When Microsoft reported its earnings last month it drew some surprises; Vista, the company’s new operating system, is selling well. Until the announcement, most of the news about Vista, and Microsoft in general, reported its problems and predicted its negative impact. It seems that in this Microsoft has had the last laugh. But as with any empire, there is a dark side. Microsoft trails its online rivals Google and Yahoo! and is well aware that it needs to make some headway in this area. Its need to do so was evidenced by recent talks between Microsoft and Yahoo! Talks were over quickly, but the fact remains that while Microsoft may keep moving ahead, its work is cut out.

If earnings reports are indicative of a company’s strength Microsoft appears to be doing well; on April 26 the company posted a 65 percent rise in quarterly profit. While the projections of the company for 2008 are only at the midpoint of analyst projections, the rise was enough to send shares of the company up five percent. “The strength of Vista is really driving this,” Kim Caughey, an analyst at Fort Pitt Capital Group, told Reuters. This piece of news was a surprise to many, and not just those in the press and analyst communities. According to Reuters, Chris Liddel, Microsoft Chief Financial Officer, said consumer sales of Vista surpassed even the company’s own expectations by $300 million to $400 million. Apart from the standard Microsoft bashing Chief Executive Steve Ballmer’s February statement that some analyst estimates for Vista sales were “overly aggressive,” had led to concerns.

According to BusinessWeek, “while some corporate customers still opt for the predecessor Windows XP when they buy new computers, for software compatibility reasons, a remarkably large number are taking the new operating system.” That ‘remarkably large number’ amounts to 85 percent of its current operating system’s sales. Given all the negative hype that is likely a surprise, but even more so when it is pointed out that Vista is selling more robustly than XP did at the same time in its life cycle. Contrary to popular expectation, Vista appears to be paying off; the Client Division which consists mainly of Windows sales for PCs reached $5.3 billion. This of course is good news to Microsoft, Windows and Office account for more than half of Microsoft’s total revenue and a majority of its profits. Benjamin J. Romano of the Seattle Times put it well, “The report served to quiet some grumbling about the new operating system’s performance and acceptance, and it seemed to assure investors that the cash cows are safely in the pasture.”

Though the new operating system and Office suite may represent cash cows, Microsoft’s online search presence may be best referred to as a dog. Microsoft comes in a distant third, behind Google and Yahoo! Vista sales make Microsoft happy; its search performance does not. According to BusinessWeek, “At the end of January Chief Financial Officer Christopher Liddell expressed dissatisfaction with the company’s search engine growth. ‘We lost market share’ . . . We are clearly not happy with that.'” The dissatisfaction expressed by Liddell was over a few numbers: As of March 1, growth on Microsoft’s search site was up 2.5 percent; Yahoo!’s 29 percent and Google’s 40.6 according to Nielsen/Net Ratings. Also while Google boasts 53 percent of searches, and Yahoo! follows with 23 percent, Microsoft stalls at 9 percent.

In early March Christopher Payne, the corporate vice-president in charge of Windows Live Search left the company and it is still being kept quiet as to why. BusinessWeek states that at that time, “Concerns over leadership of the division resurfaced,” and that, “his replacement faces a tall order.” As they look for a replacement Microsoft will also be looking for a solution. Knight Ridder reports that, “Beyond having enormous resources to spend on battling Google and Yahoo, Microsoft has a valuable roster of popular Web services and sites that can direct search traffic to the Live Search site.” Microsoft will attempt to leverage this roster and encourage users to execute more searches; it will embed search into its instant messenger client as well as on its online sites. “If we got all of these people to do one search a day, that would be a big bump for us,” says Whitney Burk, Microsoft’s public relations manager for competitive strategy. In an unusual approach Microsoft will also try to woo users via financial incentives. According to Network World, “In an apparent attempt to boost its disappointing Web-search market share, Microsoft is giving financial incentives to large corporate customers whose employees use Microsoft’s Live Search engine . . . In exchange for their employees’ Live Search usage, Microsoft is providing ‘service or training credits’ to these customers.” Justin Osmer, senior project manager for Microsoft’s Live Search group, says, “We know it’s an uphill battle, but we’re in it for the long haul.” That long haul has also directed Microsoft to look for some shortcuts.

According to the Wall Street Journal, “Recent talks between Microsoft Corp. and Yahoo Inc. over how to band together betray increasing unrest at Microsoft over how to compete with Google Inc. and get in step with the booming online-advertising market.” When word of discussions between the two companies broke last Friday various sources tossed about numerous scenarios; however those might best be discussed at a later time, when the two companies are still talking. (Word of the talks ending arrived on the heels of word that they had begun.) Still, the scenario surrounding the talks is noteworthy. The Wall Street Journal stated that “Microsoft’s online division could be heading for a shake-up, say people familiar with the situation. Failure by the Redmond, Wash., company to make better headway against Google in Internet search, combined with Microsoft losing a deal to Google last month to buy online-advertising specialist DoubleClick, has spurred Microsoft Chief Executive Steve Ballmer to consider new action, these people say.” The Financial Times has similar thoughts, “The talks have been prompted by an acceleration in the shift of audience and advertisers online, and Microsoft’s failure to build effective search engine and online advertising arms of its own, say analysts and industry executives.” And while the point is moot, now that talks are over, it is interesting to note the view that even Yahoo! couldn’t help Microsoft. On this Forbes notes, “Microsoft’s money-losing online business posted sales growth of just 10.9 percent last quarter. Yahoo! does make money, but last quarter its sales rose a mere 9 percent, excluding traffic acquisition costs.”

A company as big a Microsoft with fingers in as many pots will have both victories and its defeats; both can come hand in hand.

A more complete version of this posting, with journal articles, and research reports can be found at the website of Analyst Views Weekly.

More information on this topic can be found in Northern Light’s Software, Computers & Services Market Intelligence Center.

And in the following articles:

Microsoft, Yahoo Discussed Deal
Wall Street Journal, May 5, 2007
Recent talks between Microsoft Corp. and Yahoo Inc. over how to band together betray increasing unrest at Microsoft over how to compete with Google Inc. and get in step with the booming online-advertising market. Microsoft and Yahoo discussed a possible merger or other matchup that would pair their respective strengths, say people familiar with the situation. The merger discussions are no longer active, these people say, but that doesn’t preclude the two companies from some other form of cooperation.

Rumors Fly on Microsoft and Yahoo
New York Times, May 5, 2007
Microsoft and Yahoo are discussing a business partnership in their effort to compete with Google, people briefed on the talks said Friday. The New York Post reported Friday that Microsoft was pursuing an acquisition of Yahoo, a prospect that sent Yahoo’s shares soaring. But a person briefed on the talks as recently as Friday said they had been going on for more than a year and had focused recently on a “creative partnership,” not an acquisition.

Judge Approves $1.53 Billion Verdict against Microsoft
New York Times, May 3, 2007
A federal judge signed off on a $1.53 billion jury verdict in favor of Alcatel-Lucent in a digital music patent dispute against Microsoft. Judge Rudi M. Brewster of Federal District Court in San Diego concluded that Microsoft’s Windows Media Player software infringed on patents owned by Lucent Technologies, an American telecommunications equipment maker acquired last year by Alcatel of France.

Vista Pays Off for Microsoft
BusinessWeek Online, April 27, 2007
In the weeks before Microsoft’s quarterly earnings release, reports abounded of security problems with the new Windows Vista operating system. And talk was rife that myriad software programs don’t work well with Vista. It was enough to give the impression that Vista, launched in January, wasn’t selling all that well. Microsoft’s fiscal third-quarter results, reported Apr. 26, paint a different picture.

Vista’s OK. But Microsoft May Not Be
Forbes, April 26, 2007
It’s old news that Microsoft’s latest operating system, Windows Vista, is underwhelming. Oh, and late, bloated and buggy. What is news is that this might actually be a problem for Microsoft Chief Executive Steve Ballmer and crew.

Microsoft Profit Tops Wall St. View on Vista Sales
Reuters, April 26, 2007
Microsoft Corp. posted a 65 percent rise in quarterly profit on Thursday, topping Wall Street estimates due to better-than-expected demand for its new Windows Vista operating system. Shares of Microsoft rose 5 percent after the announcement, in which the world’s biggest software company also forecast 2008 profit at the mid-point of a range of analyst estimates.

Microsoft to Unveil Rival to Adobe’s Flash
Financial Times, April 16, 2007
Microsoft is set on Monday to unveil an internet technology to rival the Flash player, a piece of software made by Adobe that has become an ingredient in the success of video from YouTube and other online experiences. The move will touch off a fight over a strategically important internet technology, echoing earlier battles Microsoft waged against the Netscape browser and RealNetworks’ media player, according to analysts.


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