Ballmer: Investing in the Next Decade of Growth and Opportunity

April 28, 2006
Yesterday, we announced our Q3 earnings results and gave guidance for the remainder of our 2006 fiscal year and for FY07.

There has been a very strong reaction to our revenue and earnings figures. I want to provide some context for what we announced yesterday and let you know why I believe more strongly than ever that Microsoft is well positioned for sustained, robust growth in the years ahead.

Strong Revenue Growth

I’d like to start by turning the spotlight on revenue for a moment so that some important facts aren’t overlooked. First, I want to emphasize that with revenue of $10.9 billion, we turned in a record third quarter. That’s a growth rate of 13 percent, continuing a trend of revenue growth acceleration from 6 percent in Q1 to 9 percent in Q2 and now 13 percent. In addition, we returned $5.8 billion in cash to shareholders through our stock repurchase program and through dividends.

Growth in FY06 has been fueled by the richest product pipeline in Microsoft history. A 30 percent jump in SQL Server revenue due to the launch of SQL Server 2005 helped drive a 16 percent increase in overall revenue for the Server and Tools business. At more than 3 million units sold, Xbox 360 is the fastest-selling video game console ever to reach the market. Home and Entertainment, Mobile and Embedded, and Business Solutions all turned in stellar quarters. Taken together, these businesses show a combined revenue growth rate of 68 percent year over year.

All of this propels us toward the next wave of blockbuster releases. Windows Vista will be the most significant advance in PC operating systems in a decade. The 2007 Microsoft Office System will bridge the gap between information workers and the information they need to be effective. Exchange Server 2007 will reduce cost and complexity and provide more value. New offerings in enterprise search, unified communication, business intelligence and collaboration will make Microsoft a leader in developing solutions for businesses of all sizes, in every corner of the globe.

Investing to Win

Throughout our history, Microsoft has won by making big, bold bets. We’ve always taken a long-term approach, striving to solve the hardest problems in computing and working to realize huge new opportunities in vast new markets through investments in innovation across the broad spectrum of human endeavor.

I believe that now is not the time to scale back the scope of our ambition or the scale of our investment. While our opportunities are greater than ever, we also face new competitors, faster-moving markets and new customer demands.

So what accounts for the negative reaction that we’ve seen from analysts and investors?

To ensure that we win where we see opportunities and can respond with speed when the marketplace changes, we made the decision to ramp up investments during Q3 in a number of key areas. In addition, the cost of producing Xbox 360 consoles was higher than expected, while at the same time we decided to manufacture and sell as many consoles as possible to build on our lead in the race to be number one in the video game business.

These investments will continue. As a result, we also provided guidance for Q4 of this fiscal year and for FY07 that indicates our willingness to be aggressive when making investments where they are strategic for future growth.

The bottom-line result of these investments created a shift in our near-term profitability that was a surprise. The change in our stock price reflects this.

But I’ve never been more confident that we are making the right investments. In addition to adding a third manufacturing facility to enable us to meet market demand for Xbox 360, we are investing heavily in our services strategy; in our readiness programs for the launch of Windows Vista, Office 2007 and other products in the pipeline; and in a number of other areas where we see opportunities for rapid growth. We’ve accelerated the pace of our hiring and increased spending to ensure that we continue to bring the world’s brightest minds to Microsoft.

When you look across the array of businesses we are building, it is clear that we are in a position that no other company can match. We have made and we continue to make the investments needed to ensure strong growth for our core businesses, while delivering the innovation that is essential to establishing a leadership position where we see opportunities in businesses such as entertainment, mobile devices, search and software-based Internet services.

Turning Investment Into Growth

These investments reflect our blueprint for translating today’s investments into tomorrow’s growth. First, we must grow our core businesses by growing as markets expand and winning new business. Then we must look beyond this core and win in adjacent high-growth businesses. At the same time, we must continually innovate to ensure that we have an answer to the disruptive business models that are emerging. Finally, we must execute our Live strategy with speed and precision.

I think it is helpful to understand the sheer breadth of our ambitions across our businesses:

Preparing for launch: The success of Windows, Office and Exchange is critical to our growth strategy. These will be the largest launches in company history by every measure and the first time since 1995 that we have launched these flagship products simultaneously. We are making a considerable marketing and sales investment for these launches.

Windows Vista will drive growth as PC shipments increase in developed markets, through upgrades across our installed base and through the new higher-value premium versions we are bringing to market. Anti-piracy initiatives are important—in FY06 nearly 60 million PCs were sold with unlicensed versions of Windows. Windows Genuine Advantage program and recent deals with leading PC manufacturers in China are examples of our efforts to ensure that we realize the full value of our intellectual property.

The launch of Office 2007 and Exchange 2007 will enable us to build on our leadership position and grow as the market for business software and services grows from $80 billion today to more than $150 billion in FY09. Improved pricing and segmentation and a new focus on SharePoint and Office Server will help us further expand our business.

Winning adjacent high-growth businesses: Building on the launch of Windows, Office and Exchange, we see important opportunities across our businesses. Innovative offerings designed to improve the affordability of Windows PCs for people in developing countries will drive growth in emerging markets. In Server and Tools, our end-to-end security, better management products and improved development tools will enable us to win in key high-growth server and customer segments. In addition, we’ll enter the high-performance computing market this year and we’re working to establish a foothold in verticals such as life sciences and manufacturing.

Microsoft Dynamics products, which bridge the gap between business processes and business practices, will significantly broaden the addressable business market that we sell to. New versions of Microsoft Dynamics business management solutions position us as a strong competitor in fast-growing markets for business process systems, Office business applications and more.

New opportunities: We are particularly excited about the new opportunities that lie before us. Xbox 360 is a great example. By July, we’ll reach 5 million consoles sold and when Sony and Nintendo launch their next-generation consoles, we’ll be well on the way to establishing Xbox as the gaming industry leader. Xbox Live, which reached 1 million subscribers faster than almost any other subscription entertainment service including HBO and TiVo, remains the industry leader in online gaming, with nearly 3 million members today.

The success of Xbox 360 and Xbox Live is enabling Microsoft to begin to redefine how people create, deliver and experience entertainment. And they put us in a unique position to succeed in huge new markets.

After almost a decade of investment, our big bold bet on television is about to begin to pay off, as well. Today, nine of the world’s leading broadband service providers have announced commercial deployments using our IPTV Edition. Expect to see many more in the future.

Windows Mobile and the Windows embedded platform also offer huge opportunities for growth. We are making strong progress versus RIM in the business segment and we expect to expand our presence in the consumer segment. One sign of our growing importance in the mobile market is the fact that we sold more Windows Mobile devices in 2005 than RIM’s entire installed base.

In addition, our strong product pipeline positions us to go after high-growth businesses, including unified communications, information worker services and business intelligence.

Accelerating our progress in Live services: It is essential that we lead the industry through the critical paradigm shift from software to software-based Internet services.

Heavy investments in our search platform, adCenter and new data centers that will enable us to meet rapid growth in demand and show how serious we are about Live services.

Further development of adCenter is key—our goal is to create the Web’s largest advertising network, giving us an engine that will enable us to monetize our services and compete against Google. Progress depends on our ability to create a solid developer value proposition around the Windows Live Platform as we continue to build out the Live infrastructure. These are long-term efforts and we may not see results overnight. But we are making smart investments that will enable us to win in this vital area.

Our Opportunity

Over the last five years, Microsoft has seen remarkable growth. In FY01, we were a $25 billion company with $12 billion in operating profits. Last year, we hit $40 billion, with $19 billion in operating profits. Our record revenue numbers for this quarter and this fiscal year continue this pattern of strong growth, and we expect to finish FY06 at about $44 billion, a jump of 11 percent over last year.

In 2000, the top 25 companies in the IT industry totaled $62 billion in operating income combined. Microsoft accounted for 18 percent of that total. Five years later, we had increased our share to 23 percent of a pie that had grown to $84 billion. That pie continues to increase in size, and so does our share.

Today we are poised to take an even bigger piece of an increasing number of ever-expanding markets. From the server to the desktop to mobile, we sit in a unique position thanks to our willingness to make the big bold bets. These bets will pay off in FY07, when we’ll see revenue that is expected to reach $49.5 to $50.5 billion, for a growth rate of 12-14 percent. Longer term, our opportunities for growth are phenomenal, and I expect the next five years will see results that eclipse the performance of the last five.

The Bottom Line

The reaction to yesterday’s news is a lesson that the entire leadership team at Microsoft will learn from. 2007 is a critical execution year for the company and the divisional Presidents, Kevin Turner and I are immediately going to redouble our efforts on business execution and financial discipline. We are also committed to ensuring that across our businesses we are making the best use of our existing resources to achieve our key priorities.

I believe everything that this company has delivered during its first 30 years is really just the foundation for the truly profound changes we will drive during the next 10 years. Right now we are heading into a period of tremendous opportunity that will see us drive profits and improve our position in the marketplace. We are poised to achieve strong revenue growth in core businesses, meet the challenges of disruptive business models and compete in high-growth areas. But we must be agile and smart when it comes to innovation and flawless when it comes to execution. If we do that, we will see incredible returns on the investments we’ve made during the last quarter and the last decade.

Steve