Microsoft seeks its next cash cow

Microsoft’s reputation is one of a moneymaker, but the fact is that four of its seven business units are in the red.

Microsoft‘s reputation is one of a moneymaker, but the fact is that four of its seven business units are in the red.

To the tune of $1.6 billion in fiscal year 2003, Microsoft bled money from its Business Solutions, Mobile and Embedded Devices, MSN, and Home and Entertainment divisions.

Part 1: High-flying glory days past, Microsoft builds for future

Of course, piling up a loss of that size isn’t such a big deal when you consider Microsoft’s other three units turned a combined profit of $17.8 billion. And things actually are looking up compared with 2002, when the four losers were $1.8 billion in the red.

Despite the losses, Microsoft’s competitors recognize these business units as slumbering giants. They are not only coddled by a cash reserve of $51 billion but with a thirst to become Microsoft’s new growth business now that traditional cash cows – client operating systems and the Office suite – have matured.

Business Solutions

The rewards, risks and challenges are epitomized in Microsoft’s $10 billion dream for its Business Solutions group, which produces ERP, CRM and other applications to automate business functions for small and midsize businesses (SMB), which Microsoft defines as those with 1,000 or less employees.

In the past two years, Microsoft built the group based on its largest acquisitions ever, laying out $2.5 billion to acquire ERP vendors Great Plains and Navision.

In the past year, the division publicized an 84% gain in revenue – mostly because of the close of the Navision deal – but was quiet about its 44% spike in losses.

Undaunted, CEO Steve Ballmer is pegging the division’s yearly revenue potential based on selling applications, and supporting infrastructure and services at $10 billion by 2011. The goal is to draw users to the business applications and in turn sell them client operating systems, the Office suite and infrastructure servers to support the rollout.

To understand the magnitude of its ambition, $10 billion is just short of the revenue generated in 2003 by Microsoft’s top-grossing Windows Client division, which produces software that sits on 94% of corporate desktops worldwide. The $10 billion would make Business Solutions bigger than current-day Oracle or SAP, longtime business application players that will compete with Microsoft, and untold others to capture a slice of more than 45 million SMBs.

The road ahead

But Microsoft has been down this road before. In 1985, it championed productivity application suites, pulled the rug out from under competitors such as WordPerfect and Lotus 1-2-3, and built its Office empire.

“It’s hard to say if they can reach $10 billion. It certainly is an ambitious goal,” says Kelly Spang Ferguson, an analyst with Current Analysis. “But I don’t see any indication they are not following the familiar playbook of acquiring companies, developing products and building the channel.”

Also familiar is the product tie-in under the marketing jargon “integrated innovation.”

Microsoft CRM works with Office’s Outlook, and the company is working to marry its “knowledge worker” collaboration products with business-productivity applications.

Also on tap is Project Green, an initiative to replace Great Plains, Navision and Microsoft CRM with applications built on a single code base that depends on Microsoft’s dizzying lineup of Longhorn branded clients, servers and development tools slated to start shipping in 2006.

However, the effort won’t be without challenges. Microsoft will face stiff competition from large vendors moving down into SMB, such as SAP and PeopleSoft, and from smaller vendors already there, such as NetSuite and Intuit. It will have to overcome an abysmal track record with such historic business software dogs as its Small Business Manager.

“This is one case where execution will be key,” says Katherine Jones, research director with the Aberdeen Group. “The competition is mighty and all over the place.”

It includes IBM, which invested $500 million earlier this year in its SMB-targeted Express middleware and is bent on keeping Microsoft from dominating the market for infrastructure to support SMB applications.

Microsoft and its resellers will have to learn new selling tactics that highlight solving business issues as opposed to pure price/performance metrics. Microsoft also will have to assure resellers and independent software vendors (ISV) that it won’t crush them in its rush.

So far, eyebrows are raised.

“They are trying to get us to develop on their technology, but what is disconcerting is that they are speaking out of both sides of their mouth. What they really want is to get to our customer base and sweep them out from under us,” says Van Symons, president of Clear Technologies, an ISV in Coppell, Texas. Symons works primarily with IBM because its middleware provides alternatives to Windows and because the vendor won’t compete on the application side.

Another major hurdle will be convincing ISVs, resellers and end users to buy into Great Plains, Navision and CRM products that will give way to Project Green in the next two to three years and be put out to pasture within the next decade.

“It will take a compelling story to say ‘yoo-hoo, I built a new ERP system come over and buy it,'” Aberdeen’s Jones says. “Microsoft doesn’t have that story now. The assumption is they can build a better mousetrap.” Jones says anyone trying to build an ERP system from the ground up better have deep pockets.

Microsoft does, and it is getting ready for the fight with $2 billion earmarked to drive the number of resellers from 6,000 to nearly 25,000, and to fund a 300-person influx that will push its sales staff to 2,500. The group’s aggressive attitude is seen in its plan to boost its revenue between 24% and 32% in fiscal year 2004.

Microsoft has 1,700 research and development staff dedicated to the Business Solutions group, the largest commitment of any competitor, according to Orlando Ayala, senior vice president of Microsoft’s small and mid-market solutions and partner group.

Ayala says Business Solutions will garner its fair share of Microsoft’s $6.9 billion R&D budget.

The group has developed the Microsoft Business Framework, which provides basic functions such as order entry and general ledger, as a foundation for application developers to build on.

“This is a key part of our ISV strategy,” said Doug Burgum, senior vice president in Business Solutions, at Microsoft’s recent meeting for financial analysts.

Also key will be wooing end users, who already are starting to leave, citing complexity in the Great Plains software and questioning Microsoft’s ability to comprehend the task at hand.

“Great Plains is not intuitive. It’s complex, and I don’t have college-educated computer types to run it,” says Woody Sponaugle, president of Calley & Currier, a manufacturer of wooden crutches that posted $4 million in revenue last year. He recently replaced Great Plains with a hosted solution from NetSuite. “But the big thing is how the system is delivered. I don’t think Microsoft or its partners understand the small business,” he says. Sponaugle says he doesn’t have time for them to figure it out.

From mobile to games

Time is what Microsoft needs, financial experts say, not only for the Business Solutions group but also for its other units that are struggling to find their way amid a sea of entrenched competitors and economic pressures.

The Mobile and Embedded device division remains Microsoft’s smallest business unit after historic failures such as the collapse of a $5 billion deal with AT&T. Despite years of development and some success in Europe, October was the first time a Windows Smartphone was introduced in North America.

Research firm Ovum predicts Microsoft will pick up just 3% of global handset shipments by 2007, while in the same time period competitor Symbian is pegged at 20%, with simpler, Java-based devices accounting for most of the rest of the market.

MSN, for years a money loser, posted its first profits in the first quarter of fiscal 2004, but revenue is expected to decrease overall this year as dial-up connections, which Microsoft sells, are replaced by broadband connections, which are not sold by the company.

And the Home and Entertainment division, which was the only business unit to fall short of fiscal 2003 projections, has boosted Xbox to a No. 2 ranking, but InStat/ MDR says total console revenue was off by $2 million in 2003 and will drop by similar numbers in 2004.

Xbox is but one piece of Microsoft’s vision of a home network that would include a centralized PC linking Tablet PCs, mobile phones and devices such as Smart Personal Objects Technology watches.

“The question is, can they ever find any other business that becomes another cash cow,” says David Smith, a vice president at Gartner. “They are placing all these bets hoping that one will pay off.”

If one does, the trickle of red on Microsoft’s balance sheet could shrink to a drip.