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Microsoft Branches Out Beyond Personal Computers to Maintain Success

Posted on: Sunday, 3 August 2003, 06:00 CDT

Aug. 4--SEATTLE--Microsoft is still king of personal-computer software, which propelled it to legendary success since its founding 28 years ago. But to maintain the growth that made its stock attractive for years, Microsoft increasingly needs to look beyond the desktop PC.

The world's largest software company has piled up a $53.5 billion cash hoard thanks to profits from its two hugely successful franchises: the Windows operating system and the Office suite of productivity software. But those two product lines are now saturating the market.

And the company has had uneven success in other areas. Microsoft's 10-year-old server-software business is now kicking in $2 billion of operating profit a year. The other arenas Microsoft is betting on -- business solutions, the Microsoft Network and home entertainment -- are each still losing hundreds of millions of dollars a year.

Microsoft's sales hit $32.2 billion in the fiscal year that ended June 30 -- up 13 percent from a year earlier but a far cry from annual growth rates of 30 percent to 40 percent in the late 1990s.

Microsoft's passage from a sizzling growth company to a steady, mature business was illustrated by its recent decisions to pay a dividend and drop employee stock options.

To be sure, the Windows and Office businesses continue to be cash cows for Microsoft, accounting for more than 60 percent of sales. And there's no sign the personal computer will suddenly fall out of use. In fact, Microsoft expects worldwide PC shipments to grow by 5.7 percent this year, up from 3.1 percent last year.

Bill Gates, Microsoft chairman and chief software architect, said he is confident that basic research and hardware breakthroughs will continue to add new capabilities to Windows and Office and to open up opportunities for Microsoft in other areas such as business intelligence, video conferencing and computer security.

"We believe that we're just at the beginning of what we can do with software," Gates told a group of analysts and reporters recently.

If and when Microsoft's newer businesses make it into the black, most of them aren't expected to be nearly as large or lucrative as its original PC software business.

In new businesses like mobile devices or games, "the picture is a lot dicier for the company," said Dwight Davis, an analyst who tracks Microsoft for Summit Strategies. "They are going up against entrenched competition and carrying with them the albatross of their own reputation in finding partners and customers. I don't see any one of those areas having the means to pick up to load."

Here is a look at how Microsoft is doing in several of its newer businesses:

SERVER SOFTWARE: The bright spot in Microsoft's lineup has been its server software.

Sales grew 16 percent last fiscal year, and its server and tools division contributed 22 percent of total revenue. Companies moving from more expensive Unix servers have given a big boost to less costly alternatives from Microsoft and Linux, the open-source operating system.

Microsoft is "doing a fabulous job in the server business," said Drew Brosseau, an analyst with SG Cowen Securities. "They are clearly gaining significant share in server platforms."

Microsoft is expecting sales in its server division to grow 8 percent to 12 percent this fiscal year.

But Linux has built market share even faster than Microsoft and remains a serious competitive challenge.

Microsoft estimates its shipments of server operating systems will grow 9.5 percent this year, while Linux shipments will grow 24 percent. That would give Windows a 53 percent share in the server market to Linux's 19 percent, Microsoft estimates

BUSINESS SOLUTIONS: Microsoft in recent years has set its sights on the market for business applications that manage tasks such as accounting and customer service. It spent $2.6 billion to buy Navision and Great Plains -- which sell mostly to small and medium-size companies. Many analysts think Microsoft's Business Solutions division holds the most promise to become one of its main profit centers in the future.

Microsoft is investing $2 billion in the business over the next year, aiming for a greater share of a market it estimates is worth $26 billion.

Business Solutions revenue grew 84 percent in the last fiscal year to $600 million. Microsoft expects the division's revenue to grow between 24 percent and 32 percent this year.

Now, Microsoft has begun to target even larger companies as potential customers, moving into the market occupied by established players like Oracle and SAP.

"We're going to sell our product to companies as big as can productively use it," Microsoft Chief Executive Steve Ballmer said recently, acknowledging some inevitable competition with SAP, one of its partners.

MSN: Microsoft's foray into online services has hit some speed bumps. Microsoft has tried to turn its Internet portal and online access service into a means to sell all kinds of subscription services over the Web. But MSN is the only one of the company's seven business units where revenue growth is expected to decline this fiscal year -- as much as 7 percent.

"The long-term goal is to find something customers are willing to pay a monthly fee for beyond Internet access," said Matt Rosoff, an analyst with Directions on Microsoft. "Whether they can do it remains to be seen."

MSN did increase its online advertising revenue 48 percent in the last fiscal year to $832 million, performing well against America Online and Yahoo. Overall MSN revenue grew 25 percent last year to nearly $2 billion.

But the multiyear service contracts Microsoft used to promote subscriptions are starting to expire. Microsoft is also losing Internet access fees from subscribers shifting to broadband service, since it decided to stop offering its own high-speed access. MSN currently has 8.6 million subscribers, a distant second to AOL.

To compete with Google and Yahoo, Microsoft is making a push this year to improve its online search technology -- which would help it gain a piece of the lucrative paid search business.

"We think there's a huge market there that's still unserved, so we're going to see a lot of investment from us in the search category," said Yusuf Mehdi, Microsoft vice president for MSN.

HOME AND ENTERTAINMENT: Microsoft has shipped 9.4 million Xbox game consoles worldwide. That puts it neck-and-neck with Nintendo for the No. 2 spot in video games, much better than some observers initially expected. But Sony's PlayStation<29>2 has outsold the Xbox by a 5-to-1 ratio.

Microsoft is expected to lose $3 billion on the Xbox business by 2005, according to one analyst's estimate. But Microsoft views the console as a strategic foothold in the home that loosens Sony's grip on consumers. The company has higher hopes for beating Sony with its next-generation box, dubbed Xbox Next, which is under design in Redmond.

Over time, Microsoft believes it will gain the upper hand from its emphasis on online gaming, which it provides through its broadband-only Xbox Live service. Microsoft has 500,000 subscribers so far and will begin charging them $5.99 a month in November.

During the next year, Microsoft expects to launch dozens of new titles, garner 500,000 more subscribers to Xbox Live, and sell 5 million to 7 million more consoles.

Contact Kristi Heim at kheim@mercurynews.com or (206) 632-8160.

Mercury News Staff Writer Dean Takahashi contributed to this report.

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(c) 2003, San Jose Mercury News, Calif. Distributed by Knight Ridder/Tribune Business News.

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