Steve Ballmer: Microsoft Venture Capitalist Summit 2008

STEVE BALLMER: Well, thanks. Looking out, we have a fuller auditorium than we would have last year. I’m going to take it the economy is better than I heard on CNBC this morning.

It is a privilege to have a chance to be here with you. I don’t know, we’re probably six, seven years into this program, and for us the notion that the people who finance the great new companies, they’ll have choices; they’ll have choices to use our technologies to build on, to build around, to complement. You’ll have choices later as these companies mature about where to take them, sell them and take them public, how they go to market.

We want to make sure we’re doing everything we can to occupy what I would call the appropriate amount — hopefully that’s close to 100 percent; this is one place I can use that word — of your mindshare on those topics, but at least we want to make sure that you kind of understand what we’re doing, where we’re going, so that whether you’re trying to work with us, working against us in some of your portfolio companies, whether you’re looking for exit strategies or entry strategies, you can kind of appropriately think and hopefully that winds up being of good mutual advantage.

I want to start with just kind of almost a platitudinous but important slide that reminds us that the technology revolution just continues to march forward. Here I’m preaching to the choir, but I will tell you people always expect something different to come out of our industry. The notion that there can continue to be as much innovation and as much change — hardware, software, user interface — it does stun people.

The Technology Revolution and Changing Industry

You could say that’s a great thing, and you could say that in some senses it puts a high bar out there for us to continue our industry, to continue to show the kinds of things that really excite people.

Sometimes it waxes to the development community or it will wax to the enterprise or back to the consumer world what’s hot, what people want to talk about and think about; is it as interesting to see the ebb and flow, not just in terms of investment but in terms of kind of what captures the imagination of the press and the industry dialogue and the like.

But we just see so many great things, all communication, all content, all transactions going digital.

You could say, gee, haven’t we already played that book? Yeah, we’ve already played that book, and yet a huge percentage of what happens today still winds up happening without digital technologies.

You give us a world here over the next 10 years when literally we’ll get paper thin screens of this size that you can manipulate like this, put in your pocket, and yet it really is a screen attached to the Internet, you’re really talking about really quite a phenomenal world that is quite different than the world of today.

Obviously cloud computing and the move to software plus services or SaaS or whatever word you like, everybody basically believes the same things these days. We all call it something different to reflect our particular bias. But we’re moving to a world in which computation is distributed between the cloud, the servers, the client devices, be they phones or PCs, and you really get a world that can be more efficient, get more done, enable new scenarios; just amazing amounts of innovation.

Natural language, speech, voice recognition: There’s just so, so, so much to be excited about, and you reflect that every day in your investment decisions. And in a sense I won’t call myself a venture capitalist, but I do get a chance to try to direct myself about $9 billion of R&D per year. I don’t get to direct it quite — I don’t get to fail it as fast as you do I think — (laughter) — but hopefully get to also direct that in kind of interesting ways.

A New Microsoft Vision Statement

You know, for many years we had kind of what I would call the all encompassing mission, vision and scorecard statement: a computer on every desk and in every home. That was kind of a mantra, and really worked for our employees because it had a sense of purpose, it talked about what we were really trying to get done, and by the way it was a measurement system, which is counting desks and homes and how were we doing.

Well, our footprint and portfolio is broader than that, and we talk now with our folks about enabling people and businesses to realize their full potential.

I think that actually motivates not just our folks but a lot of people in the technology industry: The sense of really making a positive difference in society is important.

And yet what we found our employees really wanted from us, and frankly our customers and partners wanted from us, is not just a description of kind of this sort of societal impact, but a statement of really what are we trying to do in our core business.

So, as a vision statement we talk about creating seamless experiences that combine the magic of software, the power of the Internet across a world of devices.

In terms of understanding us, you could say this might not help you at all, and I could tell you it should help you a lot. It says three things or four things that are very important.

Number one, we think of our core competence as the development and commercialization of broad software, software-based products. That’s how we think about ourselves.

So, people say, are you a desktop company, are you an enterprise company. No, we’re a software company. We think we’re good at doing software, and we’ll follow that broadly.

This talk is not just about PCs or servers; this talk is about a world of devices: TVs, phones, PCs, servers are all very interesting. And it puts the Internet, of course, as a central part.

So, I don’t care if the software gets delivered from a cloud, software gets embedded in a device, the software gets sold in let’s call it more traditional senses or royalty. We have to have muscle and business model to pursue all of those.

Our last financial year we finished at over $60 billion of revenue. That’s one of these things since I’ve been at Microsoft 28 years and we were 2.5 million when I started, it’s kind of like pinch me, I read the numbers and I sign the Sarbanes-Oxley report, but it’s still hard to believe.

And yet you look out and you say, well, how do you keep growing, and the key to growth is to execute very well on the things that we’re good at, and to continue to build our core competence and get into new areas.

Oftentimes we’ll get questions, well, you’re not good at something, and I’ll say, okay, that’s an opportunity, and it’s always an opportunity to get good at new things. I certainly got a swirl of that around our attempted acquisition of Yahoo! People said, well, you’re not good at it, and I said, well, then we’re going to get good at it. We’re maybe more fortunate than the average startup. We can screw it up once if we need to; not a good thing to do, but just get back up and keep coming and coming and coming and coming. But it’s the only way in a sense — it is the only way to continue to do new things and get revenue growth as we move forward.

Microsoft’s Software plus Services Strategy

We’re five or six weeks out from our Professional Developers Conference, and we’ve got a lot of new things we’re going to talk about and show, all around this notion of what is software plus services, what’s going on, what’s new with the cloud, and how is Microsoft going to embrace that.

You know, when people say cloud computing or software plus services or SaaS or whatever, everybody actually means something different. It turns out not everybody really means the same thing, at least not in the level of the detail. For us I think I would say there’s at least six interesting sort of topics that we need to address and talk about, which we will.

Number one is you need a real platform in the cloud. When we wanted to go after the PC, we build an operating system. When we wanted to go after the phone, we built an operating system. When we wanted to go after the enterprise, we built an operating system. We’ll announce a new operating system, one that runs in the cloud, and has a wide variety of capabilities. That is part of what we’ll talk about at our Professional Developers Conference.

We need to have not only what I would call classic services in the cloud, but the cloud in a sense, in a platform sense offers up the opportunity to do new platform components. They may have made sense in enterprise environments. I was talking to a little group over breakfast this morning about collaboration, social graph; in the enterprise it’s a big, big deal. And yet it didn’t emerge quite the same way as a platform component inside a corporate environment as makes sense when you go out to the broad Internet. So, we’ll talk about and showcase and help clarify a few components we’ve already kind of talked about as a new set of services for the cloud. Some of those may come back, and you’ll see them in our enterprise strategy as well, but they’re really being pioneered on the cloud. That’s what I might call social web type services.

When you talk about software plus services, you’re talking in a sense also — or any of these things, you’re talking about a change in the way people think about deploying software. The old model was you get a DVD or CD, you install it, and clearly the model shifts. But as the model shifts to I click and get something off the Web, the real question is, what goes on? Do you click and just get a bunch of HTML? Do you click and get a bunch of JavaScript? Do you click and get a bunch of Windows code or .NET code? At the end of the day, you’re going to click and get a lot of things, and the way you build those applications, you construct them, the way you balance computation between the cloud and a server or other client device, the way those things get deployed, the way they get managed, the way they get constructed, development and deployment does change.

I mean, that’s certainly true in our world, but it’s true in what I would call kind of Web classic. We used to click and get HTML; now you click and sometimes you get HTML and JavaScript. Our competitors will tell you, you should also get a bunch of other code that’s tailored up for Safari or Chrome or bleety-bleety-blee, but everybody will tell you about the same thing; they’ll just tell it to you in your own words. You click and you get something that runs locally, and you’ve got to have great development tools for balancing computation.

User experience and the way we think about rich user experience also needs to be factored. I mean, let’s face it: the HTML world is not a world of rich user interface, of integration, of rich presentation. The world wants even richer presentation, bigger screens, touch interfaces, natural language, which will tend to migrate down to be executed down on N-node devices. So, we have to not throw in any sense a baby out with the bathwater when it comes to user experience, and we want to talk some about that.

And then, of course, the business models for this new world will be more diverse. Some people say, oh, the world is all going to advertising. That’s hogwash — hogwash. I could tell you at this stage I know a lot about advertising, a lot about advertising. I get to speak on both sides. One, we’re the number three seller of online advertising in the world, but we’re only the number three seller of online advertising in the world.

But the thing you learn is you’ve got to know a lot about somebody or what they’re interested in or something in order for advertising to be an effective business model.

I was joking actually with Tim Lyons, who’s here from Morgan Stanley, sure, we’ll give you everything for free as long as we get to watch what every investment banker does all day on their PC, where they go, what their mail says, and we’ll give them real relevant ads. I think we can probably get 100 bucks a year out of them instead of inflicting that experience.

So, I don’t think advertising is for everything. I don’t think transactions are for everything. I don’t think subscriptions — these models are going to come into play.

My favorite sort of case studies on this come from the gaming market, either you could say from Xbox Live or from World of Warcraft. Those things are all brilliant. They’re consumer oriented, so you would think because they’re consumer oriented they’re all going to be sort of reduced to advertising. And yet you look at them, and they have a mix of a transaction that you sell upfront, a subscription that you buy and advertisement that you receive.

So, I don’t care whether you’re talking about corporate market, consumer market, games; the mix of at least these three business models is going to continue to be an important part of this transition, if you will, to software plus services.

If you can get three revenue streams, what does it tell you? It tells you the price on each can be lower than it would otherwise be. That’s why it’s important. I think in a sense a lot of the question that we face and I’m sure portfolio companies will face is do I bet all on one model. If you bet all on one model, I’m not saying that’s wrong either, it depends, but then that muscle has really got to work effectively for the case in point.

For us that’s also part of a platform issue. What’s the billing platform going to look like, the advertising platform? We’ve got a big competitor certainly out there on that one.

You’ll see that in a sense our strategy says build from the present, embrace the future. Most of the products that kind of, what shall I say, pay the bills around our place, we will talk at our Professional Developers Conference about cloud-based implementations: Exchange, SharePoint, SQL, our identity system, Active Directory, and Live IDs, Windows in the cloud, and we’ll talk about the evolution of Windows Mobile and Office as front-ends that embrace this kind of new notion of balanced computation.

This for us is kind of a big unveiling. A lot of the things we’ll talk about have been rumored about, talked about, semi-discussed, and even semi-announced. But we have a new set of things we want to show and really bring together in I think a pretty powerful way.

If you take just a look at the stuff at the top, Exchange Online, which is the offering for our corporate customers on Exchange today, we have 90 or 100 customers signed up. We’ve got a pipeline as long as my arm, as corporations really look at what does it mean to move this stuff to the cloud. So, I think this is a phenomenon both on the business side and on the consumer side that will continue to proceed posthaste.

Growth Opportunities

Let me switch a little bit to kind of the business side. This is a slide I’ve used now for a couple of years. It’s been the same. That’s probably a good thing, but it’s a reminder, this is kind of what I tell our investors about where they ought to expect to see revenue and contribution margin growth in the company.

It turns out our biggest growth opportunity is the sale of more PCs. This is a dollar statement, not a percent statement. The more PCs that sell with a legitimate copy of Windows, it turns out if you take a big number and you multiply by a modest percent, you still get a big number. And we’ve got a lot of absolute growth opportunity, because the PC market continues to grow in a stunning way. I mean, it’s a market that’s at 300 million and is still growing double digit — still growing double digit. And despite things or including things like the EEE PC and these other kind of low-cost $300, $400 notebooks, the market continues to explode.

China will become the largest not manufacturing company but consumption market for PCs within the next two years. It’s number two today, about 45 to 50 million PCs a year. The U.S. is 65 million, but within a couple of years China will be kind of the number two market, and yet I think most companies need to have kind of a very different strategy to really think through what goes on in China.

In the corporation we see a lot of opportunity both at the desktop and server level. Maybe I’ll talk just especially about the enterprise here in a minute.

Office: It turns out the depth and level of penetration and — not penetration but real embrace for small businesses is interesting. Small businesses continue to be wholly under-automated. Nobody has got a magic formula for fixing that. I was talking to some of our guys. Yet I think that remains, certainly for us, a big opportunity.

Online advertising, search, and display: Big, big opportunity for us. Obviously we were willing to put $40-odd billion out on the table to acquire Yahoo! We’re bullish. We’re bullish but realistic. Things aren’t going to change overnight. The market is not going to flip in some way, particularly in search.

If you take a look at portal, you take a look at communications, those are strong markets for us, they’re strong for Yahoo!, they’re strong for other players across the world, but Google is a force in search. And as I mentioned to some folks this morning, this is one of Google’s weaker markets, this country that we sit in. They’re actually much stronger in Europe and some other markets where they tend to have 90 percent share.

So, we know we have our work cut out for us, but it turns out we’re able to hire great, great talented people in this area. I’m excited about the talent that’s available in the market. I’m excited about the opportunity to try to rethink from a business model and user interface standpoint where search is going.

I told our investors it may cost us 5 to 10 percent of our pre-taxed profit for several years, but I’m game to do it, I’m excited to go do that if that’s what it takes, because I think the opportunity for us, not just for the current market leader, is large.

The gaming business: good opportunity.

Mobile: Mobile is fascinating — fascinating. One of the big questions right now to me is what’s the long term shape of the Smart Phone market. The world today is largely what we would call feature phones or very low-cost phones. About 1.2 billion phones sold, but only 150 million that we would refer to as Smart Phones. At least in countries like the U.S. and Western Europe within the next three or four years pretty much 100 percent of the phones will be smart. It might take five years.

But then you say, okay, if the world is all Smart Phones, what is the market structure? Will there be five guys who build hardware, proprietary software, proprietary applications and take them to market? I’ll call that the Apple or RIM model. And you could have five guys who each had 20 percent share. It’s conceivable. I don’t think it’s likely, but it’s conceivable.

Another market structure would say you’d have two players like that who had each 10 or 15 percent share, and then you’d have 80 percent of the market that essentially was probably divided up between a couple of software stacks that ran across many pieces of hardware. That’s what we’re trying to do with Windows Mobile. That’s certainly what the LiMo crowd is trying to do with Linux Mobile, et cetera.

We’re certainly betting that the latter market structure is more likely. We remain focused on doing software and working with the hardware community. The hardware community is what I would call — in a way the Smart Phone market is about where the PC market was in ’84 or ’85 in terms of real organization on how you get hardware innovation and software innovation to be more separate as opposed to tied together. There’s a lot of work that needs to be done to do the equivalent of the old PC bioses, if you will, of the ’80s that really make sense in this Smart Phone world. But I think if that works happens, you’ll see software stacks that really get 30, 40 percent share of the mobile market.

In the enterprise I’ll just tell you — I know enterprise is less fashionable than ever before, but I will tell you that there’s a lot of great opportunities in the enterprise right now. It’s an area where we’ve got a lot of momentum, a lot of excitement, a lot of investment. It’s not an area people talk to us as much about anymore, everything is consumer this, consumer that, and yet the range of areas in which we’re investing, we made some big acquisitions this last year, we bought a virtualization company, Calista, here in the Valley, we bought Fast in Norway, which was an enterprise search company, a variety of things we’re buying to kind of fill in some of the pieces where — business intelligence we think phenomenal. We tried to buy a little company in that area. We bought one in Southern California, a company called Data Allegro this year. We tried to buy another BI company that didn’t quite happen, but there’s just so much good stuff in the enterprise. And for those of you who remain focused in that area, we’ve got a lot of good interest in both partnering and acquiring.

I get asked a lot, you know, what’s your kind of philosophy? Do you guys build, do you guys buy, do you incubate, do you do large engineering? And my answer is basically if you want to grow at our size, you’d better be good at all of the above. If you think you’re going to buy everything that’s important on the outside, you will fail. If you think everything is going to be three people for three months grinding out the code, you’ll fail. If you think everything can be done by 300-person teams working for three years, you’ll fail. We’ve got to have kind of a diversity of approach.

You’ll see us do a lot of different things. We have more incubation labs on our own nickel than ever before. We opened a new one in Cambridge this year. Our Office group opened one. We’re trying to reach out and partner with other startups out of our own incubation labs. We’re buying more companies than ever before. We’re partnering more with research universities than ever before. So, there’s a variety of different models.

If you ever start to think one size fits all for us and that means we can’t work with you, I’m [email protected]. Shoot me a piece of mail. It’s not what we need to be, not what we strive to be, and we continue to try to be creative in finding great ways to work with you and your companies.

I get asked some in the context particularly of acquisition, does everybody have to move to Redmond. That was an old Microsoft policy: We buy you and we move to you to Redmond. We’ll do that occasionally still, but largely the answer to that question is, particularly with a company that’s got any size, the answer is no.

This is a subset of some of the places in the world where we now have R&D centers. We’ve opened up one recently in Minneapolis, Madison, Wisconsin. We’ve got a center on Long Island. We’re opening up Salt Lake. We’ve got guys in North Carolina, three cities in China. We have R&D centers, two in Israel. We’ve got R&D centers. We’ve now got a center in Paris that we didn’t have before. We’ve got a center in Norway, in Denmark.

I’m not sure I think this is all a feature, but I think it’s all a mandatory, and you’ll continue to see greater spread geographically. Certainly just because you’re invested in a startup that may be in some place that seems more remote than Silicon Valley or for us Seattle or downtown Beijing, we should still talk if you think that there are interesting possibilities.

Just to give you a little bit of perspective, we continue to ramp a little bit certainly in value, but number of deals we do continues to be in kind of the 20 deal a year range. Right out of the bubble we weren’t doing much, because we had screwed up a little bit on some of our investment and deal making, so we kind of slowed down a little bit coming out of the bubble, but we’ve picked back up 17 deals in our fiscal year ’07 ended June, 24 deals last year.

I don’t think you should think of 9.1 billion as projectable. The Danger acquisition, which was more expensive than many of ours; I don’t know if TellMe made fiscal year ’08 — or fiscal year ’07; I suspect it’s in ’08. So, some big acquisitions for us.

But we’ll continue I think. Probably my guess is we’ll buy another 20, 25 companies. The sweet spot for us is under a billion more than over a billion. That’s not actually a financial statement. But companies under a billion are basically usually technology and people. Once you get to a billion, you’re buying customer-based and sales force and brand and all of the rest. We tend to like and do better with the former than the latter. But we’ve done some bigger deals that have had more of the other characteristic, and here you get a list of some of the deals from the last year.

You know, at the end of the day for us there are kind of three key things. We’ve got to have great people. We’ve had a phenomenal recruiting year around the world. It’s interesting, because you would have thought it might have been a tough market. We probably had our best recruiting year ever, both at college and industry.

Innovation breadth: We pride ourselves on that. It is important to be broad. If you want to give people exciting and interesting careers, it turns out you better do more than one thing. Otherwise they’ll leave you to go do the next interesting thing on their minds. So, the innovation breadth is both an HR strategy, as well as a business strategy.

And then, of course, long term tenacity. Tenacity is a thing I almost shy away now from talking about with investors, but I’ll talk to you about it. I think at the end of the day more companies get screwed up by not staying on point and just continuing to try and try and try. People screw up more by giving up than by doubling down.

Almost everything we’ve ever stopped doing I wish we hadn’t. I mean, I can go through a list of things that we used to do, and I say, gosh, if we had kept doing it, we might have gotten to FU earlier or BAR.

We had this business we called Sidewalk. It was local entertainment guides. We sold it to City Search. It was all wrong. There was nothing right about the idea, not a thing. Today I wish we hadn’t sold it, because I think we would have gotten to local search and doing local search well sooner.

So, in a sense I’d tell you, you ought to continue to expect a lot of tenacity, patience and persistence out of us.

With that, I’m going to kind of wrap and open up for discussion.