Beyond Binary

With a tough economic climate figuring to put a crimp on IT spending, Microsoft is already working on honing a message that it can help businesses save money.

In an interview Friday, Microsoft Business Division President Stephen Elop said that companies are certainly re-evaluating their tech spending projects, but tried to make the case that Microsoft stands to fare better than most.

"Relative to Microsoft's general approach of making all technology, all software very affordable...that plays very well at these times," Elop said. "Who knows what lies ahead, but nonetheless, we've got some pretty good messages."

Microsoft has been working on getting those messages ready in a hurry. Chief Operating Officer Kevin Turner sent an e-mail to Microsoft's sales force Wednesday night highlighting a dozen or so things the company can do to help customers save money.

The things on the list aren't big surprises--unified communications to reduce travel costs, virtualization to save on server costs, as well as Microsoft's many licensing and financing options.

"It is the case that we are very focused and getting even more focused on having a conversation with our customers around value," Elop said.

But while Microsoft has long grown sales by offering a lower-cost option than software rivals, it now finds others, including Google, using those same arguments against core products like Windows and Office.

Elop reminded me that it's not his first time managing through tough times.

"I've been through a pretty significant economic downturn in the early part of this century--boy that sounds old--when I was at Macromedia," he said. At the time, he said he told his troops that Macromedia could lead through the tough times and come through it stronger at the other end. "I think at Microsoft we can do that even more so."

SANTA CLARA, Calif.--Microsoft chief executive Steve Ballmer said Thursday that it remains to be seen how much the current economic crisis affects the technology industry.

"Our industry is not immune to what goes on in the global economy and yet as I travel and talk...I would say given the current circumstances, people see a certain buoyancy (in technology)," Ballmer said.

That, he said, comes from a variety of factors--the fact that consumer spending has not yet been harder hit and the fact that things globally aren't as severe as they have been in the U.S.

"At least for now, people that I talk to in our business (are), I wouldn't say optimistic, but better than you would feel if you watch CNBC all day," he said. (He made it clear that he wasn't speaking to Microsoft's specific results, noting that the company is in the last week of its quarter and thus in a quiet period.)

Ballmer's comments came at the start of a conversation with Hummer Winblad founder Ann Winblad at Silicon Valley's Churchill Club.

Such appearances have been frequent for Microsoft's CEO in recent years. Ballmer hasn't hesitated to take on the local names, either: in remarks following a 2006 Churchill Club appearance, he chastised Google for its demands over browser search defaults in Internet Explorer.

Those watching for signs the overall economic woes are affecting the tech industry may not have to wait much longer.

Although many big tech names say they have yet to see a direct impact (beyond the dip in their stock prices), one analyst I talked to said that it's typically not until the end of the quarter that such warning signs crop up.

Well, in addition to being St. Patrick's Day, it's also two weeks before the end of the first quarter and the time to start watching for negative earnings pronouncements from companies that realize their quarter is not shaping up the way it should be.

"I think it's going to make the markets increasingly nervous as we begin to see some of these tech companies (warn)," said the former Wall Street analyst, who now works on the buy side.

The analyst cautioned that we are likely to see mixed reports initially, with some companies seeing challenges and others not seeing any signs of a slowdown.

Whether start-ups feel the pinch depends a lot on in what stage they are in their funding. The IPO market is essentially shut, the analyst said. That means that you have a whole group of companies that were hoping to go public that are instead going to be looking to either get acquired or land mezzanine funding until the market improves.

"Valuations have been softening, but the bottom hasn't fallen out."

--Tom Vertin, Western Division manager for Silicon Valley Bank

"Valuations have been softening," he said, "but the bottom hasn't fallen out."

However, some start-ups may find it easier to get bought in this market. With credit tightening, some large companies may shift from debt-fueled megadeals to strategic acquisitions, according to Mike Shepherd and Laurie Yoler, at GrowthPoint Technology Partners, a boutique Silicon Valley investment firm.

An example of this dynamic is BMC's acquisition of BladeLogic for $800 million this morning.

"It wasn't done at the highest (price) but it still was a premium," said Shephard.

Tom Vertin, Western Division manager for Silicon Valley Bank, said he is still seeing some appreciation in values for the companies in the hottest areas or with the top management, though valuations have started to weaken for the next tier of companies.

"Valuations have been softening," he said, "but the bottom hasn't fallen out."

One thing that helps to buttress the tech sector is its reliance on venture capital. Many VC firms have already raised a significant amount of money and are unlikely to return it to investors simply because of a downturn. VC firms also plan ahead for their portfolio companies, typically reserving money that will be needed down the road.

Alain Harrus, a partner at equity firm Crosslink Capital said that the credit crunch will likely dent the valuation of late-stage private companies. These companies will be unable to go public and also be compared against their public counterparts, which are declining in value. Hot private companies will still be attractive, in other words, but maybe not as expensive.

"Late stage valuations will start suffering," he said. "It doesn't change the investment dynanmics, just the economics."

One issue that has received ample discussion is the notion that some Silicon Valley companies may have been a little too reliant on a type of investment known as auction-rate securities. Though pitched as a higher yield alternative to cash, the once highly liquid investments have proved less so in recent months as there have been fewer bidders in the auctions that give the funds their liquidity.

Anxiety on that front, though, has eased as the problem appears to be less widespread than once feared.

"Those horror stories are out there (but) the number is not that great, that we've been able to see," Vertin said.

Still, the change in economic winds has some entrepreneurs decidedly less optimistic than they were. "There's an equal likelihood that within the next ten weeks we will either get acquired, get funding, or go belly-up," said a CEO of one start-up looking to pull in its first post-angel round of funding.

Not everyone stands to be crunched equally. The aforementioned former Wall Street analyst notes that enterprise companies are likely to get hit sooner than consumer ones, with both software and hardware firms at risk.

Although it certainly has a large enterprise business, Microsoft may still be a good bet in uncertain times, Jeffries analyst Katherine Egbert said in a research note on Monday.

"Seek safety in Microsoft's numbers," Egbert said in the note, saying that, following its recent decline, Microsoft shares represent a "solid refuge."

On the flip side, those likely to be hit hardest are technology firms that cater exclusively to the financial services industry or get a lot of their revenue there. "That's a subset that is probably going to get hammered," Vertin said. "I am aware of a number of software and software-as-a-service companies that have had contracts delayed or stopped altogether."

We can also expect to see a shift in the way technology companies market their products, with a renewed focus on how the gear in question can cut costs and help the bottom line.

"Technology is a lagging indicator. As we dive into a recession, it gets hot again," asserted Shepherd. "People are looking for efficiencies and they look to technology as a way to cut heads, lower consumption of energy (and) reduce waste."

How long the woes will last is an open question, but Vertin suggests the challenges are neither likely to persist for years nor resolve themselves overnight.

"We are going to have this credit crunch, if you will, for the next six to 18 months," he said.

News.com's Michael Kanellos and Caroline McCarthy contributed to this report.

While many businesspeople are worrying about a possible recession, Microsoft says it sees its part in the economy remaining strong.

In a telephone interview on Thursday, Colleen Healy, Microsoft's general manager of investor relations, said that the company booked a greater amount of future revenue than it had expected, taking in about $500 million more than planned in its "unearned revenue" column. That comes on top of the record results for the quarter that ended December 31.

"From our perspective, we are expecting IT spending to remain stable," Healy said. "Software, in particular, remains healthy, and our ability to capture IT budgets looks good."

Healy said some of the bookings appear to be early indications of demand for its coming server and tools products, including Windows Server 2008.

On the consumer side, Healy said that both the Xbox and the Zune had a good holiday quarter. Microsoft has now sold 17.7 million Xbox 360s. Healy did not give a Zune figure, but said, "We had a good holiday season, positioning ourselves as the clear alternative to the iPod."

Microsoft also continues to see gains from reducing piracy rates of Windows, Healy said. In the past quarter, about 3 percentage points of Windows sales growth was due to reduced piracy, she said.

The company is also benefiting from a larger number of customers opting for high-end versions of Vista, as opposed to the basic edition, with premium options accounting for three out of every four Vista copies sold.

Updated 3 p.m., with additional comments from Microsoft on timing of Windows Server 2008.

One of the nice things about being Microsoft is that a lot of money comes in, good times and bad.

Asked Thursday about the impact Microsoft is seeing from the uncertainty in the credit markets, a top Microsoft finance executive said the company has yet to see anything particularly worrisome.

"We're not seeing anything different than what we said back in October (during an earnings conference call)," said Peter Klein, the CFO of Microsoft's business division, speaking at Credit Suisse's annual technology conference. "We haven't seen to date any impact although we are watching it very closely."

He noted that in his unit, which sells Office, Exchange Server, and SharePoint, more than 40 percent of revenue comes from long-term contracts, sales of which have been going rather well.

Pressed for details on when Microsoft might have a full-featured online version of Office, Klein didn't offer any new insight, repeating that company line that Microsoft intends to remain the leader in productivity, a line that suggests that if the company needs to offer an ad-supported or Web-based version, it will.

As for the release of Windows Server 2008, he noted that it will come at the end of the first quarter of next year, after the product's formal launch at the end of February in Los Angeles. "It will ship pretty soon after that," Klein said.

Microsoft had originally planned to ship the operating system by the end of this year, even cutting some virtualization features to try and make that date, but said in August that the code wouldn't be ready until early next year.

Update: A Microsoft representative said that Klein misspoke with regards to the timing of when Microsoft will finalize the code. "We remain on track to RTM (release to manufacturing) by the launch," the representative said.