14 DAY TRIAL // Windows 7 will need to be nothing short of magic in order to save Microsoft. It is in the context of the global economic crisis that the Redmond company will have to milk its main cash cow for all that it’s got, down to the very last drop. In light of modest revenue growth for the second fiscal quarter of 2009, and modest is an understatement by any measure, Microsoft announced consistent cost management initiatives, including cutting a total of 5,000 jobs in the upcoming 18 months, no less than 1,400 of them today, January 22, 2009. However, cost management will not be sufficient to keep the company afloat, and Microsoft will need the Windows pillar if it is to keep its head above water.
“While we are not immune to the effects of the economy, I am confident in the strength of our product portfolio and soundness of our approach,” revealed Steve Ballmer, chief executive officer at Microsoft. “We will continue to manage expenses and invest in long-term opportunities to deliver value to customers and shareholders, and we will emerge an even stronger industry leader than we are today.”
On October 23, 2008, Microsoft estimated that its revenue for the second quarter of 2009 would be in the range of $17.3 billion to $17.8 billion. But the company was as far away from predictions as it could be, missing revenue estimates by no less than 900 million, and announcing revenue of just $16.63 billion for Q2 ended Dec. 31, 2008. While still accounting for a 2% increase over Q2 2008, Microsoft's operating income, net income and diluted earnings per share for the quarter amounted to just $5.94 billion, $4.17 billion and $0.47, which actually represent declines of 8%, 11% and 6%.
As a result, the company expects to eliminate 5,000 jobs across R&D, marketing, sales, finance, legal, HR, and IT in the next year and a half and to cut down on its operating expenses by approximately $1.5 billion. The software giant expects the capital expenditures for FY 2009 to be lowered by $700 million.
“Economic activity and IT spend slowed beyond our expectations in the quarter, and we acted quickly to reduce our cost structure and mitigate its impact,” said Chris Liddell, chief financial officer at Microsoft. “We are planning for economic uncertainty to continue through the remainder of the fiscal year, almost certainly leading to lower revenue and earnings for the second half relative to the previous year. In this environment, we will focus on outperforming our competitors and addressing our cost structure.”
Microsoft indicated that it planned to slash off merit increases for employees in FY 2010, but also to reduce travel expenditures, spending on vendors as well as contingent staff, cutting marketing budgets, while all dwarfing capital expenditures. Still, while cutting costs, Microsoft will need to make money.
Blame OEMs and netbooks
At the end of 2008, the company introduced products such as Silverlight 2, Exchange Online, SharePoint Online, Windows Small Business Server 2008, Windows Essential Business Server 2008 and a new release of Microsoft Dynamics NAV, neither of which capable of strong profits. But at the same time, Microsoft is cooking software such as Windows 7, Windows Azure, Office Web applications, Windows Server 2008 R2 and Office Communications Server 2007 R2. Out of these, the next iteration of the Windows client has the biggest chance of turning Microsoft's profit around.
A thing that Windows Vista failed to do. Microsoft blamed the weakening PC market for the fact that revenue of the client division dropped by 8%. At the same time, the software giant pointed the finger at the proliferation of netbooks (ultra-low-cost machines) for which Windows is generating scraps instead of profit. Las week, I asked a Microsoft representative whether Windows 7 would be tailored to netbooks more than its precursors. Here is what she said to me: “We are committed to making Windows the best and preferred OS on all PC types, and we are designing Windows 7 to run on a broad set of hardware.”
“Client revenue decreased primarily as a result of PC market weakness and a continued shift to lower priced netbook PCs. OEM revenue decreased $465 million or 12% while OEM license units decreased 1%. The decline in OEM revenue reflects an 11 percentage point decrease in the OEM premium mix to 64%, primarily driven by growth of licenses related to sales of netbook PCs, as well as changes in the geographic and product mixes. Revenue from commercial and retail licensing of Windows operating systems increased $113 million or 19%,” reads a fragment of Microsoft's 10-Q filing with the SEC. “Client operating income decreased primarily reflecting decreased revenue and increased sales and marketing expenses. Sales and marketing expenses increased $80 million or 19%, primarily reflecting increased advertising and marketing campaigns.”
But it's not just netbooks, as 80% of the revenue of the Client Division comes from original equipment manufacturers; it was the poor PC sales worldwide that also hurt Microsoft. In the forth quarter of 2008, PC sales increased only by 1.1% compared to the same period of last year, according to Gartner, with shipments of 78.1 million units.
“The United States experienced steeper than expected shipment declines due to the recession. The Europe, Middle East and Africa (EMEA) region was also affected by the economic slow down across key countries,” explained Mika Kitagawa, principal analyst for Gartner's Client Computing Markets group. “Asia/Pacific recorded the worst shipment growth since Gartner started its PC statistics research. Latin America met expectations, but its growth was much lower than in the past.”
According to IDC's Worldwide Quarterly PC Tracker, global PC shipments decreased by 0.4% in Q4 2008 compared to Q4 2007. IDC estimates that PC shipments worldwide reached a total of 77,3 million, down from 77,6 million in the same period the previous year.
"For all that's been said about this recession being different than 2001, the drop in PC growth from mid-teens the preceding year to near flat growth in the most recent quarter shows that the impact of this crisis looks similar to the last time around," revealed Loren Loverde, program director for IDC's Worldwide Quarterly PC Tracker. "It is tempting to argue that international markets will be less affected, or that low prices and the transition to portables will limit the impact, but the market has taken a serious hit and the competitive environment along with a race to low-cost portables could easily undermine profits from mobile computing. I won't be surprised if recovery gets pushed further into 2010 as this crisis unfolds."
Windows 7 Magic! Magic! Magic!
The combined effect of lower PC sales and higher consumer focus on low-price netbooks has left the Windows division hurt and bleeding. Even with Microsoft cutting down costs, its main cash cow will most likely continue to produce a gap in the company's revenue as sales of netbooks are projected to increase in the detriment of more expensive PCs, which get the company more money for each pre-loaded copy of Windows. Fact is that Windows 7 will have to be just magic enough to sell not only Windows 7 but also Windows-based computers. However, Windows 7 will only be able to boost the Windows client revenue in fiscal year 2010 at the earliest. In this regard, the rest of FY 2009 looks rather bleak for Microsoft.
Ballmer: Realigning Resources and Reducing Costs
Here is the full email Microsoft CEO Steve Ballmer sent to employees, courtesy of TechFlash:
From: Steve Ballmer
Sent: Thursday, January 22, 2009 6:07 AM
To: Microsoft - All Employees
Subject: Realigning Resources and Reducing Costs
In response to the realities of a deteriorating economy, we’re taking important steps to realign Microsoft’s business. I want to tell you about what we’re doing and why.
Today we announced second quarter revenue of $16.6 billion. This number is an increase of just 2 percent compared with the second quarter of last year and it is approximately $900 million below our earlier expectations.
The fact that we are growing at all during the worst recession in two generations reflects our strong business fundamentals and is a testament to your hard work. Our products provide great value to our customers. Our financial position is solid. We have made long-term investments that continue to pay off.
But it is also clear that we are not immune to the effects of the economy. Consumers and businesses have reined in spending, which is affecting PC shipments and IT expenditures.
Our response to this environment must combine a commitment to long-term investments in innovation with prompt action to reduce our costs.
During the second quarter we started down the right path. As the economy deteriorated, we acted quickly. As a result, we reduced operating expenses during the quarter by $600 million. I appreciate the agility you have shown in enabling us to achieve this result.
Now we need to do more. We must make adjustments to ensure that our investments are tightly aligned with current and future revenue opportunities. The current environment requires that we continue to increase our efficiency.
As part of the process of adjustments, we will eliminate up to 5,000 positions in R&D, marketing, sales, finance, LCA, HR, and IT over the next 18 months, of which 1,400 will occur today. We’ll also open new positions to support key investment areas during this same period of time. Our net headcount in these functions will decline by 2,000 to 3,000 over the next 18 months. In addition, our workforce in support, consulting, operations, billing, manufacturing, and data center operations will continue to change in direct response to customer needs.
Our leaders all have specific goals to manage costs prudently and thoughtfully. They have the flexibility to adjust the size of their teams so they are appropriately matched to revenue potential, to add headcount where they need to increase investments in order to ensure future success, and to drive efficiency.
To increase efficiency, we’re taking a series of aggressive steps. We’ll cut travel expenditures 20 percent and make significant reductions in spending on vendors and contingent staff. We’ve scaled back Puget Sound campus expansion and reduced marketing budgets. We’ll also reduce costs by eliminating merit increases for FY10 that would have taken effect in September of this calendar year.
Each of these steps will be difficult. Our priority remains doing right by our customers and our employees. For employees who are directly affected, I know this will be a difficult time for you and I want to assure you that we will provide help and support during this transition. We have established an outplacement center in the Puget Sound region and we’ll provide outplacement services in many other locations to help you find new jobs. Some of you may find jobs internally. For those who don’t, we will also offer severance pay and other benefits.
The decision to eliminate jobs is a very difficult one. Our people are the foundation of everything we have achieved and we place the highest value on the commitment and hard work that you have dedicated to building this company. But we believe these job eliminations are crucial to our ability to adjust the company’s cost structure so that we have the resources to drive future profitable growth. I encourage you to attend tomorrow’s Town Hall at 9am PST in Café 34 or watch the webcast <http://townhall/> .
While this is the most challenging economic climate we have ever faced, I want to reiterate my confidence in the strength of our competitive position and soundness of our approach.
With these changes in place, I feel confident that we will have the resources we need to continue to invest in long-term computing trends that offer the greatest opportunity to deliver value to our customers and shareholders, benefit to society, and growth for Microsoft.
With our approach to investing for the long term and managing our expenses, I know Microsoft will emerge an even stronger industry leader than it is today.
Thank you for your continued commitment and hard work.
Steve
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