Sunday, April 30, 2006

Can Microsft Take a Page From its Heritage to Create Exponential Growth?

Shares in Microsoft Corp. slid more than 11 percent Friday, their biggest drop in more than five years, after the software giant said earnings would be hurt by increased investments aimed at fending off rivals such as Google Inc.

The stock had its biggest single-day decline since November 2000, lopping about $32 billion off its $281 billion market capitalization and reducing the value of Chairman Bill Gates' stake by about $3 billion.

The move shocked Wall Street, which had hoped to benefit from the company's biggest product releases in years, with its Vista operating system and Office 2007 scheduled for January.

But is there a broader issue we can learn from this? What is the Microsoft business-building model to create Blueprint Company-like businesses?
We know the powerful lessons from today’s Blueprint Companies that in order to succeed:
- Shape a breakthrough value proposition early,
- The time from founding to the inflection point is about speed and about achieving a record high revenue growth rate,
- Don’t over invest in order to scale. Get to cash flow positive early and scale a positive cash flow model,
- Earn the right to get on the 4 or 6 year trajectory at the inflection point, and
- Leverage the 7 Essentials early.
When you read “Microsoft appears to be using that potential revenue to bankroll longer term strategies, prompting investors to question when it will deliver on growth expectations.

"This is still a company that is extremely profitable. What people are worried about is whether that ever flows through ... to the benefit of shareholders, or does the company spend that money," said Charles Di Bona, an analyst at Sanford C. Bernstein.
Microsoft said Thursday it would increase spending on its software services business. Chief Financial Officer Chris Liddell said the company was willing to make a trade-off between "the set of opportunities and the revenue growth potential we see."

In addition, Microsoft did not detail its spending plans. Liddell said the company would invest in rapidly growing areas of the software market, such as collaboration, business intelligence, performance computing and security.

I am a fan of Microsoft’s assent to $1B revenue. How could one not be? They are the #1 Blueprint Company still today – more valuable than even Google at $1B revenue. That being said, they could look at their history for guidelines to create a portfolio of Blueprint Companies as lines of businesses.
Here is what I found that would give you a perspective:

The uniquely common growth pattern to $1B revenue is exponential growth. The trend for these companies was they were cash flow positive early and scaled with exponential positive cash flow growth. The mean market cap at $1B revenue is $2.8B. Consumer sector businesses have the highest frequency while Technology has the highest value. Systems software is #1 at $1B revenue with a market value of $15B.

Therefore, based on the standalone company benchmarks, the market doesn't believe Microsoft:
- Will have a high probability of exponential growth,
- Will over invest thereby creating a negative cash flow business,
- Could have a low margin business,
- Will not achieve the 4/6 revenue trajectory to $1B (see chapter one), and
- Since only 5% of all US IPO companies since 1980 made it to $1B revenue (387 of 7454 companies) and only 29 of those made it to $10B revenue, the odds of Microsoft investing this amount up front to achieve a $10B business seems low given the benchmarks and their track record.

Bottom Line, the market is saying Microsoft is over investing and doesn't have a plan to get to a $1B on the way to $10B revenue on the 4-year trajectory. I would recommend they invest less and get to $1B faster followed by a plan to scale to $10B with a proportional investment from this point. Much more digestible for the market. Also use the Blueprint Essentials to communicate the plan.

What happens as a result, investors treat Microsoft as more of a traditional story than a fast-growing Web stock, valuing it at 18 times expected fiscal 2007 earnings, compared with 34 for Google Inc.

Can Microsoft develop a portfolio of exponential growth businesses with returns that lead the market?

While history indicates that the odds are against them, they have to forge the trail for the Google’s and Yahoo’s behind them.

42 Comments:

Anonymous Anonymous said...

Microsoft is like fleas on a dog. They scratch a little, but that is about it. Microsoft is a sick stock and has been dying for 5 years. Biologists would refer to their business stage as endogenous respiration. They are the GM of the software industry. GM you remember used to be the "Concept of a Corporation", a marvelous 1960's book that some of us remember. Microsoft will grow now by acqusition alone. It is now known as the great company to have come from. The executive recruiters dream talent pool. It seems like all growth eventually is an "S" curve. A great ride on the way up though.

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