Cuts Call for Microsoft to Rethink Windows Client

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Microsoft's first-ever layoffs point to a need for the company to rethink its Windows client business, which is largely responsible for the disappointing financial results that led to thousands of Microsoft job cuts announced Thursday.

Microsoft's second-quarter results Thursday, in which net profit fell 11 percent, show that the company is still largely dependent on its Windows client business for its financial health. That business in turn is dependent on the market for PC sales, which is currently flat and shows no signs of improving over the short term.

Microsoft has been trying to diversify its revenue for some time and has made incremental progress. But until other parts of the business begin to pull in more revenue, the company should examine ways to keep its Windows client business from damaging its overall financial health if the current economic condition worsens, analysts said.

"Today really shows how dependent they are on PC sales," said Matt Rosoff, analyst with research firm Directions on Microsoft. "They're still largely a desktop software company."

Rosoff said Microsoft has done a good job trying to diversify its revenue base, and there was some good news in Thursday's results to reflect those efforts.

Besides Windows clients, one business that has been a reliable source of revenue for some time is the Server and Tools Division, which Thursday recorded its 26th consecutive quarter of double-digit growth. This was driven largely by Windows Server 2008, which is just now beginning to take hold in the market and should drive continued success in this part of Microsoft's business, said one analyst.

"Even in a downturn, [Windows Server 2008] brings a lot of new value to the market, in particular for customers that want to reduce costs" because it includes built-in virtualization software, said Al Gillen, a program vice president with research firm IDC. Virtualization software allows companies to consolidate server hardware and therefore cut IT costs.

Thursday's results also showed promising revenue growth in Microsoft's Entertainment and Devices and Business divisions -- the latter of which is home to Microsoft's other cash cow, Office.

But even Microsoft acknowledged Thursday that a flat PC market could continue to affect the overall Office business, while Entertainment and Devices' performance had more to do with holiday sales of the Xbox 360 game console than overall growth in that market.

As other businesses pull the weight of Windows client, Microsoft should spend some time rethinking how it approaches that part of its business, analysts said. Pondering ways to develop an annuity revenue stream for Windows could be one way to do that, suggested Neil MacDonald, a vice president at research firm Gartner.

Annuity revenue is any revenue that is recurring, such as from ongoing subscriptions or long-term contracts. Companies can count on such revenue and factor it into financial outlooks ahead of time.

"If Microsoft could develop a business model where you pay as you go, it would certainly protect them in times like this," MacDonald said. "I think you'll see Microsoft experiment with new models on Windows, especially with cloud-based services, based on an annuity revenue stream."

Thursday's results also show that Microsoft still has some lessons to learn from Windows Vista, which appears to have come back to haunt the company.

Microsoft put considerable investment and time into developing Vista, expecting the OS to be more successful than it has been. In the middle of Vista's development cycle, the company also had to put out a major update to Windows XP in the form of a service pack that it did not charge for, also interrupting the normal revenue flow of its client business.

At the time it was developing Vista, Microsoft thought it could "change the PC market with a new OS," Directions on Microsoft's Rosoff said.

However, consumers as a whole did not rush out to purchase new machines just because they had Vista on them, and many companies opted to skip the OS altogether and continue to run XP instead.

Microsoft has now learned that Windows client is not going to be the kind of product that will "suddenly spur this huge wave" of PC market growth, Rosoff said, and it probably will approach the business with that in mind in the future.

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