Dark days for Microsoft?

The chair car I'm currently sitting in has power outlets in the seats for notebook computers. I am bitter about this as had I known this, I'd have brought my DVD's with me in the car instead of packing them in my checked luggage. Oh well, it has given me time to finish reading the newspaper that came with my room this morning. It is newspapers that have me writing now (that and the electricity). The past two days have had Microsoft stories in the Globe and Mail's Report on Business. They weren't good news stories. The first story is that Microsoft is going to use most of its liquid cash to buy back some of its outstanding stock. It's not unusual for companies to do this, but Microsoft is doing it to support it's sagging stock prices. Microsoft stock has been hit hard lately as it's earnings haven't grown in the leaps and bound they have in the past. In fact, according to the Globe and Mail, Microsoft's profits last quarter actually shrank. In order to keep their earnings to share ratio high, and thus keep the stock price up so its executives can exercise their stock options, Microsoft needs to have way less shares out there than there are, so it's looking at taking the $40 billion it has in the bank and use it to buy back some of it's own shares.

The thing to look at here is the drop in earnings. For most of the 1990's and early part of this century, Microsoft has enjoyed double digit growth in its earnings. A retrenchment of those earnings is significant and of course has investors dropping the stock like hot potatoes. Why have Microsoft's earnings dropped? The obvious reason is less people are buying Microsoft's products, the question then becomes why have people stopped buying from Bill?

There are several reasons to this I believe. The first is market saturation. Virtually everyone who wants a personal computer nowadays has one. This means that people are no longer buying new copies of Microsoft's primary money maker, it's operating system. The same goes for it's office suite. The market has matured, to steal a phrase from economics. Once the market has matured, the wild growth that comes from the introduction of a product ends. At best a company can maintain it's sales at a reduced level as people now only buy replacements. Given the large number of computers that still use Windows 9x, it will be some time before Microsoft is going to see mass upgrades, despite it's efforts to force people to do so.

Another sign that the market that Microsoft is in has matured is the presence of competition. On the desktop, Microsoft is still the reigning champion, but that market has been saturated. The only growth is the computer industry tied to the Internet, the server market. Here Microsoft has had trouble. Initially it scored some success luring people away from expensive Unix platforms as a Windows server at about $5000 is much cheaper than any proprietary Unix platform. In fact that was their strategy, compete on price. The problem that Microsoft failed to see was the advent of open source. Open source versions of Unix such as Linux and freeBSD have clobbered Microsoft in the server market. It's easier to migrate from an expensive Unix installation to a virtually free Linux or BSD installation as there is a smaller learning curve for the system administrators, who are already used to Unix. As such, Microsoft's growth in this field has be stymied, preventing it from any real gains.

The second article points to another problem at Microsoft. It no longer innovates (such that it really ever did). The article in Saturday's ROB states that Microsoft is set to launch a rival to Apple's Ipod called Zune. Since the introduction of Windows and Office for Windows, Microsoft has been playing catch up in the technology sector. Apple's Ipod and associated Itunes control 70% of the market for MP3 players. Microsoft is not likely to gain much of that market, especially if it's performance in other areas where it has been playing catch up can be used as predictors.

Case 1: The Microsoft Network

Microsoft founder Bill Gates decided in the mid 1990's that the Internet was going to be the next big thing and that Microsoft should control it. To that end, they created the Microsoft Network (MSN). In typical Microsoft style they made it highly proprietary so that only Windows computers, using Internet Explorer were the only computers that could access the network. The problem with this was that the Internet had already taken off and people on the MSN couldn't easily access the rest of the Internet. The end result is that the MSN has become just another Internet service provider and is a perennial money loser for Microsoft.

Case 2: X-Box

Microsoft then decided to take on the video game market dominated by Japanese players Nintendo and Sony. The X-box is popular enough, but has hardly slowed down either Nintendo or Sony. The reports that I've seen show that even the newer X-Box 360 has had disappointing sales due to initial problems with the unit. Without domination in the field, Microsoft has difficulties and in the video game realm this is no exception. At best Microsoft has a third of the market, which makes sense as there are three players, and has no hope of eliminating it's competition any time soon. The X-Box division is also a perennial money loser.

Case 3: MSN Search

Seeing the failure of MSN to control the Internet directly, Microsoft has decided to try to corner the web services market. The problem is that Google got there first. Google dominates the search engine world the way that Microsoft dominates the desktop world. Given the reputation that Microsoft seems to have in the on-line world, they have an uphill battle to unseat Google. Google has beaten Microsoft to the punch not only on the search front, but into other on line services as well such as on-line applications like word processors. Again playing catch up is costing Microsoft money, and it's not likely to catch up at all. As a side note, of the referrals to this site from a search engine, 70% are from Google, MSN averages about 19%.

Case 4:Hotmail

Ok, Hotmail is highly successful and a leader in it's field. Lots of people use it all the time. Most people have a Hotmail account, even if just to use as a throw away email account to deflect spam. The problem for Microsoft here is that despite the huge number of people who use Hotmail; few, if any, of them are paying for it. This leaves Microsoft to rely on advertising revenue and that's not enough. Hotmail has yet to make any money for Microsoft and is yet another black hole for Microsoft's cash. The same can be said for it's messenger service. Since the service is free and despite changes to the protocol every now and then, many non-Microsoft chat clients are available preventing Microsoft from forcing people to use its Windows OS to run its client. Another money loser.

In point of fact, the only divisions of Microsoft that are making money are the OS division and the Office division, primarily since Microsoft has little competition in these areas. In any field where Microsoft has come in second, after others have become established, it has foundered miserably in red ink, failing to dominate the market. I expect that the Zune will pose similar problems for Microsoft. Given that others are established, and that the format it's download site will use will freeze out all but Zune users, combined with the fact that there will be little incentive for the Ipod users to switch, the Zune is doomed from the start.

So lets recap so far. First, the market for it's moneymakers, their OS and Office suite, has matured so growth there is limited at best. Everything else they have is a drain on Microsoft's financial and productive resources.

There are further signs of problems. Several failed attempts to lock users in to Microsoft products over the past 5 years have been abysmal failures, both in terms of locking people in and in terms of PR. First was the "Software Assurance" plan. Under this plan companies would pay an annual subscription fee to Microsoft which would entitle the company to free upgrades when they came. Problem is that Microsoft is notorious for missing upgrade deadlines and few companies were willing to pay the cash up front for what was likely no service down the road. This is not to mention that they tried this at a time where businesses were doing everything they could to avoid vendor lock in so this plan was doomed from the start.

Their trusted computing initiative, where they were to work with CPU manufacturers to ensure that the Intel core of chips would only run Microsoft signed software was also a non-starter. As an initiative it has been reduced to basically a pop up saying that the manufacturer of your software has paid Microsoft a fee to say the software is OK. Based on much of the software I've installed lately, this also isn't a big moneymaker for Microsoft.

Their latest endeavor is the Genuine Microsoft Advantage. This little piece of spyware from Microsoft installed itself as a "critical update" on thousands of Windows XP computers. According to Microsoft, the purpose is to tell people if their Windows is "properly licensed". However, given the actions of the program, it is doubtful that this is the case. First off, the program calls home every time the computer is turned on, and every day after that. Microsoft didn't offer a patch to stop this behaviour until after it was outed in the industry press. Further, the program often tells people who have legally installed versions of Windows that they have a pirated version of Windows and to call Microsoft to make arrangements to pay for a legal version.

Now Microsoft claimed that this wasn't happening until they were again outed by the industry press. Even so, Microsoft still denies that this is the case in most instances. Given their level of protestation I suspect they knew that this was going to happen and looked at it as a way to dupe many of its customers into coughing up more cash. That or incredible stupidity on the part of Microsoft's management, though coming up with this scheme is quite stupid to begin with.

This is all leading to a huge PR nightmare for Microsoft. Since it has began to treat its customers as criminals, there will be a point where people just won't take it anymore. There are a couple of class action lawsuits against Microsoft for it's Genuine Advantage software, by the way. Given that Microsoft has gone after non-profit organizations in the past for not paying for the software bought for them by others, this is just another nail in their image's coffin.

So Now What for Microsoft?

The way I see it Microsoft is at a crossroads in much the same way IBM was in the '80s and '90s. Unless Microsoft is able to re-invent itself over the next couple of years in the way IBM was able to, it will slowly become less and less relevant in the computer industry. Alternatives to its OS exist, and people are starting to demand interoperability between software, loosening Microsoft's grip on the office market. IBM's problem was that it was, like Microsoft, used to being a virtual monopoly in it's business. The problem was that it's customers shifted and the business disappeared. Microsoft is in that position now. It's trying desperately, like IBM did, to maintain its monopoly, but as IBM found out, the more you try to maintain the monopoly, the more you loose control. Other companies who are more maneuverable because they're not trying to control what they already have are out competing Microsoft in the new, growing areas of the computer industry. Couple this with the cost for business to run a Microsoft shop continually going up, with the total cost of maintaining updates, dealing with viruses and so forth, businesses and governments are looking for alternatives, or demanding and getting price concessions from Microsoft for them to not switch to something else, Microsoft's ability to control it's customers is rapidly getting away from them. Gone are the days were Microsoft could simply demand companies pay them money.

Will Microsoft disappear? Not likely, but even if they are able to re-invent themselves, they are likely to become just another big computer company like IBM. Still a major player, but no longer the dominate force in the market they used to be. If they are unable to re-invent themselves, which is a likely scenario given the corporate climate in Redmond, they will end up more like old time computer companies who used to dominate like DEC who were eventually gobbled up by newer more flexible companies.