Microsoft defends its big online gamble

CEO says losses are a small risk


Microsoft Corp. sought to persuade skeptical investors Thursday that spending on its unprofitable Internet business will be a worthwhile bet in the long run.

In a potential boost for that business, the company said it will be expanding its relationship with Facebook. The popular social networking site will incorporate Microsoft’s Live Search engine in the United States starting in the fall.

But executives at Microsoft’s annual meeting with financial analysts made it clear that the company still faces big challenges trying to catch up online. Microsoft is No. 3, behind Google and Yahoo, in search and advertising.

“We’re going to have to ante up in a significant way to even be in this game,” said Steve Ballmer, Microsoft’s chief executive.

He said financial losses in Microsoft’s Online Services Business will equal 5 percent to 10 percent of the company’s overall operating profit. But he called that a small risk, considering the potential payoff for the company in the growing online market.

That was the company’s overriding message during the meeting at its headquarters in Redmond.

Investors appeared unconvinced. Microsoft shares closed at $25.44, down 3.75 percent on the day.

More broadly, the company discussed the growth in its core businesses, including sales of Windows and Office software to big companies.

The company announced an agreement to acquire DATAllegro, of Aliso Viejo, Calif., which sells data warehouse appliances. Financial terms of the deal weren’t disclosed.

Microsoft also talked about its efforts to improve the public perception of Windows Vista. Bill Veghte, a senior vice president for Windows and online services, showed a video in which Windows XP users who identified themselves as predisposed to dislike Vista were shown a program called “Mojave,” described as Microsoft’s next operating system. After they declared themselves impressed, Microsoft revealed to them that the program was, in fact, Windows Vista.

“That’s our opportunity,” Veghte said. “Perception versus reality.”

But online services were the recurring theme of the day.

Chris Liddell, Microsoft’s chief financial officer, told analysts that the Online Services Business will ultimately become profitable, but he declined to give a time frame. Another of Microsoft’s emerging businesses, the Entertainment and Devices Division, reached operating profitability in the recently completed fiscal year.

Microsoft has said it will boost spending by an extra $500 million in the current fiscal year, primarily online. Analysts were seeking details on those spending plans.

Ballmer presented the company’s online strategy in the place of Kevin Johnson, the president in charge of Microsoft’s Windows and Internet units, who announced Wednesday that he is leaving to become CEO of Juniper Networks Inc.

Although Ballmer outlined the general areas where Microsoft will be spending, some analysts said they had come into the meeting looking for more.

“I’ve been pretty disappointed so far,” said Donovan Gow, software analyst for American Technology Research, after hearing Ballmer during the opening session. He said it would take more than “vague pie charts” for Microsoft to make its case.

“People probably have a little better understanding of what’s going on, but I’m not sure everyone is happy with it,” said analyst Alan Davis of D.A. Davidson & Co.

In the search market, Ballmer said the company faces a predicament. Users are drawn to search engines in part by sponsored results — the advertisements along the border of a search-results page. Delivering relevant sponsored results requires a large base of advertisers. But advertisers are attracted by large numbers of users.

That was a big reason that the company pursued an acquisition of Yahoo and, failing that, the purchase of Yahoo’s search engine, Ballmer said. Liddell told analysts that the chances of a full Yahoo acquisition are negligible. The company hasn’t ruled out a deal for Yahoo’s search engine, but Ballmer said no talks are taking place.

Ballmer hinted at other strategies for resolving Microsoft’s search market-share dilemma, but he specifically declined to describe them.

“There are alternative approaches around this Catch-22, which I’m not going to talk about today, but we need to do things to bring advertisers in the system,” he said.

Apart from that, Ballmer said, Microsoft is trying to come up with innovative approaches to the search business, such as the Live Search Cashback program, introduced earlier this year, which gives consumers partial refunds when they find and purchase specific items through the Microsoft Live Search engine. He also said the company will need to spend on marketing and its online brand.

Under the newly announced Facebook deal, the site will create “a rich search experience” for its users through Microsoft’s search technology, Microsoft search executive Satya Nadella told analysts. The service will launch in the fall.

It’s “an opportunity to further extend the Live Search reach,” Nadella said.

Microsoft has a minority ownership stake in Facebook and already provides display ads for the social networking site. Microsoft didn’t disclose financial terms or the length of the agreement. Although Microsoft’s display ad deal with Facebook is worldwide, the Internet search agreement applies only to the United States.

P-I reporter Todd Bishop can be reached at 206-448-8221 or Read his Microsoft blog at

Srinivas Katam

Do you need help growing your business? Srinivas Katam is a Digital Marketing Strategist and Consultant with over 200 successful SEO and Social Media client engagements completed. I’ve worked with brands across the world as a digital marketing consultant to deliver revenue growth from content-focused inbound marketing campaigns. He is an Innovative Marketer who specializes in digital marketing, specifically in social media, SEO and online strategy.

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