Monday, March 26, 2007

For want of a shoe, or time for a new rider?

A MSFT-employee recently challenged me to discuss what I would change at Microsoft. I have provided that commentary many times over dozens of posts on a topic-by-topic basis. However, doing it as a subject unto itself is new - and pretty daunting given a company the size and scope of MSFT (Indeed, as you'll see, I think that breadth is one of MSFT's major problems). There is also the immediate issue of determining whether you think the problems are a result of strategic shortcomings, or tactical ones. For example, while Benjamin Franklin was undoubtedly correct when he said:

“A little neglect may breed great mischief: for want of a nail the shoe was lost; for want of a shoe the horse was lost; and for want of a horse the rider was lost.”

It's also true that the right rider can make all the difference in the world. A relatively recent case in point: HP under Mark Hurd versus Carly Fiorina. While I was no Fiorina fan, given the rapid turnaround, it now seems apparent that the company must have been in better shape under her tenure than it appeared to be at the time - but it took Hurd to bring that out.

So, let's begin with the strategic:


MSFT does not appear to have a clear, honestly customer-focused mission that is understood at all levels. Importantly - and perhaps as a result - employees seemingly aren't in total accord or fully bought into it. If MSFT truly believes in "Your potential. Our passion", then it needs to do more than just pay lip-service to it. It needs to open itself to all that that entails (cross-platform support, not playing lock-in games, etc.) and deliver against it. If they do that, then most employees probably would be fully on board (i.e. maybe the problem is the current gulf between words and actions). Those that wouldn't be, need to go.


Seven years have passed since Ballmer took over as CEO, and that's more than enough time to make a fair assessment of his performance in the role and suitability to continue. While he's off the charts for passion and desire, and has done a good job growing the top line (and, much less successfully, the bottom one), overall it's been a mixed bag at best, and abysmal at worst. In particular, I think Ballmer lost the confidence of the street - and maybe employees too - long ago. In my view, it's therefore time for a change. Moreover, it's time for an external hire to fill the role. MSFT needs someone with a fresh perspective, versus someone closely intertwined with the past and what used to work. Assuming Hurd can't be lured over from HP (which is probably true), Oracle's Safra Catz or YHOO's Susan Decker might be good candidates. But I don't mind if that new CEO has a previous MSFT pedigree. That may even be wise, especially if the individual saw what was coming more clearly and, in classic MSFT politics, got pushed out for making too many waves. Brad Silverberg, for example, comes to mind (interestingly, he was also one of the financial backers in Tellme, which MSFT recently acquired). Perhaps there are others even more suitable.


I see two concerns here. First, the need to move from a culture of "good enough" to one of "excellence" and "insanely great". I've posted about this before. MSFT has a long-standing approach, ingrained via Gates, of getting something - anything - out to market and then fixing it over time. That worked well for a long time when "free" alternatives weren't prevalent, and when competitors/markets weren't moving as quickly as they are today. Now, it's a lot less successful, and yet MSFT continues to do it and be surprised when it fails. This is an area where Apple's Jobs seems to get it, while MSFT appears clueless (and no, I'm not a MAC fanboy - just calling it as I see it). The second area of concern, reported in many sources and evidenced in comments on Mini-MSFT, is MSFT's "cult of personality" versus a true meritocracy. This is truly dysfunctional, and seems to have resulted too often in the wrong people getting ahead or staying, while other [more capable] individuals have been passed over, left, or been forced out. Again, it's impossible to ignore that the culture which currently exists requires Ballmer's tacit approval, if not his full support. It needs to end and ergo, again, he needs to go.


What is MSFT's process for ongoing training and development? Does it exist? Especially within the leadership ranks, it appears to be ineffective or non-existent. Microsoft should put more cycles into trying to create a successful management development curriculum patterned after GE's highly regarded program. Obviously, it will have to be customized, but it's not a coincidence that many, many former GE senior executives go on to be CEOs of other major corporations. How many ex-MSFT senior executives have done that? One, if we count Rob Glaser at RealNetworks? Maybe this process has begun - I don't know, but the results aren't yet evident in overall execution.

Rewards and Punishment

MSFT's reward structure seems to be inconsistent, inequitable and disconnected from the things that drive shareholder value. A leadership team who misses their own earnings goals, for example, should not be eligible to earn 100%+ of their $1B SPSA bonus payout - period. While each group should have metrics that are unique to their business, certain core objectives - like earnings -should span all units and act as global multipliers. In other words, miss your earnings objective, and your entire bonus will be impacted regardless of how well you did on other non-core metrics. MSFT also needs to review the skew between the "top 500" - now morphed to 800 or more given MSFT's ongoing bloat - and everyone else. IMO, it's unjustifiably high. Since overall results don't support increasing the size of the pie, it's time to start allocating it more evenly with those who actually do the bulk of the work. Finally, punishment goes hand in hand with accountability. Sadly, it's been non-existent - at least at MSFT's executive levels - for most of this decade. Recently, we've seen some improvement there, but even then it's often late and mired in uncertainty (e.g. was the executive fired or did they quit?). Punishments, like rewards, should be clear, timely, and leave little doubt about why they're being doled out


Stop fighting major wars on multiple fronts simultaneously. It is simply ridiculous for current management to assume that MSFT can fight the biggest and best companies on earth, across a dozen or more battlegrounds, and still hope to prevail. Just take a look at some of the folks MSFT is going up against: SONY (and Nintendo) in gaming, Nokia and many others in mobile, GOOG and YHOO in Search, Everyone from Alcatel to Siemens in IPTV, IBM/Oracle/SAP (and smaller players Rightnow, etc.) in ERP and CRM, IBM/Adobe/FOSS in middleware and development, AAPL and most of MSFT's former partners in mobile media, AAPL and GNU/Linux in Operating Systems, and FOSS in personal productivity. Worse, these battles are spreading MSFT too thin, and leaving its core cash cows increasingly vulnerable (would Vista have taken 5 years to develop if management hadn't been distracted with a dozen other battles?). MSFT needs to prioritize the current list down to something more realistic, while ensuring that the appropriate vigilance is maintained on the crown jewels. As a start, any new battle should require them to give up an existing one. Notice how that NEVER happens and they're always additive instead?

Better together

Put "partnering" back in Platform. Windows and Office (to a lesser extent) have been successful historically not just because they were decent products, but because they provided a platform for others to develop on. Today, MSFT is increasingly competing against many of its former partners. If you were SAP right now, would you be putting more resources into Windows/SQL/Office, or looking to Linux/mySQL/OpenOffice? Where is Adobe putting an increasing amount of its efforts now that MSFT is competing against them in numerous categories? Ditto, CSCO? Ditto, far too many suppliers imo. If Windows and Office - not to mention most "for-profit" s/w offerings - are going to continue to succeed against increasingly functional low or no cost alternatives, its going to be on the overall platform experience and not the features of any one product. Otherwise, it's just a matter of when, not if, OSS alternatives become good enough in each category to supplant the incumbent (some argue they already are).

For-profit suppliers need to wake up to this bigger threat, and MSFT needs to get back to its roots of providing developers with the preeminent platform for adding value to other's solutions - not cherry picking them off one by one when they establish a market that gets large enough to attract MSFT's competitive interest. I'd also like to see more cross-promotions of mainstream offerings (i.e. not bundled "craplets"), and a global Window-update equivalent (like Linux/FOSS has via "apt-get" and associated GUI front-ends like the Synaptic package installer). Does it really make sense to have half a dozen separate updaters running on my PC - each with its own GUI, process and quirks? If there's a Windows anti-trust concern, make it a Live service. While you're at it, throw up a Live service to clean the craplets off new PCs automagically - the out-of-box customer experience there is terrible (yes, this is primarily an OEM-initiated problem, but since they're not economically inclined to fix it, offer a service which does - it's in MSFT's best interest).

The LBU - Linux Business Unit

Yup, time to face the music and stop pretending Linux isn't here to stay. Not only is it, it's likely to eventually gain a significant share of global desktops (read: eventually much more than AAPL). So why is MSFT resisting it so hard versus simply embracing it as yet another opportunity to sell software a la the Mac Business Unit? IMO, MSFT should be focused on what it can still sell accounts who go this route. At a minimum, that could include Servers for legacy support of Windows apps. But maybe MSFT should even develop it's own "customer-friendly" linux distro (or, if GPL exposure of that code is an issue, maybe a non-GPL licensed library to run on any distro, or a BSD-based distro)? BTW, if they haven't taken steps to at least determine the engineering feasibility of that and effort required, then they're not doing their job. Additionally, why make it a religious battle? Like any OS, Linux does some things very well. For one, it's much more modular than Windows. So why not empower an internal group to promote it where it might make sense - like say in a set-top box or audio device? The Novell SUSE distribution thing is a step in the right direction, but MSFT needs to do more. Heck, if it can't convince itself that the Windows kernel and architecture is superior - and I can't find a single analysis that argues that's the case (company published or otherwise - if you have one btw, I'd be interested in a link) - maybe it should do an AAPL, hop on board a Mach/BSD kernel, and add value at higher levels only moving forward?

Investments that make money

Duh, you say? Well consider that despite years - or in some cases decades - of effort and $10B's spent, MSFT's emerging business "bets" are STILL collectively unprofitable. Business can and do make investments for a variety of reasons. These include generating an ongoing stream of earnings, creating a asset which can be sold to realize a profit, protecting an existing earnings stream, and ensuring access to a future one. MSFT's problem is that almost all have been sold to shareholders and the market as the first, but have failed miserably to provide a return. While execution blunders and other mistakes have normally been a contributing factor, it's becoming increasingly apparently that either management plans to ignore that, or their actual goal was always defensive versus offensive and they simply misrepresented their original intent. IMO, either of those options is unacceptable.

Research and Development

MSFT spends a ridiculous amount of money on R&D - as they're happy to point out at every opportunity. How much? About $35B since 2000 (more than IBM, and more than SONY/GOOG/AAPL combined). What they don't like to talk about, is how little of that is the "R" part (only $500M or so annually). In other words, it's mostly development costs masquerading as R&D for tax purposes and to maintain the fantasy that maybe it's mostly discretionary. More importantly, like the "investments" above, you rarely hear details on the return being generated. Either MSFT needs to figure out a way to better tap the ideas coming out of the MSR brain trust, or maybe it's time to disband that group like Apple did. Someone then needs to look at that overall Development cost and figure out why it's so large. To put it in perspective, AAPL has spent less than $5B on R&D since 2000, yet doesn't appear to be lacking for either innovation or development. Indeed, they seem to be kicking MSFT's butt at both, resulting in larger returns, much quicker paybacks, and faster growth. Fixing this obvious imbalance, would likely be the biggest single contribution to accelerating earnings that any new CEO could make.

Mergers and acquisitions

MSFT's track record in this area is mixed to horrible. In most cases, the acquired company's products have either disappeared completely or been incorporated into some other offering. Additionally, the size and scale of these acquisitions have been very modest relative to MSFT's size and cash position. IMO, that's overly-conservative. I've posted before that MSFT could - and should - have done more at the bottom of the dotcom/market bust when the who's who of technology were trading at pennies on the dollar. I view this as one of the largest single mistakes of Ballmer's entire tenure - and there's no shortage to choose from. Even today, he is routinely quoted as stating a preference for many small acquisitions versus a larger one. Then why carry that much cash on the Balance Sheet? Is MSFT a bank? While larger purchases bring with them more integration risk, and MSFT hasn't exactly blazed a trail of success on smaller ones, companies like HPQ and Oracle are demonstrating that the widely-held industry perception of larger acquisitions "never working out", may not be true. As a result, I think MSFT needs to get more aggressive in this area and better at it. The recent Tellme acquisition is a positive step in the right direction - at least it's bolder. But MSFT needs to figure out how to successfully leverage new acquisitions a la the recent EMC/VMware model, versus doing their usual borgify and ultimately destroy. Again, one of the core strengths of a new CEO should be a demonstrated track record of M&A success.

A truly global structure

Don't just talk globally, act globally. While growth is increasingly shifting to emerging markets, and MSFT talks up the opportunity, it continues to be hugely Redmond-centric. Yes, the company has established some foreign labs, etc., in recent years, but it still pales by comparison to the market opportunity or similar large global entities like IBM or HPQ. MSFT sells decentralized computing but acts more like a mainframe. Time to push more and more operations overseas where the growth is, and where the greater talent pool exists. IMO, had MSFT done more of this sooner - like in Europe, for example - they also wouldn't be perceived as such a US-entity, and would be better embraced by foreign markets (and especially Governments) as part of the local community.

Oh, and freeze Redmond headcount (except for select strategic initiatives) for at least the next two years.


Marketing and Sales needs to become world-class. I'm not sure MSFT ever was a leading marketing or sales organization - although in the 90's, when things were all going the company's way, the perception was that they were incredible. Frankly, I think IBM, Oracle, HPQ, SUN, etc. were always significantly more experienced in selling to the enterprise and maintaining high-level relationships. And in the consumer space, which is increasingly important, MSFT is getting beaten hands down by AAPL and many others. Again, that needs to change. On the consumer side, MSFT needs a new advertising company pronto and/or new executive oversight. For every one good ad/campaign, there are ten bad ones. They also need help with product design, packaging and especially naming. On the enterprise side, I'm not sure whether the solution is new training, new recruitment, or new leadership - probably all of them.

Public Face

I am sick and tired of MSFT executives "trash" talking competitors in public. This is such a fundamental business tenet that it's an embarrassment to have to even list it. But Ballmer and Gates were apparently asleep the day everyone else learned it. Moreover, others throughout the organization appear to key on this and feel empowered to do likewise. It needs to stop and asap. Be judged by your products, support, and execution - not your mouth.

Put the fun back into computing

Somewhere along the line, MSFT seems to have fallen into the IBM trap of trying to please corporate IT departments instead of users. To do so, imo, is to forget the lessons of Windows 95. Windows 95 was a hit not because IT departments demanded it - they didn't. It was a hit because users embraced it and then demanded it at work. I recently loaded Vista, which I may post about, and liked it overall. But there was very little "Wow" - certainly not enough to justify upgrading my existing machine and purchasing the retail version to get it. Which makes the advertising campaign that much more ridiculous. Underpromise and overdeliver - another basic business tenet that MSFT routinely ignores. My advice? Get a feature pack (and not just a service pack) out asap. Beyond that, get back to making computing fun for users.

Okay, now on to the more tactical:


Sending in Sinofsky to clean house and get this division back on track, was smart and way overdue. IMO, Allchin and others should have been fired during the Vista reset fiasco - but undoubtedly Gates fingerprints were so prevalent in that screwup that sending others packing would have been the height of hypocrisy. As above, I think Vista is just "good". So much for Ballmer's "It'll be great - bet on it". That's pretty unacceptable after all the time and money spent, and it's going to make it that much harder to sell (all PR puff pieces about exceeding initial XP sales aside). Stepping back, I think the writing is on the wall that MSFT needs to develop a cloud-type hybrid OS that lives on both the desktop and server. Others already are, via companies like this (sporting ex-MSFT distinguished engineer Lou Perazzoli, and ex-CFO John Connors as an investor) or via technologies that promise a similar experience - like Adobe's Apollo. It would be nice to think that MSFT is way ahead of the game on this, especially given how core it is to the business and how far along others appear to be. Sadly, based on this and this, it sounds like they're late to the party yet again.

I also think MSFT has to decide whether it can continue to compete while dragging several decades of legacy code with it. Backwards compatibility is something that MSFT can be justifiably proud of. But moving forward, I don't see how the company can keep up with AAPL and Linux with the current code base. Pretty obviously, MSFT needs to be in a position where it can come to market much faster with new releases than it has done. In particular, I think it needs a consumer release that is a perpetual showcase for innovation. This addresses the more "fashion" orientated demands of this increasingly important market segment and, like Windows 95, would keep IT departments on their toes via end-user demand. All due deference to the more modular approach of Vista, I just don't see that being sufficient to enable this. Now, I don't profess to have the technical answers here, but all options - from new "cloud" OS, to dropping some legacy compatability and/or embracing a new kernel and leveraging higher-value layers only (like OS X) - should be on the table.

Business Division

Now that Raikes has finally woken up to former GE CEO Jack Welch's "when you think you've reached saturation, expand the market definition", I think the Office group is on the right track. If they can do a good job of that via telephony, etc. then justifying the additional cost of Office should be viable - assuming you get the world-class Salesforce in place that I discussed above. I also applaud the boldness of the new "ribbon" interface. I haven't completely made up my mind on it, but that took guts. Kudos.

On the ERP/CRM side (formerly BusSol), I think this group will never be the market leader as long as its mandate is polluted by trying to be an Office-delivery mechanism versus the world's leading ERP/CRM solution. In my mind, now that the moronic decision to go head-to-heard against previous partners has been made, this group should be free to pursue that objective 100%, including supporting OpenOffice front-ends, non-SQL RDBMS, etc., when and where that becomes desirable (if it isn't already).

Finally, given the renewed focus on Healthcare (which I agree with), I would seriously consider buying a large Healthcare software supplier that would be accretive - like Cerner. If you're wondering about the apparent contradiction there, I don't see that being as aggressively confrontational versus existing partners as were say, the ERP/CRM moves.

Server & Tools

This is a group that imo can be justifiably proud of their record of accomplishment. Yes, SQL suffered a huge delay. Yes, Exchange faces some imminent threats from OSS and needs to get easier to manage for larger entities. Yes, Home Server has some work to do. But quarter in, quarter out, this group has an excellent track record of profitable growth despite being in the direct line of fire from Open Source alternatives. It's going to take a lot to stay that way and adjust to the whole SAS model, but they seem up to the task.

Online Services

Let's face it, MSN has been an abject failure. Indeed, outside of IPTV and MSFT's $10B of failed cable investments, no other group in MSFT has burned through more cash, over a longer period, and still had losses to show for it. WRT the more recent efforts here in Search and Advertising, those too have been massive failures. Again, that's not just my assessment - it's the assessment of professional analysts whose opinions I have quoted on several occasions. As a result - and as I posted here - I think MSFT should give the current team until year-end to show the beginning of a turnaround. Recent monthly stats provide some reason for optimism in that regard (the ongoing market share losses having been arrested, at least temporarily), and I have confidence in at least Berkowitz. But if they can't show progress by then, it's time to pull the plug and outsource the entire effort to YHOO in return for a % of the action.

Entertainment and Devices

Why is MSFT in the device market? If they are going to be in it, shouldn't there be a plan to be #1? If so, why didn't they buy Logitech at some point? I mean, if you're going to tank overall margins with hardware anyway via Xbox, why not do it with something profitable? WRT that bigger concern - Xbox, what can I say that I haven't said repeatedly before? It will likely take multiple decades, if ever, for MSFT to recoup the $5B+ expended on Xbox to date. Additionally, it would be hard to find a buyer given that profit picture and the massive losses generated on each console rev. I also think MSFT's current management has no intention of selling it. As a result, Xbox is a financial failure by any reasonable overall assessment. That said, the $5B is now a sunk cost, and if leadership is convinced that future losses can be mitigated and a [ongoing] profit generated, then it makes sense to continue forward. Gaming is big business overall and I think MSFT needs to be represented. It should just have been done in other ways, and imo MSFT stupidly neglected the PC-gaming market in the interim (an oversight which, thankfully, appears to be getting addressed). What doesn't make sense is to pretend that Xbox has been a success or even a "great success", or to give the executives involved - many of whom are the same geniuses who predicted 2-3 year paybacks back in 2001 - more responsibility. Oops - too late - Zune.


Those are some of the issues as I see them - strategically and tactically. Again, I don't profess to have extra insight, nor do I think I have all the answers - or even any of them. At the same time, I'm not splitting $1B in bonuses with 800 other senior colleagues because of my supposed world-class brilliance. What I am, is a shareholder who has held an underperforming stock for this entire decade, while the current management team has been telling me to "have patience, our plan is working". It isn't, and it's time for someone new to come in, acknowledge that fact, and start making the tough choices required to get things back on track - or at least fail trying.

Update: Various articles that touch on the themes here in some way (i.e. directly or indirectly):

Thursday, March 08, 2007

I've fallen and I can't get up

I may be dating myself, but remember that commercial? Well, it certainly seems to fit MSFT. In a Feb 28th post, I asked:

"Given the series: $31-$30-$29-$28, what might logically come next?"

Today, several reporting services (NASDAQ, Investor, etc.) have a low on MSFT of $26.60 - although the charts suggest that might have been a bum trade and it was really around $27.27. Regardless, we're close to the "$27" I had implied in the quote above. It also came amid an escalating slide relative to not just itself, but the market. MSFT has now clearly disconnected from the latter, forming what is called a "negative divergence". That does not bode well.

On a daily basis, I track some 20 stocks. For most of today, only two were negative - MOT and MSFT (though that has moved to 5 by EOD). Here's the chart for MSFT:

Note: that's actually a bit off due to timing/charting issues on Investor. MSFT actually closed down more than 1.05% in a market that was up .55%. And it came on above-average volume - again, not good.

In that same post, I went on to say that:

While I'd like to be more constructive, there's no denying that MSFT's chart is now completely broken technically and screaming "Sell". A full 1/3 retracement of the June '06 to Jan '07 run has been completed and yet the stock is still showing no signs of firming. So if the market continues rolling over, odds favor MSFT eventually testing (and likely dropping) the 200 day moving average which is currently sitting at $26.78. If things get really bad, expect a full 2/3 retracement to ~$24.74. But hey, look on the bright side: by then, the dividend yield will be closer to market.

It's still unclear whether the market is going to find support here or not (and we're getting close the "sell in May and go away" adage), but I stand by my earlier assessment. If MSFT can't find some relative strength here ASAP (like tomorrow - which will be tough given that it's a Friday), it is definitely at risk of dropping its 200-day moving average - and convincingly so. Based on the continued and even accelerating weakness, the market seems to know something we don't. Is more bad news on the way?

BTW, quoting my previous comments isn't being done to say "good call Extrememakeover". First of all, I've made plenty of bad calls. Second, that's not my style. Third, I'm sickened for all shareholders who have once again seen the value of their holdings plummet - myself included. I offer them up instead, merely to provide a context against which you can judge my current comments, as well as on the off-chance there's anything of value for your own MSFT investment strategy.

Now, any stock can have a bad day. This isn't about that - so save me the comment complaint. The chart above, however, would yield the same net result - underperformance versus the NASDAQ - if currently drawn over:

  • 5 days
  • 10 days
  • 1 month
  • YTD
  • 3 months
  • 1 year
  • 2 years
  • 3 years
  • 4 years
  • 5 years
  • 6 years

If you don't believe me, try it yourself (posting separate charts would have taken too much space). In fact, let's look at how the stock has performed this entire decade so far:

BTW, the red line is the NASDAQ and the black one is MSFT - in case it's not easy to read.

An employee commenter recently suggested we should all be used to this by now, and wondered why I'm harping on it. The former is obviously true, but I reject the logic implicit in the latter. As investor owners, it is our right to communicate our dissatisfaction with current management's track-record. In particular, because that record is one of abject failure to drive realizable shareholder value - as detailed above. In fact, as a shareholder, I'm embarrassed that we haven't been more vocal (as a group) in expressing our concerns. Had we done so earlier, changes might have occurred, and we might not have gone this decade (so far) underperforming the market. But sadly, much of MSFT is held by large institutions who, unlike you and me, can invest in complicated hedging strategies to mitigate the underperformance or even benefit from it. Many are also forced to hold MSFT because they track the indexes in which it is a prominent member (especially the S&P). However, there are signs that even this group may be tiring of holding a stock with such an abysmal performance record - they actually being rated on their results.

Of course, the usual Ballmer apologists will come out of the woodwork and talk about the need for "patience". They'll talk about how you have to focus on "managing the business" not "managing the stock". The more analytically inclined, will add that MSFT got too expensive during the late 90's (at least when growth subsequently fell off a cliff), and that this extended period of stagnation has been about "restoring fair value" or "growing into its market cap". Still others - convinced this is all an anti-MSFT conspiracy - will tell you it's because the market just "hates" MSFT and is therefore ignoring what Ballmer has managed to accomplish. And then there's the company's many detractors, who will wade in with "Duh, the company's best days are behind it" or, more likely, something less eloquent and more juvenile like "that criminal, monopolist felon M$ is screwed". There's at least an element of truth in most of these. However, I don't think any of them goes to the heart of the matter.

WRT "patience", that argument is getting pretty tired by now (see above if you're confused). It's also worth noting that, when it came to his own personal investment in Six Flags, Gates himself didn't seem to put much faith in "patience" as an investing premise. WRT focusing on managing the company not the stock, that's clearly true, but then the visible business results of that strategy haven't been overly evident, have they? WRT the "overvaluation" argument, that could be said of most tech stocks in the late 90's (MSFT even missed out on much of the final blowoff because concerns over the DOJ trial were already rising), and yet many have outperformed MSFT in the period since, including Oracle, HPQ, AAPL (don't even look, you'll depress yourself) and many, many others. WRT the conspiracy theory, why "MSFT" (although it is a lightning rod for critics - perhaps a message there), and then why isn't this borne out in the valuation measures? MSFT may be cheaper than some, but it is by no means "cheap" relative to growth, sales, earnings or many other measures. WRT MSFT's "best days" being over, I don't think that's true by definition, but it certainly seems increasingly plausible given the current trajectory. Still, there are numerous other companies who this could be said of, and yet they've still managed to outperform MSFT since '00 - and handily. Example: IBM.

While many of the above have played a role (and add in all the legal fallout), I think MSFT stock has underperformed for several - mostly objective - reasons. In order, these are:

  1. the failure to drive earnings commensurate with revenue (most of the post '00 growth having been of the profitless variety). IMO, this is far and away the #1 reason. To date, Ballmer's "emerging bets" have cost shareholders billions in cash and foregone earnings while collectively failing to pay off at all.
  2. a perception, based on demonstrated execution failures, of a company that is getting weaker versus stronger, and less agile versus more so. Again, many of these are demonstrable and even in supposedly "core" areas of expertise (e.g. Longhorn/Vista).
  3. a concern that competition is getting fiercer and that MSFT is increasingly fighting battles on too many fronts, against too many players, and losing many of them.
  4. a dawning realization that technology is once again going through a major tsunami, coupled with a belief that MSFT is more concerned with avoiding being crushed - or even denying its existence - rather than adapting quickly enough to catch the wave and eventually lead it.
  5. a management team that comes across as largely oblivious to all of this, and by their actions, have made it clear that they are unwilling and/or unable to change course regardless of impact on the business or other stakeholders - especially shareholders.

As a result, the street is losing confidence and - since they figure they can't affect a change of leadership given Gates' and Ballmer's stakes - voting with their feet. That process began when MSFT first disconnected from the market in 2003, and it continues. So far, based on results, the market - and not Ballmer - got it right. Which is why I get irritated - and frankly, insulted - when I read a comment in this article. In it, CFO Chris Liddell discusses MSFT's acquisition strategy. FWIW, on that score, I completely disagree that MSFT couldn't and shouldn't have done more numerous and larger acquisitions (except that they generally suck at it, but that shortcoming needs to be addressed pronto). In fact, when you consider that at the depth of the bear market most companies were trading for pennies on the dollar, and MSFT had the largest cash horde of anyone, why didn't they buy more? Likely a combo of being conservative by nature, but also totally distracted by the anti-trust legal fallout. That's a shame, because it could have been a once-in-a-lifetime home run for shareholders by now. Nevertheless, it's not Liddell's overview and justification of their approach that bothers me, and he even makes a few decent counterpoints. It's this:

It's ironic that we can probably get more of a pass from our shareholders at spending $5 billion on an acquisition if there's a very strong short-term impact than having a $2 billion R&D spend over the next three years, which may have the same impact.

Chris, did you accidentally swallow the [Matrix's] blue pill instead of the red one? If so, wake up and face the truth. It's not ironic at all. It's a reflection of the pathetic track-record of driving shareholder value that I've discussed above. Against that backdrop, shareholders are naturally more inclined to give you a "pass" on doing something - anything - new, versus continuing to do what clearly hasn't worked for shareholders this entire DECADE. Indeed, why you and the rest of the management team assume you don't have to justify a continuation of business-as-usual and your previous/current/future investments, and are seemingly taken aback when you are even asked to do so, is really the only thing that is ironic - or just plain ignorant.

Update: 3/13/07 - The 200-day moving average was officially broken today. Despite the extreme selloff YTD, the stock still managed to end on its low, underperforming the NASDAQ - again - in the process. News about another potential DOJ investigation didn't help, and the market didn't appear to like the potential Tellme acquisition. Next likely stop is low $26's or high $25's. If that doesn't hold, the 2/3 retracement level mentioned in the post - $24.74 - would be the next logical target.

Sunday, March 04, 2007

Live? Yes, but just barely...

Okay, so you already knew that MSFT wasn't doing well in Search and Advertising, despite repeated assurances by Ballmer, years invested, and $B's of shareholder's cash spent. But just how bad is it? Well, this article (courtesy of David Hunter's Microsoft News Tracker site) provides US market share detail through January 2007:

The news is not good for MSFT. Among their conclusions:

Looking at trends from the past year, a couple of things are apparent. First, Google continues to grow at a faster rate than its its competitors. All three metrics firms reported significant gains for the company since the beginning of 2006. Second, all the time and money that Microsoft has invested in growing MSN is not paying off.

Ballmer's fanciful view of MSFT's past track record on "investments" aside, that "not paying off" part could be said of MSN generally and since inception. However, in this case, they mean the massive extra transfusions of "time and money" pumped in more recently to bolster Search/Advertising. Here's their concern pictorially:

The prognosis is never rosy when flatlining would represent a dramatic improvement. Now, admittedly, that's the worst-case scenario - a 45.6% drop in market share in one-year. It might be a lot better - just, 20% loss (guess which one the VPs are going with for their own performance reviews?):

MSN started out 2006 with between 11 and 12.44 percent of the search market, according to the three metrics firms. Since that time MSN's search traffic has seen a steady downward trend. According to Net Applications, its search traffic has almost been cut in half, handling just 6.76 percent of all queries in January 2007. That's a 45.6 percent drop in a year. The picture painted by comScore and Nielsen/NetRatings is a bit better, but not by much: they show MSN search usage dropping by nearly 20 percent.

Hmm...this doesn't sound much like Ballmer's recent characterization of their efforts in this space:

And in a sense you could say it is impressive what a great job we've done coming so much later in the cycle in terms of the innovation, and frankly with the team today that is still smaller than the Google team, so we continue to ramp.

But maybe the "sense" he's referring to is "nonsense".

All of which perhaps explains the timing and tenor of Friday's statement by UBS analyst Heather Bellini, detailed here:

Analysts generally tend to mince their words, especially regarding stocks they have "buy" recommendations on (or where their firms hope to do/continue doing investment banking). Which makes Bellini's statement - that MSFT is "massively underperforming" against the competition - about as in-your-face as it gets. Sadly, it's also accurate.

Her firm adds the worldwide perspective:

According to UBS, Google's worldwide search query market share grew from 56 percent to 65 percent between August 2005 and December 2006. At the same time, Microsoft's declined from 11 percent to 8 percent, even though the company launched its rebranded and revamped Windows Live Search during this period. UBS cited research from comScore Networks Inc. for this data.

In dollars, that translates as follows:

Google continues to be number one in worldwide online search revenue, taking US$10.5 billion of the $24.5 billion online advertising market in 2006, according to UBS, citing figures from ZenithOptimedia and company reports. Yahoo came in second with $5.6 billion in revenue, while Microsoft was a distant third with $1.6 billion online advertising revenue in 2006.

Indeed, she's apparently so concerned that the patient may go into full cardiac arrest (along with her credibility), that she even wades in with some helpful CPR suggestions of her own:

Quoting research that only one in four people who purchase Windows also buy Microsoft's Office desktop application, she suggested Microsoft should offer an ad-supported online version of Office for free to customers who don't purchase Office to boost its ad revenues.

Microsoft also should leverage its strong position with large enterprise customers and strike deals to distribute its Windows Live Toolbar and Windows Live Search as the default in applications, Bellini said. She likened such a deal to one struck between Google and Dell Inc. to preload Google Desktop on Dell PCs and add Google Search in a side pane on Internet Explorer.

Another analyst offers this gem:

Additionally, Microsoft should "push the regulatory envelope" to see how far it can go with legally integrating its Windows Live Search and Toolbar with its own software products, Schachter said.

Yeah, pushing that "regulatory envelope" worked out real well for MSFT and its shareholders previously. UBS's suggestions also raise some concerns. For one, their "research" appears to overlook corporate "home-use" rights (which entitle many to run Office at home w/o buying it separately) and piracy. It also sounds dangerously close to investment genius Peter Lynch's final stages of "deworsification", whereby a company ends up giving away the very product that made it successful in the first place.

That said, I agree that MSFT needs to be more creative with Office (or Office-lite) in the consumer/small business space (GOOG isn't going to leave it any choice). I also agree that if MSFT could fix its advertising problems (huge "if" given the above), then ad-supported Office - and many other MSFT products - might not only be attractive to customers and useful competitively, but also lucrative. I mean, forget the list prices quoted at your local computer-retailer for a moment; The bulk of Windows and Office goes out heavily-discounted via OEM, the "don't ask, don't tell" Student/Teacher retail edition of Office, and corporate licensing programs. With upgrade cycles now routinely stretching to 5 years and beyond, how much do you have to generate in annual advertising per user to be ahead over say, a two-upgrade timeframe? And, of course, "free to me" likely results in much faster adoption cycles and lower marketing costs. Then again, so would more-compelling and better-marketed products :-) The risk inherent in such a strategy is obvious: any "free" consumer/small business could bleed over and/or otherwise pressure the current huge margins enjoyed in the Corporate space. But hey, either you start obsoleting yourself, or somebody else eventually will - and you might even discover a more lucrative market along the way (though given MSFT's current high margins, that will likely have to take the form of larger addressable market and/or faster growth rate).

Adding to this generally negative tone, we get word that VP Blake Irving - head of Windows Live Platform Group - is resigning after less than a year on the job (Ah, but what a year it was judging from the stats above):

Of course, maybe that's a good thing - I really don't know.

On a brighter note, I've mentioned before that I was impressed with the recent webcast delivered by Steve Berkowitz. Unlike the empty bravado, spin, and generally content-free nature of too many MSFT executive presentations, this one provides a humble, honest and detailed assessment of the market, including thoughts on where it's going, competitive landscape, opportunity areas, and - gasp - the potential in dollars. It also gives some insight into MSFT's resultant strategy which is customer-focused. How refreshing. Excerpt:

We're going to build the best software, we've always done that historically, but the challenge for us now is to realize that we have to build the best experience, and we have to earn it every single day, because the cost of switching, especially in search, is very low.

Of course, whether he and the rest of the team will be able to actually deliver is TBD. But at least he seems to have a solid understanding of what it's going to take. Also, echoing earlier comments from MSFT's Erik Selberg (kudos, btw, for being so boldly honest there) - and unlike Ballmer, he was candid that things would get worse before they got better (this was December):

And I hope you'll start to see that by the end of our fiscal year, and going into next year we'll start to see ourselves leveling off and gaining share, both in search and across other properties.

While I don't fully buy into the hype that currently surrounds web-advertising (have you ever clicked on an Internet ad? I never have), this is not a battle where MSFT can afford to be a distant also ran. Keep in mind that GOOG's various current ad-supported software offerings (and even much-rumored Linux-based cloud OS) don't have to win to hurt MSFT materially. The latter can be accomplished by simply taking away pricing power and growth - as Open Source has already done to some extent.

So what if Berkowitz ends up being wrong, and the envisioned turnaround isn't apparent by Fall? Then, imo, MSFT is likely in serious trouble and had better be prepared to consider drastic alternatives. The current pundit favorite is to buy YHOO, but that's far from a guaranteed panacea. First, while it would be accretive, it would be very expensive (especially given YHOO's recent, impressive stock recovery), take a long time, and be extremely disruptive (two very different technology platforms). Second, MSFT would likely screw it up - as they have many other previous acquisitions (and this would be their biggest ever). Meanwhile, GOOG would gain traffic during the initial uncertainty, and then again later as the scope of the resulting mess became evident. The only way I could see this working, is if MSFT bought YHOO but left them completely autonomous - and you know they never do that for long.

That leaves MSFT with seemingly two other options: partner, or throw in the towel and outsource to YHOO for a cut of the action. Partnership hasn't worked so far, and the nature of current market segmentation leaves only a few logical choices. But with others also losing share, maybe it's time to revisit that (or consider partnering with non-traditional players). Outsourcing, on the other hand, would catapult YHOO into serious contention against GOOG, could be done more quickly, and would be less disruptive. Moreover, YHOO has shown the ability to at least hold share against GOOG. For MSFT, it would obviously be a huge admission of defeat (or maybe pragmatism), and the company would lose direct control of its destiny in this area. But, it would save a ton of expenses, and sometimes a share of something is better than 100% of nothing. More importantly, YHOO hasn't shown GOOG's same desire for world-domination and/or determination to go head-to-head with MSFT by offering "free" (or low-cost) alternatives to the bulk of MS's core software stack.

Bottom line, MSFT needs to start showing success on the current strategy ASAP. At this point, that's our best scenario and there's still an outside chance it could happen. Failing that, it's time to acknowledge the wisdom of the adage "the enemy of my enemy is my friend"...