Original URL: http://www.theregister.co.uk/2008/10/18/microsoft_online_services_cuts/

Lights out for Microsoft 2.0?

How the economy will focus minds

By Gavin Clarke

Posted in Software, 18th October 2008 00:08 GMT

Analysis Microsoft's conversion to Web 2.0 concepts like online, ad-funded services and software-as-a-service in the last few years have made it the oldest startup in town.

Chief executive Steve Ballmer has evangelized search and advertising as his company's manifest destiny and, from chief software architect Ray Ozzie on down, has brought on individuals and companies to help make that transition.

We now have Windows Live, Office Live, Live Search, MSN Video, an ads-serving platform, and online business applications. Microsoft has even tried to grease the pump by paying people to use its online search services.

Such is the commitment to drive traffic to its own versions of Google search, YouTube, and Digg, Microsoft has done what most other startups couldn't: spend billions of dollars and almost double it's workforce in just three years. Microsoft now has nearly 100,000 employees.

Despite its size, though, Microsoft is poised to experience the same pains of junior startups, if the money that fed Web 2.0 optimism has - as it seems - dried up. If and when that happens, and if Microsoft's business managers behave like most do during a downturn, that'll hurt Microsoft's three-year-old Web 2.0 strategy.

Don't bank on the bank

The economy, as you're well aware by now, is in trouble. Banks are not lending money, and some big names have gone out of business.

That's going to cause problems for companies of any size who rely on cash flow to keep their heads above water. Caught between suppliers and employees that need paying and customers who pay the bills, operations can get very tight.

Microsoft is already concerned about the implications of bankruptcy on its customers' ability to pay its software bills. It was telling that Microsoft is closely watching developments in the Washington Mutual bankruptcy case. Microsoft won't say why it's watching the WaMu case, or whether it's watching other bankruptcies, but odds are WaMu is a customer and owes Microsoft money.

This is just one case, but it's symbolic. What if other customers also start struggling to pay the bills when their cash flow begins to dry up?

Then there's the usually lucrative fourth-quarter Holiday shopping season, when consumers gorge on new PCs and Xboxes along with turkey during Thanksgiving and Christmas. Consumer confidence is already at record lows, meaning they aren't spending. The omens portend this will not be a happy Holiday Season for retailers, including those Microsoft relies on to ship PCs and Xboxes.

That brings us to online services, Microsoft's supposed future. In May 2006, Microsoft promised to spend $2bn more than everyone had expected in online services for the coming fiscal year - to catch Google on search and in ads and to turn the MSN properties into a major destination for online traffic.

Since 2006, Microsoft's head count as grown 28 per cent to 91,000 as it has hired individuals and bought companies like online ads house aQuantive - Microsoft's biggest acquisition at nearly $6bn, an 85 per cent premium on the company's actual value. Go back to 2005 when Microsoft bought Ray Ozzie on board with his Groove Networks start-up, and Microsoft's head count has grown a staggering 49 per cent. There have been increases across R&D, sales, marketing, and support.

Despite, or because, of this investment Microsoft's online business has made the opposite of a profit. Last fiscal year, it lost $1.2bn despite a 32 per cent increase in revenue. That's little surprise when the company is increasing its costs with growing numbers of staff while splashing out on online cash-back programs for little obvious return on investment.

As the economy slows and there's a huge question mark over income, you should expect Microsoft to begin re-assessing where it invests.

If Microsoft's managers do what's in the blood of all good managers, they will start to hunker down for a period of economic uncertainty and cut the unproven stuff. In other words: focus on the core business while freezing or scaling back the ventures that have yet to payback.

In the case of Microsoft, the core business is Windows client and server and tools. These have seen growing costs, too, but are still the company's engines: the Windows client business saw revenue increase 13 per cent to $16.8bn revenue, while server and tools expanded 18 per cent to $13.1bn during Microsoft's fiscal 2008. Importantly, Microsoft is beginning to build new products in these core areas - Windows 7 on the client, a new Windows server, Visual Studio 2010, and SQL Server 2010. If these are the core business, they will naturally demand the lion's share of funding.

Online services will be in the firing line because they are not core, they're losing money, and - probably like most other Web 2.0 ventures - it is unclear how they will make money. Microsoft has talked of some payback in 2010, but that might as well be 3010 when the money that had enabled such start-up activities has tried up.

Staff shuffle

Should the economy continue heading south, you should expect to see Microsoft freeze or rein in its online expansion. First Microsoft will - if it hasn't already - stop taking on new people. There are already reports Microsoft has instituted a hiring freeze from too many different people for this not to be the case, even though Microsoft has denied there's a freeze.

Then it'll shuffle people around. Expect people to move from the online business areas to the cash generators - client, server, and Office.

If that still doesn't work, expect Microsoft to slim down, by removing people who came in with acquisitions such as aQuantive. Contrary to what it likes to think, Microsoft is not an online ads company. It's a software business.

Microsoft's online strategy requires a leap of faith and time to bloom. In a down economy, when the money's drying up, it's fiscal planning based on hard realities that help you survive. If and when Microsoft begins to cut spending and staff, expect investment online to drop, the rhetoric about destiny to get canned, and some properties to be put on hold or go dark. ®