Microsoft Sees Threat From Android Notebooks

Microsoft CEO Steve Ballmer
Microsoft CEO Steve Ballmer speaks last week in Barcelona.
Source: Reuters

With the grim economic climate weighing on all sectors of its business, Microsoft reiterated warnings about slowing revenues and profits for the second half of the year, but vowed prudent spending as the company looks ahead to new fronts in its war with Google.

But sparring with its archrival in areas like wireless — where Google (NASDAQ: GOOG) recently staked a claim with the launch of its Android mobile operating system — won’t be an easy matter, given the gloomy prognosis for Microsoft’s (NASDAQ: MSFT) other key areas of focus.

As a result, Microsoft CEO Steve Ballmer said in a presentation to analysts Tuesday morning that the company’s financial team has taken to the history books, studying comparable crises of the past and trying to extract lessons to apply in the current downturn.

“They all have a story associated with them and none of them is a quick recovery,” he said. “That’s kind of the mindset we have relative to the economic situation — you don’t beat it, you manage in this environment.”

He added, “It’s not like anyone’s able to cut costs fast enough in any industry to maintain the profits of yesteryear.”

The strategy update comes a month after Microsoft reported its fourth-quarter earnings, when the company missed guidance and announcing the first layoffs in its 34-year history.

Against that picture of general gloom, Ballmer today outlined some specific areas where Microsoft is seeing opportunity in crisis, particularly phones, search and advertising, and the low-cost, downsized portable computers known as netbooks — all areas where he looks ahead to vigorous competition with archrival Google (NASDAQ: GOOG).

In the midst of a flailing economy, Ballmer said he liked to measure success in each of Microsoft’s business lines relative to the competition.

“You can always take share,” he said. “I tell our people, ‘I don’t know why you get grim. Even in a down economy we can take share. Especially in a down economy, it’s time to take share.'”

One market where Ballmer acknowledged that share will difficult to acquire is search, where Google enjoys a substantial lead in the United States and an even stronger position in Europe. With display advertising getting weaker by the day, search is critical to Microsoft’s Web strategy, he said.

Ballmer reiterated his belief that Yahoo (NASDAQ: YHOO) and Microsoft, the second- and third-place players, respectively, needed to team up on search to take on Google, quickly adding that he didn’t care to be asked what form such a partnership might take.

[cob:Pull_Quote]For the better part of 2008, Microsoft and Yahoo were engaged in stop-start talks about various scenarios to combine all or part of the companies. No transaction was reached, and amid widespread shareholder frustration, Jerry Yang stepped down as Yahoo’s CEO, to be replaced by Carol Bartz.

“The fact of the matter is these two guys should somehow figure out how to get together and create more competition for this guy,” Ballmer said of his a potential alliance to take on Google. “And I’m hoping that that’s perhaps a reasonable conversation to have with new management at Yahoo as Carol comes on board.”

Microsoft’s search and advertising division is currently a big money loser. The company recently hired away Yahoo’s top search engineer Qi Lu, as well as about 10 other high-grade engineers from Yahoo to beef up its online division. Ballmer pledged promised to deliver significant innovations in search, and said that the company would continue to invest with something like cautious aggression.

[cob:Special_Report]”I don’t want to wind up being known as the Jerry Yang of this market,” he said, referring to “the guy who invested forever and got no…”

Ballmer cut himself off, leaving for inference the charge that for all of the development initiatives Yang presided over, the gap between Google and Yahoo in search share widened under his tenure.

“I’m not trying to be rude to Jerry, but that whole episode left me understanding how shareholders can get frustrated with managements who aren’t serious about performance,” he said. “I’m serious about investment, but I’m also serious about performance in this business.”

Page 2: Ballmer on Android’s implications — and a Microsoft smartphone.

Page 2 of 2

On the mobility front, where Microsoft plans to roll out Windows Mobile 7 next year, Ballmer took the occasion to quash speculation about a Microsoft smartphone.

“People ask me, ‘Will you build your own phone?’ It’s not our strategy to build our own phone,” he said. “It’s our strategy to sell software that we can use and support across a wide range of device manufacturers.”

In the face of contracting consumer spending, Ballmer is expecting the smartphone market to favor lower-cost models with modest form factors going forward, hinting that Android-powered phones might be a bigger competitive threat than Apple’s iPhone.

But Google’s Android won’t just be a threat to Microsoft’s mobile business. While the company continues its efforts to stave off challenges in the operating system sector from Apple and Linux, Ballmer is looking ahead to a convergence of the PC and mobile device as the computing platform of choice, and sees an Android-powered laptop on the horizon with Google entering the OS market.

In the netbooks sector, where that convergence is already evident, Microsoft enjoys a market share of roughly 80 percent with its XP operating system. The company is hoping for an aggressive push with Windows 7, an upselling strategy that would deliver significantly higher margins, Ballmer said.

In the traditional PC market, sales have slowed and will continue to trend down, Ballmer said.

“I have a basic theory that in the consumer market, the things that get hit most in this economy are going to be big-ticket items that are viewed as discretionary,” like cars, flat-screen TVs and replacement PCs.

“On the business side, we’ll see the equivalent. We’ll see a slow in capital spending.

IT is about 50 percent of capital spend in developed markets, so we’ll see a slowdown in IT spending and that will affect PC, PC hardware and server sales rates. This is definitely a business that sees the effects of the economy.”

The next big step forward in the company’s Office line, version 14, will not hit the market this year, Ballmer said.

On the server side, Ballmer said Microsoft plans to invest aggressively in areas where the company lags behind Linux in market share, specifically targeting the areas of Web hosting and Web applications, as well as scientific applications.

[cob:Special_Report]In its enterprise software business, Microsoft is looking to compete aggressively with market leader Oracle in the database and middleware sectors. Ballmer said he hopes to challenge Oracle in business intelligence, and also make inroads against the licensing agreements the database giant enjoys with large enterprises.

Internally, as it absorbs the recent layoffs, Microsoft is trying to move some of its people around to match its shifting priorities, Ballmer said, but that reorganization has presented its own set of challenges.

“It’s not easy,” he said. “It’s not like you can take someone who thinks they’re a video game designer and put them to work on SQL server. But we’re doing some work to reshape our cost basis.”

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