Microsoft Risks Margins as Office Unit Fights Google
Bloomberg News
Microsoft Corp. President Stephen Elop is preparing for the biggest shakeup to the $19 billion Office business in a decade as the company races Google Inc. to sell Internet-based programs.
Two years into his career as head of Microsoft’s business software unit, Elop says cloud computing and social-networking sites have created a “constructive disruption” that could be more of an opportunity than a threat. Office 2010, due by June, will include a free Web-based version for the first time, matching similar software from Google. Future updates may add Twitter-like functions that allow users to post short messages.
The dilemma for Elop, 46, is how to embrace Web-based software while protecting his unit’s 64 percent profit margin. Under the cloud-computing model, Microsoft would store Office programs on its own servers and deliver them to customers online, which costs the company more than supplying software installed on computers. Elop says the shift will mean businesses actually end up spending more money with Microsoft.
“In that cloud environment, we are not only selling them software but we are also saying, ‘We’ll take care of your networking, your hardware your operations, your customer support,’” Elop said in an interview. “We’re doing much more work for the customer. What that does is increases revenue and allows us to participate in more profit.”
Elop’s Office unit is Microsoft’s biggest business, accounting for a third of the company’s $58.4 billion in sales last fiscal year. The shift to Internet-based versions of Office may cut margins by 5 to 10 percentage points, said Matt Rosoff, an analyst at Directions on Microsoft in Kirkland, Washington.
‘Have to Do Something’
“Elop’s challenge is to move carefully and not undercut the traditional software business,” Rosoff said. “You don’t want to give everybody free Office over the Web because that jeopardizes a highly profitable business, but you have to do something.”
Microsoft rose 24 cents to $28.59 at 4 p.m. New York time on the Nasdaq Stock Market. After gaining 57 percent last year, the shares have lost 6.2 percent in 2010.
Microsoft’s Office division, which dominates the word- processing, spreadsheet and presentation management software market, reported a 2.8 percent drop in revenue last quarter, with sales to businesses falling 6 percent. Consumer revenue rose 12 percent -- a slower pace than personal-computer sales, the Redmond, Washington-based company said.
Free Version
Microsoft is projecting that consumer and small-business sales will pick up with the release of Office 2010. The program will offer Web features, such as the ability to collaborate and share documents over the Internet. There also will be a free version included on some PCs and a student offer that’s two- thirds the price of the current product, which starts at $149.
That will attract consumers who might otherwise be reluctant to upgrade, Elop said. A record 4.5 million people have downloaded a test version of Office 2010, said Chris Capossela, a senior vice president who works for Elop.
The U.S. Olympic Committee used Office 2010’s SharePoint program to set up a Web site for reporters covering the Winter Games in Vancouver, allowing them to access the latest information on hometown athletes and follow their Twitter feeds.
Dell Inc. plans to install the new Office on at least 25,000 of its employees’ computers by year-end. It will rely on the software to help engineers and sales teams share notes and collaborate on projects over the Web, said Tom Piegat, a manager in Round Rock, Texas-based Dell’s information-technology department. Microsoft is taking the right steps to let employees work, save and share on the Internet, he said.
‘Jury Is Still Out’
“Whether that promise gets completely fulfilled with Office 2010, I’m not sure about that -- the jury is still out,” Piegat said. “But the building blocks are there.”
Office’s Web-based features are unlikely to generate significant additional revenue for the next few years and investors may not like the narrowing profit margins that result, said Heather Bellini, an analyst at ISI Group in New York.
“It’s a market they need to be involved in -- if that’s the way the industry is going, you don’t want customers to rip out Microsoft and go to a Google solution,” Bellini said. “But I question whether we’ll be able to have a company where the stock will go up even though margins are going down.”
Margins Shrink
Microsoft is selling more of its software as a service, which may hurt profit margins, said Bellini, who hasn’t yet calculated by how much. Besides the Web-based Office project, the company started charging this year for its Azure cloud- computing services, which store and run programs on behalf of customers.
Gross margin, the percentage of sales remaining after the cost of making the product, was 79 percent in the fiscal year that ended June 30. Ten years earlier, it was 86 percent, according to data compiled by Bloomberg.
Elop is playing catch-up in cloud software. Companies like Google and Salesforce.com Inc. have more experience with Web- based programs. Even so, Microsoft has an edge over Google in selling to large companies, Rosoff said.
Google, based in Mountain View, California, offers Internet-based word-processing and spreadsheet programs for free to consumers. It charges $50 a year per user for businesses.
“We welcome Microsoft’s movement to the cloud,” Google said in a statement. “Choice is good for users, and their direction further validates that the future of computing is in the cloud.”
In October, the Los Angeles City Council voted to have Google manage e-mail for city workers. Rexel SA, the world’s largest distributor of electrical equipment, also considered using Google -- until Microsoft cut the price of its e-mail software by 30 percent.
‘Pushing the Envelope’
“That’s going to be the challenge for Elop,” said David Smith, an analyst at Gartner Inc. in Stamford, Connecticut. “He is going to be competing more and more with things that are free or lower cost.”
Sales of cloud-computing services worldwide rose an estimated 21 percent to $56.3 billion last year, according to Gartner. By 2013, that number will hit $150.1 billion. The shift is of the same magnitude as the move to graphical computer software and the advent of the Internet, Elop said.
Elop, who was chief executive officer at Web-video pioneer Macromedia Inc., has experience building successful businesses out of Internet programs. At Macromedia, he helped make Dreamweaver the top Web-page authoring program, edging out Microsoft’s FrontPage. Macromedia also developed Flash, the Internet’s most popular video and animation software.
Elop said Microsoft CEO Steve Ballmer hired him in part because he had competed with the company for most of his life. Now that he’s at Microsoft, he’s championing the idea of making software that’s more compatible with rival products.
Rival Browsers
Elop wants to make sure that Office’s Web applications work on Mozilla Corp.’s Firefox and Apple Inc.’s Safari browsers, as well as Microsoft’s own Internet Explorer, Capossela said.
Elop’s interest in competing products impressed Capossela, who interviewed him for his current job without realizing he was screening his own boss. Elop walked into the Sunday morning interview at the Woodmark Hotel in Kirkland, Washington, with an iPhone, BlackBerry and Windows Mobile phone holstered to his belt, Capossela said. He pulled out each one to talk about them. Elop discussed his experience installing Microsoft’s Windows Vista on an Apple Macintosh computer.
He arrived as an outsider at the company, at a time when all the other product units were led by executives who had been at Microsoft more than a decade. Elop spent his initial few months listening to a team he inherited from 27-year Microsoft veteran Jeff Raikes, Capossela said. After about a year, Elop started talking about changing Microsoft’s approach to the market.
“He did a good job of articulating that we needed to be leaders in this disruption even though that can be scary,” Capossela said. “We can either worry about a disruption happening to us or we can do it in a way that’s constructive.”
Two years into his career as head of Microsoft’s business software unit, Elop says cloud computing and social-networking sites have created a “constructive disruption” that could be more of an opportunity than a threat. Office 2010, due by June, will include a free Web-based version for the first time, matching similar software from Google. Future updates may add Twitter-like functions that allow users to post short messages.
The dilemma for Elop, 46, is how to embrace Web-based software while protecting his unit’s 64 percent profit margin. Under the cloud-computing model, Microsoft would store Office programs on its own servers and deliver them to customers online, which costs the company more than supplying software installed on computers. Elop says the shift will mean businesses actually end up spending more money with Microsoft.
“In that cloud environment, we are not only selling them software but we are also saying, ‘We’ll take care of your networking, your hardware your operations, your customer support,’” Elop said in an interview. “We’re doing much more work for the customer. What that does is increases revenue and allows us to participate in more profit.”
Elop’s Office unit is Microsoft’s biggest business, accounting for a third of the company’s $58.4 billion in sales last fiscal year. The shift to Internet-based versions of Office may cut margins by 5 to 10 percentage points, said Matt Rosoff, an analyst at Directions on Microsoft in Kirkland, Washington.
‘Have to Do Something’
“Elop’s challenge is to move carefully and not undercut the traditional software business,” Rosoff said. “You don’t want to give everybody free Office over the Web because that jeopardizes a highly profitable business, but you have to do something.”
Microsoft rose 24 cents to $28.59 at 4 p.m. New York time on the Nasdaq Stock Market. After gaining 57 percent last year, the shares have lost 6.2 percent in 2010.
Microsoft’s Office division, which dominates the word- processing, spreadsheet and presentation management software market, reported a 2.8 percent drop in revenue last quarter, with sales to businesses falling 6 percent. Consumer revenue rose 12 percent -- a slower pace than personal-computer sales, the Redmond, Washington-based company said.
Free Version
Microsoft is projecting that consumer and small-business sales will pick up with the release of Office 2010. The program will offer Web features, such as the ability to collaborate and share documents over the Internet. There also will be a free version included on some PCs and a student offer that’s two- thirds the price of the current product, which starts at $149.
That will attract consumers who might otherwise be reluctant to upgrade, Elop said. A record 4.5 million people have downloaded a test version of Office 2010, said Chris Capossela, a senior vice president who works for Elop.
The U.S. Olympic Committee used Office 2010’s SharePoint program to set up a Web site for reporters covering the Winter Games in Vancouver, allowing them to access the latest information on hometown athletes and follow their Twitter feeds.
Dell Inc. plans to install the new Office on at least 25,000 of its employees’ computers by year-end. It will rely on the software to help engineers and sales teams share notes and collaborate on projects over the Web, said Tom Piegat, a manager in Round Rock, Texas-based Dell’s information-technology department. Microsoft is taking the right steps to let employees work, save and share on the Internet, he said.
‘Jury Is Still Out’
“Whether that promise gets completely fulfilled with Office 2010, I’m not sure about that -- the jury is still out,” Piegat said. “But the building blocks are there.”
Office’s Web-based features are unlikely to generate significant additional revenue for the next few years and investors may not like the narrowing profit margins that result, said Heather Bellini, an analyst at ISI Group in New York.
“It’s a market they need to be involved in -- if that’s the way the industry is going, you don’t want customers to rip out Microsoft and go to a Google solution,” Bellini said. “But I question whether we’ll be able to have a company where the stock will go up even though margins are going down.”
Margins Shrink
Microsoft is selling more of its software as a service, which may hurt profit margins, said Bellini, who hasn’t yet calculated by how much. Besides the Web-based Office project, the company started charging this year for its Azure cloud- computing services, which store and run programs on behalf of customers.
Gross margin, the percentage of sales remaining after the cost of making the product, was 79 percent in the fiscal year that ended June 30. Ten years earlier, it was 86 percent, according to data compiled by Bloomberg.
Elop is playing catch-up in cloud software. Companies like Google and Salesforce.com Inc. have more experience with Web- based programs. Even so, Microsoft has an edge over Google in selling to large companies, Rosoff said.
Google, based in Mountain View, California, offers Internet-based word-processing and spreadsheet programs for free to consumers. It charges $50 a year per user for businesses.
“We welcome Microsoft’s movement to the cloud,” Google said in a statement. “Choice is good for users, and their direction further validates that the future of computing is in the cloud.”
In October, the Los Angeles City Council voted to have Google manage e-mail for city workers. Rexel SA, the world’s largest distributor of electrical equipment, also considered using Google -- until Microsoft cut the price of its e-mail software by 30 percent.
‘Pushing the Envelope’
“That’s going to be the challenge for Elop,” said David Smith, an analyst at Gartner Inc. in Stamford, Connecticut. “He is going to be competing more and more with things that are free or lower cost.”
Sales of cloud-computing services worldwide rose an estimated 21 percent to $56.3 billion last year, according to Gartner. By 2013, that number will hit $150.1 billion. The shift is of the same magnitude as the move to graphical computer software and the advent of the Internet, Elop said.
Elop, who was chief executive officer at Web-video pioneer Macromedia Inc., has experience building successful businesses out of Internet programs. At Macromedia, he helped make Dreamweaver the top Web-page authoring program, edging out Microsoft’s FrontPage. Macromedia also developed Flash, the Internet’s most popular video and animation software.
Elop said Microsoft CEO Steve Ballmer hired him in part because he had competed with the company for most of his life. Now that he’s at Microsoft, he’s championing the idea of making software that’s more compatible with rival products.
Rival Browsers
Elop wants to make sure that Office’s Web applications work on Mozilla Corp.’s Firefox and Apple Inc.’s Safari browsers, as well as Microsoft’s own Internet Explorer, Capossela said.
Elop’s interest in competing products impressed Capossela, who interviewed him for his current job without realizing he was screening his own boss. Elop walked into the Sunday morning interview at the Woodmark Hotel in Kirkland, Washington, with an iPhone, BlackBerry and Windows Mobile phone holstered to his belt, Capossela said. He pulled out each one to talk about them. Elop discussed his experience installing Microsoft’s Windows Vista on an Apple Macintosh computer.
He arrived as an outsider at the company, at a time when all the other product units were led by executives who had been at Microsoft more than a decade. Elop spent his initial few months listening to a team he inherited from 27-year Microsoft veteran Jeff Raikes, Capossela said. After about a year, Elop started talking about changing Microsoft’s approach to the market.
“He did a good job of articulating that we needed to be leaders in this disruption even though that can be scary,” Capossela said. “We can either worry about a disruption happening to us or we can do it in a way that’s constructive.”
