Microsoft's problems begin to hurt its earnings

Blackfriars noted last month that Microsoft's size and complexity were hurting rather than helping its prospects. Those observations showed up in Microsoft's earnings yesterday that fell short of analyst estimates. Financial analysts have viewed this as evidence that Bill Gates and Steve Ballmer intend to go to war with Google and Sony. While that might reassure those who like that type of combative attitude, I might remind them of one of the lines from the Godfather: "Blood is a big expense."

Companies often think getting big gives them economies of scale. But in an information and attention economy, it also increases communications costs. It just flatly costs a lot more to get 61,000 employees on the same page and to innovate than it does 6,000. Want proof? Think about this statistic: Microsoft is on track to spend nearly $6 billion this year on research and development. Now name six innovations from Microsoft over the past 12 months (note: it isn't easy once you get past XBox 360). Would you value those innovations more than those from companies like Google? Are they worth $6 billion?

The problem with Microsoft today is that for the last 10 years, it has been focused more on protecting its monopoly in Windows and Office (the only two divisions that routinely make a profit) than in doing anything new. And it has grown so big that even communicating any new strategy costs millions of dollars and months of time. For example, next Monday, Ray Ozzie -- someone that many business publications have annointed the savior of the company -- will have been at the company a full year as of May 1, 2006. And yet his most significant impact on Microsoft so far has been a multi-page memo on the Internet. Compare that with people like Paul Otellini at Intel who is doing a top-to-bottom review of the company to deal with its problems, and he's only been in the top job a few months.

Microsoft needs to be a smaller company to communicate better, reduce its costs, and innovate. It has two choices: it can shrink itself by breaking up into smaller companies, or the market will do it for it through decreasing its share price. Judging from today's reaction to Microsoft's earnings, it may not have that many more years to make that choice.

Full disclosure: I have no financial investment in Microsoft, nor does my firm do any business with Microsoft.

Technorati Tags: Analysis, Earnings, Financial analysis, Microsoft, Opinion, Research