Headquartered in Redmond, Washington, Microsoft is the world’s largest software company and had record revenues of $73 billion in fiscal year 2012 that ended on June 30, 2012. Microsoft develops a variety of software and hardware products and services for customers around the world, including its Windows Office, Windows 8 operating system for personal computers (PCs), Windows Phone 7 operating systems for mobile phones, Windows Server operating systems, Windows Azure, Microsoft SQL, Visual Studio, Silverlight, and the popular Xbox gaming and entertainment console. Many PC makers such as Acer, Lenovo, Dell, Hewlett-Packard, and Toshiba pre-install Microsoft software on devices. The firm also offers consulting services, cloud-based services, and training certifications as well as online products such as Bing, MSN, adCenter, and Atlas. Microsoft has strategic alliances with Nokia, NIIT, and Dominion Enterprises. The company owns Skype and recently introduced a Windows Phone and a Windows tablet computer named “Surface.”
Microsoft’s third quarter of fiscal 2013 results reported April 2013 were outstanding, with its Business Division’s revenues up 8 percent to $6.32 billion, its Server and Tools’ revenues of $5.04 billion up 11 percent, its Windows’ division revenues of $5.07 billion up 23 percent, its Online Services segment revenues up 18 percent to $832 million, and its Entertainment and Devices segment revenues up 56 percent to $2.53 billion.
In August 2013, CEO Ballmer announced he would resign from Microsoft within 12 months, so the firm is scurrying to determine who will be a good replacement. The month prior, Microsoft revamped its organizational structure, dissolving its eight business lines up in favour of four new segments to focus on engineering and encourage collaboration across the company. Basically the company is now structured as a division-by-function type of structure. The divisions are expected to focus on operating systems, apps, cloud technology and devices. The move largely reversed the strategy and structure put in place by CEO Ballmer in 2005. Microsoft’s stock price jumped in response the Ballmer announcing that he would resign soon.
Copyright by Fred David Books LLC. (Written by Forest R. David)
Founded by Bill Gates and Paul Allen in 1975, Microsoft was established to develop and sell BASIC Interpreters for the Altair 8800. The company rose to dominate the PC operating system market in the mid-1980s with their MS-DOS software, followed by the Microsoft Windows operating system, which was a graphical extension of MS-DOS. Microsoft went public in 1986, instantly creating three billionaires and 12,000 millionaires from Microsoft employees. In 1990, Microsoft introduced its software office suite, Microsoft Office that bundled MS Word and MS Excel together.
Microsoft acquired Skype Technologies for $8.6 billion in 2011 in its largest-ever acquisition. Following the release of Windows Phone 7, Microsoft underwent a gradual rebranding of its product range throughout 2011 and 2012. Its logos, products, services, and websites adopted the principles and concepts of the Metro design language. Microsoft in early 2012 introduced Windows 8, an operating system designed to power both PCs and tablet computers. Then in May 2012, Microsoft introduced its own tablet computer, the Microsoft Surface. As the company continued to diversify away from operating systems, it paid $1.2 billion to buy the social network firm Yammer and then launched its Windows Phone 8. To cope with the potential increase in demand for products and services, Microsoft is slowly but surely opening its own Microsoft Stores across the USA. Bill and Melinda Gates are today one of the richest couples on the planet, and one of the most giving couples in terms of philanthropic endeavors through the Bill and Melinda Gates Foundation.
Vision and Mission
A statement at the corporate website says: “At Microsoft, our mission and values are to help people and businesses throughout the world realize their full potential.”
Among the 17 executives listed in Exhibit 1 , there are three women in Microsoft’s management hierarchy. Note in Exhibit 1 that Microsoft uses a division-by-product organizational structure, with Steve Ballmer being chief executive officer (CEO) and Kevin Turner being chief operations officer (COO). Some analysts say that executive titles could be more effectively named. For example, President of Microsoft Corp. versus President of Microsoft Business is unclear to some observers. It is unclear from the structure where Microsoft Phone and Microsoft Tablet and Microsoft Stores reports. Such items would ideally be clear in executive titles. Perhaps a strategic business unit (SBU) structure would be more effective.
The Surface Tablet
EXHIBIT 1 Organizational Chart
Source: Based on company documents.
Sales of Microsoft’s Surface tablet are not good; analysts expect the company to sell between 500,000 and 600,000 Surface tablets in their second quarter of fiscal 2013, much lower than the company’s original estimate of 1 to 2 million. Introducing a tablet is a good idea for three reasons: (1) Microsoft has the cash to invest heavily in research and development (R&D) for its own tablet; (2) the tablet market has been booming; and (3) the PC market is declining. But the problem perhaps is that Microsoft priced the Surface too high at $499 and up, roughly the same price as the competing Apple iPad. Microsoft likely should compete on price, not luxury, when up against Apple products. Microsoft could undercut Apple’s price, and even if it loses money on Surface, the initial loss could be worth it if it revitalizes sales of other company products. The success of Windows 8 largely hinges on widespread adoption of the Surface tablet. The whole point of Windows 8 was to launch Microsoft into the world of tablet computing, and with weak sales of its tablet, Microsoft’s transition away from the faltering PC market may be a difficult one. Microsoft should perhaps consider McDonald’s successful strategy of offering and heavily marketing inexpensive products (for example, the Dollar Menu) and by promoting low-grade items.
Microsoft has five reportable business segments as listed in Exhibit 2 . Note that Microsoft Business is the largest segment in both revenues and operating income, whereas both the Windows and Windows Line (called Windows Division from here on), and Server and Tools segment, contribute greatly to the company’s financial position. A sixth segment, titled Corporate Level Activity, includes all financial dealings not allocated to specific segments. The division includes costs related to marketing, product support services, legal, finance, and other business activities. Some analysts contend that the company’s segments could be more effectively named to reveal their nature.
The Windows Division receives approximately 75 percent of its revenue from the Windows operating system, with the bulk of this revenue coming from equipment manufacturers such as Dell, Sony, Toshiba, and others pre-installing Windows on their machines for customers. The division in addition to providing Windows also provides related software, online services, and PC hardware products. This division could be vulnerable if worldwide PC sales continue to slump, as they did in 2012 with a 3.2-percent decline. Windows 8, launched in October 2012, provides better communication with cloud services and enables tablets and phones to run with near PC power. The whole world is becoming less dependent on traditional PCs, which historically has been Microsoft’s bread and butter and is a key reason why the firm is looking to diversify.
EXHIBIT 2 Microsoft’s Revenues by Segment (in millions)
|Server and Tools|
|Entertainment and Devices|
|Corporate Level Activity||(5,090)||(4,597)||(4,136)|
Source: Based on 2012 Annual Report, p. 21–25.
Microsoft’s Server and Tools Division is Microsoft’s third most profitable division, producing name brand products such as Windows Server, Microsoft SQL, Windows Azure, Visual Studio, Enterprise Services, and others. Enterprise Services include product support and consulting services and account for 20 percent of the division’s revenues. The division also offers developer tools, training, and certifications. Around 55 percent of Server and Tools revenues are derived from multiyear licensing agreements, with the remaining 25 percent coming from transactional volume licensing programs. In 2012, revenues increased by 12 percent in the division mainly attributed to growth in the SQL and Windows servers, although Enterprise Services grew 18 percent over the same period from an increase in both product support and consulting services. Overall operating income still increased 17 percent.
The company’s Online Services Division designs products that aid customers in simplifying tasks and making more informed decisions online. Products include Bing and MSN, which generate sales through advertising. In fiscal year 2012, advertising revenues grew 13 percent in this segment to $2.6 billion. Online advertising revenues grew 13 percent over the fiscal year to $2.6 billion; however, operating losses totaled $8 billion resulting from $6 billion in goodwill impairment from fourth quarter of fiscal year 2012, resulting from the 2007 acquisition of aQuantive. Expectations of future sales growth and profitability are significantly lower for aQuantive than anticipated.
The company’s Microsoft Business Division produced 32 percent of total companywide revenues and 72 percent of operating income in fiscal year 2012. The segment derives revenues from software and online servers that help to increase personal team and organizational productivity. Microsoft’s most notable product, its Microsoft Office System, makes up more than 90 percent of this division’s revenues. However, future reliance on this segment is somewhat tenuous because Google and other competitors are now offering Web-based products that work much the same as Microsoft Office products work.
The company’s Entertainment and Devices Division generated 13 percent of total revenues in fiscal year 2012, led by the Xbox 360 entertainment platform. The division includes Xbox, Skype, and Windows Phone. Skype is a free popular video chat platform and for-pay phone service. Sales from Skype and Windows Phone increased 6.5 percent in fiscal year 2012, but Xbox sales declined $113 million even though Xbox LIVE revenue increased. Skype reported revenues of $860 million, net losses of $7 million, and long-term debt of $686 million in 2011, leading some analysts to say Microsoft paid too much for Skype. Overall, Microsoft has a history of using poor judgments in acquisitions, as indicated by the company’s goodwill being more than $13 billion. Skype does overlap considerable with Windows Live Messenger in that both offer free chat, voice chat, and video chat. Windows Messenger though has around three times the users as Skype, but Skype offers a more refined platform for video chats. The one key difference between Microsoft’s existing products and Skype is that about 8 million Skype users pay for the service through telephone connectivity, making it easy for many customers across the globe to buy phone numbers in foreign markets affordably. With the purchase price of $8.5 billion, Microsoft is in essence paying around $1,000 for each customer who is worth around $30 each, assuming most of Skype’s income is from call charges, leaving much to be made up on possible advertisements or some synergy with existing Microsoft products. Compounding problems for Skype, it is estimated a large percentage of their customers come from emerging markets and do not have much money to spend. However for Microsoft, preventing Google and Facebook from obtaining Skype also played a role in the purchase.
Exhibit 3 reveals that approximately 52 percent of Microsoft’s 2012 revenues are derived from the USA. Note that international revenues have increased as a percent of total revenues in each of the three years provided.
EXHIBIT 3 Microsoft’s Revenues by Geographic Region (in millions)
Source: Based on 2012 Annual Report, p. 80.
Microsoft’s fiscal year ends on June 30 of each year. As indicated in the financial statements provided in Exhibits 4 and 5 , Microsoft’s revenues have been growing annually in recent years, a good thing. However, note in Exhibit 4 that the company’s net income dropped 26.7 percent in fiscal year 2012 and that the company’s R&D expenditures have held at 13 percent of revenue for the last three years. Microsoft’s sales and marketing expenditures for the last three years have dropped from 21 to 20 to 19 percent of revenues.
EXHIBIT 4 Microsoft’s Income Statements (in millions)
|Other Revenue, Total||0.0||0.0||0.0|
|Cost of Revenue, Total||17,530.0||15,577.0||12,395.0|
|Selling/General/Administrative Expenses, Total||18,426.0||18,162.0||17,218.0|
|Research and Development||9,811.0||9,043.0||8,714.0|
|Depreciation and Amortization||0.0||0.0||0.0|
|Interest Expense (Income), Net Operating||0.0||0.0||0.0|
|Unusual Expense (Income)||5,895.0||-80.0||-10.0|
|Other Operating Expenses, Total||0.0||0.0||0.0|
|Interest Income (Expense),||0.0||0.0||0.0|
|Gain (Loss) on Sale of Assets||0.0||0.0||0.0|
|Income Before Tax||22,267.0||28,071.0||25,013.0|
|Income Tax, Total||5,289.0||4,921.0||6,253.0|
|Income After Tax||16,978.0||23,150.0||18,760.0|
|Equity in Affiliates||0.0||0.0||0.0|
|U.S. GAAP Adjustment||0.0||0.0||0.0|
|Net Income Before Extraordinary Items||16,978.0||23,150.0||18,760.0|
|Total Extraordinary Items||0.0||0.0||0.0|
|Total Adjustments to Net Income||0.0||0.0||0.0|
|Basic Weighted Average Shares||8,396.0||8,490.0||8,813.0|
|Basic EPS Excluding Extraordinary Items||2.02||2.73||2.13|
|Basic EPS Including Extraordinary Items||2.02||2.73||2.13|
EPS, earnings per share; GAAP, generally accepted accounting procedures.
Source: Based on company documents.
Note in Exhibit 5 that Microsoft’s goodwill increased another $900 million to $13.4 billion in fiscal year 2012. Goodwill represents the cumulative amount the company has historically paid “above book value” for acquisitions, so such a high number is not good.
EXHIBIT 5 Microsoft’s Balance Sheets (in millions)
|Cash and Short-Term Investments||63,040.0||52,772.0||36,788.0|
|Total Receivables, Net||15,780.0||14,987.0||13,014.0|
|Other Current Assets, Total||5,127.0||5,787.0||5,134.0|
|Total Current Assets||85,084.0||74,918.0||55,676.0|
|Property, Plant, and Equipment||8,269.0||8,162.0||7,630.0|
|Note Receivable, Long Term||0.0||0.0||0.0|
|Other Long-Term Assets, Total||1,520.0||1,434.0||1,501.0|
|Other Assets, Total||0.0||0.0||0.0|
|Liabilities and Shareholders’ Equity|
|Notes Payable and Short-Term Debt||0.0||0.0||1,000.0|
|Current Portability of Long-Term Debt Capital Leases||1,231.0||0.0||0.0|
|Other Current Liabilities, Total||23,407.0||21,002.0||17,839.0|
|Total Current Liabilities||32,688.0||28,774.0||26,147.0|
|Total Long-Term Debt||10,713.0||11,921.0||4,939.0|
|Deferred Income Tax||1,893.0||1,456.0||229.0|
|Other Liabilities, Total||9,614.0||9,470.0||8,623.0|
|Redeemable Preferred Stock||0.0||0.0||0.0|
|Preferred Stock, Nonredeemable, Net||0.0||0.0||0.0|
|Additional Paid-In Capital||0.0||0.0||0.0|
|Retained Earnings (Accumulated Deficit)||−856.0||−8,195.0||−17,736.0|
|Treasury Stock, Common||0.0||0.0||0.0|
|ESOP Debt Guarantee||0.0||0.0||0.0|
|Unrealized Gain (Loss)||1,523.0||1,658.0||1,231.0|
|Other Equity, Total||−101.0||205.0||−176.0|
|Total Liabilities and Shareholders’ Equity||121,271.0||108,704.0||86,113.0|
ESOP, employee stock ownership plan.
Source: Based on company documents.
Being so diversified, Microsoft has different competitors in different segments. The company’s Windows Operating System faces competition from Apple and Google who have their own operating systems. Microsoft’s server products face stiff competition from Hewlett-Packard, IBM, and Oracle, who all offer preinstalled operating systems on their server hardware. Microsoft’s cloud-based services compete with Amazon, Google, and Salesforce.com , whereas Microsoft’s SQL Azure faces intense competition from IBM, Oracle, and many other firms.
The Microsoft Office package (Word, Excel, Access, and other products) faces heavy competition from Adobe, Apple, Cisco, Google, SAP, and many other Web-based competitors offering word processing, spreadsheets, and databases. The company’s Entertainment and Devices segment, producer of Xbox360, faces intense competition from heavyweights Nintendo and Sony. The average life of an entertainment console is surprisingly long at 5+ years, and game selection is one of the largest factors in deterring the success of a gaming console.
EXHIBIT 6 A Financial Comparison of Microsoft to Rival Companies
|Number of employees||94,000||72,800||53,546||115,000|
|Net Profit Margin||21.7%||26.7%||22.2%||28.7%|
EPS, earnings per share.
Source: Based on company documents.
Microsoft’s new Windows Phone competes with market share leader Apple with their iPhone and Google with their Android platform powering Samsung and other phones. Also, Research in Motion is revitalizing their once-popular Blackberry. Microsoft’s alliance with Nokia to power Nokia phones with Windows 8 hopes to inch away at market share in the phone industry.
Exhibit 6 provides a financial comparison of Microsoft with three competitors. Note that Microsoft has the lowest earnings per share (EPS) among the firms included, partly as a result of having by far the most shares of stock outstanding.