Microsoft Weathers Tech Downturn

As Sun Microsystems, AOL Time Warner and Oracle struggle with low stock prices, revenue declines and layoffs, the company they all love to hate had a phenomenal year.

Microsoft rang up record revenue in its most recent quarter, launched a flashy new video-game service and rolled out the Tablet PC, a pet project of chairman Bill Gates.

And while its legal troubles aren't over, the Redmond software powerhouse scored big when a federal judge approved the company's antitrust settlement with the U.S. Justice Department.

Just how long can Microsoft's roll continue?

Much of that depends on whether Microsoft can mature, said Matt Rosoff, an analyst with Kirkland-based Directions on Microsoft, an independent research firm. Microsoft needs to outgrow bad habits of missing deadlines for delivering new software and evolve into a leader that can clearly articulate its vision for the future.

It also needs to prove to angry customers that a new licensing program Microsoft forced on them was worth the cost and trouble.

"Microsoft's biggest competition, in a sense, is itself," Rosoff said.

The company's gains occurred against the backdrop of an industry languishing from tightened technology spending, internal strife and even accounting irregularities.

Sun posted a $111 million loss in its most recent quarter and laid off 11 percent of its staff. AOL Time Warner is restating two years of financial results and has shifted its business strategy. Oracle saw its sales and profits plummet in its third quarter.

In November, the year turned even bleaker for Microsoft rivals, who had hoped a federal judge would opt for harsher sanctions against Microsoft for illegally using its dominance over the desktop operating system to hobble competition.

Instead, U.S. District Court Judge Colleen Kollar-Kotelly approved the settlement with Justice. Only two states - West Virginia and Massachusetts - are continuing to press the case.

Others, including Sun, AOL and the European Union, are pursuing their own antitrust complaints. But taking the U.S. government out of the equation removes the biggest threat to Microsoft, analysts say.

For its part, Microsoft has been talking in recent weeks of its newly realized responsibilities.

"We need to create opportunities for lots of other companies to succeed if we're going to have an opportunity to be successful ourselves," said Brad Smith, Microsoft's general counsel. "There's a certain responsibility that comes with leadership."

That means talking with government on issues such as privacy, working with competitors to establish industry standards in emerging technologies and trying to be more responsive to customers.

The lawsuit wasn't the only big news out of Microsoft in 2002.

The company released MSN 8, a redesign of its Internet service and its most competitive effort yet against industry leader AOL. Microsoft also joined with hardware manufacturers to produce the Tablet PC, which includes handwriting recognition and has long been championed by Gates as a logical next step in making computing more portable. It also launched the Xbox Live online games service, a big bet for the future.

Still, Microsoft is anything but home-free in 2003.

As the world's largest software company delves more deeply into everything from software for wireless services to ways to make transactions on the Web smarter, Microsoft has more than a few competitors sharpening their knives.

IBM has thrown its considerable weight behind open-source software, particularly Linux, in which the underlying code is public and open for modification unlike Microsoft's proprietary software. Other big tech guns, including Sun and Hewlett-Packard Co. also are embracing Linux and open-source technology in their product offerings.

Microsoft's heft as a dominant global brand could suffer as Linux gains traction. Government agencies from Germany to China and even the United States are adopting software that is cheaper and in some cases politically more palatable.

Alternatives like Linux aren't Microsoft's only challenge - the whole notion of "computing" has expanded as well to include wireless devices that manage everything from e-mail to digital photos.

"They want to grow that space in 2003 aggressively," said Michael Gartenberg, a research director with Jupiter Research, adding that Microsoft will "continue to find ways to leverage its powerful position in the PC desktop space beyond the PC into other realms" - meaning crossing paths with the likes of Palm Inc. and Symbian PLC.

Microsoft will also need to better lay out the roadmap for upcoming versions of software, including the next Windows, codenamed "Longhorn," Rosoff said, adding that the company itself doesn't seem to have determined what the next version will include.

Perhaps as never before, Microsoft will need to prove its programs are worth the investment after it imposed a new licensing scheme that has already peeved many businesses and other bulk purchasers.

The program, which drove its revenues for the quarter ending Sept. 30 to a record $7.75 billion, imposed a subscription model on software upgrades, eliminating various discounts and forcing companies into multiyear contracts to avoid steeper prices when they do upgrade.

Microsoft is also dealing increasingly with grumbling from investors over its stock price, which is trading about 20 percent off year-ago levels. The rapid-fire sequence of stock splits over the years - that turned one original share back in 1986 into 144 shares today - came to a halt in 1999.

Some shareholders are calling for the company to pay dividends from its $40.5 billion cash hoard, a move Microsoft executives are resisting.

Microsoft, which is now revealing the revenues and profits of its seven business divisions, may also face added pressure to justify the millions it spends each quarter in four money-losing areas.

The company's 85 percent profit margins for Windows and 78 percent for productivity applications including Office, remarkable in any industry, allow Microsoft to easily sustain losses in Xbox and MSN.

But Microsoft is confident its massive investments will pay off.

"We don't think this is a mature industry in the sense that the inventions and the excitement are all beyond us," Smith said. "We think we have another two decades of innovation and change ahead of us. And we all share a great faith that these changes can be of profound benefit to society."
By HELEN JUNG