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Microsoft is losing some of its elbow room

As software king Microsoft's growth slows, rivals stake out their own territory.
/ Source: a href="" linktype="External" resizable="true" status="true" scrollbars="true">The Washington Post</a

Rob Enderle, a longtime Silicon Valley analyst and observer of Microsoft Corp., remembers what used to happen when a tech start-up sought funding for a business that might brush up against the software giant's universe.

"It would be hard to get a meeting" with venture capitalists, Enderle recalls. "It would be harder not to get laughed at in the meeting. And to get any money, you'd have to get them drunk first."

The danger was that if Microsoft felt threatened by, or even jealous of, a new or rival technology, it could create something similar and fold it into its Windows operating system. Since Windows powered just about every personal computer on the planet, Microsoft's version of the new program would get unassailable, worldwide distribution.

Windows is still the brains of nearly every PC, and Microsoft remains one of the most profitable, powerful and storied companies ever created. But the shadow cast by the colossus of Redmond, Wash., is looking less imposing today.

Its financial growth is slowing -- in the single digits in sales growth for fiscal 2005 over the previous year, for the first time in the company's history -- and its stock has been flat for five years. It missed some of the most popular technology advances in recent years, such as searching the Internet and downloading music. It continues to fight antitrust battles in Europe and Asia and has had to divert resources to confront persistent security holes in its software.

Rivals mature
Meanwhile, a handful of Internet companies such as Yahoo Inc., eBay Inc. and most particularly Google Inc. have matured into well-financed rivals challenging Microsoft in several areas. In the most recent example of Microsoft's fall from almighty status, Google outmaneuvered and outbid it for a stake in America Online Inc., a combination Microsoft hoped would boost its own MSN online service.

Today, Google is the verb for search. AOL's instant-messaging service still dominates the landscape. File-sharing software and Apple Computer Inc.'s iTunes have redefined how the digital world gets and listens to music and videos. Yahoo is the most trafficked Internet portal.

"Now," Enderle said, "it's Google" that worries venture capitalists eyeing software start-ups.

These might seem like mere speed bumps for a 60,000-employee company that in the 2004-05 fiscal year generated $1.4 million in profit every hour. But they speak to what many analysts say is the most significant challenge Microsoft has ever faced:

The center of the computing experience is rapidly moving from the desktop of the PC, which Microsoft largely owns, to the Internet, which it does not. With Internet connections getting faster and more able to handle large volumes of information, whole software programs can be delivered or used online.

Thus, in what is known as the Web 2.0 world, a start-up aptly named Upstartle LLC offers an online program for creating, writing and sharing documents. Whereas the Microsoft Office suite that includes such tools costs more than $140, Upstartle's service is free, with add-on features to be made available for a subscription fee later.

"Where I do my word processing, how I collaborate, maintaining my social network . . . those things are shifting away from Microsoft," said Tom Bittman, a research fellow at Gartner Inc., a market research company.

George F. Colony, chief executive of Forrester Research Inc., which analyzes market trends, argues that companies that serve consumers via Web pages will begin to do so using actual software programs, to increase the services they provide.

Dubbing the trend "X Internet," for executable Internet, Colony said it is a revolution being led by Google, at the expense of Microsoft's hegemony.

"I predict that Microsoft, under attack from advertising-funded software," Colony wrote, "will lose its monopoly-driven 25 percent net profits over the next several years, having to settle for 13 percent to 15 percent nets (still astronomical compared with the average for most large corporations)."

Perhaps as troubling for Microsoft, Bittman added, is that "the typical teenager five to eight years ago knew a lot about Microsoft, and lived and breathed their stuff, a lot more than they do now."

Microsoft bristles at this kind of talk and refused to make a top executive available for this story.

"We are a company focused on the future," according to a written statement from spokesman Vivek Varma. "Regrettably, the premise of this article is a rehash of stories previously published in other publications. Microsoft is operating on all cylinders, delivering breakthrough products this year including Xbox 360, Windows Vista and Office 12. And we invest in the future, we are breaking new ground in areas like search and services and we continue to aim at best in class for each category of product we develop. In short, we are extremely bullish about our future."

'Sea-change' moment
Yet early last month, Microsoft founder, chairman and chief software architect Bill Gates issued one of his periodic calls to arms to his troops, warning them that the industry and their company were at a pivotal, "sea-change" moment:

Microsoft's software must operate "live" and online, Gates announced, to engage users in today's always-connected world. Gates and the company's chief technology officer, Raymond Ozzie, outlined how the coming versions of Windows and its Office suite would incorporate online components such as instant messaging, mobile telephony and search.

"Even beyond our large competitors, tremendous software-and-services activity is occurring within startups and at the grassroot level," Ozzie wrote in a blunt and lengthy October memo to company executives titled "The Internet Services Disruption." Failure to take leadership of this change, he said, would put Microsoft at risk.

Essentially, Microsoft hopes to straddle the fence: extend its software with online features but lead its rivals by continuing to leverage its power over the PC. Gates and Ozzie said the company's advantage would derive from a "seamless" computing experience with Windows still at the core, enabling users to do more than if they cobbled together alternative, Internet-based software or services.

Similarly, the strategy for the just-released Xbox 360 gaming platform is for it to become an Internet-based hub for home entertainment and communication, working with other Windows-based applications.

Some analysts are confident Microsoft can pull this off, and even its most ardent detractors say it is foolhardy to write the company's obituary, or even to consign it to aging, slow-growth status more akin to an old-economy company.

"They are not on the ropes," said Bill Whyman, an economist and analyst for the Precursor Group, an independent financial research firm. "I think their prospects are very strong."

Whyman is particularly excited about the upcoming Office 12 release, which he said will turn the software package "into a rich, smart, networked front end" that many businesses will use as their primary computing environment, for both online and off-line work.

These new product offerings will boost the company's already healthy bottom line, Whyman said, but he agreed that some of Microsoft's slowing growth curve is inevitable.

"They're not giving out monopolies anymore, so get over it," he said. "Anything Microsoft does will have lower margins" than it once did.

Throughout its nearly 25-year history, Microsoft has faced moments of major challenge, most dramatically when the Internet first burst onto the public scene in the mid-1990s. Microsoft's fierce response to the threat from browser pioneer Netscape Communications Corp. included actions that ran afoul of antitrust laws and nearly resulted in a court-ordered breakup of the company.

Each time, Microsoft persevered, won the battles and kept growing. And with a cash hoard of $40 billion, it has resources almost no challenger can match.

But skeptics think a combination of factors make this moment in time different.

Creators move away from Microsoft
When its dominant desktop software was the only game, Microsoft could dictate the direction of the development of many related programs and tools. Developers who wanted their creations to get wide use had to work on software that would work in the Windows environment.

Now that the Internet is a mature platform for writing and distributing software, it is teeming with creators who often work collaboratively to develop programs that are deliberately not oriented toward Microsoft.

"When we were there, our influence on where things were going was dramatically higher because of the lack of an open-source community, standards bodies, and the inability of developers at-large to communicate," said Rick Segal, a Microsoft employee in the mid-1990s who now is a partner in a Canadian venture capital firm. "Those days are so over, it's frightening."

In fact, Segal said, he has informally surveyed many ex-Microsoft engineers who have left the company to strike out on their own. A surprising number, he said, are not interested in pursuing programs that would take advantage of Microsoft's platform.

"I found they were not only leaving the company, they were going ABM . . . anything but Microsoft," Segal said. "They were actively producing products that Microsoft would consider competitors."

Whereas once Microsoft had its pick of the best and brightest engineers, Google is now the hot company. Competition for talent has been so fierce that the two companies recently battled in court over whether Google could hire a Microsoft senior scientist in China. (It could.)

In a deposition, a Microsoft engineer said that when he told Microsoft chief executive Steven A. Ballmer that the scientist -- Kai-Fu Lee -- was defecting, Ballmer went into a chair-throwing, expletive-laced tirade about Google. Ballmer denies the account.

Other analysts say that Microsoft's size has become a disadvantage and that its ongoing strategy of linking everything to Windows and its siblings adds complexity, delays new products and frustrates its engineers.

Vista, the next version of Windows, is scheduled for the second half of 2006, pushed back from a hoped-for release this year and without some originally planned features.

'Big, bureaucratic organization'
Peter S. Cohan, president of his own management consulting and venture capital firm, measures a company's ability to move quickly against competitors by examining its "OODA loop," or its ability to observe, orient, decide and act.

"Microsoft has a very, very ponderous OODA loop," Cohan said. "It's become a big, bureaucratic organization" that is constantly trying to balance the interests of various divisions.

In his memo, Ozzie ticked off several areas in which the company failed to grab leadership, even though in some cases its engineers were first to develop the underlying technology.

"While we've led with great capabilities in Messenger & Communicator [voice-over Internet software built into its instant messaging software], it was Skype [Technologies SA], not us, who made VoIP broadly popular and created a new category," he wrote as one example.

And he warned that "complexity kills. It sucks the life out of developers . . . it introduces security challenges, and it causes end-user and administrator frustration."

Ironically, given how hard Microsoft fought the idea, Cohan and a handful of other analysts think the company would be better off broken up. The Windows company could be the slower-growth, dividend-paying firm, while gaming and other Internet-based initiatives could be its version of a start-up.

Matthew Rosoff, an analyst with Directions on Microsoft, which publishes a newsletter that tracks the company, disagrees.

"For a company their size, they are actually quite agile," he said.

But perhaps its greatest strength, he said, is its discipline and perseverance even when its early efforts are not successful.

"They've been putting money into interactive TV" without financial return, he said as an example. "But they keep hammering away at it, because they say, 'If this takes off, we have to be there. It's a software business.' "

He particularly credits Gates and Ballmer with taking the long view in an industry often blinded by short-term fads.

"They want to make sure there is a Microsoft in 30 years, and that it is still a dominant company," Rosoff said.