Small and Midmarket Solutions & Partners
2003 Financial Analyst Meeting
July 24, 2003

ORLANDO AYALA: Good morning and welcome again.

After 12 years with the company in many field assignments, I could not be more excited and pleased to be the one helping the company making our push and making our offerings as broadly, as visible to this very, very exciting and important segment. Many players in the marketplace have talked about this for many years, and we do believe this is a time where great opportunity is there for a lot of people—especially for customers.

Let me just define the segment very quickly, a few seconds on that. We define the small and medium segment basically as a thousand employees and less; that's how we consider that segment.

Within that segment, of course, there's a clear differentiation between those companies that have very little IT or no IT and the companies that have some sort of an IT resource. That I just wanted to level set a little bit how we segment this marketplace.

Let me speak about opportunity because as I said before the industry as a whole I think has been working in this marketplace for a long time on trying to deliver great solutions. And I would like to speak of the opportunity in three dimensions first: the customers, the industry, and partners.

And let's just start with customers. This market, the way we segmented it, is about 45 or so million customers and without a doubt this is a space that has led for the most part with a very, very, very fragmented type of solution. It's been basically point solutions or solutions that have been from the enterprise scaled down to try to service small and medium business.

There is no reason why these customers should not be able to operate as a global enterprise, no reason why they cannot connect to the supply chain, their customers in a much, much better way. So we believe there is a huge amount of opportunity here for customers specifically to be able to run their companies much, much better.

Again, fragmentation has been an issue. That touches the industry also. There are many, many solutions that are actually very low volume. We believe that there is a lot of R&D money in the marketplace today applied by ISVs in solutions that are very, very targeted to very, very type of narrow solutions.

So we believe that that amount of R&D that is being applied in horizontal business type of applications with no differentiation is there for the industry to basically and, of course, Microsoft also to be able to bring innovation at that level and then allow R&D that ISVs are doing today to be applied more directly to the customer needs. So we see here a real opportunity also in the industry specifically for ISVs as we bring a platform that can be basically extended to them.

And then last but not least there is no doubt that partners play a very important role for us here. They're really extending the value to customers specifically, and that's why we have been committed for a long time to the partner asset. The partner asset delivers still 95 percent of the revenues that we are able to achieve in the marketplace, and we see them also as a very, very important and integral part of how we're going to deliver this value to this customer segment.

So very important here and the industry has strived for a long time, a lot of promises, but the reality is still I think this segment is underserved and our mission as a company is to try to bring that value not just to a few customers but to many millions of them. I spoke of about 40 or so million customers out there. This is the size of this opportunity.

And I want to relate this challenge with the early challenge the company had in the personal productivity space. There was a dream back in 1985 when we believed that personal productivity mattered and, well, we are sitting here in 2003 with 600 million customers. Certainly after you have seen Jeff's presentation, I hope you agree the job has not been done yet and we're taking it to the next level.

But what we think still as an opportunity for customers is to realize the opportunity of broad, very broad business productivity and insight. That is where the opportunity has not been realized, and that's how we're bringing the assets together with our Microsoft® Business Solutions asset to ensure that we create the same opportunity both for customers and the whole system to allow massive value to be delivered in that space.

I put a question mark not because I have a doubt we're going to get there; I firmly believe that we have the opportunity to create that effect of value in the marketplace for customers. I'm just putting up the question mark just to say the company is very committed to this for the long-term, and again I am very excited to have the opportunity to be able to lead that effort.

Let me talk about our core strategies. We spoke about opportunity. We spoke about the fact that this is a broad-scale challenge. We don't believe in just a few customers really realizing that value but many of them.

There are four strategies here we are pursuing for this segment. Number one is targeted research and development. Yes, we are investing a lot in many things, but I do believe we are the company that for a long time has been investing in this space and we're going to take it to the next level. I will go into more detail, a little bit more detail later.

Second, I said this is not about just one customer or a few customers receiving this value. This is about a broad set of customers. Our target would be 40 million customers that should be able to benefit from this value.

And three, an extensive system, a system that basically can enhance the value proposition to these customers and certainly in that process achieving that value that customers are expecting.

Great business value is the fourth strategy. You have seen a lot of that; I hope in the morning, you have realized that. But it's really not just about the software. Of course, software innovation is very important to how we enable the opportunity for these customers but certainly the services and all the other elements that truly create a solution for these customers are a very important part of the equation on how we will pursue this opportunity moving forward.

Let me start with great business value, the bottom-right side of the slide. You have seen already Bill, Jeff, Jim, and others talking about different pieces of this value stack, but it's really our team in the field that's the one that needs to bring this and make this value very real to customers.

This is a platform that's highly integrated, and as I said before, the fact that we are investing significantly in the small and medium space to be able to deliver that value—not just for the big enterprise but for millions of enterprises—is the role that will be played in the field is basically taking that integrated value through the platform and be sure that it can get consumed in the easiest, most effective way by customers with the help of partners.

In the next fiscal year, year 2004, year '04 I have to say that throughout the 25 years of the history of the company, we never had a year where we had so much value package really targeted for this space. In the first half of the fiscal year, from here to December, we're going to bring to the marketplace a series of products that really start completing that picture. That really speaks to the fact that we are investing for this space. It's more Business Server. It's a clear interaction, but this version of this product package is so much value that it's allowed to be consumed by customers in such an easy way that I'm sure we are going to make big, big, big inroads in this market.

Just think about this: The fact that you can load the system in an OEM system in a server and basically just like you can take that system and in 15 minutes, you can put basically a customer together to have the operating system, e-mail, their portal, and all the other elements to be able to run that enterprise, 15 minutes from boot-up all the way to be working on it, remote management—all of these things that small businesses have as business issues—so I'm very excited about that.

New versions of Office and Small Business Server bring what we call the ability to truly use Outlook® as a—I don't want to call it CRM because it clearly is not that, but the ability to use Outlook with Business Contact Manager, which extends the functionality of Outlook to be able to track customer opportunity, leads and so on, you're going to see millions of small businesses using Outlook with this element that comes with our small-business version of Office that allows you to basically do more with their customers.

And then CRM, which is a very important product on this strategy and I don't want to mention all the products because Doug is going to talk about that in the Business Solutions side, but again this year the next 12 months are really a milestone in the history of the company of how we have been able to use our R&D to target specifically great value for customers, so I'm very, very excited about that.

I spoke about these four strategies, these four core strategies. Let me just give you some numbers. At the top level we announced and we are very committed to invest about $2 billion in this space, the small and medium space, to drive this opportunity for customers.

Of course, we leverage a lot of the work that we do with Windows® and Office. As I said, I'm very excited about the new products. But this year when we bring these things together we are basically bringing to the mainstream also 1,700 R&D people on the Microsoft Business Solutions side. This by far makes the largest R&D team focused onto the small and medium space, so I'm very excited about that. This is just the beginning, 2003 is the beginning of a great round of additional value that we bring to this marketplace.

Broad customer connection: We're bringing the sales forces together from Navision® and Great Plains® to the mainstream of Microsoft. Let me just say that in the past general managers of the subsidiaries of Microsoft didn't have a goal around our Microsoft Business Solutions type of products. This year we have made basically the merger of both sales forces and marketing, and we are going mainstream as part of the goals in the field for this marketplace, so 2,500 people. We are adding roughly another thousand as part of the merger, meaning as part of the 2,500 but it's about 2,500 people altogether that are going to be selling this whole value stack to small and medium businesses.

Of course, this is not enough, and we cannot extend really an ability to reach millions of customers through partners. So we have the largest partner network, about 800,000 of them; 30,000 of them are being certified by Microsoft and about 5,000 of them will be certified to sell Microsoft Business Solutions.

And we are really taking again this to the next level of effectiveness in the marketplace. I told my team we have to be the company that basically has second to none partner programs out there. It's the only chance we have. We are not like Oracle or IBM that they just are happy with serving a few hundreds of customers. We believe that millions of customers should benefit from this software innovation. Therefore, our partners are super critical.

In October we're going to make the largest partner event we ever did in New Orleans where we are bringing together our old Fusion event and our SMP event, which used to be the MBS event, in a single place where we are going to unveil our next-generation partner program, which is really taking to the next level how partners will work with us to realize this opportunity.

And last but not least, I said we are investing as part of this $2 billion a lot of money in what we call our go-to markets to target not only to the product but how we bring the services, the partners all together to understand scenarios and audiences to be able to really make it very relevant to these customers.

I would like to close really with the voice of the customer because I can stand up here and blah-blah-blah about $2 billion and all that. But, in the end, we all know that this is all about helping customers deal with business problems and realize their potential.

I had the distinct pleasure and honor last week to be with a couple of gentlemen talking to our internal people in New Orleans as part of our annual event. And this company, called Fingerhut, was together with a partner, in this case Fred Archer, the chief information officer of Peter's group. This is a consumer catalog company—very, very amazing story. I decided to share it here because really it speaks specifically to what I am talking about with the vision of the company in this space.

Fred came to really help the company after being almost in bankruptcy. The company was acquired and in the process of that acquisition, after a few years, they were in a situation of almost being out of business or basically they were sold out there, and they ended up with a very, very heavy IT infrastructure. We're talking about $250 million of PeopleSoft and Oracle software, about $100 million, $112 million of IT budget.

And the challenge for this team was they are being downsized. They were basically sold to somebody else. They were basically at the end of October. They needed to come out in December with a catalog on the Web to be able to survive; 80 percent of the business of this company happens in December.

So an incredible challenge that was placed to that individual to Fred, and by the way these are his slides. I'm using his IP here. I asked permission of him to be able to use his slides.

But again this was the infrastructure that we're dealing with, and basically the call was we've got to get this resolved in a few weeks.

We were able to partner closely with, as I said, one of our partners in the field, a very strong one, and we were able to virtually replace the whole infrastructure with SQL servers, of course, Microsoft business applications with Great Plains specifically and some Web servers.

And I would say that after all that had been done, in the end I'm very excited to report that this was the result that happened as far as all that effort.

I wish I had time to walk you through the fine detail of this case because I believe it is a really amazing case. I am going to concentrate on the last three points; you can read the other two. But they were able to achieve today basically 5.5 percent as a percentage of revenue, which is half of what the average of the industry is, 12 percent, a very important thing. They were able to reduce their IT operating expenses by $100 million—$100 million. And I really love the last line of Fred, which is in the end I was able to keep my job, because I think in the end that's also part of the equation.

So this is what it's all about. I keep telling my team in the end it doesn't matter what we say internally. It doesn't matter how much we even innovate if in the end we cannot turn that innovation into great gain for customers. That's where the story starts; that's where the story stops.

And my mission and the mission of my team in the marketplace is to ensure that it is just millions of Fingerhuts out there—not just a few—millions. Because I believe no matter what the size of that customer is, there is that opportunity out there for that customer to do better and to realize this potential of growing their business in a better and significant way.

So that's my mission. I had a little short time. I have the opportunity to perhaps interact with some of you at lunch, and I'm very excited to be here and be the one with my team and our partners to make this a reality.

Thank you.

END

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