75 Acres and a Mule: Microsoft Builds for the Future

Microsoft plans to significantly boost spending in the upcoming year to battle with Google and other rivals. The company is starting from scratch, and it scares Wall Street. The reason, reading between the lines, is that Microsoft now has to compete on something like a level playing field. With its new services strategy, it can’t effectively use its monopoly to lock in customers as easily.

The core of Microsoft’s new spending will be on software services. Windows Live is evolving to be an advertising funded one-stop shop for everything from e-mail to instant messaging to blogs. According to a report today on Reuters (available from ZDNet), Microsoft will spend heavily for computer servers and data storage and has already bought a 75-acre property in central Washington state to build a server farm that will hold thousands of data-serving computers.

Microsoft’s stock tumble last week put Wall Street’s concerns about the company in the press. In a note to clients (as reported by Todd Bishop of seattlepi.com, who participated in the conference call), analyst Rick Sherlund of Goldman Sachs said the company’s earnings-per-share guidance for the year, $1.36 to $1.41, is “way below” his previous $1.57 estimate. “While revenues are fine, spending is snowballing,” Sherlund concluded. All told, Microsoft lost about $32 billion in market value, as investors reacted to its less-than-expected earnings announcement.

Indeed, the money is flowing… but not necessarily into research and development. Quite a bit must be going into the coffers of gatekeepers such as Amazon.com. According to another Todd Bishop report (and others, including this one on Slashdot), Microsoft struck a deal with Amazon.com subsidiary A9.com to provide underlying technology for the A9’s search service, replacing Google as the default option. Searches from A9, Alexa and the A9 search box on the Amazon home page now show results “powered by Windows Live Search.”

Google is looking for ways to block Microsoft’s encroachment. According to a report today, “New Microsoft Browser Raises Google’s Hackles” by Steve Lohr of The New York Times (which at first rejected my non-Microsoft browser, but then let me through), Google expressed concerns to the U.S. Justice Department and the European Commission that the search box in the upper-right corner of Internet Explorer (IE) 7, which is typically set up to send users to Microsoft’s MSN search service, puts Microsoft in a position to unfairly grab Web traffic and advertising dollars from its competitors.

Of course it does.

Microsoft’s response so far is to point out that the default settings in IE 7 are easy to change. “The search box in IE7 is not Microsoft’s. It belongs to the user.” Good luck with that.

As I pointed out in a previous blog entry, if Microsoft would start from scratch and redirect its energy into Web services, the strategy would at first put Office out of business, but it also would shore up Microsoft as a company that delivers the best, most innovative solutions. Microsoft is coming from behind in the Web services markets for business and especially for consumers, where it is also lagging in the competition for online advertising. Todd Lowenstein, a co-portfolio manager for HighMark Capital Management’s Value Momentum Fund who holds shares of Microsoft, was quoted in the Reuters report:

If you look at Microsoft historically, it’s usually had a second-mover advantage. Microsoft hasn’t really been the one to innovate, but to copy and then leapfrog the first mover and that’s been the company’s modus operandi. Microsoft must feel threatened and it wants to draw a line in the sand. The jury’s still out on whether that makes good economic sense.

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