USA: Mr Microsoft is sitting pretty - WILLIAM H GATES.

USA: Mr Microsoft is sitting pretty - WILLIAM H GATES. - The world's biggest software company is closely tracked, but competitors still find its youthful chairman and its future fairly inscrutable.

by Malcolm Wheatley.
Last Updated: 31 Aug 2010

The world's biggest software company is closely tracked, but competitors still find its youthful chairman and its future fairly inscrutable.

"We never expected the kind of growth we've seen," claims Microsoft's chairman and CEO, William H Gates III. The name may bring to mind a typical hard-boiled American executive, but no one could be less like a Henry Ford figure than this 36-year-old Harvard drop-out. In 15 years he has built up a software program business that is now, in stock market terms, worth more than either General Motors or Boeing.

A sales growth rate of around 30% would normally be more than satisfactory for the future, Gates continues. Nonetheless, a 30% rate would actually represent a substantial slowdown from that achieved over the last decade. And especially so, he adds, when one considers that this would still imply an 18% profit after tax.

While many City chairmen might feel uneasy about someone who uses expressions such as "real neat" and "supercool" to describe financial performance, most would give their right arm to achieve the growth and profits that Microsoft has turned in since 1976, or simply for the fame and fortune that it has brought Gates. His one-third stake in the business is worth around $7 billion, ranking him top in Forbes magazine's annual list of the 400 richest Americans.

What is really remarkable is that it is a company with real growth. It has eschewed the '80s deal-making and leverage with paper that brought down Robert Maxwell et al. Microsoft's $686 million cash pile has grown as fast and consistently as its sales revenue. Its 1991 accounts showed profits of $462 million on sales of $1.8 billion. IBM, by contrast, posted its first ever loss.

The son of a successful Seattle lawyer, Gates demonstrated his money-making skills early on. In 1972, at the age of 16, while working on the Democratic presidential campaign, he bought 5,000 campaign badges at three cents each. When the vice-presidential candidate, Thomas Eagleton, withdrew on health grounds, Gates was left with the seemingly useless badges. But not for long - he sold them for $20 each as novelty items.

Gates went to Harvard in 1973, but dropped out after a year to co-found Microsoft with Paul Allen, another former schoolboy entrepreneur. The company started off by developing computer language software, including Basic, for the burgeoning number of microcomputers on the market. His big break came in 1980 when IBM contracted Microsoft to write the operating system for its PCs. Operating systems were a new venture for the company, and potentially a risky one. But risk, costs and development time were cut down at a stroke when, for $50,000, Gates bought the rights to an existing operating system from a company down the road.

The payback was enormous. By 1984, Gates was already worth $100 million on paper. Virtually every PC sold in the world today uses that same operating system - now in its fifth version. People who have already bought versions two or three, are now buying version five, so that sales currently top 100 million worldwide.

Then came "Windows", a combined operating system and front-end that aims to make IBM-compatible PCs as user-friendly as Apple's products. This is now in its third major release - as is Excel, a spreadsheet designed to topple Lotus 123. Wordprocessing, graphics and language programs are all selling strongly, too.

So the profits are rolling in, just as they have done from the start. But will they continue to? Don't rely on the analysts. Wrong-footed several times throughout the company's history, they see little further than the rest of us. A whole host of people now track what Microsoft and Gates do, trying to figure out what the future holds. Gates's response to these groupies appears disingenuous. Outwardly, his strategy is to play down expectations. After our chat - and feeling obviously uncomfortable in a suit - he went off for a television interview. His lines were crisply delivered: "I've already said that we're not going to grow, percentage-wise, as we have in the past. There is a saturation issue." This is certain. With one operating system per computer, software package sales must logically be constrained by the slowing rate of growth of personal computer sales worldwide.

Nevertheless, it is equally clear that a large part of the company's strategy is aimed precisely at circumventing this constraint. Windows and DOS are chiefly sold to hardware vendors; they are usually part of the computer "package" and are priced accordingly. Gates won't be drawn, but indicates that each copy of Windows brings the company around $20 when sold to a volume hardware manufacturer such as Compaq or Dell. DOS is even cheaper. Multiply that by 24 million PCs a year and it's a lot of money - but not as much money as could be earned by selling higher-priced "application programs" (word processing, spreadsheets and the like) direct to the end users of the 100 million PCs out there already.

"Machines, number of applications, dollars per application, plus Microsoft's market share equals Microsoft's revenue," recites Gates, checking each off on his fingers.

While virtually every other major software supplier was laying people off last year, Microsoft carried on hiring. Microsoft likes to hire the best, straight from university, and many apparently opt to work for the company because the transition between the two is so smooth. Russell Warner is head of the company's corporate account marketing group. Like Gates, and many of the people strolling around Microsoft's 29-acre Seattle headquarters, Werner is casually dressed in T-shirt and slacks. Not that the dress code is the sole incentive for working for the company. Once on board, prospects are very good. Thanks to the company's stock option scheme, a sixth of its 12,000 employees are dollar millionaires on paper.

Recently he has split the top jobs between three long-serving managers - Frank Gaudette handling finance, Mike Maples product development, and Steve Ballmer to cover sales and marketing. They are all personally close to Gates - Ballmer, for instance, was at Harvard with him, and has been with the company from the time when it employed only 30 people.

The move seems to have been welcomed both inside the company and out. The share price shot up to $5 with the announcement, and employees breathed a sigh of relief when business continued as usual. The company's 24-hour-a-day culture is a notoriously difficult one for outsiders - and employees' spouses - to adjust to, but it does deliver the goods. Drive past Microsoft's Seattle campus late at night and the office lights show that Gates isn't the only one still working. Among PC aficionados, Windows has been criticised for being ponderous, consuming megabytes of memory and seemingly acres of hard disk in order to achieve little more than an ordinary DOS does. According to Werner, this misses the point. The vast majority of PC users are not computer buffs, but managers and secretaries. They are looking, not so much for hardware efficiency, but for an easy wordprocessing or spreadsheet system.

By wrapping users in user-friendly cottonwool, Windows gives them just this. As a result - they buy more Microsoft applications. The comfortable "look and feel" of Windows wordprocessing is carried over in Windows spreadsheeting, which is much the same as Windows graphics. Running under DOS, says Werner, users typically possess two to three applications. Running under Windows, the number rises to six or seven programs. He then explains how the company's new "object linking and embedding" programming works. When a user changes the figures in a spreadsheet, the computer automatically goes into all the other applications that use that spreadsheet and updates them as well. The benefits to the user are obvious - as are the benefits to Microsoft. The net result, inevitably, will be more purchases, especially by the big corporate users for whom such linking is most useful.

The final icing on the cake is that all this should make people go out and buy more PCs - leading to more purchases of DOS andWindows, and we're back to Gates's litany: "Machines, number of applications, dollars per application and Microsoft's market share equals Microsoft's revenue." Unfortunately, one variable in the equation isn't moving in the right direction. Hardware prices - and margins - have crashed with a vengeance. What cost £5,000 a few years ago costs £1,000 today.

Based in London, John Leftwich, who cut his teeth in computing as a marketing director with Apple and Apricot, is responsible for marketing Microsoft's products in the UK. He forecasts "massive increases" in unit sales, but does concede that what he terms "revenue per licence"-the dollars per application in Gates's formula - is set to decline. "Hardware prices have basically been trashed," says Leftwich. "It's now essentially a commoditised marketplace. We're seeing slight signs that this is happening with software, too."

If he is coy about revealing quite what these signs are, others are more forthright. Competitor Lotus has been involved in a number of widely publicised aggressively-priced combined PC and software offers. A glance at any computer magazine these days reveals pages full of advertisements for popular packages at around half list price and there is also a burgeoning market in backlisted software.

So the strategy comes back to other elements in the formula. First, the number of machines. As Leftwich puts it, the concept of one person, one computer is outdated. There's the desktop machine back at the office, of course, and the still growing second machine market for travelling laptop and notebook PCs. But he is also heralding the imminent arrival of a third, the PDA or "personal digital assistant". "Personal computing", he pronounces, "is starting to be something you do anywhere, any place, whenever it's appropriate." Not only will this bring in more sales of existing applications, it will also encourage the adoption of new ones waiting in the wings, such as workgroup software, to enable departments of people to move information around between each other, even whilst they're on the move. The company is also looking at the integration of PCs with ordinary telephones.

But Gates's smartest move could well be in art rather than computers. For both education and entertainment, multimedia - where sound, software and crystal clear high definition television images are combined - is seen by many see as the next huge market. Sony, IBM and others are racing to develop the hardware, and Microsoft the software - but it is Gates himself who is buying up the images. Although it is Microsoft that formally owns 26% of London publisher Dorling Kindersley, whose richly illustrated backlist is seen as ideal for multimedia, it is Gates personally who has been buying up the electronic reproduction rights to the world's great works of art.

A picture emerges of a business determined to do everything to make Gates's formula for the future possible. Werner points out that the company's applications division alone is already a $1 billion business in its own right. Leftwich won't detail the UK proportion, but industry watchers calculate that the 1.4 million units shipped from the new Reading offices last year accounted for about £100 million of UK turnover.

Once a piece of software is written, a larger proportion of each successive sale is pure profit. The company's worldwide accounts for 1991 reveal that net revenue per employee has risen 13% in three years - despite a steep increase in the number of those employees, and an inevitable lag between taking them on and recouping the additional revenues that they bring. Even more profitably, as volumes have soared, costs have fallen - from 25% of revenue to under 20%. So the future, in the short to medium term at any rate, looks lucrative.

At the time of writing the four-year saga of the legal battle with Apple over Windows's alleged copyright infringements looks close to a settlement in Microsoft's favour. Dealing with the 300 or so alleged infringements, a Californian court has progressively ruled that they were in fact covered by a licensing agreement between the two companies. Only four points now remain unresolved.

Microsoft is a major vendor of Apple MacIntosh software, and throughout the battle Gates has tried to remain close to Apple Chief Executive Officer John Sculley. "I love Apple," jokes Gates, "but hate their legal department." Only time will tell what the longer term brings, but Gates refuses to admit to being worried about how far his formula can go. "Worry". says the high priest of the cerebral, "is kind of an emotional term, isn't it?"

For reprints of this article, contact Anne Oakley (071) 413 4336.

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