How Will Microsoft Adjust Its Strategy To Survive The ITC Downturn?

It’s some weeks ago now, but Microsoft posted a 6% drop in its FY09 Q3 (calendar Q109) revenues to $13.6B as well as a 32% drop in net profit to $3.0B. It’s a company which always spends a lot of time in its last financial quarter planning. For once it isn’t so easy to see what it will come up with, as it not only has to produce a strategy to take advantage of increasingly sophisticated Web 2.0 Internet usage, but also to help it weather the current economic storm. As with my other vendor profiles, I want to describe what Microsoft has been doing in the last 6 months or so and make some predictions about what its new strategy will look like.

Entertainment And Devices Has Been Performing Best Of Microsoft Divisions

There are a number of interesting trends in its quarterly results by division (Figure 1). In particular:

• Its Entertainment and Devices business has been the most successful over the last few years. Gaming and extending applications to mobile devices is clearly one area of growth in the current downturn.
• As with other PC vendors its Client business has fared badly in the last year, under-performing Microsoft’s other divisions. This is not just due to the economic downturn, but also because potential PC users in emerging countries are more likely to favour subscription (as opposed to purchase). Microsoft’s Unlimited Potential strategy has been formed to try to extend its products and offerings to the ‘next billion’ users.
• Its On Line Services business, having grown strongly from the beginning of 2007 has seen its growth rates reduce since the middle of 2008. I expect Microsoft to enhance its Cloud Computing offerings following its introduction of Azure, even if it sees less return from this area. I hope to write in more detail about what Microsoft intends to do in thus area soon.
• Its Server and Tools divisions have done reasonably well – especially compared with the poor revenue being return for non-Windows servers.

Microsoft’s Long List Of Collaborative Activities Dominate Recent Announcements

As always it’s announced a huge number of collaborations with many hardware, software and telecoms suppliers. For instance:

• Windows Live! – In the telecoms and mobile phone areas Microsoft struck numerous deals to extend Windows Live; for instance: separately with Telefónica (February 2009) and América Móvil for mobile services across Latin America (February 2009), an alliance with LG to use Wndows as primary smartphone platform (February 2009), Orascom for mobile services (February 2009), Personal Provide for services on all PCs (February 2009).
• Telecoms – It also signed of telecom-related agreements with NTT for Software as a Service over Next Generation Networks (December 2008), Singtel for telecoms services (November 2008), Telstra for business services (November 2008) and Vodafone for Microsoft Online services (voice and data) (February 2009)
• Patent Cross-Licensing – Agreements with printer manufacturers included Brother (February 2009), HP (May 2009) and Lexmark (March 2009)
• Unified Communications and Collaboration – Cisco, Polycom (both March 2009) and HP (May 2009)
• Servers and Storage – Microsoft signed agreements with Cisco and Intel for global educational assessments (January 2009), extended its strategic alliance with EMC until 2011 (February 2009) and then announced it working with EMC’s RSA division on security (December 2008). Other HP collaboration included private-label hosting for VARs (December 2008) and virtualisation (November 2008). Microsoft also struck deals with, Marathon Technologies for fault-tolerant computing (January 2009) and NetApp for storage virtualiation (May 2009). Sun agreed to included Live Search toolbar as part of Java runtime environment (November 2008)
• Other Collaborations – Included Lenovo for academic PCs (March 2009), Akamai for consumer video using Silverlight (October 2008), Godaddy.com for a hosted Exchange (October 2008) and Novell for continued work on interoperability (November 2008)

Microsoft has not been very busy in the acquisition area, only announcing its agreement to buy BigPark Inc and the assets of Rosetta Biosoftware in the last six months. It also continues to partner and build out into the Health and Education sectors – both of which I believe will prove good investments in the current downturn.
Microsoft’s product announcements included the launch of Explorer 8 and the early pre-announcement of Windows 7, which apparently is expected to be launched as early as October 2009. It also released a public beta version of Exchange 2010 and launched BizTalk Server 2009.

Microsoft Has Been Performing Well As A Large Global Software Company

When we compare Microsoft’s software business (extracting its On Line Services revenues) with the software revenues of other major players (Figure 2) we note that Microsoft has been performing well. In fact (apart from Telecoms services in 2007) software has out-grown all other ITC categories since 2004. This is due to a number of factors. For instance the on-going dis-aggregation of servers has created software categories such as virtualisation and fault-tolerance, which previously were tied-in features of proprietary systems. Also, the increasing use of industry-standard components has enabled software companies to address complex applications and tools without having to rewrite the code for multiple platforms.

I’ve shown annual growth by quarter Figure 2. It’s interesting to note that – of the 4 largest players – only Computer Associate’s software revenue is currently in decline. I expect that to change over the next few quarters.

Microsoft Has Fared Badly As A Web 2.0 Company

It’s clear that Microsoft hasn’t performed as well as other ‘Web 2.0’ suppliers (see Figure 3).

As by far the largest software player – with a 10% share of the whole area – we can’t expect Microsoft to perform as well as these smaller, newer companies. However trying to emulate some of the magic of their approaches must be part of Microsoft’s strategy. Of course things will change if it does eventually manage to acquire Yahoo.

Some Conclusions – What Should Microsoft Put In Its Strategy?

I’m sure Microsoft will adjust its strategy in some surprising ways. However I expect it to continue to expand in a number of areas. In particular:

• It will announce a major initiative in the Cloud Computing to take advantage of under-utilized compute resources and – more importantly – to extend the use of its applications to emerging countries.
• It will aim to enhance its status as a Web 2.0 player. In particular it will leverage its current strength in entertainment and devices to add new businesses. Its launching of Bing – its new search engine – on June 4th illustrates its intentions.
• It will become more aggressive in trying to prevent the widespread piracy of its products around the world, maximising its traditional revenue in the process.
• It will place more emphasis on the Education and Health sectors, under-pinning its business with community activities. I expect it to align its Corporate and Social Responsibility (CSR) strategy even more closely with these sectors in the coming year.
• It will turn its extensive list of partnerships and alliances into more targeted businesses by forming dedicated business to promote specific services and products.
• It will continue to spend massively on advertising – consolidating its leading position in the software sector.

I expect worldwide software revenues to decline in each quarter until Q111 (see Figure 4). Although the decline will be in single digits and be less than other ITC categories, I would be very surprised if Microsoft’s results return to growth for the current quarter (see my earlier post for world ITC forecasts by category). As a result I expect it will continue to tighten its belt and reduce expenses – as all other ITC suppliers are doing. Reaching an accord with the EU over competition cases would be a way of reducing its spending (paid in massive fines). I also think it should put a time limit on the Yahoo acquisition, as the uncertainty is badly affecting both Yahoo’s and Microsoft’s status as Web 2.0 players. We’ll have to wait a few weeks, but it’ll be interesting to see what it comes up with…
What do you think? Is there anything else you’d put in Microsoft’s new strategy? Let me know by emailing me or commenting on this blog.