Changing the World with Software
2003 Financial Analyst Meeting
July 24, 2003

STEVE BALLMER: Great. It's a pleasure to have a chance to be here with you today, and it's been a long day; that I'm aware of. And yet we still have, I think, some important material left to cover, and I'm going to try to do that hopefully in the 45 minutes they allotted me, and then we'll have a chance to take some questions.

When I talked to John, he said there's probably three or four things that are primarily on folks here's mind, and hopefully you had a chance to get something of a perspective on those topics—what's going on in our new businesses both through the financial discussion as well as the discussion by all of the business groups on some of their plans and progress. Hopefully you have a sense of that. There was certainly a lot of interest coming into the meeting on the discussion of that cash, cash, what are we going to do with the cash. You're not going to get much more than you got from John, so I hope that was useful and valuable. And then the last topic that we have essentially been talking about all day long, and that I will talk about in some additional length has to do with the competitive framework for us in the business, and how do we see things evolving, and what impact might that have on us financially.

Before I go there, I want to, in the context of that interest, have a minute to give you my perspective on the last 12 months. You heard a lot of things that were very precise, and quantitative, and important. I'm going to try to riff over some of the things that I think of as being very important that may or may not have shown up as obviously in our numbers.

First is market share, which pretty much everybody had a chance to talk about. But if you just step back to 50,000 feet and say, "How did we do over the last year?" The truth is we’ve built share. We've grown share in almost every business in the last 12 months. And you've got to feel good about a year in which you build share. The only exception, not even an exception to that, but the only thing I think is a flag that we ought to consider is the notion that Linux also in the server market built share in the last year. So both we and Linux gained share, but in the client, in the variety of things that we do on the server, in the database business, in the e-mail business, in the development tools business, in what's going on online, in what's going on in the video game business, in what's going on in business applications, we've built share, we've built share, we've built share, we've built share. And I'm going to feel very good about that, marking the flag that I marked about the progress that Linux also made, in terms of market share in server operating systems.

Second thing I want to talk about is customer satisfaction. We have really over the last three or four years put a distinct focus, from a resource investment perspective, as well as a management bandwidth and focus standpoint on improving customer satisfaction. The numbers that we keep internally tell us we still have a ways to go. We've made some progress. But, I think subjectively I feel that the last 12 months was really a turning point for not just having our people really fully embrace the mission, which I think they did before, but really a turning point in terms of us being able to operationalize for every employee what they personally need to do to help us improve customer satisfaction. The kinds of tools that Bill talked about, and Jeff Raikes, and Eric, in terms of capturing customer feedback, are very important to the development group. The key metrics on what we need to do in product support are important. The work we've done in our field organization to systematically capture, respond to and analyze the kinds of complaints we're getting from our customers, all of those things help us make very actionable things that I think will help us continue our quest to absolutely provide top customer satisfaction in the business.

From a governance and legal perspective, governance is sort of a funny thing, that a good year I guess is a year in which you have no problems; we had no problems. I actually think that in many ways the moves we made on compensation and on accounting for our old and new equity compensation programs, many people are viewing as a positive, from a governance and transparency perspective.

On the legal front it was obviously a good year, in the sense that we were able to resolve more actions than started up. But, as John said, there are still a number of actions that we need to resolve. We had a good appearance today in front of Judge Kollar-Kotelly, in terms of her review and assessment of our compliance with the consent decree. That is absolutely a critical priority for me, and for the management team here. And we keep a lot of good focus on making sure that we're executing 100 percent consistently with the consent decree.

Product shipments—I don't mean unit volumes—new products shipped, we had a big year. We need to stop and step back. We shipped MSN® 8 this year. We shipped Tablet PC, Media Center PC, the new version of our media products, Windows Media® Series 9, all shipped this year, which is very good. Xbox Live™ we brought to the market this year. Windows Mobile phones we brought to the market this year. A new release of Visual Studio® and Windows Server™ we brought to the market this year. In all cases I think we have products that are very innovative, deliver great value, and where customers are seeing quite, quite high quality in terms of their experiences.

We made progress in most of our emerging businesses this year. Somebody asked me at lunch today how many more years of progress do we have before the ones that look red look black, and it varies all over the map. And I was asked, "Are we patient? Are we long-term? What's our thought process?" The basic answer is, I feel very good about the portfolio of things we're investing in. I think they're all tremendous opportunities that we or somebody else will realize, so they should be us. I think they all fit very well with the basic technology portfolio that we have. And I think all of them focus on extending basic experiences that have a relationship to that which goes on naturally around Windows® and Office. Whether that's the work we're trying to do in Business Solutions, or Mobile Devices, the extensions in the way the PC and other devices fit together in the living room, including the video gaming console, or the work we try to do to extend our offline experiences to be more online, in terms of information, communication, and IT services through MSN. We have more progress to make, it's not a perfect—it's certainly not a perfect story. But I think we have good teams in place that made good progress, and understand both from a share standpoint, as well as a profitability and customer satisfaction standpoint what they need to do to succeed.

I'm not going to comment on innovation. You heard Bill. You had a chance to hear a full set of folks today, to get a glimpse at some of the new things coming. And it's an important way for you to assess how we're doing. If we don't innovate, if we don't do new things that add substantial value, our company is going to run into problems. We don't have to get into "new businesses and new products," but we've got to be able to innovate and add value. And that will create new opportunity for us, either in existing businesses, new products, and I feel like our innovation pipeline is in pretty good shape. It can always be better. People ask, "Are you going to continue this thing where you keep increasing R&D every year?" Yes, we are, as long as we can, because we know we need to continue to push forward the frontiers of what we do. And we're going to prioritize that as sort of Job One, if you will, from an investment perspective.

From a people perspective, and a how the company works perspective, I would say this was a barnburner year. We have hired more great people this year, as John said, than sort of anytime on record. Senior folks on the technology side, from IBM, a number of them, from Sun, a number of them, from Oracle, a number of them, from startups, a number of them, from failed startups, a large number of them, Microsoft returnees, a large number of them. Distinguished engineers, fellows, top-level technical talent from the best companies in the business, and that's a good thing. And on top of that, we continue to recruit and promote our own.

If you look at the new vice presidents that we promoted this year, a lot of them came up through the ranks here at Microsoft. We had our best college recruiting year probably in history this year, we hired about 700 people off college campuses, and really from campuses some of which we had a hard time recruiting people three years ago, like Stanford. We've got a couple dozen really bright, young, talented folks joining us off that campus this year.

We did a lot of work on our organization in the last year, particularly the way our business groups and our field interact, and I think that will give us a greater efficiency, and in some cases it's given us an opportunity to look harder, and take some cost out. We certainly have done that. We put together some of the sales force activities that Doug and Orlando described earlier today. So, I feel very good about that.

And the new compensation system, I think, is incredibly important for us. We said when we announced the thing, we're not sure if it's for anybody else or for everybody else. Who knows? Everybody has to look at their own issues and make a decision. And forget accounting for a minute, and everything else about it, and just say, "Will this allow us to better attract and retain the best people?" I'm 100 percent convinced that it will, and it will do so in a way that is at least neutral, and maybe positive from a shareowner perspective. I think that was a big, big step forward.

On the financial front, you heard from John. There's not really much for me to add. Some of you were deluged with numbers last week, and with a simplified version this week. What I will tell you is, I think we had a very good year financially, very good year. And the most important reason for me to say that is so that you understand where my expectation level is for a good year, this was a very good year. I got asked by somebody, "I thought FY03 was the year of investment. Is FY04 not going to be a year of investment?" I think FY03 was a year of performance. At the front of the year, we agreed we're going to go invest to secure our future. But we performed, and we performed very well in absolutes, and we performed in my opinion financially very well relatively. And so, I consider that a great year. That all years would be that good would be an amazing thing from my perspective.

And at the start of every year, you're going to hear us say we're investing for the long run, and at the end of every year we'll tell you whether the short run was a good year or not. The last one, I think, in my opinion, was quite a good year.

I want to turn and migrate to perspective on the future, and then the competitive environment. If you stop and think about it, there's kind of an interesting dialogue implicitly going on in our industry these days. And the dialogue really relates along whether or not IT is going to continue to be a positively transforming thing for society at large. There's been such positives that have come out of the PC revolution, the cell phone revolution, the Internet revolution. And there are people, whether it's, as Bill talked about earlier today, the Harvard Business Review, there are plenty of people who are just willing to say, "I just don't think the next years are going to be as exciting as the last years."

Our fundamental response to that is—hogwash. We think the next 10 years will be very exciting and very dynamic. We talk about this mission of working to help businesses and people around the world realize their full potential. The number of new scenarios that we think need to be developed or more fully developed is incredible. The way you help IT people, unrealized potential; developers, unrealized potential; business analysis, unrealized potential; communications, unrealized potential; entertainment, unrealized potential; business transaction and processing, unrealized, unrealized, unrealized, unrealized. So we can just look out there like kids in a candy store saying, what a great world to live in. That doesn't translate to 38 percent growth or 2 percent growth, I'm not going to talk about that. But the fact that the world is there to be transformed, and we're actually in the business and in the industry where we see more opportunities to make a difference than not is a fantastic thing.

So, if the users are the center of our world, innovative new scenarios are the center of that world. Scenarios for consumers, for developers, for information workers, for small businesses, for large businesses, and we've got to wrap that with the right kind of customer experience, both from a technology perspective and from a sales, marketing, and service perspective. But it all starts with innovative scenarios powered by high-value innovative technology.

And so we sit here and we see a land rich in opportunity. And it's a weird thing for me to feel like I've got to be a cheerleader for the amount of incredible things left to be done by people who write software and are in the information technology business. But we feel that way very, very much. So, when people say, "Is there opportunity in your business?" I say, nothing but. I don't know what that means financially, but nothing but opportunity.

In that context, you have to say, okay, well, what are our goals? What is it we're working on? And we think of ourselves as having essentially three goals around one core piston of progress, if you will. We have to win new customers with new scenarios. Everybody should stay grounded in the fact that we think of ourselves as a high-volume, low-price company. I have a lot of people say, "Boy, aren't there opportunities if you just do more in the enterprise? Raise your prices? blah, blah, blah, blah, blah. Wouldn't that be great for profitability in FY foobar?" Having a lot of customers is a very important part of our balanced goal set. Driving customer satisfaction, which has added cost to our cost structure over the last couple years, is a second important element of our balanced goal set. And then growing short-term profitability is a third part of this balanced goal set. And, as I said, the other thing that sort of sits there and is the fundamental piston, if you will, driving this bus, is new innovation. So, we need to develop and promote new concepts, sometimes even before they are fully baked, or before they're fully ready to get to high volume. And if we follow this balance, that's the best thing for optimizing long-term profits coming out of Microsoft.

And so when we sit and look at a one-year, two-year time horizon, we're not sitting there just looking at short-term profits. People asked me today about cost cutting. You know, we have something like $18 billion in total cost in our company. So, let's say we are super good, and we can take out $2 billion of cost. Okay, that's not the dream. A nice thing, it would be nice though to get $2 billion more of profit and all that kind of stuff, but I'm not trying to suggest that number is possible or achievable or anything else. But the long term is better served by new innovation, more customers, better satisfaction and maybe a little less short-term profit growth in order to maximize for the long term.

So, this is kind of the perspective we bring as we look at these incredible opportunities to serve customers. In order for us to prosper as a company, to succeed on these goals, one reasonable question is: What is the competitive frame? What's your plan, first, and then how will that play out in the competitive frame? Our plan, the things that we talked to our employees about, you saw it basically in the course of the day that the things that we're emphasizing to all of our business groups to work on fall into six buckets. Number One is, we believe in integrated innovation, and we believe in the next generation of Windows. And when we say integrated innovation, we mean we think it is better for the customer if we can get a whole scenario integrated, both within our products and where Product A works well with Product B works well with Service C in order to implement a full customer experience. We think those scenarios through holistically. We expand into new scenarios because we think sometimes if we expand into the scenario, we can do a better job than if we just let third parties participate in those scenarios.

In the "Longhorn" case we're sort of taking this to the next level because we're absolutely trying to think about not just the next generation of Windows but the next generation of a whole series of products.

Some people say, "That sounds like the highest-risk thing I've ever heard, Steve, cut it out. Why don't you dribble-drabble some things out here?" That's now how this industry is going to continue to be transformed.

We think there needs to be, not every year, but there need to be periodic big bangs both for our company and for our industry in order to rejuvenate the innovation cycle, and that's how we think about Longhorn—as one of those fundamental big bangs.

People say, "Oh, it sounds scary. That means you might not ship it on date foo or bar or whatever the heck date you think it's going to be." And I say, you're right. That's why we don't try to talk about the date. We're trying to talk about the conceptualization. We're going to do our best; we've got teams working hard, great plans, good focus, but having a breakthrough and having scenarios that are integrated around that we think is Job One.

Job Two is we need to be a platform that creates opportunities for other developers—independent software companies as well as custom developers—because no matter how good our integrated innovation, we're not going to have all the answers.

And so, amongst all the customers we serve, we're starting to tell our people developers have this special sort of high place on the pecking order, because they bring this stuff to life for people in a variety of ways. People have to make money on our platform. We have to make sure that our platform can be most easily customized.

We have to think about our platform as bigger than Windows. It includes Office; it includes Microsoft® Business Solutions. We need to focus on simple, high-value offerings for our customers. We've got to wake up every morning and say, "How do we take this product through and make sure it has more value next year than it does this year?" That's different than saying, "How do we make sure we make more money on this product?"

How do we increase the value in this product? How do we put more into it? How do we simplify it? And one of the ways we might simplify it is by adding in more things, which are somewhat chaotic today, that aren't part of that product today. How will we use the Internet to create a more service-oriented experience for our customers that adds simplicity?

We like the kinds of things that are going on with Windows Update and our software update services in terms of what it allows us to do: to simplify and increase the value in the proposition for our customers.

While we're out trying to blaze new trails—and as they used to say on Star Trek, "boldly go where no man has gone before"—we also have to be better and better at listening and responding to customers. And that's why all the work on customer satisfaction and the feedback loop through sales, through support, as well as through the products themselves, is incredibly important.

I talked a minute about cost. We can take cost out or we can get more productivity out of the work force that we have. But we are asking our people, perhaps in a way we didn't a few years back, not to make it the only goal, but to make it a greater priority than it's ever been for us before.

And last but not least, we keep this notion of really being a player that builds popular enthusiasm and groundswell for its products. We sell in a way always from the bottom up. We may sell enterprise CIOs, and that's very important, but we have to build enthusiasm with the guy who's got a smart MOM client device, monitor server, from the trader who likes the new things they can do in Excel, to the analyst who likes the new things they can do in collaboration.

We have to build from a groundswell of enthusiasm that starts with the end user. And that's why you see us investing in increased advertising support, as John discussed, next year.

So what's the competitive situation? Somebody asked me at lunch today—it was kind of a funny question—they said, "Gee, you guys don't seem to have a clear competitor in mind. There doesn't seem to be anything out there." I hope I was polite in my response, and I tried to be, but I think our thinking about the competitive situation is as clear and focused as it's ever been at any time that I've been at Microsoft.

There's one critical issue: Will software—and will IT, you could say generally, but I'm only going to talk about the software piece—will software be a business of innovation and value, or will it be a business that gets commoditized? And it's commoditized by clones, it's commoditized by lower costs, or freer alternatives to that which the commercial vendors build. And that's the question.

It's not just a question at Microsoft. It should be the question of Oracle; it should be the question of even guys like SAP. Will software continue to be an area in which innovation creates value, innovation is protected for a period of time, creates value, creates new customer scenarios, is able to attract people to spend money? That is the sort of highest-level competitive frame.

Will there be a bigger software business fight for the world at large? Will the software business be bigger five years from now than it is today? Or will the work of people for free be as good as the innovation and value that the commercial companies create? So that's the Number One dialogue here. And people say, "Okay, I get it. That's about free software. That's about open source. That's about noncommercial software. Blah, blah, blah. It's about Linux."

Yeah, it's about all of that stuff. And it's not just about our company; it's about a bunch of other companies in this business. Now, I am enthusiastic, as I said, about new scenarios. I'm enthusiastic about innovation and the value that it can create. I'm enthusiastic that we'll be able to charge positive prices for software five years from now.

Somebody asked me at lunch today, "Well, will they be the same as the prices today?" Could be the same. Could be lower. Could be higher. All I know is we have a chance to create great value, and we're investing in that value. People say, "Well, okay. But, you know, this cost thing, it's big in this environment." It's big in every environment, but it's not the only thing in any environment.

It's about value. It's not just about acquisition cost. It's also about total cost of ownership, where I think we have incredible stories. Some people tell you, "Ah, um-hmm, the world's moving to a services world." Put IBM down on the list of people who will be first and foremost on this. "There won't be any commercial software left, that's why we don't invest in the applications business. It's just services. Hundreds, and hundreds, and hundreds of thousands of people doing custom work." Again, I might say hogwash to that theory. I think software products will be an increasingly important part of the business.

There's a debate you can have. Is it better to have a group of people who are paid and work in a coordinated fashion on integrated breakthroughs, or is a fragmented community of people going to be better able to create new value?

I've got a strong point of view on that topic. I'm a fan of coordinated innovation. And I think, frankly, commercial companies like Microsoft are the only people that have done that kind of coordinated innovation to create new value. Simplicity versus complexity. The commercial software companies do put the extra work in to make things simpler for the end user, where large customer bases are already out there. That makes a difference.

People like to stick with what they know. People rate security—I'll talk about that in a minute. And as I said, at the end of the day, one of the core questions you have as you think about this place, as a shareholder, is: Will the software business be bigger in five years than it is today?

I assure you that this company is doing all the right things to make sure that it is as large or larger a percentage of the software business five years from now than it is today. And I feel very good about our position.

The second part of that question is: Is the business bigger or not? I think it depends on innovation and value. I feel good about our innovation and value, but you all get to make your own judgments based upon the kinds of things that you've seen and heard today, and the reactions you see and hear from customers.

There are some things, at least, Windows gets attacked on, frankly, where I think there's just confusion. There's no doubt that, I think, we're leading in terms of innovation and value. But there are places where people say, "Look, Windows is just more expensive than Linux." Gartner Group says, on the client, "15 to 30 percent lower total cost of ownership with Windows XP than Linux."

IDP says about the Windows Server, "The cost advantages are 11 to 22 percent for Windows Server versus Linux over a five-year period, all costs in." Okay. I'm not sure these are improvements or better. They have some drama to them. But the most important thing is, I think they help debunk this concept that says because something's free to acquire, it's actually low cost.

Some people argue that, you know, essentially, against innovation. They say, "Hey, look, there's things out there in the market today that are good enough." Here's some numbers that you see coming off of test results from VeriTest in terms of file server performance, Web performance of Windows Server 2003, versus a variety of different Red Hat releases.

We know that we have the lower total cost of ownership. There's better performance. There's a next-generation collaboration system built into the Windows Server. There's been integrated innovation. Good enough? I don't think it's good enough. I think there are plenty of new scenarios that we enable with the Windows Server that are simply not enabled in other environments.

People say, "Okay, the Achilles heel for some reason, because all of your software that gets built by you, is it's less secure than that which comes out of this fragmented community." Windows Server does have common criteria certification from the U.S. government. If you take a look at the number of CERT advisories coming out of the center at Carnegie Mellon that looks after Internet security, CERT advisories by OS during the year 2002, we had fewer than a number of the UNIX alternatives, Red Hat, and Solaris.

If you look at the data that comes from, I think it's ISS X-Force, in terms of the number of vulnerabilities reported by year, by operating system, fewer vulnerabilities in our environment than in the Linux environment, and growing less quickly. Is this definitive? Is that good enough? No, it's not good enough. We're not doing a good enough job.

We may be better than the other guy, but we're not doing well enough. We're telling our people we have an opportunity here to break through to create innovative new value by being the most secure place in the world to manage, and to share, and to conduct information, and to conduct business transactions. So it's not just a question of being ahead of the game on some of these things. It's pushing the value and pushing the benefits to a new level.

Sometimes people, and they appropriately give us a hard time: How are you doing on patching your system? We had a real set of issues that we have top management in the Windows team very focused in on. How do we make sure that from the time we have a piece of software that a customer wants—a patch, a new piece of software, whatever—how quickly, how easily does that really get deployed?

And we are not where we think we need to be. But, on the other hand, if you take a look at what's going on with Linux and some of the big Linux distributions, and open source, what you actually find is that the rate of deployment, the rate of creation, of releases of Linux that address security problems also has, perhaps, even bigger problems than we have.

So we think we've got a lot of positives, and we think we have ways of adding value by eliminating some of the areas where neither of us are doing a particularly good job. When people want to flip this thing around, they say, "Well, this isn't about Linux, and the community, and blah, blah, blah. This is about IBM." Because in a lot of the enterprises it's IBM that brings Linux or other open source—typically, Linux. Because you've got to remember, IBM competes with most other open source software products. It's usually only Linux they bring in.

And people say, "Now, it's like an IBM product." To which I say, "Really? Like an IBM product." Will IBM tell you the road map for Linux? Can they respond to your request for a new feature? No. They can't do that. They don't control Linux. Does IBM fix Linux problems the way IBM stands behind and fixes the MBS operating system? Of course not.

Does IBM indemnify the intellectual property in Linux the way it indemnifies the intellectual property in every IBM software product? I think there's plenty we all can read on that topic right now in the press. The answer is certainly, no. So in a sense, this competitive dialogue is pretty pure. It's: What will be the work of commercial software companies like Microsoft? How will that innovation and value compare to the work that comes out of this community?

We think we're making great progress in the marketplace versus where we would like to be in terms of customer goals. I'm not happy that we grew share and Linux grew their share a little bit more at the server level last year. But if you take a look at the kind of customers that we have, where we've won important UNIX and Linux migration—Safeway, Dell, which is a real leading edge user of .NET, LexisNexis, Hard Rock Café if you're in a lighter mood, Institutional Investor if you're not, governments, we're winning governments every day. The ones that are easy to read about in the newspaper are the ones that we're not winning. But whether it's governments in developed markets like Finland, the bastion, shall we say, of Linux in a certain sense because it grew up with Linux, where we recently announced a major win with the city of Turku. Work we're doing in developed markets like Latvia, where we've won the city government of Riga. The recent win we had with the city government of Frankfurt, the German cities are all under incredible financial pressure. Some of the reports we're seeing coming out of the analyst community, Gartner, IDC, and others. These are all important parts of us telling not only why our integrated innovation adds value but they all have an aspect of this and some of those things that people are touting for the Linux world, for the open source world—they may not be what they at first blush have appeared to be.

I tell our folks in a certain sense I feel like I'm in a movie. When I was a kid we watched a movie called—not a kid, I should say—when I was a young adult I watched a movie called Taxi Driver and they talked, there's a scene in there where Robert DeNiro talks about in a sense too much abuse has gone on for too long. Well, we think it's up to us to play a part in putting the facts out there, not as we see them but the facts as IDC sees them, the facts as Gartner sees them, the facts as our customer sees them, the facts as the ISS X-Force group sees them, et cetera, because I think the facts are good.

And if the facts on these dimensions are good and we're really driving hard this innovative new value, this integrated innovation that we've talked about all day today and that we've tried to show you all day today, then I think we're going to have, in absolute—not just relative to other commercial companies, but in absolute—I think there's a rich and bright future.

There's plenty of work that needs to be done. We're investing, I think, uniquely across the industry in these new scenarios, and I think we have a very clear plan to help our customers and derive value from the new benefits and innovation we bring to market.

And that's kind of our story, and I hope that provides a little bit of a context for the third big question John said many of you had, which is, you know, where do we stand competitively and what do we think happens going forward, based upon competition coming from software without an acquisition price.

With that, I want to wrap my comments, I want to say thanks to everybody very, very much for the time and I'm sure you'll have fun joining us for Q&A, which Bill Gates, John Connors and I will now do. Thanks.

END

Due to the varying sound quality and subject matter of tapes, the information in this transcript may contain inaccuracies.