By Carl HoweToday's New York Times covered Steve Ballmer's announcement yesterday that Microsoft's (MSFT) Vista and Office 2007, as well as a lot of server products, are now available to corporations. The Times' photograph (below) showing Steve Ballmer ringing the opening bell for the NASDAQ with gusto portrayed many other corporate executives sharing the euphoria of the moment with Steve and presumably, with the anticipation that billions of dollars would soon be raining down onto their heads and into their backdated stock option packages.
The ringing of the opening bell for the NASDAQ was completely and appropriately symbolic. Why? Because both events -- the ringing of the bell and the release of Windows Vista -- were in the words of MacBeth, "full of sound and fury, signifying nothing."
The bell signified nothing because the NASDAQ is a completely electronic exchange. There is no trading floor. The big electronic scoreboard in Times Square was in fact built entirely for marketing purposes, so that investors and consumers could be shown something that had comparable impact to all those traders running around the floor of the New York Stock Exchange. But be assured that if Steve Ballmer had not rung the bell yesterday, somehow the NASDAQ still would have managed to trade a few billion dollars anyway.
But the corporate release of Windows Vista and Office? Surely they must mean something?
Um, actually no. They are completely immaterial to Microsoft's earnings this quarter and next. And it's not just me saying this; John Dvorak, and The Wall Street Journal are chiming in with similar takes (the latter being less extreme than the former).
See, most large corporations don't buy software the way you and I do. Instead, they sign enterprise licensing agreements that provide a customized suite of software including Windows, Office, and other products for every desktop under license. The licensing agreements are largely secret in detail, but they provide substantial discounts from list prices of the software packages in exchange for the enterprise agreeing to rather stringent (and in my opinion silly) terms, such as guaranteeing that they are licensing every desktop in the company, regardless of whether it runs Windows, Office, or any other software being licensed, or not. Oh, and by the way, this license fee is in addition to the cost of Windows bundled with PCs for the corporation; Microsoft insists that that version of Windows doesn't actually grant a corporation the right to use it. The terms of these licenses run anywhere from two to five years and, provided that the company signs the "Software Assurance" license, include upgrades.
What this means is that most corporate editions of Windows Vista and Office 2007 have already been paid for. The net impact of the Vista corporate release on Microsoft's actual cash flow and revenue (as opposed to the GAAP accounting which has reserves for these payments) is largely zero. The only way Vista would have affected Microsoft is if it hadn't been released. After five years of Software Assurance contracts with no upgrades, companies might have started bolting at renewing their contracts. And that would have had a very negative impact on Microsoft's future earnings.
The reality is Microsoft isn't really a technology company. It's a toll collector. It buys up toll-generating properties and then just collects the tolls on them, just as Spanish and Australian consortia are buying up the Chicago Skyway and the Indiana Toll Road. Don't believe it? Take a look at this list of Microsoft innovations; you'll find that most of them actually were built at other companies, and then bought by Microsoft. That's why Vista took five years -- Microsoft actually had to build something instead of just maintaining it. It's just not the company's core competency.
Make no mistake: there are a lot of great technology people who work at Microsoft. But what innovations they might be able to achieve have been stifled by corporate organizational chaos and stifling development processes. When it takes 24 developers and their management to design a single button in your product, you know there is something wrong with a company. When you combine this with the fact that Microsoft has bought, not built, most of its successful technology, you don't exactly have a formula for the next great technology breakthrough. Remember, only two of Microsoft's product lines consistently make money. All other product lines actually dilute earnings instead of contributing to them.
So what's wrong with being a toll collector? Not a thing. It's just like being a utility -- it provides a consistent earning stream that should generate significant dividends. The only problem: Microsoft isn't valued like a utility; it's valued as a technology company with a price earnings ratio of 23, whereas utility companies tend to be in the teens. And its dividend yield of 1.3% is a far cry from the 2% to 4% of utility firms. And utility companies don't devote seven billion a year to research and development either, nor do they launch me-too music players like Zune. They do, however, have an obligation to do maintenance on their properties, and that's exactly what Vista and Office are: maintenance.
But the story is actually more dire than I've described, because while Microsoft is counting its tolls, competitors are now building lots of quite viable bypasses to Microsoft's toll roads. In operating systems, Apple and Ubuntu now have quite competitive offerings that run on the same hardware base as Windows. With Office 2007, migrating to Open Office now will require less training than moving to the Microsoft product. And the list goes on and on; someday, someone will have to explain to me why anyone ever pays for Microsoft's Outlook Mail licenses when they could have Google run their mail systems for them for close to free. Despite the corporate licensing deals, demand for those licensing deals will soften as Microsoft continues to do five year release cycles.
If Microsoft ever wants to become anything other than a toll collector with a valuation to match, it really has only one option: change the leadership and break up the company into smaller pieces that an actually compete. But until that happens, we should stop pretending that Microsoft is driving the technology industry any more than we think that Australia's Macquarie Infrastructure Group is driving the US auto industry. Toll collection isn't innovation, no matter how many billions get collected. And the sooner we stop praising the toll collectors as the apex of US business success, the better.
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