Speech Transcript – Bob Herbold, The Microsoft Analyst Summit 97

MR. Herbold: Thank you very much.It’s a treat to be here, to talk about Microsoft operations.As the slide suggests, we really do believe it’s a secret weapon.We believe we’ve had a great year, in terms of the impact on this company.And we’ll talk about a few of those things this morning.In fact, there’s a lot of analogies to a stealth fighter, in regard to operations at Microsoft, in that there’s a lot of things that we go under the radar screen.On the other hand, the impact is not under the radar screen at all.

There are really four points, or four areas, that I want to focus on, in the course of this 45 minutes.One is being paranoid about fundamentals.We really think we are paranoid about fundamentals, and we’ve got some great examples to demonstrate that.

The second thing I want to talk about is really leveraging out IT organizations, to not only run the company well, but improve our products, and help us sell our products.Third, I want to talk about marketing and, in fact, our continual striving to be the best marketer out there.Last, but in fact, most importantly we’ll talk about people issues, and the fact that it’s our intention to always hire the best and our people need to keep that principle in front of them all the time.And we think we continue to do that.

So let’s get into some of the fundamentals and the impact that they can have.So I have a few principles that we operate from, in the operations area.One of them is having the best product is the key to any business.Now, who first said that?I think, as far as I can tell, it goes all the way back to Moses, tablet 4.Basically, this is the heart of anybody’s business.And we believe that here at Microsoft the way to approach that is to really crank up R & D.

So one of our objectives, at all times, is to make sure that we’re investing, investing, investing, for the future, and getting good productivity out of that investment, of course.But, the fact is, the heart of this business is the product.Winning those reviews, having the best product versus our competitors, is what motivates us.That’s why we exist and we really think we have that principle well in hand and focused on in regard to all of our endeavors.

So the task of cranking up R & D, we did a pretty good job over the course of the recent years.In fact, R & D dollars are up over 3X, if you look at a two-year period.Actually, a three-year period, from ’94 up to Fiscal Year ’97.What you see here is the percent of net revenue, on a GAAP basis, that we spend on R & D.Moving from 13.1 up to 16.9, almost 17 percent, and we’ll drive that higher next year.That’s our intention.It’s consistent with the principle that I just laid out.

So the key task in front of us is, given that kind of increase of expenditure, how does one pay for it?So let’s talk a bit about that, because we think over the course of the last 12 to 18 months we’ve done some smart things, as far as picking up the tab for that bill.

First of all, we’ve had a tremendous program within the company to really focus on costs.This is the dreaded cost beast, we introduced him a year ago.Everybody at Microsoft understands that’s the villain.That’s the villain that absolutely wastes dollars.Now, we have several ways in which we measure how we’re doing in regard to controlling our cost.But, probably the best way is to simply look at cost per head, within Microsoft.

As you can see in FY95, that was growing over 10 percent on a year to year basis.FY96, we did a little bit better, but plus 8 percent is still fairly significant.In FY97 we had real focus on this issue, all 12 months of the year.We launched this campaign about 15 months ago and it has had a real impact.If you look at those dollars per head at the end of FY97, it was absolutely flat versus FY96 and that’s a terrific result.That helps us a lot in terms of our profitability.But, most importantly it creates a mind set for our people in regard to how they approach a lot of tasks, and that’s simply smart.

If you look at where we got those dollars, it wasn’t from salary.That would be a stupid thing.We try to pay our people very, very fairly.We think we have a great compensation package.On the other hand, there are areas like travel and entertainment, seminars, conferences, supplies, equipment, that we put a lot of focus on.And you can see with these percentages how we did, versus a year ago.

FY97, we turned up a lot of dollars per head in these three categories, that enabled our cost per head to be flat.This is a great result.Our people deserve the credit.They really have the mentality of corralling the cost beast.And it’s been very effective.

When you look across marketing, for that four-year period that we have been talking about, what you see here is the percent of net revenue that goes for marketing.Now, the jump between FY94 and FY95 was very intentional, and it had to do with the broad reach campaign, where in fact, we’re trying to strengthen at all times the basic trademarks of Microsoft.And we’ll talk about that a little bit in a moment.But, since 1995, or Fiscal Year ’95, we’ve really been working on getting that percent of net revenue allocated to marketing down as much as we can.

Now, I must tell you that next year that percent will probably go up.Steve suggested that yesterday.You saw it written.And, in fact, it will increase, similarly, in the support area.This is a great story.You can see this percentage of net revenue going against support, hovering above 5 percent for the three fiscal years, until this year, when it’s down to 3 percent.

So what’s really going on?There’s actually two things.One is the fact that our Web site, today, microsoft.com, contains a lot of materials that can help people answer questions that they might have about our products.And we’re getting 80,000 visitors a day, probing that knowledge base in regard to ways to operate our products.That contrasts to 20,000 calls a day, and the rate of 20,000 calls per day has been stable for the last two years.So what has that enabled us to do?It’s enabled us to save a lot of support costs.

Now, as we get further and further into BackOffice kinds of activities, mission critical applications and the like, these percentages, or this percentage, in regard to support, is actually going to go up next year.So you should anticipate that.So in both of these areas great progress, in fact, we’re squeezed very tightly right now.And you’ll see increases next year.

As far as cranking up R & D and paying for it internally, let’s tally it up.We saw R & D go from 13.1 up to 16.9.Sales support and marketing, right from the published report, has gone from a level of about 30 percent down to 25 percent this year.That is an incredible result.As is the G & A figure, where we continue to drive down the percent of net revenues that’s going against G & A.

So you add those things up and what you get is operating expenses being at about a 45 percent level, it’s stated as a percent of net revenue.It’s almost back to where we were in FY94, before we increased these things pretty significantly.So it’s a great result.It’s just running the operation tighter, focusing on some objectives, in terms of tightening up several different areas.

Now, let’s talk about finished goods for a moment, because some dramatic things have been happening that you’re aware of.But, when you step back and look at the trends, they’re absolutely amazing.As far as full package products, in FY94 it was at 77 percent, 60 percent in ’95, down to 55 percent in FY96, down to 43 percent in FY97.Licensing, as you all know, is a heck of a lot cheaper to administer than actually making boxes and selling products as a full packaged product.So a significant trend has a big impact on our cost of goods sold.

Let’s take a look at within full packaged products what happens on a unit basis.CD ROMs, back in FY94, were only 7 percent of our business, disks were 93 percent.It’s incredible how fast things have changed.FY97, 81 percent of our units of full packaged products were in fact CD ROMs.As you all know, the different in cost and manufacturing a CD ROM product is very, very significant.If you take a product like the Windows 95, you’re talking 20-plus floppy disks in that box, to sell it to a user.Where, in the case of the CD ROM, you can not only put the code on one CD ROM, you can give them a lot of extra information as well.

So these trends have really worked hard for us over the course of the last couple of years.And it’s demonstrated here.Let’s take a look at cost of goods sold.We’ve really capitalized on those trends, down to 14.8 in ’95, 13.7 in ’96, and 9.6 percent in FY97.It’s a fantastic result.It’s a gift, so to speak, of the technology.On the other hand, I give our people a lot of credit, to actually drive those potential savings to the bottom line, so that we can report these kind of numbers.

If you start adding all of that up now, this is the chart that we had before, showing total operating expenses — so if you add in that cost of goods sold going down from 16.4 percent down to 9.6 percent, it gives you a gross profit margin of 45 percent.So a couple of things in regard to technology to drive that — to give us some real advantage on COGs, some great programs internally, to try and control our costs, setting some real objectives in the marketing area, getting some advantage of the Web in the support area.This is a fantastic picture.

And I must alert you, as I did before though, especially in that sales and marketing area, we’re going to have to spend some money next year that will drive those percentages up a bit.On the other hand, we won’t change our basic mentality, in terms of being very careful with these costs and making sure that our people understand what it is that we’re trying to achieve.

Another basic principle, if you’re going to be paranoid about fundamentals, this is the principle that we have really saluted over the course of the last 18 months.And that is, don’t get caught with useless fixed assets.Now, if you’re a student of Henry David Thoreau or Ralph Waldo Emerson, clearly, these are the people that knew this principle very well.So attributing to them, as appropriate, let’s take a look at how we have taken advantage of their tips.

Canyon Park, a facility north of here by about 20 miles, was owned and operated by Microsoft.When we met last year we were in the last stages of negotiations with an outfit called KAO Information Systems.And in fact, in August of ’96, the purchase was complete, 408 people were moved from the Microsoft payroll over to the KAO payroll.Some people left, but it was actually a low percentage.KAO has taken advantage of that basic expertise of those people, and we got off to a very fast start, in terms of the transition of that facility from our ownership, to their ownership.

We’re still the biggest customer for Canyon Park, as is appropriate.But, the thing that is so amazing about the last 12 months, is being taught the lesson that when you do something like manufacturing, you often think, well, I must be really good at this.And then you turn it over to somebody that truly does it for a living, and is very professional about it, and what you find out is they can actually do it better.So if you look across the mix of products that’s produced up at Canyon Park, and that’s what you see in that slide, on a per unit basis our costs for FY97for the same product mix would be down 9 percent per unit.That helps us with that COGs number that you saw before.

Yes, the move to licensing helps us.The move to CD ROM helps us big time.But, also there are some good efficiencies in there, in terms of our people taking advantage of these kind of opportunities.Talk about another change during FY97 that was very important, and may not have been very visible at all to you, just like that stealth fighter.

If you look at our European operations center, there are a bunch of physical facilities.In fact, if you look at it, what you see here is an office building, then there’s a distribution facility that sits right next door, and there’s the manufacturing facility that sat right next door to that.Across the street is one R & D unit.A couple of kilometers away is another R & D unit, and then a whole bunch of leased buildings that are used for R & D.

Now, when I say R & D here, obviously what I’m talking about is primarily localization of our product, for that region of the world.So what did we do?Well, we kept the office exactly the same.We took the distribution facility and turned it into a manufacturing/mini distribution center, and outsourced a fair amount of the distribution activities.We then took the manufacturing building, took the smoke stacks off, and turned it into an R & D facility, kept the two R & D facilities and did away — or we’re in the process of right now of doing away with all of the leases as they run out, during the course of the last six months and the next nine months.

So when the smoke clears what has occurred?Well, we’re operating with 92 less people.Secondly, we got out of a number of leases, which has a real advantage to us, in that the cost of rehabbing this building into an office facility was very, very reasonable.So it’s a great salute to the principle of not getting caught with useless fixed assets.

Another area where we manufacture product, and in fact the only other area where we manufacture products is in Puerto Rico.There, in the past, we have built both floppy, as well as CD ROM products.And naturally, over the course of the last six months, we have terminated our floppy disk manufacturing activity there.With that, 47 people had to be let go, which we hate to do, but we must face the reality of where this industry is going.So some great results in terms of fixed assets.

Let’s go on to the next principle, in terms of being paranoid about fundamentals.And this is the fact that standard, ongoing tasks, as I mentioned before, in regard to manufacturing, are done a heck of a lot better by outside professionals.Who gets attributed with that comment?Me, I sayit every day, of this fiscal year in regard to where are the opportunities to further outsource.The principle is, if there is something that’s going to be done, that’s going to be done regularly, and we’re probably going to do it in the future, and in fact there are organizations out there that do that for a living, and do it professionally, they can probably do it better.

So with that principle in mind, over the course of the past several years, we’ve done a lot of outsourcing at Microsoft.I list several things there.If you add up all the people that we would have to have on our payroll to do those things, if we did them ourselves, it would be over 1,000 folks.We have great relationships with these vendors, in regard to carrying out these tasks.And we usually partner up with some real professionals, such as in the food area, with Marriott, we have a great relationship.

Now, during FY97, we did a lot of further outsourcing.I’ve already mentioned manufacturing.We’re doing work with not only KAO, but an outfit called StarPack, which makes a lot of our consumer products, down in Colorado.Stream, naturally, is a very important partner as well.So this year we also outsourced the mail room.Now, who would you outsource that to?Well, Pitney-Bowes, of course.It’s the obvious candidate.Two others, print and copy center, Xerox is the perfect candidate.They came in, gave us a great bid.They now are the people who employ those 15 people that were previously operating that center.

So in most of these cases, when we do an outsource, it’s quite typical that our employees simply become employees of the outsource vendor.That was also the case in regard to our receptionists.You might say, wow, that’s a risky move.Those are the people who are supposed to greet people every day and smile and make them feel warm about Microsoft.

Well, Tascor has a billion dollar business, on a global basis, in regard to administrative functions.One of the most popular is receptionists.We looked at IBM, and in fact all the receptionists from IBM are Tascor employees.Why not do it ourselves.And, in fact, that’s exactly what we did.Again, a lot of those 63 people, in fact, got jobs with Tascor, which we were very pleased about.

Company store, we’re right in the final stages of having someone else operate that facility.Why should we think that we’re great in operating a retail facility?Why not get a professional to do that?Another thing that we’ve done over the course of the last three months, is we’ve looked at all these outsource activities and said, wow, just managing the outsourcers is quite a task.Isn’t there someone who does that well?And, in fact, Johnson Controls, when I mention that name you probably think of thermostats, but in fact one part of their business is to manage facilities.

We took advantage of that.They now manage our outsource vendors.And, in fact, they’re in charge of our facility management, which is super, because we can take a subject like energy utilization and ask Johnson Controls, how good are we?And they’ve made a lot of great suggestions in regard to how we can operate more efficiently.We’re really confident that on a yearly basis we’re going to turn up a minimum of $2 to $4 million of operating bucks, just because of the tips that they’re providing in terms of how to professionally operate a facility.

Okay.Add all that up and what you have is Microsoft worldwide operating groups is the fastest shrinking organization within Microsoft.And, in fact, if you look at six-month intervals, you see in 1-97 it took a big dip, and by 7-97, we’re down to just a tad over 3,000 employees, having started with 3,700 back in July of 1995.Now, that’s pretty, I think, significant, in that our revenue has gone up 91 percent, and our head count has actually decreased 19 percent.Of course, you make the argument, yes, a lot of that is outsourced.Exactly right.On the other hand, when you look at the fixed assets that it’s taking to operate those things, we feel very good about these numbers.

Okay.I want to change subjects.The next mission for the stealth fighter is, in fact, our ITG organization, which stands for our information and technology group.You know, besides just running this company, ITG can play an incredible role for us.Naturally, it must run the company well, but it really can be a key asset in getting our company’s systems to be so good that, in fact, we’re a showcase for our own technologies.

In fact, our goal is to become a showcase of the classic central nervous system for a company.We think that objective is dead right and will be very important to our customers to come in and look at.And I must tell you that we’re well on our way to making that happen.

Third part of the objective, or the role of the ITG group, though, is they need to help develop and improve our products.So as we implement systems to run our shop, to run our company, using our own products, it’s amazing what we find out about the performance of those products.And that can lead to new features, new capabilities in those products.

So the relationship between the product groups and ITG is just getting tighter and tighter.If you go back 12 months ago we weren’t a bit satisfied with that relationship.It is really coming along very well at this point.And it can have a big, big impact.And I’ll talk about that with a couple of examples.

As far as running the company, naturally, our objective is 100 percent network and e-mail reliability.The flawless flow of business transactions is clearly a key objective.Tight cost control, if you look at our ITG budget back in July of 1996, as we started FY97, we actually beat that budget by 17 percent, which is quite a bit of money.And you see that savings when you look at those percent of net revenues that I cited earlier, because a lot of organizations get to share in that savings, which is actually, you know, exactly what it should be.

Reduce the number of going systems and rely on off the shelf packages.That’s a key objective for this organization in terms of how it runs its business day in and day out.And, in fact, we’ve got a large grid, which we call the applications matrix.And we take core processes and ask ourselves, how many applications does it really require — are we really requiring of ourselves to run this company, with respect to this process.

And we look at that regularly and ask ourselves, how can we drive that to be a smaller and smaller number.And, in fact, when we look at the list, hopefully more and more of those components are, in fact, packaged products that we’re purchasing from someone else.

Okay.In terms of that changing role, getting key company systems that are real showcases for our technology is absolutely critical.It’s a new advantage for ITG, it’s a new advantage for Microsoft, in terms of selling its products.There are three that I would mention, that have gotten a lot of attention over the course of the last 12 months.A lot of our executives, when they’re out talking to customers, know the details of these examples very well, and they are incredibly robust.

We also allow our customers to come in and talk to the people within ITG, who in fact have built and are running these particular applications.So it’s an incredible sales tool.As far as SAP at Microsoft, we first did the finance and procurement modules.We just finished the HR modules and, in fact, we’re about to tackle the sales, distribution and materials management modules.This has been a great effort.

I had the advantage of doing SAP twice in my life.I did it the long, hard expensive way, with my prior employer.And I could take advantage of a lot of those experiences, as we did the very concise, short, and relatively inexpensive way, here at Microsoft.But, most importantly, the tips that we have generated in regard to telling other companies about how to do it, have been invaluable, and we share those with customers on a regular basis.

Our architecture here is exactly what you would expect.We’re going to use NT.We did use NT.We did use SQL Server.As far as SAP at Microsoft, it’s helped us run the company better, which is the first objective of ITG.It is a showcase application, for Windows NT and SQL Server.An increasing percentage of SAP applications are going the NT/SQL route.

Our scalability is just improving and improving, and when customers come in and see what we’re doing with this system, it enables them to have the nerve to go take those huge savings that they can get by using NT and SQL Server, compared to the dreaded competitor that I won’t even mention.

As far as helping identify ways to strengthen products, if you look at SQL Server 6.5 there are a lot of features in that new version of SQL that are, in fact, directly from this SAP application.That’s the kind of thing I’m referring to earlier, as far as ITG helping the product group make better and better products.ITG and Microsoft itself represents a great pilot plant for our products, to make them stronger and stronger.

The finance Web page, which I’m sure most of you have seen a demo.It is really a thing of beauty.All of us here at Microsoft, who deal with the financial results regularly, have come to rely on this tool, virtually every minute and every hour of the day.This makes one of the great demos out there today.When you show this to CIOs and CEOs they really salivate.

It immediately brings to the forefront, though, the discussion of infrastructure.It brings to the forefront the issue of standardizing the desktop.Windows 95, or Windows NT everywhere, in terms of those desktops, so that they too can take advantage of these great kind of applications that cut across their entire company.So this demo of the FinWeb, is really a good one from the stand point of selling a lot of different Microsoft products, while demonstrating how we operate within the company.

If you look at the advantages for the FinWeb, we get broad, namely global, access, secure access, instant worldwide access.When we update those tables, which come from SAP, and get put into Excel, and you can access them right from the FinWeb, when we instantly update those tables, everybody instantly has it available.So everyone is always up to date.You can no longer make the excuse, well, I’m using data that’s probably from a different period than you’re using, much to the disappointment, occasionally, of some of our geographies.But, in fact, it’s a huge advantage for our company.

It utilizes existing tools to be implemented.So we’re not talking a lot of mysteries here, as far as developing these applications.In fact, most of the FinWeb was developed by a couple of financial analysts, within finance.So from the standpoint of developing this application, this is not one of those things that takes years and years, or in fact, many, many months.It takes a few months, using standard kind of Microsoft technologies, now that most all of our products are incredibly Web enabled.Saves tons of time in the development of a system.Saves tons of time in regard to getting access to key information that you need everyday in order to operate the company.

Another application that we have internally, which is a fabulous showcase, is what we call MS Market.It enables our employees to order things in a very automated way.In most companies when someone wants to buy something, like a PC, or they want to order a particular set of supplies, paperwork starts flying galore, big delays.This enables our employees to order supplies and all kinds of things, on the fly, right on their PC, through the MS Web.So they call up that Web sheet that you just saw, and they dive into exactly where they want to make their purchase.

On an annual rate, we’re running about 250,000 transactions, per year.And it represents a spending of a little over a billion dollars.So our procurement activities are becoming more and more electronically driven, which is terrific, in terms of speeding up the process, putting a lot of good logic in there, to avoid errors that people always make in terms of those kinds of tedious, detailed tasks, such as purchase orders and the like.

The number of users in the past 12 months were at about a 6000 level.How much does this whole thing cost to develop and execute and the like?Just over a million dollars.It’s a terrific buy.Savings of 12 people in our procurement area.So it’s a fantastic application to show to customers.It gets them really interested in how can I build those kind of intranets within my company, which as I mentioned before, immediately puts on the table a lot of great issues in terms of infrastructure, that we at Microsoft think we can really contribute to.

Okay.Changing roles, the last point I want to make is one that I made earlier in regards to SAP.But, with all of these applications, we’re really helping Microsoft make their products stronger and stronger, through development of these applications, at very early points and the like of new versions of these products, so that we can learn about them, new features can be built into the next version.So I give some examples here.

Microsoft Exchange, naturally, we had to have a great pilot plant to prove that you could run a large company with Exchange.Obviously Microsoft was that candidate.The things like NT and SQL, in regards to SAP, and IIS, in regard to our intranet activity, it’s been a great marriage between our product people and our ITG people.

The next area I want to spend some time on is marketing.Our objective, obviously, is to be the smartest marketers in this industry.Again, we think we’ve got some great work going on, and I want to mention just a couple of things.One is in the area of online marketing.

Expedia represents a great example of that.If you look at Microsoft Expedia, the start up banner focused on locations that you might want to visit, locations with snow for skiing, locations with sun for relaxation.Putting those banners out we had a transfer rate of 1.3, a transfer cost of 76 cents.Within four weeks our people had tested and figured out a way to double the effectiveness of their marketing.Now, those kind of examples you’ve seen a lot of.

The thing that’s exciting in regards to Expedia, is after learning how to sharpen the edge of their marketing, in regard to the basic proposition for Expedia — some of the attributes, by the way the transfer rate is more than double, thus more than double increase in the effectiveness of their marketing.They went a lot further though, recently, in terms of creating some very exciting marketing opportunities with some of the vendors that they work with very closely.

Here you see one with American Airlines, and that’s the banner that pops back and forth, in terms of the great deal that you can get on Expedia, through this buy one American Airlines ticket, and get another one at 50 percent off.This was an unbelievable promotion.Those banners were active from May 6 to June 6 of 1997.The May Expedia revenue was up 65 percent.The last day of the offer we had almost a half-million dollars of revenue, which was a little better than 3x to normal.But, most importantly, the June Expedia revenue was only off 15 percent versus a record May.

So what’s really going on here?That promotion was a classic trial device, speaking academically about marketing.A great trial device, where the triers became very comfortable with that service and, in fact, came right back in, the very next month, and did a lot of other travel activities that didn’t relate to this promotion.That’s exactly why you run promotions.This is classic.And boy did it ever work.But, what’s phenomenal about online marketing is your ability to measure all this, your ability to learn very specifically what the impact is of all this marketing activity.So it’s a terrific example of that.

Last year at this time, I put up a chart that said, hey, in regard to online marketing, our objective actually is to be the number one spender.And I indicated that we probably spent about $4 million in FY96, because we had just about closed the books at that time.And in fact, that’s what we spent.I indicated at that time we’d probably spend three times that next year.Well, in fact, we have spent six times that.Our share of overall advertising, online or Internet advertising has gone from 5 to 7 percent.We have, in fact, made our objective of being the number one spender, in terms of Internet marketing and advertising.

Now, why do we think that’s a sensible objective?The reason is because our very, very best customers are, in fact, incredibly Web friendly.So it’s a great tool to get at them in very creative ways.So we’re very bullish about continuing this leadership position, with respect to online marketing.The creativity is unbelievable in this area.And I’m confident next year, when we talk at this session, we’ll have some great new examples that we haven’t even thought of, as far as how to creatively tap this new tool, from a marketing perspective.Those are the top five Web ad spenders that you see there.The source of that information is Web Track.

Okay.Let’s shift gears now and talk about the tender loving care that we apply to the Microsoft trademark.I’m talking about the campaign that is designed to do only one thing, and that is to keep the Microsoft trademark very healthy and top of mind.What do we want people to remember about Microsoft?What are the mental bank accounts that we want to build up, that Microsoft is all about in the mind of our users?There are three.

Microsoft leads the way, leadership, is one of those key attributes.And providing access to a new world, access is one of those bank accounts that we want to build up.A new way of thinking and communicating, some new ways to communicate, it’s another bank account for equities.It’s a mental bank account that we want people, when you say Microsoft, to think about these kinds of things.And when presented with these attributes, we want our company to be rated very high, our trademark to be rated very high.

We also have character elements that you’ve seen before.They’re listed here.What’s important about this slide is it should be the same every year.The reason why is, when you start changing your mind in regards to the equities that you want to put in people’s mind, you’ve got quite a marketing task ahead of you.Because once you build up those bank accounts, it’s actually hard to decrease them.So our intention is to live with this proposition for a long time.Our intention is to live with that brand character for a long time.That’s the way users want it and that’s the way great marketing is done, behind the trademark.

So how are we doing?Well, let’s first of all take a look at a couple of examples of the campaign, and then we’ll look at some measures, so you get a sense for how carefully we try to measure exactly what we’re getting for our money and whether our advertising is being effective.

The first ad I’ll show is called election.Obviously we ran it in the October-November period, here in the United States, when the election was just around the corner.We think it’s got a great message in regard to Microsoft.You see a lot of software.But, it’s also got a good feel, in regard to what Microsoft represents.So let’s take a look at Election:30.

[Ad plays]

Our ratings, in regard to being Internet savvy, were really driven up by this Software Is campaign, which is the title we give to that campaign.You see a lot of great screen shots, a real association of the Internet to Microsoft, plus a great feel, in regards to what our company really represents.

The second ad that I’ll show you is called Competition:30.It’s a lot harder hitting ad from the standpoint of, hey, Microsoft is very industrial strength in regard to applications.So this is much more business focused.It’s also a very cool ad, in terms of the look and the feel and the music and the visuals.So let’s take a look at Competition:30.

[Ad plays]

Okay.The proof is in the ratings on those key attributes or bank accounts, that I mentioned earlier.So we measure that regularly.And, in fact, the way we measure it is the following.You’ll get PC users, a representative panel of PC users, on almost a quarterly basis.And you’ll ask them the question, please rate Microsoft as being the software leader on a scale from one to nine.

So when you think of the attribute,
“is the software leader”
, rate Microsoft in terms of how it fulfills that.And then you measure the percent of people that give you a seven, eight, or nine.Now, I must tell you on a nine scale, humans head for the five, as you would expect.So to be able to get this high a percentage of people giving you a seven, eight or nine, is really terrific.But, what’s more important is the advertising has been able to drive that further and further.

Next attribute, obviously, is access.I mentioned that earlier.It’s the second bank account that we worry about a lot.Same scale, 1 to 9, percent of people that give us a seven, an eight, or a nine, when asked the question, rate Microsoft in regard to access to new capabilities.So we’re up to the mid-70s, which is terrific, when you think about 76 percent of people giving us a seven, eight, or nine.So those are good ratings.

New ways to communicate.We got a bit more to go in regard to perfecting our communication on this attribute.But, we’re making progress.We’re up to just about 70 percent of people giving us that very, very high rating.We do this kind of measurement not only in the United States, but the other major countries as well, where we run this advertising.Another thing we did this year, which is very important, is what I’ll call your classic consumer products split cable tests.What’s a split cable test?

Well, you go to a research supplier and they provide a couple of cities, where in each of these cities they’ll have 3,000 households that have agreed to have their cable spliced.And they don’t know how it’s being spliced, but they do know that they may be seeing different commercials than their neighbor.But, they don’t know exactly which ones.All they know is they get their $20 a month for allowing this research organization to fiddle with the advertising that they might be exposed to.

You then balance those panels, and what’s important, in any one of these cities where you’re doing the test, in fact, your neighbor could be getting commercial A and you might be getting commercial B.Now, in our case, what we tested was one household got the Microsoft advertising of the type you saw earlier, and the other household got no Microsoft advertising.And after nine months, in regards to software leader, you do the same kind of research that I just described.

So software leadership dropped by 7 percentage points.Being the online Internet leader dropped from 39 to 22.I should point that 39 is building very significantly.Naturally, we want to get that number higher.Product for business, we dropped from 84 to 74 percent.So why do you run this test?You run the test to make sure that, in fact, the advertising is having some impact.

We also did a test exactly like this, where we tested higher media weights, in order to see whether if we pump it harder, in fact, we get more bang for our buck.And in the case of the Microsoft advertising that you just saw, in fact, you do.And then you have to decide where it is that you want to place your bets, as far as the amount of money that you want to put behind this effort, to keep the Microsoft trademark very healthy.

Okay.Change gears again for my last subject.And that is one of having the very best people.This is a sacred subject at Microsoft.One of the things we’re very proud of is our ability to attract and develop and keep really good people.Now, from the standpoint of attracting the best, who do we look for?We look for very smart folks, and most importantly, folks that have a real passion, a passion for this industry, but also just a passion for whatever it is that they’re doing.Those are the kind of folks we want to hire.

Lastly, it helps a lot if they come in with a big wad of expertise in a particular area.On the other hand, we do a lot of hiring off campus, and we’re willing to do investing on our own, and we do a lot of it.As far as how many, if you looked at FY96 we hired about 2,500 people.These are exempt hires domestically.That was about the same level in FY97, and in FY98 we intend to crank that up to 3,600.

Remember I told you, and Steve mentioned to you yesterday, that in fact, we’re going to hire some sales and marketing people.And in fact, you see it reflected there.Paul and Pete are going to hire more product people.And you see it reflected here.So the fact is, we’ve got quite a recruiting task ahead of us in FY98.But, one thing you won’t see us budging on is that basic criteria that you see up above.It’s one of the key secrets to the success of Microsoft.Okay.

So how are we doing in regard to acceptance rates.We think acceptance rates are important to study, because it gives you a barometer of how well you’re doing as a company in competing for the very best talent.FY95, 73 percent acceptance rate, FY96, 81 percent acceptance rate, FY97, we repeated the FY96 performance.That’s a very high acceptance rate.We’re very proud of it.We think we do a great job of seeking out the really cream de la cream of the people out there that are willing to work and are interested in working in this business and have a real passion for it.

Another thing we look at very carefully, besides the ability to accept our offers, is the attrition rate.On a worldwide basis you see the voluntary attrition of Microsoft employees in this chart.FY94, we were up at 8.9 percent, FY97, steady as she goes, we’re at about 7-1/2 percent.We’ve been there for two years.Now, how does that compare to industry and, in fact, this industry in general?It compares very well.

This is from an outfit called Saratoga, they publish these stats for various industries on a regular basis.We haven’t gotten their latest numbers, that’s why the N/A is in there for FY97.But, given the track record, we think that number, in terms of the computer products industry will probably continue to be in the 12 and 13 percent range, which means we continue to do a pretty good job of attracting people.They want to work for us, and that’s what’s giving us good acceptance rates.And they want to stay with us, and that’s what’s giving us the good attrition rates here, that we’re very proud of.

From the standpoint of the campus, this is an amazing story.You go back to FY91, we had 1.1 million square feet under roof to house employees.Then that increased by about a half-a-million square feet per year — excuse me, per every two years from ’93 up then again to ’95, giving us up to about 2.1 million square feet.A full 1.1 million square feet of office space was added two years later, bring us to current.And over the course of the next two years we will add another 1.1 million square feet, to house employees here on our campus.

So we’ve been very busy from a construction standpoint.And I must tell you, we have a crackerjack crew to implement our plans, in terms of construction.Our latest project that we had, which we call Pebble Beach, which is a group of three buildings that we just opened a couple of months ago, if you go back to the very beginning of that project, 16 months before completion, they were predicting 16 months.And, in fact, we completed it in about 15.7 months.

If you look at the cost, what they completed it for was basically about 99.8 percent of what they said they would complete it for.So we’re getting good in regards to construction.Of course, you all know the tip in regards to coming in on estimates is you don’t let anybody change your mind in terms of the plans.And we religiously adhere to that.And that’s why we can keep the schedules.We have to keep to the schedules, otherwise our people aren’t going to have any place to do their work.

With that, I will conclude and simply remind you that we think operations at Microsoft is a very important activity, that really contributes significantly to this company.We have a great deal of pride in focusing on those fundamentals, a great deal of pride in making that ITG organization really work for Microsoft to sell products.We’re really proud of our marketing.We think we’re leaders, in regard to all aspects of it.And we’re pushing those frontiers regularly, particularly in regard to online marketing.But, the real secret of Microsoft is the people.

With that, I will conclude and thank you very much for your attention.

(Lunch break.)