(The following is exerpted from “Partnering With Microsoft: How To Make Money In Trusted Partnership With The Global Software Powerhouse” by CMP Books)

Yet for all its structures, communications, materials and initiatives, Microsoft has neither precisely nor completely advised its

partners how to engage the company as such.

Not that partners are entirely in the dark about how and when to engage Microsoft, but they often only know certain principles and employ ad hoc tactics in partnering with the company.

The ordinary Microsoft partner’s experience is a lot like the blind fellows in the elephant story – feeling its trunk, one thinks it is a snake; walking into its side, another thinks it is a wall; grabbing its tusks, yet another thinks it is a pair of swords; and so on-so that each partner knows only part of the approach to Microsoft and altogether they do not know the entire approach.

Many partners are mindful that they operate within Microsoft’s expansive partner ecosystem, but few seem to know the depth and breadth of its outgrowth from Microsoft’s culture. Nor do they uniformly appreciate the dynamism of that culture, and the corresponding vitality of Microsoft’s strategy and organization, both of which, too, reflect the company’s culture. Without a full appreciation of Microsoft’s culture, strategy and organization, a thorough understanding of the partner ecosystem-and the best ways to work within it-is elusive.

So Microsoft’s partners need to refine their knowledge of the company’s inner workings-culturally, strategically, organizationally-to understand how best to engage Microsoft.

The question of why a software, services or reseller firm would partner with Microsoft is relevant because every firm in the information-technology (IT) industry must come to terms with Microsoft. Whether as friend or foe-or somewhere in between- high-technology firms’ coming to terms with Microsoft is rarely characterized by ambivalence. For those firms that elect to engage Microsoft as partners, the guiding question addressed in this book is howto partner with Microsoft.

Yet, for the sake of a clear, compelling and comprehensive answer to the latter question – and to address counter-arguments as to why one would partner with the company at all – we must consider Microsoft’s position in the IT industry, as well as the risks and rewards that high-technology firms have in partnering with Microsoft and, indeed, with its competitors.

Microsoft is a software empire, with a current market capitalization of US$272 billion, and it dominates the information technology (IT) industry. The company was incorporated nearly 30 years ago by chairman and chief software architect, William H Gates III – Bill, as he is called – a Harvard dropout who has become the richest man in the world as a result of co-founding and leading Microsoft since its inception.

Microsoft’s Windows desktop operating system, which first debuted in 1985, runs on more than 95 per cent of PCs worldwide, a colossal market share that continues to expand in spite of antitrust prosecutions and mounting competitive pressures worldwide. As of this writing, Windows’ market share of server operating-system revenues fell just under all UNIX servers combined while its market share of new servers shipped surpassed the 50 per cent breakpoint several years ago.

Microsoft’s partners should consider some basic facts attesting to the company’s global market power. In terms of overall raw market value, Microsoft is the most powerful software company in the world. Microsoft’s current market capitalization of US$272 billion is buoyed by gross annual revenues that exceeded US$30 billion in 2003, climbed to US$36.8 billion in 2004, and are projected to reach US$40 billion in 2005-despite a major slump in IT spending since 2000.

Of that, Microsoft earned US$10 billion in profit in 2003, and posted a lesser but nonetheless respectable gain of US$8.2 billion in 2004, making it a company that verges on US$1 billion per month in net income. Microsoft ranks in the top 25% of the Fortune Global 500 and the top 10% of the Fortune 500. There are only two other high-technology companies ranked ahead of Microsoft, and their fortunes are tied to selling more expensive hardware:

_ International Business Machines (IBM), which posted US$7.6 billion in its fiscal year 2003 (FY03) but whose current market capitalization of US$146 billion is about half of Microsoft’s, and whose number of employees (319,273) exceeds Microsoft’s headcount by nearly six times; and

_ Hewlett Packard (HP), whose 2003 net income was US$2.5 billion, with a current market capitalization (US$58.2 billion) about one-fourth of Microsoft’s, and whose number of employees (142,000) exceeds Microsoft’s headcount by almost three times. Ranked well below Microsoft on the Fortune 500 list is Oracle, whose 2004 net income was US$2.7 billion, with a current market capitalization (US$65.5 billion) about one-fourth of Microsoft’s, and whose number of employees (41,658) is about 75% of Microsoft’s.

Viewing Microsoft’s earning power in perspective is instructive: in its fourth fiscal quarter of 2003, Microsoft realized more operating income (US$3.1 billion) than HP reported for its full fiscal year 2003 and more than Oracle in its fiscal year 2004. Microsoft’s net profit in FY03 and FY04 exceeded that of IBM by a substantial amount, as well. Unlike its two closest rivals on the Fortune list, Microsoft has grown year-over-year for 20 consecutive years and the company projects double-digit growth in its fiscal year 2005.

Microsoft’s consistent growth accounts for its ability to amass nearly US$60 billion in cash and short-term investments since its founding. Of the nine companies with the greatest cash holdings at the end of the first quarter of 2004 on the Standard & Poors (S&P) 500 List, Microsoft ranked at the top. Its cash holdings were nearly four times greater than the second-richest company, Aetna, and greater than the top three combined (Aetna, Exxon Mobil and HP).

In mid-2004, the company announced an increase in its regular dividend as well as a payment of an unprecedented one-time US$3-per-share “special dividend” to its investors-a US$32 billion payout-to dispose of a significant portion of its cash war chest. The special dividend payout rewarded founder Bill Gates with an additional US$3.4 billion, and Microsoft CEO Steve Ballmer with US$1.2 billion; Mr. Ballmer will benefit to the tune of US$132 million from the increased regular dividend alone.

Put its wealth in perspective: after that US$32 billion payout, Microsoft continues to retain more cash than Aetna. Microsoft’s cash holdings, in fact, were more than one and-one-half times greater than the three other high-technology companies on this same S&P 500 list: HP, for example, had US$15 billion, Intel banked US$13 billion and Cisco had US$8.9 billion.

There has been much public debate about the future of Microsoft in light of its legal challenges and competitive threats. Following a guilty verdict on antitrust charges issued by a US District Court in 2001, Microsoft faced-but evaded-two potentially devastating penalties: a possible breakup of the company and a court order forcing the company to remove Internet Explorer from Windows.

Microsoft was ultimately forced to make changes to its business practices and to release more technical information to competitors but it essentially side-stepped remedies that would have adversely impacted the company. As a result, Microsoft is free to extend its massive desktop and server operating-system business, and to take bigger steps into the business-applications market.

In the midst of a massive legal crisis that might have toppled any other company, Microsoft’s senior management displayed remarkable resolve. After a grueling four-year court battle that cost millions to defend, Messrs Gates and Ballmer shifted strategy, as well as positions, with Stanford-trained Mr. Ballmer assuming the reins as new CEO and Mr. Gates going back to his developer roots to serve as chief software architect.

Together, the two businessmen charted a future course that would move them out of the litigation spotlight and focus public attention on Microsoft’s next-generation .NET technology. By the end of 2004, Microsoft had resolved the vast majority of antitrust litigation filed against it by a bevy of entities, including US federal and state governments, and rivals AOL, Sun and Novell.

Between 2004 and 2005, Microsoft was found guilty of anti-competitive practices in the European market and paid a onetime fine of US$613 million to the European Commission. It was also forced to release a version of Windows XP without Media Player.

In total, Microsoft spent more than US$3 billion settling antitrust litigation and acknowledged that the final tab could exceed US$4.5 billion-half of its revenues in FY2004. Yet its decision to settle most of the outstanding litigation has enabled the company to set aside legal distractions and focus on new growth.

Increasingly less subject to regulatory and judicial penalties, for which it has held cash in reserve, Microsoft announced in mid-2004 that it would buy back US$75 billion of its own shares over the next four years in order to boost its stock price and renew investor confidence in the company’s future.

In the midst of its legal battles and a serious downturn in the global economy and IT spending, Microsoft moved ahead with its vision for growth. As many CEOs cut operating costs and stockpiled cash to allay the fears of jittery investors, Microsoft sailed briskly forward, investing heavily in its research and development (R&D) efforts, headcount and partner channel in order to advance its empire. At a CEO Summit in mid-2004, Mr. Gates committed to spending more than US$40 billion on R&D through 2010, in order to drive a new era of business productivity and IT spending.

Microsoft increased its R&D budget again in its fiscal year 2005 to approximately US$5 billion (up four percent from FY04), approaching the net income of HP and Oracle combined. Much of that investment is tapped for emerging ventures: Microsoft Business Solutions group, for instance, received nearly US$1 billion of that R&D budget in order to accelerate its growth into a projected US$10 billion business by 2011.

Microsoft’s revenue growth has slowed in recent years but partners have little reason to question the company’s health or longevity. Its sustained growth over the past two decades, its cash-backed push for innovation and its enviable cash war chest taken altogether with its confidence in accelerating results defy market analysts’ perceptions that Microsoft is a mature company incapable of growth. In fact, Microsoft intends to accelerate its growth into new markets worldwide with innovative products. Microsoft’s per-share earnings are consistently favorable as a consequence.

In 2003, amidst a sustained downturn in IT spending, Microsoft’s growth rate was 17 per cent (US$32 billion). A year later, it had grown by 14 per cent to US$37 billion, far better than the results of many of its competitors. For its FY05, Microsoft projects its annual revenues will grow still more toward its US$40 billion milestone.

(Ted Dinsmore worked with a UK-based systems integration firm where he gained exposure to Microsoft’s partnering model. Currently, he is managing director of a British business and technology consultancy. Edward O’Connor is a managing partner of a U.S. consultancy working with early- and mid-stage software, hardware and services firms.)

CDN This Week will present part two of Partnering with Microsoft next week.

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