Is Microsoft A Slowpoke?

By Chris Taylor/San Francisco

When a company's revenues grow 17%, as Microsoft's did in the past quarter, it might seem a little churlish to suggest its glory days are over. Its chairman, Bill Gates, even reclaimed his title as the world's richest man, after a widely published story claiming that the founder of Ikea had replaced him turned out to be so many Swedish meatballs. And Gates' baby, based in Redmond, Wash., is still by far the largest software maker in the world, with a healthy $56 billion in the bank and revenue conservatively expected to rise 5% next year, to about $38 billion. It has buried the hatchet with Sun Microsystems and AOL with billions of dollars in legal settlements. What could possibly be wrong with Microsoft?

Answer: quite a lot. When you fly as high as Gates & Co. did during the 1990s, growing an average 36% annually, maintaining that altitude is nearly impossible. So Microsoft's growth rate is now no larger than that of the PC industry as a whole. Its stock price has stalled at 1998 levels. A new version of its flagship Windows product, once expected as early as 2003, may ship in 2006, lacking many of the cool new features Microsoft had hoped to include. By then, Windows is expected to be squaring off against its toughest challenge to date, from Linux, a rival operating system that literally gives itself away.

So as Microsoft began its 30th year last month, investors wondered whether it's a little long in the tooth. "It's clear that Microsoft doesn't see itself as a high-growth company anymore," says Matt Rosoff, a financial analyst with Directions on Microsoft, based in Kirkland, Wash. "The boom days are over." Last year Microsoft CEO Steve Ballmer started giving employees stock grants instead of stock options--a sure sign that the share price is flatlining. Ballmer okayed a minuscule dividend for shareholders, but he has resisted calls to let them dip any further into the $56 billion cookie jar.

That money is reserved for big bets in growth industries--the bigger, the better. "If you can't bring a $100 million business plan to the table, they're not interested," says Alec Saunders, a Windows programmer who recently quit after nine years at the company. Stung by a slowdown in corporate IT spending, Microsoft made a major play for our living rooms and pockets, with mixed results. It sank billions into the video-game business (Xbox and its soon-to-be-announced successor, Xbox 2), the cell-phone business (partnering with longtime ally Intel) and something called smart personal object technology (SPOT), which uses FM-radio bands to deliver sports, weather and stock prices to devices like watches and refrigerator-door magnets for a subscription of $59 a year.

Results have been mixed. With its price slashed from $179 to $149, way below cost, the Xbox is on course to overtake the hallowed Sony PlayStation 2 as the top game system in North America. But Sony holds a strong lead in sales of games, which is where the money is. Microsoft has created three flavors of Windows for cell phones, but none have caught fire. "Windows is just a lot more than a cell phone needs," says Simon Yates, an analyst for Forrester Research. And the clunky SPOT watch--a derisive critic said wearing it is "like having a golf ball strapped to your wrist"--has been a commercial disaster.

Like a kid with a $100 bill in a penny-candy store, Microsoft has been trying too many things at once, critics have long charged. To keep the company focused, Ballmer sliced it into seven supposedly equal and semiautonomous product groups, each with its own CFO. Two of those groups--Windows and Office--account for 62% of revenue and the lion's share of profits. The others deal with mobile devices, business services, entertainment, the Internet (MSN) and server software. Those last two are marginally profitable; the others are optimistic bets on the future. Says Jupiter Research analyst Joe Wilcox: "It's like dealing with two giants and five pygmies." Kevin Johnson, Microsoft's vice president of worldwide sales, who is regarded by many as heir apparent to Ballmer, defends the reorganization: "The value we deliver comes from collaboration between the groups."

Yet even within Microsoft some say the seven-way split is unwieldy. Robert Scoble is the most widely read of a new wave of Microsoft employees who have been allowed to write freely about the company in online journals, or blogs. His blog, Scobleizer, has repeatedly called for the company to voluntarily do what the Justice Department couldn't compel--split into separate, nimbler companies, a.k.a. Baby Bills. (Gates is vehemently opposed to the idea.)

Microsoft appears to be going through a mid-life crisis--buying flashy toys and having prolonged bouts of soul searching. Take this piece of dissent from a rank and filer: "The products are there. The marketing is not. Gates and Ballmer have been our salespeople for so long, but we need more voices out there selling our products." Even the executive suites are not immune to mea culpas. "We need to be more predictable to our customers," says vice president Johnson. "We need to make it easier to do business with us."

Though the company is trying to shed its arrogant, customer-unfriendly image by providing road maps to new software releases, its biggest product of all isn't playing along. The next version of Windows, code-named Longhorn, has been delayed so much that it has acquired the nickname Long Wait. Gates recently warned that we would have to cool our heels until 2006 before we would see it--five years after the release of Windows XP--and even that date isn't certain. "We'll ship it when it's ready," says Neil Charney, director of product management for Windows. One reason for the delay is that Gates' "trustworthy computing" plan has pulled programmers off Longhorn to work on fixing Windows XP, patching the kinds of security holes that led to record-breaking viruses like the Blaster worm.

A bigger problem for Microsoft is that fully 65% of Windows users have not yet upgraded to XP. Why should they, when there's another new version taking shape? As Gates is fond of saying, "Our biggest competitor is our installed base." Now the Longhorn team has been told to scale back its ambitious plans for the new operating system in order to make sure it will work with the average PC.

The Longhorn delay is causing an industry logjam both in Redmond and down in Silicon Valley. Since 95% of the world's computers run on Windows, practically all software makers tie their development process to the life cycle of each new version. But nowhere is the long wait for Longhorn more damaging than at Microsoft. After all, you can't have the new Longhorn version of Microsoft Office until Longhorn ships.

Result? There's little in Microsoft's immediate output to make consumers go wild. The biggest product the Windows team is touting for 2004 is a service pack containing mostly security updates to Windows XP. There's also an improved version of Office for Macintosh (see the review in the Your Time section), but that is a niche product compared with software for the vast PC market. "This is not going to be a banner year for products, that's for sure," says Mary Jo Foley, editor of the Ziff Davis Media website Microsoft Watch.

At the same time, Microsoft faces renewed competition from old enemies. Less than a year after its surprise release, Apple's iTunes for Windows has garnered most of the music-player market, sidelining Microsoft's Windows Media Player and fueling speculation that Apple guru Steve Jobs will release more free Mac software (like iPhoto or iMovie) for the PC.

Then there's Linux, the free, customizable operating system that threatens to shatter the desktop dominance of Windows. Each week brings a fresh Linux victory. Sam Palmisano, CEO of IBM, wants his company to be Windows-free by 2006. The governments of South Korea, China and Japan--usually not the greatest of allies--have teamed up to create their own flavor of Linux, which could well flood the Asian market. A study by research firm Gartner predicts that Linux will run 21% of desktops by 2008, taking its market share directly from Microsoft.

Such a threat is exactly the kick in the pants the company needs to get its mojo back. "Microsoft works best when there's a foe," says financial analyst Rosoff. And as Apple and Netscape discovered to their chagrin, the folks at Redmond are not shy about adopting their rivals' good ideas. The real attraction of Linux is that it is open source--anyone can poke around in the software code, and engineers around the world can suggest improvements. That is anathema to Microsoft, which fiercely protects its intellectual property. Yet to meet the threat, Microsoft has hired some top Linux brains and released its first open-source product. It's a relatively insignificant geekware tool called WiX. But considering that Ballmer previously called open source "a cancer," WiX may signal a major change of heart.

Which at this company is pretty much business as usual. "We have a treasure chest of technology that allows us to be very agile," says Rick Rashid, Microsoft's senior vice president for research. "If the world changes, we can change with it." Being aggressively agnostic about technology is the only way Redmond has a shot at double-digit growth again. Gates & Co. may never soar as it did in the 1990s, but it can still avoid the industry's penchant for crash landings.