Many columnists devoted a lot of column inches last week to the announcement that Microsoft (MSFT) is entering the retail space. As usual, these articles were generally variations on the same theme; comparisons to Apple (AAPL), the mention of Wal*Mart (WMT) and DreamWorks executives being hired, the description of stores being full of software boxes piled high, but no deep critique of why Microsoft deems this seemingly crazy idea necessary. No one, at least that I read, hit upon the key strategic point of this development. This is a most costly pursuit for Microsoft, and even though Microsoft is almost certain to fail, this move is necessary. Here's why, in my opinion. The general consensus is that these stores will have some hardware (Xboxes and the like), some fancy mouse or drawing pad units, but largely these stores will be devoted to software. And, they won’t just have boxes of software sitting there, because that would provide no additional value for customers who could otherwise buy this software anywhere. Microsoft doesn't care that much about its margins to undertake this move to simply sell direct. In order to compete with the Apple retail stores, Microsoft will need to become a full service provider in these stores, in much the same way that the Genius Bar functions for Apple. In order to fully showcase Windows 7, which must be the OS profit driver upon which the entire empire is based, these stores will need to have technical assistants focused upon ripping out the 23.5% share in Windows Vista, 63.8% share in XP, and 0.29% share of 98 (!) from customers’ machines (statistics from January 2009 web share by OS figures, as listed here) and replacing with Windows 7. How else to explain Microsoft’s timing, in the worst recessionary retail period in the last half- century, to open retail locations? The company needs to do something urgently to re-make itself as a company capable of solving problems and not creating them. There is good reason why a 7-year old OS has almost 3X the share of an OS it introduced just 2 years ago; it's because Vista is a disaster and there is no longer any possibility to deny it. Here’s why this is will become a quagmire. Suppose a customer has an AST Microedge with mid-level Pentium processor, a SoundJammer sound card, a GameTech graphics accelerator card, a Logitech camera, a Microsoft wireless mouse, an Epson printer, a Canon (CAJ) Printer/Scanner/Copier with the printer broken but only used for the scanner/copier, a Maxtor backup drive, Altec Lansing Speakers, a Sony (SNE) digital camera, with USB connection, and another 10 peripherals. You get the point. (Author's note: I have no idea if all of those parts exist, it's dramatic license to make a point.) And the 19-year old store employee, who likes computers and thought that the Microsoft store seemed cooler than Best Buy (BBY) for the summer job, gets to help the customer drag all of this stuff from his or her car, because of course unless you have it all hooked up, how can you test that the drivers really work? This will not be pretty. Nearly every job will be custom, many jobs will be messy, it would be a challenge to even design the store layout. Will customers wait while employees help reinstall their OS? Do customers drop their computers off? How do they schedule? How does Microsoft keep it from looking like Fred Sanford's IT junkyard with all of these different computers in various states of repair? Does it sell or recommend hardware that's 'Windows 7 Capable'? None of this will be easy. And, Microsoft does the service for free, which cannibalizes their existing fee-based technical service. What else could be the motivation for Microsoft to open retail locations, other than a way to custom install Windows 7 on every machine and make sure that any conflicts are resolved? Many new product efforts that Microsoft undertakes now relate to itsmonopoly protection, and they have, to put it kindly, very mixed results. Againn, the problem with this scenario is that there are countless configurations of CPU, cards, and peripherals for Windows machines. Remember, for most of Microsoft’s existence, this was a selling point. Microsoft is a software company and let others make the hardware. The problem is now that there are so many existing devices that designing a single overarching operating system has become nearly impossible, and patching and reinstalling drivers is beyond the expertise of the average user. What then, other than this flailing attempt to provide belated service? Apple provides the same service with the Genius Bar, except it that it covers a relatively tiny combination of different devices, due to Apple's limited models, and better OS engineering. Very few of Apple’s customers would homebrew a computer the way it’s common with Windows, and Apple's hardware is designed with OS and service in mind. As one piece of supporting evidence for why Microsoft is very sensitive to its declining operating system monopoly, I would point to the cash on the balance sheets of Apple and Microsoft. A cursory glance at the figures says that they are similar. However, what is most interesting is the RATE OF CHANGE over the last 4 years. To begin, Microsoft's current ratio (current assets divided by current liabilities) is just above 1.5 and dropping. Apple's is almost 2.5 and rising. That figure can give a sense for the financial quality of the company. Next, look at the cash piles annually for the past 4 years. Microsoft will go below $20 billion in cash this year, and probably this quarter. It reduces its cash position with 5,000 layoffs, the subsequent restructuring, and by missing guidance in the last quarter. Apple should go well above $30 billion. $32 billion at fiscal year end may be achievable. Here are the numbers: MSFT cash and short-term equivalents by year-end, millions And here is the fiscal quarter ending Dec-08 AAPL cash and short-term equivalents by year-end, millions And here is the fiscal quarter ending Dec-08 In summary, Microsoft may feel that it’s necessary to backstop its OS decline as Windows 7 is launched, but it really may get more trouble than it bargained for. Like many of its recent investments, this initiative is likely to be one more way it taps its shrinking cash pile to attempt to protect its Operating System monopoly. And, like the Zune, Xbox, applications, and mobile, it is diversionary at best unless it fundamentally redefines how the stores add value. So, in conclusion, this may be necessary, given the stakes, but it's still unlikely to end very well. I predict that it will be great for Apple, though, like most other Microsoft efforts during the reign of Ballmer have eventually ended. Author's Note: Long AAPL, Short MSFT.
