Realizing Potential with Business Applications
Financial Analyst Meeting 2004
July 29, 2004

ANNOUNCER: Ladies and gentlemen, please welcome back Curt Anderson.

CURT ANDERSON: Well, good afternoon. I hope you had an enjoyable lunch. We've got a very busy afternoon ahead of us. We've got coming up Doug Burgum with Microsoft Business Solutions, Pieter Knook from our Mobile and Embedded Devices Group, Brian Lee from our Home Entertainment Group, and Yusuf Mehdi from MSN; then we'll wrap up with John and Steve; and then time for Q&Amp;A.

I would like to remind you that you can submit Q&A online using the online service that we talked about this morning. So feel free to submit your questions there. We will also have “mike runners” for live Q&A, as well, during the Q&A session. But if you would like to submit questions in advance, I would appreciate that. It would be helpful to us. And then also to remind you, again, if you could, please take a few minutes to fill out an evaluation form when you have the time; we would appreciate that as well.

With that, I would like to introduce Doug Burgum, our Senior Vice President at Microsoft Business Solutions.

DOUG BURGUM: On December 12 at 12:30 P.M. in 1901, the world changed. The world changed because on that day Guglielmo Marconi was the first individual to successfully transmit a wireless transmission across the Atlantic. And even though this began a transformation around shortwave, specifically ship-to-shore, which saved thousands of lives over the earlier part of the century, and that Marconi himself was involved in advances in microwave and shortwave technology and wireless transmissions his whole life, through the 1930s, it's really not even the technology that is that interesting. It's the fact that this young 27-year-old believed in something that none of the scientists of the day believed in. This individual, Marconi, believed that these waves would, as he would say, serenely follow the curvature of the earth and allow this to happen. And the common thinking of all the brightest people of the day was that, no, wireless might work, but it would only work on point to point or straight line of sight.

So again, a transformation began in the thoughts about technology and wireless, and what communications could mean. And in the same way here, when we think about business solutions, we're talking about a transformation. When Bill talked this morning about the unlimited potential for improving solutions that we can bring for consumers and businesses through software, I fervently believe that. And I believe that we have an opportunity as Microsoft in business applications to affect the transformation of the business applications business. And to do that we have to transform ourselves as a company, we have to transform the way we interact with our partners, and we have to even transform our own thought processes. It begins, again, with an individual or a team that believes that something can be different from what it is today.

We have a huge opportunity in business applications, and we have a huge opportunity to really be effective against our mission statement of helping people and businesses around the world realize their opportunities. As we've taken on that big challenge and taken on that transformational activity, we've had some challenges. Microsoft has only been in the business applications business for just over three years, and we've had challenges. We've had the classic challenges that you have of integrating companies into larger organizations. We've had to overcome and change, and drive transformation around our field structure, around our comm systems, around our lead systems, around our billing systems, around our support systems, around our organizational structure, around just virtually everything we've done. It's been a complete remaking of the foundation to do that. But a lot of that hard work that we've done over the past three years is behind us, and I think what we've seen in the last part of FY04, as we're beginning to see the velocity that can come with conducting a transformation that allows us to achieve the kind of scale that Microsoft has achieved in other businesses, and allows us to be in a position to begin the transformation of this business the way Microsoft has transformed other segments of the software business.

We have some very high aspirations, and right at the top of the list is that we desire to become the worldwide business applications leader in the markets that we pursue. And we define those markets as small, midmarket and corporate, which would mean, again, the larger divisions or the smaller international subsidiaries of the world's largest corporations. But again, the prime focus is small and midmarkets. Of course, our products can scale on either side of that space.

As we approach that, this business applications space has traditionally been low-volume, high-priced, and lots of services after-the-fact. And just as Microsoft has transformed other segments, our goal here is to achieve over time a high volume of enthusiastic customers, and in Microsoft terminology that means millions, not tens of thousands or hundreds of thousands. Along the way, for us to do that, because the myriad and different waves of business applications across vertical industries, and across the fact that in ERP specifically the accounting rules can change country by country, we need to have a thriving partner ecosystem of ISVs, of reselling partners that can allow us to go into different industries, different niches, different segments, and different geographies.

We're going to achieve that, both the business opportunity for partners and customer value, by really focusing on delivering value through integrated innovation. And we'll talk about that today. And in the end, of course, we have a goal for our shareholders to build another profitable billion-dollar business inside of Microsoft. Let's take a look at the FY04 highlights, and see how we're doing against these long-term aspirations that we have. We achieved 18 percent growth in FY04 over FY03, and we had record revenue in Q4. And I should just note that this 18 percent growth, depending on which analyst you view and how you take a look at the market, that's two to three times higher than the growth rate for the market in the segments that we're serving.

We added over 23,000 new customers, the majority of which are coming from our midmarket ERP products, and this is far and away the market leader in terms of volume within that category. We've also driven innovation broadly across Microsoft, across the new Microsoft partner programs, and these partner programs will, again, create even better partner opportunities--specifically within those that are called the competencies, creating strong business opportunities for those partners that want to be involved either as ISVs or as resellers of the MBS solutions.

We launched CRM 1.2 in additional geographies and languages in Q3. We released our Microsoft ERP Navision 3.7 this year, and we've continued to have very strong growth of the Navision product lines, particularly in EMEA. In Q4, we took a hard look at our investment structure and said, “hey, there's some more streamlining we can do.” We made some very tough choices. We reduced headcount by 147 people within MBS, and not just shoved into some other part of Microsoft. This was an actual true cut in headcount. Done appropriately, but we took those out. We looked at shutting down specific locations, but still preserving our commitment to customers. And so again, we've really focused on making sure that we're achieving cost synergies where appropriate, and making sure that we've got our investments aligned against the right priorities going forward.

And toward the end of the year also, we took a big step toward increasing the senior leadership focus around MBS. Orlando Ayala has come on as the COO of MBS in addition to his responsibilities of driving all these small midmarket solutions and partner groups globally for Microsoft, and as you heard this morning, Craig Bruya is rejoining Microsoft after a three-year retirement as our CFO, and that's in addition to the very strong team that we had across MBS and SMSMP this last year. So again, we continue to look at really building the leadership capacity to go along with our aspirations.

As we take a look at the market this past year, I'm going to torture you with a slide with a lot of numbers, which some of you may enjoy or some may view this as an eye test. But if you take a look at the line across the top where it says highest 12-month revenue, and then there's some dates at the top of that chart which, again, hopefully aren't too hard to read, but some of them go back as late as, if we take a look at Oracle applications, February '01, which would have been the quarter in which Oracle reported their highest license revenue in business applications. And so the blue bars represent the percentage that each of these companies are relative to the highest level they ever achieved in business applications license revenue.

So this is a little bit of a snapshot of the segments that we don't directly pursue, like the enterprise, all the way down to very small businesses, where we've got Intuit QuickBooks. But it gives you a sense of the broad industry that, since Y2K, this is an industry where most companies have been tracking at below the size that they were during the late 1990s. There are some exceptions.

Sage, Intuit with their QuickBooks product, Salesforce with their hosted CRM offering, and MBS are the four companies out of this group of leaders that we tracked that actually are, today, coming out of their current quarter, at their all-time high for license revenues. So again, that tells me that certainly when you take a look at Sage, Intuit, and MBS, there is certainly more momentum in the segments that we're in, small and medium, than there are in the enterprise space.

If you also take a look going from left to right, this ranks the companies by their actual size and license revenue, and we've broken through the $300 million mark in license revenue. Next ahead for us to knock off is Sage, and then the four to the left of that are actually companies that primarily compete in the enterprise space. So again, we see ourselves as having the next goal of moving up to the No. 1 spot in terms of license revenue, relative to small and medium. And of course, Sage is made up of over 30 different acquisitions that they've made over a number of years, but we see ourselves as again having higher and faster growth rates than they have, relative to license revenues. As we want to continue to outrun the market, we also want to continue to pass particular competitors, as we're moving to become a very strong player in this segment.

In terms of revenue itself, the first real year that Microsoft was reporting this revenue was after the acquisition of Great Plains. We had about $300 million in revenue the following year. We acquired Navision and added that in. This last year we did not do any major acquisitions. We grew the business about $100 million in absolute growth year over year, which again, take a look at some of the other companies on the chart that are publicly traded that are much smaller than that, or even take a look at Salesforce.com--our $100 million in growth comparable to the revenue that Salesforce achieved in the last 12 months.

So we're not thrilled with this, we want to continue to grow faster than the market, but again, the point is that we are growing in absolute terms, organically, as we start to get traction going forward.

So as we have our aspirations to build a large business, I thought it would be helpful for people to sort of get a sense of how are we doing versus other businesses that Microsoft has taken from scratch and built to a $1 billion. In 1989, Microsoft released 1.0 of SQL Server, and many of you who are in this audience would remember those days. Twelve years later, Microsoft hit the $1 billion mark. And you heard Eric Rudder talk this morning about what a powerful and tremendous franchise that we at Microsoft have today in servers and tools that began from those very humble beginnings in 1989.

Entering into business applications, Microsoft took a different tack, which again was primarily seeded by the acquisitions of Great Plains and Navision, we jump-started the business. But on the track that we're on right now, we're on track to hit $1 billion in more or less six years, or about half the time it took Microsoft to reach $1 billion in the SQL Server business. So again, we'd love to be going faster; we feel good about this benchmark; and we again feel that a lot of the foundational work to allow us to scale has been put in place, particularly in the last year.

As we take a look at the market opportunity for Microsoft, we would say, “is there a market opportunity there?” Now, this slide I almost hesitated to include, because I know that this audience has seen thousands of slides like this, so there really isn't much you need to take a look at other than the title, which is that we have a large, fragmented, and growing market. This shows, again, according to IDC, about $62 billion in a market in terms of license and maintenance in 2003. The addressable market for us in terms of the products that we serve across small, midmarket and corporate accounts is roughly about half of that, or about $32 billion. So still a big, big opportunity relative to the $600 and change in revenue that we had this year. And if you take a look at the fragmentation here, if you take a group of the select large leaders across all of these segments, including enterprise, even all the leaders don't even add up to 20 percent of the space. If you take a look at the next 44 percent, it's 571 companies. This is a very different market structure than a lot of the other segments of software, even if it reflects the nature of customer need that creates all this fragmentation.

This market structure does create a unique opportunity for Microsoft, as a server and tools company, as a platform company, as a company that understands partner programs and ISV programs, to bring all the skills of Microsoft together, to really harness the capabilities of lots and lots of companies, to be in a Microsoft ecosystem as we pursue this and create a large business for ourselves, but also a large and profitable ecosystem for partners.

One thing I might add, because there's a lot of predictions about how this market is going to grow--you can read all those analyst reports--one thing which I would just sort of personally want to share in my view with this group, I think most of the estimates relative to growth tend to get lumped into spreadsheets and become very linear. Going back to the chart that had the blue bars, it showed all the enterprise players being a fraction of their highest revenue, and the highest revenue point occurred during the tech boom, but also with Y2K. Y2K was a huge driver of system replacement in this particular business.

Most companies, including small and midmarket companies, use these systems for anywhere from seven to 10 years, and they're on a replacement cycle. But like throwing a magnet into a dish of iron filings at some children's museum and everything lines up, the giant magnet that got thrown into this market was Y2K, and lots and lots of purchases got pulled from '01, '02, '03 back to 1999, and I think there will be an echo. A rabbit to the snake, whatever you want to call it, Y2K echo, starting around 2006, 2008, this could be a very interesting market in terms of replacement business, because that will also align with "Longhorn" coming out. So new innovations on "Longhorn" align with lots of people hitting the replacement cycle. Again, I think that Microsoft will appear in that time frame as having very, very good timing in terms of being positioned to really take advantage of this market when it starts growing at faster rates than it is today. So again, the bottom line is I don't think growth rates will be linear; I see accelerating growth rates in the second half of the decade. But, that's a little bit down the road; that's sort of mid-term.

FY05, how do we plan to grow in FY05? We have a very simple approach: We want to grow with existing customers, we want to grow with new customers, we want to innovate, and we want to trigger new decisions and bring new people into the market. Let's take a look at how we're going to drive each of these.

The first place we want to start with is having a deep understanding of customers. And as we have spent, in the last couple of years, thousands and thousands of hours of deep, deep research, some of the best research I've ever seen done in this segment, and it's research that involves, again, face-to-face, live in, move in, understand how small and midmarket customers actually use these systems. If they have these systems, why do they have Post-it notes all over their machines? Why do they have a bunch of files up here that are paper manila folders that are actually tracking ad hoc data that is with companies in order, as opposed to the structured data that's just in the system?

How can we, as Microsoft, having the great skills that we have--you heard from Steven Sinofsky this morning, and our ability to manage and communicate around ad hoc information, and communicate around that, with the structured capability within a financial system--how can we bring those skill sets together to automate the rest of the tasks that are still happening manually within a system? And again, as Bill said, you go on a visit like this to a small company, and you realize how much opportunity there is in the software business for us to do a better job of delivering value to these customers.

As we went through these in-depth interviews, we tried to bucket the actual types of things that even small and medium businesses do, and we were able to identify over 50 different personas, or 50 different roles that occur within the company--everything from warehousing clerks, to AP, accounts payable managers, etc. So with that, then we took the interviews from all these folks, and we tried to really understand what their pain points were.

Their pain points can be put into five rough buckets, which is, for small and medium companies that have small IT staff, this stuff still costs too much--costs too much to purchase, costs too much to install, and costs too much after the fact in terms of services. The usability, each of the systems is different--doesn't look the same, doesn't work the same, and they have to maintain too many different points. The connections--they want to be able to connect with their vendors, with their suppliers, with their own employees, and with their Web site. They want to be able to have transactions flow back and forth between those. And they want to have better insight when they make business decisions. As a small-business owner they want to be able to understand, “how does the information instead of just paying my bills, how can I make better, forward-looking decisions?”

The bottom line, all of this relates to processes, which is different from a lot of other categories of software. This is about helping people automate processes. But the thing about processes, processes change. Processes change because customers demand it; processes change because companies grow; processes change because companies get acquired; and one of the big costs around ERP systems is that the ERP systems cannot change when people want the processes to change without expensive consulting. So we think about adaptive processes; how can we build solutions where we can deliver adaptive processes to these companies?

So these are the big five pain points. Those five pain points have driven what we call our “design pillars,” which include--we've made a commitment from our development team, over a 1,000-person strong development team within business solutions--which is we are driving them specifically against how do we create the best ROI (return on investment) and TCO (total cost of ownership) in the industry. How do we get better on the whole category of “connected?” How do we drive insight through business intelligence and capability? How do we empower users with familiar interfaces that are there, and how do we create the software in a way where the processes really can be adaptive?

That thinking is driving, even today, what I would see as our strongest product release cycle that I've ever been involved with in my 21 years in the business applications business. We are set for a lineup this year that is very, very powerful, starting with Great Plains 8.0. I've got a little bit of a screenshot there that you can see. We've taken all of the Microsoft ERP products, Navision, Great Plains, Solomon, Axapta, all of them are going through major upgrades this year. All of them will have interfaces that look and feel like Outlook. And if you want to take a look at Great Plains 8.0, which is just shipping, we've got a team set up across the way in the demo area where you can take a look at the product, and how we take that product, how we integrate with Office, how we integrate with CRM, etc. So again, strong, strong product cycles coming across all of our areas.

With that, again, we've got an existing customer base of over 200,000-plus customers. We're in more countries than anybody else within the small and midmarket space. Our partner channel is strong and growing; we've got a very strong ISV channel. We feel very good about how we're positioned in ERP. Some people say, h”ey, you've got too many ERP products.” Some view it as embarrassment of riches. I view this as we've got all the top brands in the category and that many times customers are choosing among our brands. And, yes, there may be some conflict with that, but this is like any car manufacturer or any consumer goods company that puts out multiple brands in a category with different flavors and different niches. And we're in a position as we extend into the next decade where this portfolio of the leading products in the midmarket is going to be a very, very strong proposition for us and our partners.

In CRM, where we started from scratch, we have the benefit of having a global code base. Again, I talked about the 1.2 release coming up in Q2 of '05. We've got Microsoft CRM 2.0 which, again, will really push the product strongly forward, but we're out there now. We just had an announcement: We've hit the 2,500-customer mark faster than anybody else in the midmarket space. We've got a very robust set of ISVs out there working on everything from marketing management to telephony to public sector verticals, etc., where, again, the ISV community, using CRM and the Microsoft tools as a platform to create industry-specific solution, is a really, really strong driver for us in this business.

We also this last year had a little bit of a hiccup as we moved CRM into our volume licensing in Q2, and that slowed down our CRM growth. We've started to see the benefits of being in volume licensing start to show up in Q4 as we've really accelerated the business, and we've built a broader channel for that product going forward. So again, very excited about the momentum that we see within CRM. In terms of the channel itself, again, as part of this transformation there was some skepticism about, is there still going to be a great partner opportunity around business solutions inside of Microsoft. And I think we've come back with that. We've just come off of our conference in Toronto, our Worldwide Partner Conference, with a resounding “yes.” The enthusiasm coming out of that conference about what we're doing in terms of us committing deeper field resources to support our partners, in terms of how strong the ISV platform value proposition is--I mean, if you're an ISV and you're selling in small and midmarket, small and midmarket customers aren't like, “hey, I've got to worry about heterogeneous environments.” They want things where they can build quickly to integrate across a number of different products. Undisputed, Microsoft has the best value proposition for ISVs across these target customers, and that's bringing lots of great companies into the fold that are extending our ERP products and our CRM products into new countries, new segments, and new industries.

And we're very, very committed to driving our vertical approach to our products, with ISVs on top of the core capability that we provide within CRM and ERP. And then again, we've added more support to our reselling partners in terms of all the work that Kevin Johnson and the field team is doing to be inclusive in terms of driving people--whether it's from Web sites, advertising, or our GTMs; our demand generation; driving people back to partners so that partners themselves can help be a part of driving the solutions. Again, there's enormous synergy across the ecosystem in terms of people really driving that for us.

And one of the things that we have is we believe that our partners actually, today, probably understand integrated innovation better than most people in the industry. Why do our partners understand integrated innovation better? They understand it because they're living it every day. They understand how much customers in this segment value the ability to have the products work together and integrate well with each other, and these partners are part of that integrated innovation because with all of the extensibility we have across both our applications and our tools, they're creating these terrific solutions.

So at our conference a couple of weeks ago, I think a few of you had a chance to be there, but certainly not all of you were, we had an opportunity to capture some reactions or thoughts from partners, so these are very fresh, and I wanted to share some of them with you. Let's take a look.

(video segment)

So as you heard from the partners who are out there every day selling products, not just from Business Solutions, but broadly across Microsoft to a single customer, as you can hear in their own words the tremendous value proposition that they see in doing that. And as we have in sort of the classic strategic triangle down here, we've got an opportunity, certainly. And I believe Microsoft is uniquely positioned to bring all of these capabilities across all the groups at Microsoft into a position of delivering undisputed value to those customers ahead of our competition. So again, as we've talked about, we've got the integrated innovation; we've got the great product lineup; we've got the channel, which is more integrated than at any time I've seen probably since Y2K, and that's both in terms of the opportunity they see in field, and also because of the alignment of our field and partner programs, etc. We've backed that up with a tremendous team in terms of a leadership team that's very committed to driving and supporting and growing this business.

And then the last thing we've got listed there--actually as sort of the logo--it's not a mistake to have it there twice, but the brand itself. The Microsoft brand plays so well in this business because when people buy a business application, they want to make a safe choice. They want to buy it from a company that they know is going to be around, and in a highly fragmented market, Microsoft really stands out as a recognizable brand that is a safe choice that can deliver solutions to people that they know they're going to back. And so again, our partners and we can really benefit from Microsoft's brand position in the market, as well, and we can certainly benefit from all the synergies that we have and the success of other products as we continue to find ways to serve existing customers, reach new customers, and then trigger new decisions to bring people into the marketplace.

So in closing, I just wanted to offer--I started with this whole topic of transformation and how transformation begins with someone having to believe that something can be done that couldn't be done before. Well, we have a lot of believers at Microsoft, and we have a lot of believers that believe that we really can make a difference in terms of how we help people and businesses around the world realize their potential.

So I thought I would leave you with this one quote, which says, "Never doubt that a small group of committed people can change the world, because," as Margaret Meade, the famous anthropologist said, "it is the only thing that ever has." Thank you for your attention, and I look forward to talking to many of you tonight at the reception.

END

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