These Days, Microsoft Isn't So Scary

By Alex Salkever A few years ago, few analysts would have predicted that Microsoft (MSFT) might share the key computer code that powers its dominant Office productivity software with dozens of foreign governments and international agencies. Yet in late September, the industry barely blinked when the world's largest software outfit announced it would open the code to one of its crown jewels. Ostensibly, Gates & Co. coughed up its code to keep customers happy and maintain a lucrative line of business with governmental organizations. A host of alternatives from StarOffice, OpenOffice, and other pretenders can do much of what Microsoft Office now does, and at a fraction of the price.

Not that anyone is tossing out Office yet: It remains a superior product and enjoys a near monopoly on the desktop market for word processing, spread sheets, and other basic office software. But the move to defend Office is one more sign that Microsoft is no longer an unstoppable force. "It was going to be the company that had the operating system for everything, and they were going to win the game. Today when you ask people about this, they are not sure," says Jim Mackey, director of development at the Woodside Institute and a research who studies the performance of very large companies.

FOGGY CRYSTAL BALL. Microsoft declined to comment for this story. But many analysts now see the Colossus of Redmond losing influence in the IT universe. No doubt, some of that perception among competitors -- and their new sense of courage -- comes from witnessing the bloody, multiyear battle waged in the 1990s against Microsoft by the Justice Dept. for alleged antitrust violations. Also important: broad structural changes in the IT sector that play against Redmond.

Computing power is shifting away from the desktop, where Microsoft still dominates. Business customers more and more treat software as a commodity and a service. The inability of Microsoft's own massive research efforts to divine the next big thing in IT also has left Redmond in no better position to capture the future than small startups or smaller competitors. "You look at the earnings numbers and they are not doing badly," says Merrill Lynch software analyst Jason Maynard. "But competitors and customers don't feel the same threat. There are definitely some dents in the Death Star."

Fixing those dents could prove a tricky test for Microsoft's management, particularly as innovations in desktop and laptop PCs lag while innovations in smaller, yet increasingly powerful, handheld devices continues to flourish. While Microsoft remains a front-runner to provide software for those devices, it has failed to lock up the dominant market share in any category.

In some cases that has been due to resistance on the part of the service providers. Mobile-phone outfits, for example, wish to supply Microsoft-powered smart phones, but they are wary of Redmond becoming their sole supplier. "Cell phones and smaller devices are taking away from the PC and from Windows. That has affected perceptions of Microsoft," says Michael Cusumano, a professor at MIT's Sloan School of Business.

WANING INFLUENCE. Equally important in Redmond's waning influence has been the declining profitability and revenue growth of the software sector as a whole. That's come courtesy of the creeping commoditization of a field where more and more companies are all too happy to give away their product in exchange for service deals down the road, and where the products themselves have become more interchangeable.

That hasn't much affected Microsoft's consumer-products units, but it could start to hit Redmond's nascent business software divisions, where CEO Steve Ballmer hopes to gain the most growth. "We've seen dramatic declines in revenues for software-product companies. It's hurt more companies like Oracle (ORCL) or PeopleSoft (PSFT) or SAP (SAP) as revenues have flattened out. In general, the whole industry has waned in influence. Microsoft has been the leader of that industry, and it has struggled to keep up," says Cusumano.

In trying to go beyond its heritage as a desktop giant, Microsoft has found the going hard on many fronts. That's despite Redmond's whopping $6 billion annual research budget. Take the ongoing ascent of the Java software system. Developed by Sun Microsystems (SUNW), Java code can run on multiple platforms without modification or customization. Java was specifically targeted at programming for the Internet.

ATTITUDE ADJUSTMENT. In the past three years, Java has become a highly popular tool used by Web programmers to build simple applications that can run inside Web browsers on most PCs. Several years ago, Microsoft offered its own version of Java and refused to ship Sun's Java on Windows machines. Today, every Windows PC coming off the assembly line is compatible with Java.

Another manifestation of Microsoft's waning influence is its inability to set the technology standards that could dictate future winners and losers. On Sept. 15 a group of Internet service providers (ISPs) rejected a basic standard for antispam policy proposed by Redmond. While antispam policies have proven particularly contentions, Microsoft controls the overwhelming majority of desktop e-mail software through its Outlook franchise and proprietary MAPI mail format.

True, in this case Microsoft is merely trying to play nice with other Internet powerbrokers. But such behavior is hardly a hallmark of the old Microsoft, which built standards first and asked questions later.

The loss of clout affects Microsoft in subtle ways. Not long ago, Redmond could take its pick of tech talent, and usually did. Now other tech notables seem to have the edge. Of late search-engine powerhouse Google (GOOG) has raided Redmond's ranks for programmers.

MEAGER RESULTS. "Microsoft still has the critical mass and the franchise of Windows and Office, but there are fundamental changes going on in how we computer and how businesses get value out of IT," says Merrill's Maynard. He further points out that many of these trends, including the rise of on-demand computing models, and software as a service, putting more computing power into the networks, are somewhat antithetical to the Microsoft model.

Could Microsoft buy its way back to leadership in technology innovation? Probably not. Redmond's acquisition track record has been spotty at best. It reeled in Navision and GreatPlains for a total of $2.5 billion to buff up its product line in financial, human resources, and other applications for midsize businesses. But those units have failed to add much to the bottom line -- or create synergies with Microsoft's other products.

In the past, the Microsoft culture has proven a formidable barrier of entry to acquisitions. In fact, the only acquisition that has ever been fully integrated into the fold is Web-based e-mail service Hotmail. "They have bought companies, but they have never learned to integrate them," says Mackey. "It was buy it and kill it."

BIG-BUCK BARRAGE. Microsoft continues to command respect bordering on fear from rivals When e-mails emerged in a U.S. Justice Dept., antitrust case against Oracle in the summer of 2004 that revealed Microsoft had considered buying business-applications software behemoth SAP (SAP), the rest of the corporate software market reacted with terror, says Merrill's Maynard. It's a measure of Redmond's continued clout and its massive wallet, which grows ever fatter off the $1 billion cash the outfit's two premier franchises generate each month.

Should technology "next big thing" reveal itself in the not-so-distant future, Redmond could again swing into action. "When they have a target, they shoot at that target until they win. But they don't have a clear target right now," says Haim Mendelson, a professor at the Stanford Graduate School of Business. For Microsoft, the challenge is to recognize that target before it's too late. Salkever is technology editor for Business Week Online

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