VideoIt all depends, he says, on what happens to price. "As long as volumes grow and prices remain relatively firm or even soften a bit," says Connors, "we can have a great business from the revenue perspective, and we can also have a good business from a cash generation or a value generation perspective."
All Eyes on Price
Put another way, Microsoft is relying on current pricing and a goodly portion of the world's tech growth to sustain its 31 percent net profit margins. But an increasing portion of global tech growth will come from Asia's burgeoning economies. And it's precisely in Asia—with China in the lead—that pressure to alter the uniform pricing structure for its software is the strongest in the world.
"I would like to use your software, but how can I invest in it when I now have cheaper options available?" asked a CFO of a healthcare chain based in Singapore at an executive breakfast where Connors was speaking that morning. The CFO added: "What can I tell my shareholders?"
Connors responded that the total cost of ownership of Microsoft Windows and Office products—which account for 80 percent of its revenue—is in fact less than that of cheaper, open-source software, because Microsoft can offer the entire weight of the 'eco-system' that supports its products. This eco-system can be described as the support, customization, integration services, and software that evolve around the Windows product. Connors cited studies that have endorsed this view from Forrester Research and Merrill Lynch (see "Two Views on Total Cost of Ownership").
But while Connors' arguments hold true in the Western world, they don't stand up so well in emerging markets. That's because Microsoft has a one-size-fits-all pricing policy for the world. And while it offers discounts in various sectors—such as to governments and universities—it remains inflexible on the cost of its software. Critics say that the total cost of ownership argument does not apply in markets like China, where labor costs are cheap and the real cost of Microsoft products is extraordinarily high. It's partly for this reason that Microsoft has such serious piracy issues in Asia.
Research gives an idea just how much Microsoft products cost in the region. A group based at the University of Maastricht in Holland called Free/Libre/Open Source Software (FLOSS) released a study last year that showed the cost to businesses of a basic 'toolkit' of Windows XP and Office XP in 173 countries using purchasing power parity rather than market exchange rates. For data on the countries, the FLOSS study drew upon World Bank figures published in 2001 using a figure of US$560 for the Windows and Office toolset if it was purchased in the US, based on contemporary pricing from Amazon.com. The FLOSS study said the same package would cost a Chinese business US$21,678, equivalent to more than seven months of the nation's per capita GDP. In India the cost came to US$42,725, or 14 months of per capita GDP. In Cambodia, the price tag reached US$71,184, or 24 months of per capita GDP. Says Rishab Ayer Ghosh, program leader for FLOSS: "In developing countries, even after software price discounts, the price tag for proprietary software is enormous in purchasing power terms." Ghosh argues that lower labor costs and higher licensing fees tilt the debate about the total cost of ownership between open-source and proprietary software in favor of open source in most developing countries.
In this context, Linux presents Asian governments with a low-cost opportunity to develop a competitive market for software, causing downward pressure on price. Security-minded governments like China's see a benefit in developing a home-grown software industry independent of the proprietary code of the largest American software company. Moreover, a lively Linux market, if it developed in China, would provide a solution to the nation's software piracy problem. Illegal users could naturally gravitate to the lower-cost Linux software rather than buy Windows at seven months per capita GDP.
All of this amounts to tremendous bargaining power against Microsoft.
Is It the Same?
Microsoft bashing is so common worldwide—and so much of a knee-jerk reaction—that it's almost iconoclastic to look at how the familiar devil isn't so familiar anymore. For one, on the finance side, Microsoft has turned itself into a more agile company, and in a remarkably short amount of time. Two years ago, Steve Ballmer, Microsoft's CEO, suggested to John Connors that the company should restructure along the lines of General Electric into separate businesses reported on separate P&Ls. (The Wall Street Journal reported that Ballmer had his revelation after reading former GE CEO Jack Welch's memoirs.)
Connors has enacted the change with remarkable swiftness for a company so large. Last summer, he appointed seven CFOs to the seven P&s, which are business solutions, server and tools, mobile and embedded devices, home and entertainment, MSN, client, and information worker. The seven finance chiefs were given the power over setting targets, performance measurement, and budgeting. Analysts said the new structure represented Microsoft's maturity from a tech wunderkind to a giant industrial company.
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