Most of us are somewhat familiar with some form of The Infinite Monkey Theorem, which whimsically postulates that if you have an infinite number of monkeys, banging away on an infinite number of typewriters, over an infinite amount of time - eventually those monkeys, fingers flying, will accidentally produce the works of William Shakespeare.
While the theory overlooks the higher likelihood that the typing simians will be recruited to punch-up NBC's new fall line-up; the theorem illustrates the idea that a company can overcome a problem by overwhelming it with resources (even if those resources are ill equipped for the task).
With this in mind, let us turn our attention to Microsoft's (MSFT) level of spending on research and development (R&D) for the past 5 years and compare it with its competition, in particular Apple (AAPL).
Five Year R&D Spending Levels Compared
Where's My Jetpack?
Based on Microsoft's stunningly high R&D spending levels, shareholders very well might be wondering why there have been no company announcements of amazing new products: Where are the personal jetpacks and flying cars, Redmond?
Instead, owners of Microsoft stock have had to be satisfied the last decade with a predictable flow of slow-second offerings from the company, most recently: Window's 8 OS (compare to iPhone 2007 launch with iOS) and the Microsoft Surface tablet (compare to iPad 2010 launch).
A Slow Second: Worked for PCs, Not in Mobile
Microsoft's slow innovation cycle reflects a company accustomed to the benefits of competing in a space where the hardware evolved at a measured pace, and where Microsoft enjoyed +90% market share for its software: A slow second works fine, when you control the OS for the hardware (Examples: Explorer over Netscape, Excel over Lotus 1-2-3).
Contrast the slow, steady growth of the PC market over the past +30 years with the rapid evolution of smartphones and tablets over the past 5 years, and it's not surprising that Microsoft is facing an extreme challenge in attempts to adapt the company's structure to compete in the mobile computing space.
Despite the company's envious positioning in the early 2000's as the clear technology leader and cash generating machine - Microsoft has managed to miss each new wave of tech innovation, including:
- Web search
- Online content (MP3, Video, Books)
- Social Networking
Should Have Been A Contender
Microsoft's market miscues are all the more perplexing given some of the company's early development leads: Microsoft debuted it's first eReader and a Tablet PC prototype in 2000; Windows CE released in 1996, gave the company an early lead in mobile operating systems ((OS)). Yet the company today is struggling for a foothold in the mobile market it helped start.
Microsoft bulls will point to the company's success with the Xbox gaming console as some proof of R&D success, but despite strong sales in the segment, the chart below (source: Microsoft) shows the small impact that Entertainment & Devices makes to the company's bottom line. (In contrast, the Apple mobile business, launched in 2007, now contributes more revenue to Apple than all of Microsoft's businesses combined.)
The Xbox further highlights the business philosophy which is burying Microsoft in the consumer market: Company's CEO Steve Ballmer has regularly stated that with new technology, Microsoft will not be the first, but it will be first to profit. In other words, Microsoft still believes it can buy itself into the market, as it could in the past via Windows' long coattails.
Launched in 2001, it took Xbox seven years before it turned a profit, meanwhile, the current market for technology has become less forgiving: The Zune, launched 6 years after the iPod and less than 60 days before the iPhone, was DOA - never exceeding single digit market share before it was abandoned in 2010, despite Redmond's deep pockets.
R&D Investing: Where's The New Revenue?
Perhaps most troubling to investors, considering the extreme levels of R&D spending, is the fact that all profit growth for the company continues to come from old business divisions (Windows, Microsoft Business and Servers & Tools - see chart above). Hardly what an investor expects to see from a company spending 14% of its revenues on R&D.
Again, bullish investors will point to the recent launch of the Microsoft Surface tablets as a sign that the company's R&D spending is finally bearing fruit. Initial market reaction, however, is difficult to gauge: The company is not releasing sales figures for the Surface and the early reviews have been somewhat mixed - with many questioning the tablet/PC hybrid design and choice of price point by the company.
Microsoft's high levels of spending in R&D continues despite the lack of any material profit growth from new products. While the stability of the company's current business and margins continue to provide an attractive valuation and dividend stream for investors - the disconnect between R&D spending and new sources of profits remains troubling.