Connecting People to the Information & People They Care About Most
Financial Analyst Meeting 2004
July 29, 2004

ANNOUNCER: Ladies and gentlemen, please welcome Corporate Vice President, MSN, Yusuf Mehdi.

(Applause.)

YUSUF MEHDI: Good afternoon. I'm happy to talk to you about our progress on MSN, and this is a great year to be talking about it, so let's go ahead and jump right in.

The MSN service, for most of you who know, is really about connecting people to the information and to the content they care about most. And within MSN we've organized into two lines of business to go pursue that opportunity: one that's all around personal communication services, things like Outlook and MSN Messenger and the future of communications; and one around best of breed information services, which includes our Search effort, our e-commerce efforts, entertainment, et cetera, and our portal.

And with these two efforts we basically are driving now a very good business, which I'll talk about in a second, behind two forms of monetization: the online advertising, which is very fast and growing, and premium service subscription. As you all know, we have the MSN Internet access business that is alive and well, and doing a great job for customers, but our focus is really around these two things—software as kind of the focus of where we're heading.

In terms of our year, we had a pretty fantastic year. I'd say it's the best year we've ever had in the history of MSN from a financial perspective. And in particular, we've had roughly a $700 million profit dollar swing year-over-year, from last year to this year, where we are profitable. We are now a profitable business. And we've made really good progress across all metrics.

What's driving the growth, among other things, is online advertising. We had a 43 percent year-over-year growth in online advertising, which as you all know is a big business, and doing well. And we did better than our share there. We've also grown very well in terms of starting to ramp up non-access Internet subscriptions, and we've done a very good job on cost containment. We've actually worked very hard to get the business to scale, and to grow well.

You can't quite use these numbers for direct comparison to competition. There are some caveats there; it doesn't include all of the revenue from our joint ventures; and there are one-time things in there with the stock-option transfer, et cetera. So I would say, net from what you see here, there is a lot of upside in this business. So, in fact, we are a profitable business, and I see a lot of upside, just in terms of what we've got going. I'll talk about some of the user statistics in a second, as well.

I want to talk specifically for a little bit about online advertising and how we're doing there. We're doing very well in a hot segment. Overall, most of you who have studied the online advertising market know that in the last year it grew roughly 25 percent year over year, whereas the traditional media business has grown 5 to 6 percent.

Online, as a percentage of total, is very small—it's only roughly 2.1 percent, 2.5 percent in the United States. And yet total media consumed by people online is more like 12 percent. We have this disconnection where people are spending 12 percent of their time online, and yet only 2.5 percent of the dollars are chasing, and that's catching up pretty remarkably. So year-over-year online advertising is growing very well. We've done better than, I would say, average in that business. In fact, last year we actually took share. We grew from 11 to 12 percent, so we actually grew our business significantly. As the market grows, I'm not sure if we'll keep that pace or not, but we will certainly continue to grow our business, and do very, very well in the online ad business.

One of the things that happened in addition to the revenue, a couple of things have been good, we've had continued success getting big brands to come online. So we participated in Coca Cola's C2 campaign as it came online. We did a big effort with Adidas and broke some major milestones there in terms of what you can do with online media. We've continued to drive up, so whether you're talking about advertising client renewal rates, you're talking about CPMs that we receive on top properties on the network, or you're just talking about the number of Fortune 100 accounts who are now coming on and spending online, we're kind of firing on all cylinders in the online ad business. So we're very pleased with that progress.

What's the opportunity for this business? In the next three to four years it could be a $20 billion market opportunity. So from today roughly about $7.5 billion—this business without any crazy numbers, in terms of the penetration of online—you can see that $7.5 billion ad business grow to roughly $20 billion year over year. This is a huge business opportunity for a number of companies, including ourselves, in that space. We see this growth, as you see the numbers here, across Search, brand, and direct e-mail advertising. And there are a lot of possibilities in here.

Search, in particular, as you can see, is looking to roughly triple, and is a big area. It's been a big focus of ours, which we'll talk about in a second, and this is one big opportunity. But, even display-based advertising, or what we call sort of banner-based, the future of banner-based advertising is also growing pretty dramatically. So even without us taking any additional share, this is a very big market opportunity, and we have some aspirations to take some share as we try and grow.

So what are the opportunities as we get there—what has to happen? A couple of things that we're going to ride and then help drive. No. 1 is the continued proliferation of broadband. Broadband in the United States, and even outside the United States, has now become really a mainstream phenomenon, and the implications for this business are that a broadband user, compared to a narrowband user, is amazingly more valuable from a pure business perspective.

They spend five times the amount of time online. They, depending on who you talk to, are anywhere between three to four times as likely to shop online. They're also much more likely to be using music and video, and in general are much more likely to click on ads if they're a broadband user. So the adoption of broadband is a very significant effort, and we're working very hard with a number of partners in the cable and telecom space to help drive the adoption of broadband.

Another big area is, obviously, the proliferation of new media formats for online advertising. For online advertising, so much of the reason it's held back today is just from basics of like standards of how you buy an ad across a number of networks—Yahoo, MSN, AOL—and there are a lot of challenges, as well, about just getting new forms of ads online. So things like video advertising, which I'll also talk about in just a second, are things that are catapulting the rise of opportunities for dollar creation.

E-commerce and transaction is a big opportunity for us in MSN; certainly in general for the industry e-commerce has really hit the mainstream and is driving significantly. If you look at all the stuff on how people are spending time online, the amount that they're shopping, and it ages dramatically well. So as people are online two years, versus four years, versus six years, the amount and propensity and frequency with which they shop rises dramatically. We have historically not done a lot in the e-commerce space, besides offering kind of a mall for shoppers, MSN Shopping. This year now we're really getting after it, and starting to do a lot of specific things, in terms of actual transactions that we'll drive with our upcoming music services. One, we helped work with the Windows team on the Windows Marketplace that was just announced, and we're going to continue to scale up our own MSN shopping service, so we broaden out and be much more of a mainstream player, in terms of how you decide to come and buy online. So that's going to be a big area for us.

Search and communications are also two big opportunities for us. We have in general just a very small amount of query shares as relates to Search. It's still roughly 2.2 billion queries a day, and yet, with the competition it's just nothing but wide-open opportunity. So if we can get out and market and provide a better search engine, which we're in the progress of doing—and I'm going to show you some of our progress—it has a lot of upside for our business. Likewise in the communication assets, we have invested for some time and built some unbelievable properties. Hotmail, as you probably know, now has 190 million Hotmail users on a regular basis. If you count it as a total population, in terms of scale, that makes it the sixth largest country in the world. So it is an amazingly large base. Likewise, MSN Messenger is now upwards of 120 million people, who actually instant message back and forth at any given second. We'll peak out at about 12 million people simultaneously talking to each other. That is another amazing opportunity. And we have yet to really tap the premium software capability on those products, let alone the online ad opportunity in those products, two things that we plan to start doing over time. But, particularly through targeting and personalization, these are some things that we have not yet brought to the Web; in fact, no one really has done a great job at any of the major portals in terms of personalization. As we start to get better return on investment for clients, and delight customers by being able to give them targeted content, we think this will dramatically improve our business, and I'm going to show you a couple of things on this front. Finally, just the maturing of international, the international has continued to grow. We've been a leader in the international area for some time, and that investment we've made in over 34 markets, with 18 localized versions of MSN, is starting to pay off now in terms of our position in the marketplace, and the ability to take advantage of new things like the growth of the ad business. What are some of the challenges? Just to give you a sense of a couple of things—one of course is there is a lot of strong competition in this area. That's what makes this thing fun for us. This is where we do our best work, comparing against competition. Clearly, there is some strong competition, in terms of how we continue to drive, and maintain our leadership position with 350 million people worldwide. Personalization is a great opportunity, but there are a lot of issues with privacy and trust, and we have to make sure that we cross that hurdle, that we do a good job of making people feel positive about their experience, and about the sharing of data. If we can cross that privacy and trust battle we will do amazing things, both for the consumer and for our business.

Clearly, spam, viruses, and spyware—you heard Will Poole talk a lot about it, the efforts in Windows SP2, these are things that are holding people back in general. This last year, last 18 months, is the first time that these things came up as the No. 1 and No. 2 requested features online. Unless we address solutions to these problems, we can't talk about all the other great stuff that we want to talk about: new search engines and new music services. Making online as easy to buy as offline: it's still very costly for advertisers to buy online. They can't take the investment in traditional media, so when they spend a couple of million to create a great ad on TV, they want to be able to take that ad and run it online, but they can't. They have to do this special work, and every time they do that they say, "Well, I'm not going to spend as much of my budget. I'm not going to put my best creative people on that problem, unless you make that simple to do."

Finally, launching new services to delight customers. So one of the things you'll see from MSN this year is, in spite of our fantastic progress in advertising, we want to continue to do a good job to build a better and better user experience. So in some cases, we actually are pulling back on some advertising to build a better user experience and to go take share. Search is one area I'll show you where we've actually made the conscious decision to decrease the amount of advertising we have on the page in Search, because it's taking up too much of the algorithmic results, and now that we're building our own algorithmic engine we want to make sure that those great answers come above the fold. That is a major investment from a revenue perspective, which will be revenue that we will forego in an effort to getting market share, and to take leadership on the Search space; likewise with a number of other efforts in that area. So these are some of the challenges that we have as we move forward to try and get there.

So our strategy, as I said before, is really to invest in two major areas: in the communications area, which includes Hotmail and MSN Messenger; around our portal, MSN.com and where we're going to take that,as well as MSN Search; and finally on the ads platform and the payments platform. These are kind of the six major areas where we're making big investments with MSN to drive a great new business.

This coming year, what you can expect out of us in this coming year, will probably be one of the best years of innovation we've had from MSN. We have been kind of hard at work on a number of things technologically, and in this year, just to give you a flavor of some of the things that are coming, we'll be shipping our first-ever Microsoft-built MSN Search system.

We're going to be shipping a big upgrade to our MSN Messenger service. We will offer some advanced e-mail and small-business services. I think a year ago I demonstrated for you the Outlook connector for MSN. And that was shipped as part of MSN Premium. We're working on getting that out there and making that great product for small business available later on in this fiscal year, and that's going to be a great service for people. We're working on the MSN Music service I talked about; updated MSN video; and then launching a number of things around our new advertising platform, our new personalization platform, and the scale-up of shopping. So these are just a couple of the things that are coming, and there will be a number of other things that will be coming, as well, in the year.

So what I wanted to do then is I wanted to go ahead and show you a couple of things in terms of some of these products, so you get a sense of what's coming in the year, and give you a look. And there will be a couple of things here that we haven't seen before. The first thing I want to do is I want to talk to you a little bit about our investment in the Search area. We have been, as I said, investing over the last 11 months. We started with a big investment to go after and build our own algorithmic search engine. We've started to make some fast progress on that.

We achieved two milestones as of a few weeks ago. The first is that we shipped the first-ever technology preview version, which I'm gong to just briefly show you, and the second is that we did a massive update to our current MSN Search service to basically get on par, or even a little ahead, with the best Search services that are out there.

So as you know, at the top of Search page here, a very popular page, viewed by 300 million people every month, we have our MSN Search Bar. And this Search page is a great place to come search. But we got a lot of feedback from people that said, "well, we really like this clean and fast look that some of your other competition has out there, and we like that as a faster way to go do that." So, we built a special page for people who want that called Search at MSN.com. It looks like this page here. I hear some chuckles out there, and so what we did here is, if you want a light and fast start page but you still like MSN, we're going to build that page for you. And, in fact, we've built this page, and I'll submit to you it's a better page than the competition's in the sense that, in addition to a great Search service, which I'll show you, we have down here single clicks to things like MSN Home, Hotmail, Messenger, news, sports, entertainment. So we give you one-click access to the things that you care about. So, if there are things that you like to find, and you're an MSN customer, and you like MSN, this will be a faster way to get one-click access to the things that you care about. If you're logged in, you'll automatically get to your Messenger.

So, our opportunity is that we have a lot of MSN users, a lot of MSN users. But a lot of them have left to go use other Search services, like Google, because they said, "Well, I really like that other Search service." And now what we're doing is going to make it simple. "Hey, if you like MSN, and you want a great Search service, we'll make that simple here for you."

So, this whole page, not only does it offer more than what you get with Google, it's actually 50 bytes lighter than Google. So this is a faster page. So anyone who doesn't think we can build small, fast, light pages, we're going to put that to rest with that first page.

The second thing we've done is, I want to show you how we've improved the Search results for people. I'll type in a query for Seattle in case you guys are looking for something to do when this Financial Analyst Meeting is done. As you can see, this is a look at our new Results page. We've clearly marked advertising, sponsored sites, these two links. We've retained the right rail of sponsored sites. And this has basically the same number of links that you would find with Google, so there's no more advertising than you'd find on any other service. And we've added some special things, like an Inside MSN guide that, if it is met by user demand, we'll provide. That's an unsold spot, so that's only if customers demand it. And then all of our algorithmic results are below. Of course, we don't want to just sit there and provide what's out there today. We want to go further. So, we do some things here that you can't get on other services. So, we have this drop-down list that lets you get access to special types of searches for news, for dictionaries, for encyclopedias, stock quotes, et cetera. Encyclopedia is an important one; a lot of other people don't have this. We have one of the best encyclopedias online with MSN Encarta. And I can actually do a one-click search for Seattle in the encyclopedia, and what you'll see is, I'll get access to not only those results that I see on the Web, but I can go get special access behind our MSN Encarta encyclopedia. So, here are all the articles from that effort.

We're taking a lot of special content from our premium encyclopedia, and we're going to make it available for free if you use the MSN Search service. So, for example, you can look at multimedia clips. I can come back and get the full introduction. So, a full-fledged encyclopedia. We don't provide everything that's in the encyclopedia, but we provide a lot of the high-quality content. This is now one reason why people may say, "I may decide to go choose the MSN Search service because it's got a more expansive set of content." We have the full Web crawl, plus we have premium encyclopedia. And we'll be adding more things.

We also do a better job now with news services, and you can go out and find, there are other types of news aggregation services out there. Here is the one that we launched internationally in 13 markets. We just launched it in the United States about three or four days ago. This is called Newsbot under the MSNBC effort. This is basically an aggregation of all the news that's on the Web from 5,000 different news sources. It's kept very up-to-date in real time. And it comes from a number of providers, so I can pick from any number of wire services, media outlets—not just MSNBC, but any of the news outlets that are out there. Now, one of the things that we do that you can't get with other services is, if I want take a look at a story—for example, let's say I want to come in and read this story, war crimes tribunal—I can come back and find that effort, and I can come back and look at photos. And what will happen is, that story didn't come up, but what you'll see now is that I have this personalized news module. So before I started this walkthrough these stories were actually not here. This was completely blank. And as I just clicked around, without having to tell MSN anything about who you are, or where you live, or what you do, just by watching the news things that you click on in the story, it will put together for you personalized news, the things that might be more interesting for you, based on implicit behavior.

If I click the "why" button, we will tell you why did we recommend this story. So, we'll come in and say, "Well, we recommended this particular story because you read this story on the Bosnia court." And so now you have an easy way to find out why things are personalized. If I want to delete that, if you don't want Microsoft or MSN to know your history, you can click Delete, and we will delete that and clear out the cache. So now, when you go back to Newsbot, you won't have any more personalized news. So, this is a way to go beyond. No other service is providing this kind of personalized news capability on the Web. This is an effort to go above and beyond. I encourage you guys to give it a shot.

And in Tech Preview, this is a look at our end-to-end, Microsoft-built Search system. So, this is live running code. We have over a billion documents in the index. We are running it on a number of servers, and it's working. I'll click Search, and you can see we have our own live algorithmic effort. This is a basically a live end-to-end crawl. In about 11 months, we built an end-to-end system that does crawling, indexing, ranking, and displays results in a very quick and fast effort from over a billion documents, and that was built by a very small team in roughly 11 months. And we are now scaling beyond that. We have a large degree of optimism, I would say. I'm duly humble about the challenge, and incredibly optimistic about what we can get done in this area. To that end, I want to show you something that we haven't shown anywhere before. So, I'd like to show you now this live code. All the caveats apply about trying to show you live code not yet shipped. We've never demoed this anywhere. A lot of people talked about trying to solve the problem of expanding Search, and a lots of times people say, "Hey, what do you bring, Microsoft? What do you bring special to the party? What are you doing other than just a plain old Web search?" I want to show you one of the areas where I think we do have something special that you haven't seen before, you're not seeing from anyone else—at least today—and I put to you, we'll do a very good job on it, and that is the ability to look and search beyond what's on the Web today. The Web today is roughly 20 percent to 30 percent of all crawlable material. If you can crawl it, you can find it. But, you can't find things on intranets, you can't find deep Web databases, you can't find stuff on your local PC very easily. It's certainly not an integrated experience.

So, I want to show you local PC and e-mail searching that we have built as a joint effort across the company—the Microsoft Office Team, the Microsoft Research Team, the Knowledge Interchange Team, and the folks on the "Longhorn" Team, and our MSN Search engineers. We have put together a working version of Local PC File Search. I want to show it to you, and you can draw your own conclusions about how far you think we've come. I'll start here with e-mail, and I'll be in Microsoft Outlook. And let's say I want to look for physicians—and this is live code, this is not a mockup. Watch how fast this works.

I'll click on physicians, and like that, I have searched my entire hard drive for e-mail, my e-mail store, and I find e-mail messages both read and unread. I've got a Contact, I've got a Calendar request that had the word physicians, I've got PowerPoint, and I've been able to find all those documents within this service that quickly. And this is on this PC looking for services. And this, as you saw, was built right into the e-mail service—very simple to use, very fast.

I'll give you another example. Let's say that I wanted to PC search in a different way. Let's say I'm in the My Computer folder in Windows, and I want to look for a file on my PC. I can type in, let's say, Madonna, and click Enter, and just like, that I've searched the entire hard drive and back, just like you do on Web search, in milliseconds. We get all of the Madonna references across my hard drive, which include things like JPEGs, pictures of Madonna; I've got music files; I've got all sorts of other things. I can very quickly, through the power of client code, sort by pictures, by music, videos if I had videos, and they'll show up very, very quickly. So, you can see that's a very, very fast system.

I'll try one more. Let's say that I'm looking for something really hard, so I'm looking for a document that is stored in an e-mail message with the keyword "Total Attendence." And, again, just that fast, you see this is an Excel spreadsheet that is in an e-mail attachment, and so the term is inside an Excel spreadsheet that is inside of an e-mail attachment that's in my e-mail store. And I'm able to find that keyword that fast on the hard drive. And so this kind of capability—we are, as you can see, making very nice progress internally in terms of being able to search—is a way that we will be able to come and superset the ability to search on the Web beyond what any of the other competitors are providing in a very fast fashion.

We have not given a ship date. As you can tell from what I've shown you, the progress is actually very good. This code is working very fast. It has been based on years of work in the company. It's not like we just started the thing a couple of weeks ago. We have made a lot of progress in the last couple of months on it. And this service is going to be one way, I think, we'll move beyond what's out there today.

Actually, one last thing came up here; I want to see if I can show it to you. You see over here on the right rail, one of the other things that we're still working on, as I search here on my local drive, on the right side are Web-related efforts that are related to the keyword that I typed in. So, we're not actually looking at the content of what comes on the page. I want to be very clear about that: none of the content of your results, but the keyword that you typed in—in this case, Madonna. We are working on a right-rail concept that keywords off that and provides Web-related queries.

In the case of Madonna, we tend to find out that you might want to link to her art page, downloads, lyrics, news. You may want to go buy some additional music. So, the ability to have that contextual link out to what's in the keyword that you were looking for is something that we will provide, as well as e-mail results. There may well be opportunities here to drive additional revenue as well in appropriate cases where we're doing keyword efforts that are related to what the user is looking for. So there's another way to also grow the business. Let's talk a little bit about online advertising. One of the biggest areas in online advertising I want to talk to you about is getting people to bring their high-quality ads to the Web. I talked to you about three big opportunities.

Broadband as a way to do rich streaming media, provide an easy format for traditional advertisers to bring and put their money online, and do it in such a way that it all works very seamless.

What I'm showing you here is the next rev of the MSN Video broadcast service. For those of you who haven't used it, this is a site on MSN today where you can see a bunch of images that you can click on and will play live video from great content across the Web. We have obviously all of the games from Major League Baseball as a result of our partnership, MSNBC News, and a number of other great content providers. What we've done now is, we've integrated it into the Windows Media Player as a very simple way to come in and watch high-quality broadband advertising. And I'll give you a quick look here. I'll click on that.

And what you'll see is, we'll have a little 15-second advertising spot that comes up before we run the content, which is MSNBC. That ad shrinks down, and then you see the video broadcast. This ad is contextual. So a thing that you can't do with TV ads is, you can't interact with the ads while you're watching the broadcast. Here, I can interact with the advertising.

To give you a sense of how powerful this video advertising is, three of some of the top five advertisers have come online, so we have Procter & Gamble, McDonald's, and one other company now spending—I think Procter & Gamble alone, who helped basically invent TV advertising, has put aside roughly a $20 million budget to go target online advertising. We get CPMs anywhere from $35 to $60 now on the TV advertising. And unlike traditional media, like television, where you have no idea if people saw your ad, here you're able to tell based on what people are clicking on and viewing. So you have a much richer opportunity.

To give you a sense of the other type of format that we've got on there, and the richness, here's our MSN Autos channel. I can look at a targeted ad here. You can come in and type in an e-mail address. One other version now is, up top here you see another ad that allows you to interact with it, so there's an Expand. This is a new industry standard where people get to opt in to the ad so that we don't just jam them on you. People really don't like when ads pop up out of context of a user's experience. And that's a very negative thing, so we are not doing that. We're taking standard ads where the user would come and click. I can click on Expand, and I can watch the ad here. And, again, standard formats for closing. I can close that out, and that gives you a sense of what you can do.

Another thing I want to show you is a new effort we're also launching called orchestrated advertising, which is a way to provide a next-generation media experience on the Web, where we decrease the amount of advertising that's on any given page. If you've seen a lot of Web pages with a bunch of different ads, it looks like an Auto Trader book; there are so many ads you can't tell what's content and what's ads.

One of the things we're doing is we're going to decrease radically the amount of advertising, and through targeting and orchestration deliver a set of messages. Think of this in the same way that people put science behind how you lay out a grocery store—that when you walk into the grocery store, the end caps and what's promoted there, what's promoted at checkout, what's promoted when you go into the aisles, there's signs to all those things. There's a reason why they put milk in the back, so you've got to walk by everything to go get the milk.

Orchestrated advertising is the same kind of concept. We take the combination of rich media, and personalization, and we do something. Here's one that should get Bryan Lee excited. I had the team do one up for Halo. So here's your Messenger, and you see Halo here, that's targeted, because we know that user is live in the Messenger. I can click into e-mail, as I go into e-mail you see the banner up here now, the superbanner, is also targeted for Halo, so it's orchestrated. And there's time frequencies. I can come in and expand upon it, and I can come in, and I can actually watch the trailer for it, as you saw before, I can click on screen shots, and I can take a look at the product, I can even enter a contest, and then close out.

Then when I go into and type an e-mail, so let's say I go create an e-mail—we don't serve ads when you're in Compose E-Mail, but after you send, an ad in the confirmation page. Again, we can pop up the e-mail advertisement that's there, and again, put up the information for our local copy. Finally, when I click around the network in other areas, you can see here we've got the Halo system, we've got targeting now, because we know that those users that were logged into Messenger and Passport, are from a certain demographic in the Seattle area. So you get a sense there of what we can do on the entertainment effort.

So that gives you a look at some of the things we're doing in the online advertising space. The last thing, that I won't talk much about, but one of the things that's coming, is our MSN Music service, and that's a service that we will be coming out later in the year. I'm not going to talk about it here, mostly because we are getting to the end of our presentation, but here's a sneak peek of what the user interface will look like.

We're very excited about the progress on this service. We're making very fast progress across the industry, getting access to all the music that's out there, building a very, very simple, easy-to-use service. We've been testing it. It has phenomenal emotional appeal to folks, so this is one of the things that we're working on getting together and getting to the market.

So all told, in summary, it's been a phenomenal year for MSN. We're very excited about the progress. We think it's a huge business opportunity. We're focused on some key areas—communication, Search, our ad platform—and the future of driving that business. And we think with those, hopefully, we can come back here a year from now, and I can give you another statement that we've had another banner year for MSN.

Thank you.

END

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