Daily Archives: July 21, 2006

It’s Official: Microsoft’s “Zune” to Challenge Apple’s iPod

Details remain scarce, but it is now official that Microsoft will go mano-a-mano against Apple and its iPod-iTunes tandem in the market for music and entertainment players and attendant services.

I’m always willing to revise my opinion as further facts become known, but my initial response is that Microsoft is throwing good money after bad in a desperate bid to resuscitate its increasingly moribund MSN franchise.

Microsoft is reaching into its strategic playbook here, looking to see whether it can leverage the rising strength of its XBox home-gaming platform and its Windows Mobile operating system for smartphones to somehow make its Zune-branded products serious contenders. It’s done a similar thing in enterprise markets, where it has attempted to build on its Windows and Office franchises to catapult its Office Live Communications platform to success.

But there are crucial differences between those markets and their respective buyers. It’s not clear to me that there are mutual-reinforcing associations between gaming consoles, smartphones, and portable music and entertainment players. In fact, all the evidence to this point suggests that each product offers a different experience warranting disparate platforms. Consumers don’t necessarily want them mashed together in an unappetizing stew, nor do they to be roped into a walled garden of Microsoftian proportions.

Unfortunately, that seems to be where Microsoft is heading. What follows is a quotation from an exclusive Billboard magazine article on Zune that was excerpted at Gizmodo:

That scenario is to provide ubiquitous access to digital media from a wide range of Windows-powered devices in what ultimately aspires to be one part MySpace, one part iTunes and one part XBox Live.

What a mess. It seems like a spaghetti-against-the-wall gambit rather than a coherent plan. And it’s all in being done in a misguided bid to rescue MSN by transforming at least part of it into a hybrid MySpace-iTunes Frankenstein’s monster. What’s worse, Microsoft is alienating its erstwhile hardware partners to pursue its Zune muse.

Even if it wraps WiFi, Bluetooth, and all the other wireless standards into this thing, I don’t see it taking away appreciable market share from the iPod, which now accounts for about 75 percent of the market.

So far, based on what I’ve heard and seen, Microsoft seems to have neither the brand, nor the expertise, nor the vision to topple Apple on its own consumer-savvy turf.

F5 Networks Dragged Down By Probes Into Stock-Option Backdating

I have a lot of admiration for F5 Networks. It is a company that made its mark initially during the Internet boom, developing and selling load-balancing switches for customers that wanted to capitalize on the tsunami that was Internet commerce. It customers were a who’s who of Web-based businesses, a few of which are still with us today.

Cisco Systems took aim at F5, concerned that the upstart might be able to parlay its toehold in load balancing into a bigger presence in network infrastructure. In most other markets, especially back then, when Cisco targeted its adversaries, it usually beat them to a bloody pulp. Witness what happened to Cabletron Networks, 3Com, and Bay Networks (subsequently subsumed by Nortel Networks) in enterprise networking.

But F5 Networks persevered, surviving not only Cisco but also enduring the deep, dark nuclear winter that followed the Internet bust. F5 diligently developed new features and functionality for its BIG-IP traffic-management switches, ensuring their usefulness for internal Web-based applications as well as for Internet storefronts.

More recently, recognizing that customers depend on its products for all facets of application availability and optimization, F5 made security and WAN-optimization acquisitions that added considerable value to its product portfolio. Security, as F5 knows, is integral to availability. If an application disrupted because of malicious traffic, enterprise continuity is broken and productivity suffers.

Cisco, which essentially folded its tent and had to lick its wounds after its first encounter with F5, is taking another run at the company, hoping to dislodge F5 from its position as the market’s leading vendor of application-acceleration equipment worldwide. Cisco, which once targeted F5 with its LocalDirector load balancer and its DistributedDirector WAN load balancer, is now competing against F5 with the Cisco Application Control Engine (ACE), a high-performance platform that integrates application delivery and security functions. If you look at presentations given by Cisco’s brass, you can see that Cisco identifies F5 as ACE’s primary competition.

So, F5 Networks deserves our respect. It has good management and products that have satisfied customers and stood the test of time, not to mention the onslaughts of an industry juggernaut.

That’s why it’s surprising to see the company temporarily staggered by the stock-option backdating phenomenon. F5 announced last night that it will restate its earnings for the past five years after an internal investigation into questionable stock-option practices turned up at least one disparity between the date options were awarded to an employee and the date those option grants should have been recorded.

As a result, F5 plans to restate earnings for fiscal years 2001 through 2005 and for the first two quarters of 2006. It also will be forced to delay the release of its fiscal third-quarter (which ended in June) financial results until its review of prior earnings is complete. The company says it is “unlikely” the review will be done in time for it to file its quarterly report by an August 14 deadline.

F5’s stock was down sharply in reaction to the news, even though the company tried to counterbalance the bad tidings by disclosing that revenue in its fiscal third quarter grew 37 percent, to $100.1 million from $73.1 million for the same period in 2005. The revenue number surpassed Wall Street’s estimate of $97.3 million, according to Thomson Financial. For it’s fourth quarter, which concludes September 30, F5 expects revenue of $104 million to $106 million, again beating analyst projections of about $103.4 million.

Good news, though, often gets overshadowed by bad news, and the uncertainty associated with stock-option backdating will hang over F5 like a black cloud. The company and its questionable stock-option practices are facing lawsuits as well as investigations by the U.S. Department of Justice and the Securities and Exchange Commission.

F5 needs to get these matters settled sooner rather than later. When you’re fighting against Cisco Systems, distractions of this magnitude are always unwelcome.

Dell Decline Confirmed

Dell Inc. pioneered the direct sales model, predicated on a lean, mean supply chain that allowed it to offer customers, both consumers and enterprises, lower prices on PCs and servers than they could find elsewhere.

But those days are gone. Competitors such as Hewlett-Packard, Lenovo, Acer, and others have adopted or otherwise emulated Dell’s direct-sales model and manufacturing practices. What’s more, Dell has squandered its most valuable possession, its formerly stellar brand and corporate reputation, by countenancing customer service that seemed more an afterthought for the company than a priority. That sent a bad message to customers: Dell wanted them to buy their PCs, but was relatively indifferent to them once the checks cleared. Another factor was Dell’s loyalty to Intel, which caused its PCs and servers to fall behind those of its competitors, who had been shifting their PC designs to AMD’s microprocessors, in several market segments.

All of which leaves Dell where it finds itself today, apprising the world that profits and revenue from its second quarter will be lower than expected. Dell blamed “aggressive pricing and slow commercial sales worldwide,” but it could just as easily have pointed the finger at itself. Dell now says second-quarter earnings will land between US$0.21 to $0.23 per share, on revenue of about $14 billion. Analysts had been expecting earnings of $0.32 per share on revenue of $14.2 billion, according to Thomson Financial. The results, which had better not deviate any further from this downgrade, will be announced August 17.

There have been signs that Dell recognizes its own culpability in its travails. It is spending $100 million to improve shoddy customer support, it is investing in products (such as office color printers) and regions offering compelling growth prospects, and it has greatly reduced the number of promotions and rebates associated with its products for consumers and SMBs, cutting costs and improving efficiency in the process. It also, belatedly and just as Intel is reawakening from a long slumber, has begun using AMDs microprocessors in its personal computers and servers.

Is it enough? Probably not. The worm has turned, and Dell has lost its dominance of the PC market. Its growth will suffer as a result, as well its stock price.

Inferences from Microsoft’s Latest Earnings Report

I won’t regurgitate all the line items in Microsoft’s earnings report. The raw data is available from multiple sources and from Microsoft’s website. I want to make a few observations, though, regarding aspects of the results and guidance that seem salient, at least to these tired eyes.

First, I suppose Microsoft is capable of listening to its investors. The company’s announcement of a share-repurchase program, which will include a $20-billion tender offer for shares until Aug. 17 and authorization for as much as $20 billion in additional buybacks through 2011, was in direct response to shareholder agitation for Microsoft to use its mountain of cash more gainfully and to buttress a share price that had been suffering from the company’s market identity crisis — namely, the ongoing uncertainty about whether Microsoft remains a growth stock, has transmogrified into a value play, or whether it is sitting in the purgatory between those two worlds.

Of course, the buyback isn’t just a magnanimous gesture by Microsoft board of directors toward the company’s shareholders. The buyback also is in the company’s best interests. With the shares it will repurchase, which will total 8.1 percent of its outstanding shares, Microsoft will put itself in a better position to retain employees who have been defecting to arch enemy Google and to other firms with seemingly better growth prospects. By bolstering its share price, and by having more shares under its control, Microsoft can now do a better job of attracting new staff and retaining high-value personnel being lured elsewhere.

As for problem areas, it’s now obvious that MSN is listing badly. Compared to performance in the corresponding quarter of last year, MSN revenues fell nearly 10 percent, to $580 million, and the unit lost $190 million. We also know from market-share figures that it is losing ground in Internet search to Google and falling a bit further behind Yahoo in the race for second place. MSN just isn’t a great place to hang out online — it’s hard to ascertain exactly what Microsoft wants it to become — and its search, search-related advertising, and content just aren’t compelling enough to steal share from Google or Yahoo, respectively. Microsoft needs seriously rethink its objectives for MSN and its Live.com services. What’s the raison d’être for this stuff?

On the bright side, the XBox 360 appears to be knocking the cover off the ball. Yes, Microsoft continues to lose money on hardware sales, but the company eventually will benefit from making the right moves in product management and development and Sony making what appear to be the wrong ones, especially in overpricing their forthcoming PlayStation 3 for the mass market. Sony seems willing to cede market share to Microsoft in exchange for profit margin on a lower number of units sold. That’s good conservative business practice, but Microsoft will see a a huge benefit in a growing wave of software titles that get ported to its console. It also will see greater unit sales of its gaming consoles going forward. Microsoft would rather take the mainstream than the rarefied high end in any market segment, and Sony, of choice or necessity, is letting Microsoft have its way.

Microsoft’s core business, the Windows and Office franchises, are chugging along, and they’ll get an infusion of new revenue with new revisions of those flagship offerings next year.

What’s interesting, too, is where Microsoft is choosing to invest its research-and-development money. Approximately $1 billion is being allocated for development of what Microsoft deems “high-growth” products and services, in areas such as business intelligence, unified communications and IPTV (Internet Protocol TV). Security is another area where Microsoft will continue to place considerable emphasis.

The focus on unified communications isn’t only beneficial in its own right, as I explained in a previous post, but also because it will drive and support future sales of Microsoft’s operating systems and its personal productivity and business applications, embedding presence everywhere and incorporating multimode communication into an extensive range of enterprise processes and workflow. It’s a smart move, and it is vintage Microsoft, leveraging its existing enterprise real estate, in this case Windows and Office, to help establish a new offering (unified communications), which in turn reinforces and revives the original product franchises. It’s a mutually reinforcing product strategy.

Microsoft also intends to spend $500 million to bolster its embattled online business, including its adCenter advertising platform, as well as its Live services, such as Office Live, CRM Live, Windows Live Search and other Web-based offerings. These need the investment, but most of all they need a plan with strategic coherence.

If Microsoft knew where it wanted to go online as much as it knows what it wants in the enterprise and home gaming, respectively, it would be poised for a second era of industry domination rather than having to repurchase its share to lift its sagging stock price and retain its most talented employees.