Microsoft No Longer A Presumptive Buy-And-Forget Holding

This article first appeared in the June 7 week-in-review note to Kelly Letter subscribers.

We’ve owned shares of Microsoft for almost seven years — with nothing to show for it. I’ve been wrong on the stock, and something is wrong at the company. What is it?

Microsoft has been a non-innovator from the start, so to say that its lack of innovation is crippling it is to ignore the strengths that made it a great business for the first two decades of its existence. The company’s model has always been to copy the best-of-breed and then defeat the creator of that technology through marketing. It invented none of the applications in its Office suite, nor the main concepts of its Windows franchise. The former came from various innovative firms like Lotus and WordPerfect, while the latter came from Unix and the way Apple elegantly used it in its operating systems. The Xbox copied leading game companies; the Zune copied the iPod; Internet Explorer copied Netscape; and so on. This is not a new observation. It’s a well-known part of Microsoft’s strategy.

Why isn’t it working anymore? Computing is shifting from the local hard drive to the internet, true, but Microsoft is also a big player online. Its IE and Outlook Express software packages remain popular for browsing the web and managing email. Its Office suite is integrated with online applications and offers a limited amount of online file storage and manipulation. The company is not oblivious to the migration to the web.

It appears to me, however, that the wide variety of options presented by the internet make it a much harder beast to control through monopolistic practices. Switching from one website to another is effortless. Most publishing now happens online, so proprietary formatting is gone. As a writer, I used to have to worry constantly about whether the format of my documents would carry over to the recipient. Not anymore. Almost everything is plain text anyway, or rich text, and both of those work anywhere. Blink! Just like that, compatibility with Word disappeared as a reason to keep paying money to Microsoft.

It’s in the same trap regarding almost everything online. Outmarketing Lotus 123 with Excel worked to snuff out 123 because as more people started using Excel, more people needed to remain compatible with its files. People began saying “send me your Excel file” instead of “send me your spreadsheet” or even “your 123 file.” With online search, for instance, it can’t work that way. Google’s dominance doesn’t mean I can’t prefer just because I like it. I don’t have to worry about my way of searching being compatible with your way of searching. The compatibility issue no longer drives users into the arms of Microsoft.

It’s the same with the OS. I mentioned in the past that the freedom to switch to any computer that could get online would give Apple a leg up and cause Microsoft trouble. I also said that my firm would migrate to Apple over the next few cycles. That began two weeks ago when I replaced my own PC notebook with a MacBook Pro, and was able to start working differently within a week. Apple’s ads don’t lie. Its technology is gorgeous, powerful, and easy. For me, there was a little adjustment period as I unlearned old habits and learned new ones, but it’s been more fun than stressful. I love not caring whether Microsoft can do a better job with Windows 7 than it did with Vista, because it no longer matters to me. I’ve moved on.

Will the rest of the world move on, too? The longstanding argument in Microsoft’s favor is that while one guy with one notebook might be able to convert to another way of working, entire corporations with proprietary apps built on PC platforms won’t. Therefore, Microsoft will always thrive as a giant among giants, supplying the framework within which serious business gets done.

Is that true, though? Databases run on other platforms. Browsers increasingly handle more of our workload. Text has ceased being proprietary. Email works the same way anywhere. People seem more concerned with whether the home office works with their mobile appliance of choice than the other way around. The parts of business that people use and personalize have moved past Microsoft, it seems, and that leaves the company vulnerable to losing the other parts behind the scenes.

Every analyst report I read on Microsoft stresses that incremental revenue from Windows and Office upgrades will keep the company afloat, but it seems I’ve read that same report for seven years with no change in the stock price. I don’t think Windows and Office forever are enough to keep Microsoft a compelling business.

To be sure, it’s good at milking them. To assure a better adoption of Windows 7 than Vista, for instance, Microsoft stopped enterprise support of Windows XP. Many businesses stuck with XP because there was no compelling reason to upgrade to Vista and plenty of reasons to avoid upgrading. The ability to keep working fine without the upgrade shows how mature computing has become, and how increasingly stretched the constant upgrade path to profitability has become. These days, beyond just not wanting another upgrade, users fear them. That’s a pretty sketchy situation.

It’s made more so when you realize that Windows, Office, and Server/Tools comprise 80% of Microsoft’s revenue. That much of the cash depends on upgrades that need to be forced on people through planned obsolescence and support rationing. In the past, such measures worked because people knew less about computing than they do now, and had fewer options. These days, with most personal users doing almost everything online and most business users having everything they need already in place or migrating online, it’s not guaranteed. There are many non-Microsoft options, some cheap or free, and the Microsoft brand is taking on the tarnish of old school. Who wants a Microsoft-powered mobile phone? Who searches online with Microsoft sites? What power user opts for Internet Explorer over Firefox, Opera, or Safari? Why send a Word document via email when you can just share effortlessly with an online productivity suite like Acrobat or Google Docs or ShareOffice or Zoho?

Unlike Apple, Microsoft has created few ongoing service revenue streams from individual users. Apple’s iTunes store, Mobile Me online storage and data sync service, and photo album printing service are all good examples of how Apple keeps getting money from its users after the initial sale. It does so in a way that doesn’t make the user feel bad. Nobody wants to pay for software they don’t need, but they don’t mind paying for songs they want, renting movies they want to see, managing their data conveniently, and printing the pictures they want to share. These are all great ideas that give people what they want at prices they don’t mind — the essence of business, really. One problem with monopolies is that they lose that drive to make customers happy, and when the monopoly power falls away, the unhappy customers are quick to make a switch. The former monopoly is slow to adapt, in most cases, and we’re witnessing that with MSFT 2.0.

Exhibit one is the new Microsoft Bing. Have you seen it yet? It’s the company’s latest attempt to gain market share in internet search, where it just can’t get any traction. Its inability to make headway in online search shows that it’s stuck with the desktop, the very real estate that’s declining in relative value because people spend less time there than before. Nobody is going to stop Googling stuff in favor of Binging it.

It’s so lopsided online that Yahoo isn’t interested in doing any kind of deal with Microsoft. Remember a little over a year ago when Microsoft tried to buy Yahoo, and Yahoo snubbed it? That’s still going on. Yahoo feels more confident in its battle against Google without Microsoft on its side. Yahoo CEO Carole Bartz said last week at Bank of America’s 2009 Merrill Lynch tech conference, “I personal
ly think we would be better off if we never heard the word Microsoft.” That’s a pretty clear repudiation.

Bing is a convenient case-in-point for what ails Microsoft. It calls itself a “decision engine,” which is already lame. When I search online, I’m no more making decisions than when I drive my car and “decide” at an intersection whether to turn or keep going straight. Sure, life is a series of decisions, but what I’m doing online with search is searching. I may be finding information to help me make a decision, but the main thing I’m doing is searching. So, already, the attempt to differentiate falls flat.

Beyond that, Bing is no better at helping me make decisions than the search results at Google and Yahoo. Besides, its real game becomes clear with its focus on buying things and enticing me with its garish cashback feature. That part is inelegant and transparently against my interests. Cashback pops up from the most expensive options, and tempts me to get a 5% rebate by paying 25% more on the price. This is straight from the playbook of discredit cards and the worst retail practices. Once I wised up to cashback being a con from Redmond, the entire set of search results from Bing became suspect. If it’s skewing the shopping results toward expensive items so it has a profit margin that enables it to give me 5% back and still retain a slice for itself, why wouldn’t it skew search results in some way?

The big killer, though, is that even if Bing gets something really right and really cool, Google and Yahoo would just implement it at their own much more heavily trafficked sites and Bing would fall from whatever little perch it had managed to attain.

Microsoft is trying hard, with a $100 million ad campaign, to get you to switch from Google to Bing, but it won’t succeed. It’s trying to convince you that you need better search results when:

A) You don’t think so, and,
B) It doesn’t deliver them.

Other than that, it’s off to a great start.

I give it points for presentation, though. The site is nice looking. As for functionality, comparing the news section to Google’s news section is all you need to do to understand why Bing is a bust. Bing’s news page looks like somebody’s blog with pictures, not at all an up-to-the-minute feed from the best sources online. Google News, by contrast, has an official feel, comprehensive coverage, and many options for customization to follow the news you want the way you want.

While Microsoft embarks on another lost year against Google and Yahoo, it’s losing the cloud computing war. That’s where it should be focusing its efforts. It will continue snubbing open standards, clinging as it does to its monopolistic practices that served it so well during the desktop phase of computing, so users will not embrace Microsoft’s own cloud computing initiatives. Why? Because they’ll require access from Windows and installation of Microsoft’s server software in companies, and will somehow always work best with Internet Explorer. By the time it gets its cloud services model doing anything interesting, it will be in the same situation it faces in online search today: up against entrenched competitors and offering no compelling reason to switch.

Permit me to step outside my bounds a little and tell you an idea I have for Microsoft. The company owns a well established operating system, industry standard office software, and the most widely used internet browser. Combine those with its deep pool of development talent, and I think it has all the ingredients needed to make the most powerful virtual desktop on the market.

Call it World Windows, for now. It would be built into every new copy of Windows and offer the option of complete replication online of a user’s computer desktop by incorporating two existing technologies: remote PC access and online backup. Investing in a server farm to handle everybody’s hard drive impression would be smart, as it would provide everybody with data back-up and convenience when they travel. With World Windows, from any internet-connected computer in the world, I would be able to pull up my precise desktop with all of my software usable via a browser-based emulator that could be maximized to fill the screen. Any net-connected computer could become my computer exactly as I see and use it at home or work.

Once that was in place, it would provide Microsoft with plenty of new opportunities to place smart ads and add-on services, such as more deluxe back-up for a price. Bing or another Microsoft search service could be built in to gently show people a different way to search, with maybe some kind of customization like saved searches to make it stickier so they don’t run right back to Google.

It’s possible that if such a platform took off, Microsoft could charge online ad placers like Google and Yahoo a percentage of click revenue that happened via the virtual desktop that spreads like wildfire.

This approach would accomplish several goals:

A) Keep Microsoft at the center of the computing experience
B) Get everybody cloud computing with familiar MS software
C) Provide ad revenue to MS without needing search
D) Entrench Microsoft in a new way — online

So far, we’ve seen nothing so visionary from Redmond. Instead of pulling together something big and bold like World Windows, it continues trying its method of copying and outmarketing. It has not yet adapted its business to a changed business climate.

In the meantime, the company is managing its cash cows well for the short term. Senior Vice President Chris Liddell said in the March conference call: “Over the next 18 months, we will be delivering updates to our core franchises, namely Windows 7, Windows Server and Office 2010, as well as bringing new services like Windows Azure to market.” That’s all the optimism, the core franchises. They’re fine today, but what kind of future do they have?

Judging by the stock’s performance this decade, investors don’t think much of one. As MSFT’s revenue per share has increased every year since 1993, the stock has been a loser this whole decade. Its value has become better because the same share price buys more revenue and earnings, but the lack of share price appreciation is troubling.

We’ll hold for now to see if the company can’t get back over $30 just on economic recovery prospects alone, and the fact that almost nothing positive is priced into it at $22. For the long term, though, Microsoft has lost its presumptive status as a buy-and-forget holding.

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