFT executives? Gone is orthogonal in every second sentence and in its place we have "on the cusp of". As in: Microsoft is on the cusp of a year of innovations; Xbox is on the cusp of beating Sony's Playstation; Vista is on the cusp of shipping. I guess when you can't actually deliver results, then saying you're on the cusp of sounds a whole lot better than "we've failed so far" - not an unimportant consideration especially for senior executives hoping to take home a boatload of SPSA grants at year-end or those about to face skeptical analysts and angry shareholders. So speaking of on the cusp of and failure, we have this interesting article:

• Stability Drives Sanity For Microsoft

In it, James Utzschneider, general manager of Microsoft Dynamics marketing, tells us that MSFT Business Solutions is - you guessed it - on the cusp of profitability. Sarcasm aside, it's an interesting read and James seems to actually have no problem with the truth (which you'd suspect will be a career killer in the current MSFT):

Utzschneider admitted that MBS had struggled to integrate its new acquisitions, blaming "indecisive leadership" for its struggles.

"Indecisive leadership"? Whoa there big fella! At MSFT? Now, it's unclear who he's referring to exactly (maybe he has some political smarts after all) but since he credits "better overall leadership" under Orlanda Ayala, one gets the impression that it could be former MBS head Doug Burgum - who in the Alice in Wonderland upside-down world that is MSFT executive accountability, got promoted to Chairman of course. In any event, I give credit to Utzschneider for doing more than either Ballmer or Raikes and that's state the obvious: MBS has been poorly led and that has resulted in years of false starts and missed opportunity. When MSFT first entered this arena in 2001, I didn't buy into Jeff Raikes' asinine "MBS will be a $10 billion division by 2010" fantasy, but I did think MBS offered to most obvious payback of any of the so-called "emerging businesses". Which is why I have been deeply dissapointed by the constant screwups and excuses in the intervening years while folks like Salesforce.com and Rightnow have been on fire and even industry giant SAP has been putting up better growth numbers. The good news is that MBS finally seems to be on the right track and may start consistently contributing to the bottom line versus detracting from it. I still question the growth rate of 25-28% as that isn't anywhere close to either Salesforce.com or Rightnow and seems insufficient to take share against any of the main competitors in the space - which is what the goal should be and what SPSA bonuses should be judged against.

On another note, Mini-Microsoft referenced my humble little blog today. Thx Mini! I've been a long-time reader and fan of your site. I'm under no illusions that my efforts here will have anywhere near the same impact your's have had, nor do I have your gift for writing, but I figure every bit helps and I especially wanted to provide a forum for the MSFT shareholder.

Update - Another day, another potential legal problem - this time Adobe

Looks like Adobe finally released a public statement on this whole PDF flap with MSFT.

Here's the salient part:

Microsoft has demonstrated a practice of using its monopoly power to undermine cross platform technologies and constrain innovation that threatens its monopolies. Microsoft’s approach has been to “embrace and extend” standards that do not come from Microsoft. Adobe’s concern is that Microsoft will fragment and possibly degrade existing and established standards, including PDF, while using its monopoly power to introduce Microsoft-controlled alternatives – such as XPS. The long-term impact of this kind of behavior is that consumers are ultimately left with fewer choices.

So Adobe is concerned that MSFT might "fragment and possibly degrade" PDF? It's hard to see how that couldn't have been covered off via some contractual guarantee. More importantly, if MSFT shipped a non-conforming PDF utility, it would be near-useless and users would simply go back to the numerous 3rd party PDF add-ins for Office. Adobe's real concern is seemingly that by including XPS in Vista and Office, MSFT can use its market position to eventually supplant PDF with its own XPS. That comes across more clearly in this post by Mike Chambers, Senior Product Manager for Developer Relations at Adobe, who seemingly doesn't believe in a rehabilitated MSFT and paints it all as Adobe protecting open standards from big bad MSFT on behalf of the consumer. Mike, maybe I'm jaded, but I think this is about self-interest not concern for consumers and playing the "monopoly" card is simply an expedient way to try and limit choice not enhance it. Still, giving you the benefit of the doubt, MSFT's new plan to strip out both PDF and XPS and offer them as seperate downloads, should address your monopoly abuse concern while still preserving that choice that you're so fond of. Right? LOL.

Scoring MSFT against its own self-selected peers

In July of 2004, John Connors (then MSFT CFO), presented the following slide in a presentation to financial analysts:




To see the full slide deck and/or read the presentation transcript, click here.

The basic message was that the company had outperformed many of its peers on key financial metrics such as revenue and operating income. Now you could argue that MSFT's near-monopoly and massive recurring revenue was a huge relative advantage in the aftermath of the 2000 technology bust, but that's a seperate debate. In fact, I'm not bringing up the slide to fault the analysis or John Connors for making it; it was a reasonable point and Connors was a very capable CFO who's subsequent departure imo was a big loss to MSFT (and perhaps foreshadowed some of the current messs). The reason I bring up the slide is that it was one of the first times that MSFT provided its own view of who it should be compared to.

Keep in mind that at the time, MSFT has already underperformed most of these names badly from a stock perspective - a fact that was conveniently omitted from the analysis. Today, of course, it's company MO not to mention the stock or even go as far as Ballmer's ridiculous “We have never really used the stock market itself as a barometer of our success” uttered at the last shareholder meeting no less. But I thought it would be interesting to see how MSFT's stock performance has compared to these names two years later.

Using a 5-year chart, MSFT is down approximately 40% (yes, I'm leaving off the incredibly stupid $3 one-time and collective dividends). Here's how the rest of the list has done:

• SAP +40%
• ORCL -30%
• IBM -32%
• CSCO +10%
• DELL -2%
• SNE -35%
• NOK -10%

In other words, MSFT has underperformed not just some of them, but ALL of them. But wait, it gets worse. Inquiring minds might note that even in 2004, that list was pretty self-serving and excluded obvious competitors like Salesforce.com, Google, Yahoo, Redhat, and Apple. How have those folks done over the past 5 years?:

• CRM +60%
• GOOG +275%
• YHOO +200%
• RHAT +575%
• AAPL +400%

Oh, and the NASDAQ itself over that period? Flat (0%).

Bottom line, 40% underperformance versus the index, lagged every one of its self-selected peers and wasn't even in the same league as several of its most formidable competitors. I give that a score of "F" for fail and only because miserable failure isn't available.

Another day, another potential legal problem - this time Adobe

Okay, so we're all pretty much used to this by now - unfortunately. But if you missed the latest, it appears that Adobe and MSFT are having a spat over how MSFT will include support for Adobe's PDF format in Office 2007. Needless to say, this could spill over to the EU where Adobe has already raised concerns and where regulators are, shall we say, predisposed to lending a sympathetic ear to all complaints MSFT-related.

Various media links here:

• Microsoft Will Take Adobe Out of Office After Talks Break Down
• Bowing To Adobe, Microsoft Strips PDF Support From 2007 Office

Microsoft's Brian Jones gives his seemingly reasonable perspective here:

• Legal issues around PDF support

I'm not going to wade into this one further until I hear Adobe's side of things. Off the top, it does seem like Adobe is trying to treat MSFT differently than they have other folks like OpenOffice and Apple. And while I can appreciate that the potential impact from lost sales in the MSFT case is much more substantial, it occurs to me that they should have considered that possible development when they offered up PDF as an "open standard" in the first place. That said, I can't help but think that MSFT's increasingly competitive approach with partners, especially Adobe of late, has probably contributed to getting Adobe management's back up. Jupiter Research's Joe Wilcox has made that point repeatedly on his Microsoft Monitor weblog and I think he's right. At a time when all for-profit software vendors face increasing competition from Open Source, you'd think common sense might argue for them to work more closely with each other to enhance to overall value proposition for customers. Apparently not. For Wilcox's take on this specific mess, see his post here:

• There's More to This Story

On a brighter note, if it does end up going to court but the facts are as laid out by Brian Jones, maybe MSFT's legal team might have a shot at actually winning one for a change? But that's another post...

Ballmer presents his case in Manhattan - and bombs

The big news this week was Ballmer's unprecedented trip to Manhattan to try and reassure analysts in the face of the recent guidance fiasco and associated $40B stock haircut.

• Read the transcript - in case you simply saw the stock down the next day and wondered "wtf?"

Media coverage was extensive, but the most insightful article imo was this one by Mitch Ratcliffe:

• Penetrating Ballmervision

He brings up several interesting points. One that I've wondered about for a long time is what exactly MSFT's massive $7B/annual R&D spend represents? According to Ballmer, only about $250M is actual "R" leaving $6.5B of "D". Is that simply operational product development costs masquerading as R&D for tax purposes? If so, it's pretty concerning wrt to what the true [non-variable] costs of MSFT's product development might be. It also calls into question whether Ballmer should be touting it as the massive differentiator that he does. Anyway, if someone has some insight into how that $6.5B is seperate from general product development, I'd be interested.

A second comment he makes is critical imo:

The really cogent argument Ballmer did offer for the reliance on internally developed technologies and products was XBox. He pointed out that, if Microsoft had acquired Nintendo (whose U.S. headquarters is just down the street and now surrounded by Microsoft's campus), it would have spent three to four times as much as it will lose in the early years of XBox and "we would have had a business we didn't understand as well, wasn't as good, wasn't as well-positioned and essentially would have cost our shareholders an additional $6 billion, $8 billion." All true, yet it doesn't seem to inform Ballmer's strategic approach to extending Microsoft's business.

If the build-it-don't-buy-it case is proven by XBox, Ballmer should be much stronger in his defense of Microsoft's $35 billion cash reserve, more of which should be going into basic research now to put the company at an advantage later.

Exactly! If Ballmer believes that the massive investments he's made over the past 5 years have been wise for shareholders, then he needs to articulate that and in some detail - in particular because these emerging businesses as a group are still collectively unprofitable and detracting from earnings and hence the current stock price. His unwillingness to do so suggests that he can't because he doesn't know the answer, or that he won't because he knows the answer might not be sufficiently compelling to convince investors that it was a good risk/reward. IMO, it's more likely the latter, although I'm still willing to give Ballmer the benefit of the doubt. However, until he comes across with some detail, investors will view all the new "investments" through the prism of this past track record and conclude that it simply means more big dollars being spent upfront for unclear future returns.