Speech Transcript – Bob Herbold, Tech ’98 Conference

Herbold, Executive Vice President
and Chief Operating Officer
Microsoft Keynote
BancAmerica Robertson Stephens
Tech ’98 Conference
San Francisco, California
February 23, 1998

Good morning. Thanks for getting up early and coming out to hear our story. I want to talk, just for a few moments, about this industry which continues to amaze us all in terms of what’s going on. Telco used to be sleepy, now it’s exciting. What’s going on with the small firms as well their relationship to cable and conductivity in general is incredible. Naturally, there’s a lot going on in hardware also, and the software business is always incredible. Add up all the numbers and what you see is a huge increase in total revenue compared to 1991. This industry continues to march along. In fact, if you measure it and try to forecast it out for a couple more years, what you see is we’re clearly on track for this to become a $1.3 trillion dollar business on a global basis, which will make it the largest industrial sector by the year 2000. An incredible amount of technology innovation, an incredible amount of great applications.

In fact, when you ask the question
“What’s really driving this growth?”
the answer is obvious-
“It is incredible applications”

When you look at intranets today and realize how firms can use them to re-engineer processes, to clean things up, to help standardize data, to throw away old procedures that depended on people and paper, and how they can use these technologies with applications that can be put together in weeks and months as opposed to years, no wonder we’re seeing the kind of growth that we’re seeing. Also, a reference was made earlier to off-the-shelf software, to assist people with year 2000 issues, but more importantly, to assist people to standardize processes, standardize data, if possible, on a global basis, if possible across all your subsidiaries so you can really drive some efficiency. That coupled with a great fundamental network and infrastructure can really drive simplicity in a firm. That’s what causing this growth.

Once again it’s just incredible how much easier things are getting in terms of putting these great applications together.

What it results in, from the standpoint of the basic economics of this industry and their impact on the United States, is phenomenal relative to jobs. Looking at software only, you see a 70% increase versus 1990. We’re up to about 600,000 jobs in the software industry. If you look at it from the standpoint of companies, we’re now over 40,000 companies. That’s an 80% increase versus 1990. So this industry, particularly the software industry, is incredibly vibrant. A lot of innovation. A lot of small companies are being successful. Mostly importantly, from the standpoint of our own economy in this country, a lot of jobs are being created.

Ok, I want to shift gears now and talk a little bit about the legal issue, relative to Microsoft. People always want to hear a few words on this subject. First of all, let me tell you that we are focused on making great products at Microsoft. That is number one. It remains number one, even though, yes, we have some issues to deal with. We try to do that as efficiently as possibly, but we do want to make sure that we pay the proper attention to these issues, and we do. In regard to the browser issue, I want to spend a few moments on what caused the dilemma that was written about so thoroughly in the last couple of months. If you think about Microsoft Internet Explorer as a browser, and if you think about the Netscape product, Navigator, or the subsequent browsers that they have generated, really the approach is completely different by the two companies. From a Microsoft perspective we’re talking about being an operating system. From a Netscape perspective you’re talking about a stand alone application that runs on top of the operating system.

Now, if you look at it conceptually as to Microsoft’s situation, while the operating system has many components to it, our browser capabilities were really chopped up into several small pieces and each piece was stuck in the proper place in the operating system. For example, you take the component of Microsoft Internet Explorer that projects HTML on a screen. Now where do you put that in the operating system? You stick it into that part of the operating system that has code that projects other things on the screen as well. So that you’ve got commonality right in that particular area of the operating system in regard to that functionality of projecting things on the screen. So as an operating system, all the software vendors can count on this capability being there. That particular section of the operating system, it’s a Microsoft Word document, can project out on the screen. If it’s a Microsoft Excel spreadsheet, it will project out on the screen. If it’s HTML, it knows how to project that on the screen. So that code is actually taken and inserted in that part of the operating system.

That story goes on. For example, the code that takes a URL and finds that particular URL out on the Internet, you naturally stick that code in the section of the operating system that knows how to take addresses and go find things. That address might be on the hard drive. That address might be on the Net. No matter what it is, that particular section of coding is all about going out and finding things. That story continues in regards to the various components of Microsoft Internet Explorer. They all get put into the operating system in the proper place. Now what you’re left with when you’re finished is a small piece of code that’s about 58K. It represents a screen that can be put in front of the user, to help simulate what browsing is all about. So when you browse with Microsoft Internet Explorer your first stop is this small code. Then what happens is you’re bouncing back and forth amongst that code that we’ve already inserted into the operating system. Now the real dilemma takes place when you look at the picture in front of you and you ask the question
“Please remove your browser from the operating system”

We had two rounds with the Department of Justice and the conclusion was take all those little eyes out of each of the components of the operating system as well as eliminate the 58K. That, as the press reported, left a product that didn’t run properly. That’s why it was supplemented with the basic retail version of Microsoft Windows 95 that has no Internet capabilities. That lead to a lot of controversy because most of the software vendors out there are counting on all those components of Internet capabilities being in that operating system. So, consequently, this was a product nobody wanted. So what happened? It led to a dialogue, which eventually led to another decision where all those files were left in there, as well as that small module of 58K was left in there, only it was covered up and hid so that people couldn’t really click on an icon on the desktop.

Now, in regard to this basic infrastructure, the important thing to understand is it’s totally different than Netscape’s. That’s what led to the problem, because there was a perception that both of these were just browsers, when in fact, one was a set of fixes, so to speak, to the operating system that enabled all the independent software vendors to know that those components are there. It’s very important for an operating system to have things there when the independent software vendors want them. You’ve made that promise and you can’t let them down. So, two completely different approaches to a task and that’s what led to a lot of discussion.

I will switch gears now and talk about Microsoft’s basic business. If you look at it from the standpoint of growth prospects as well as market share, you’ve got desktop systems which is the oldest part of our business.

We think there’s still good growth there because basic PC growth fuels it. We also have a high market share. It’s a very active part of our business with Microsoft Internet Explorer components being inserted into the operating system with Windows 98 on the way.

The second part of our business is desktop applications. Yes, we have a high market share. We’re always worried about the growth rate of desktop applications. We’re having a very good year with Microsoft Office 97 that we will talk about a bit more in a moment.

In terms of the server and the Microsoft BackOffice systems, it’s one of our newer areas of business. We’re somewhat the new kid on the block, but at long last we’re winning the reviews versus our competition. So our growth prospects are quite high. Our market share is not as high. But it’s an area of real strength and Microsoft Windows NT operating system on the server as well as the desktop have emerged as real towers of strength.

The last part of our business that I’ll mention is interactive media, the most youthful part. People always ask the question
“Have you got a financial model that’s going to work long-term?”

The answer is
“No, it’s too early”
. We’re learning a lot in regard to this area and, in fact, this is where I want to focus the remainder of my remarks after I comment on a few statistics on these basic fundamentals of the business.

In terms of desktop operating systems, the installed base of 32 bit operating systems is now over 100 million users. We’re very pleased with that. It clearly acknowledges the fact that 32 bit operating systems are here to stay. Relative to the various components of activity in this part of our business, not only are Microsoft Windows 98 and Microsoft Windows NT are critical for us, but what’s going on with Microsoft Windows CE and WebTV are also very important. So Windows as an entity is beginning to fan out in terms of the devices you’re seeing it on with a full spectrum, from small to large.

Moving over to desktop applications, we’ve just passed the 20 million benchmark in terms of number of copies sold of Microsoft Office 97. This product does very well in the reviews and the trade press. It’s no wonder things are moving so fast, it’s a terrific product. As far as where we’re going with Microsoft Office 97, we’re working on a new version right now. Part of the issue that we’re working on is what is going to be the role of the server in the future. We want to enable our desktop applications in the future to take advantage of all the tools being put in place to enable people to operate with a lot lower cost of ownership. Microsoft Office will be ready for that world. Naturally Microsoft Windows NT 5.0 can help terrifically in combination with the kinds of things that are going on with desktop applications as far as lowering those costs.

As far as new server growth in Microsoft BackOffice systems, we’re up 45% in the last quarter versus a year ago with Microsoft Windows NT. As far as Microsoft Exchange goes we’re up 160%. Microsoft Exchange is really hot right now. These are new server growth numbers. Microsoft SQL Server is up 90% in terms of new server growth units.

In terms of what’s new with Microsoft BackOffice systems, two very important projects, as you know.

Microsoft Windows NT 5.0 is going to be a fantastic product. We continue to be on the schedule that we’ve talked about before in terms of getting a beta out. Then we’re intentionally vague in regard to when we’ll actually be shipping this product. We have to be because it depends on what we learn in the beta activity. The same holds true for Microsoft SQL Server 7.0. That product is well on its way. It’s getting a lot of beta testing right now and it’s going to be a fantastic product with full locking capabilities.

As far as consumer platforms go, that’s an emerging part of our business that’s growing in importance. We’ve learned a lot from WebTV in terms of simplicity of use. We now have over 250,000 subscribers after the holiday season. Microsoft Windows CE is over half a million units at this juncture. You heard a lot about the various new elements related to consumer platforms in our business. The deal with TCI on set top boxes was very encouraging, in terms of further use of Microsoft Windows CE. You’ve read a lot in regard to the Palm PC and Auto PC.

As far as interactive media, we continue to learn. Some of the things we’ve learned are very positive in terms of services that we believe will be very important for people in the future. Other things we learned, naturally, represent battle scars.

If you look at the CD-ROM activity, it’s very good at this juncture for Microsoft. During the holiday season we had two titles in the top ten, Microsoft Flight Simulator at number two and Microsoft Age of Empires, an incredibly popular game with very high ratings at this juncture.

In terms of travel services, I just picked this one as an example because it has such a valuable piece of consumer learning associated with it. If you look at calendar year 1997, there were 173 million airline tickets sold. The estimates are- we haven’t seen the final figures- that 2% of those tickets were done over the Internet. By calendar year 2000, the estimate is that number will probably be about 8%. Why is this such a hot idea? Because consumers trust the computer to rank order all flights by price. They trust it to a greater extent than human beings. They’ve had a lot of experience in working with human beings in rank ordering those prices. Their experience says the machine can probably do it better. Anyway, we continue to believe that basic dynamic will work for this part of the industry and probably for other parts that are dependent on a lot of human interaction in order to carry out a transaction.

If you look at the basic Internet numbers they’re phenomenal. We’re getting the updated figures right now, but by July of 1997 we were up to 22 million households in the United States that had been on the Internet over the last 30 days. That’s an 80% growth rate versus a year ago. You can see those growth rates have been in the 80%-90% range now for a while. That has to slow down. This is now beginning to be a reality from a marketing stand point. That’s a lot of households to be regularly using this kind of tool to get information and to exercise various capabilities that exist.

What’s the nature of those households? From a standpoint of income, they skew very strong.

In fact, if you looked at them from the standpoint of $40,000 of income or higher, we’re at 65% of those users over the last 30 days being at that level. If you look at it from a standpoint of education level, it’s even more mind blowing. What it shows is that 91% of these people have some college experience, which is incredible. So they’re highly educated and they skew high in regard to income. Given that we’re now up to 22%-23% of households on the Internet over the last 30 days, this is beginning to look like a medium that can be used for advertising quite significantly to particular demographic groups that match these kind of characteristics.

So what’s happening? Internet advertising is really taking off. If you look at this year it was double last year. The estimates are it willl probably be up about 100%, you can see estimates any where from 125% to 175% growth for calendar year 1998. If you look at it relative to Microsoft’s ad spending on the Net, you see that ours goes up by a factor of 6% versus the year before. As far as our share of the total Internet advertising, it’s 7%. It’s logical that we would be a big spender on the Net. Why? Because our customers are very Internet savvy. If you looked at it from the standpoint of who are the big advertisers on the Net, here are the top 5. These are 1997 figures for fiscal year. So Microsoft is the largest, then you can see, obviously, search engines are a good tool to generate advertising revenue.

Another thing we watch closely is how much time people spend per week online. Those numbers, compared to 1995 and 1996 are really heading in the right direction. What you see is people are spending more and more time per week. That one hour or less figure has gone from 60% of people who go on the net down to about one third, which is quite encouraging. They’re beginning to use the tool, more and more, as a device that’s useful to them to get information.

Another thing we watch very carefully-

are users beginning to trust the Internet to actually make a purchase, to give the Internet their credit card and have merchandise sent to them. We continue to make progress as you can see from the figures here. People should be more confident than they actually are to use these kind of services with their credit card numbers and they’re beginning to realize that. Now if you step back and you think about that in terms of 22%-23% of households being on the Web in the last 30 days, highly educated, skew high in terms of income, who should be advertising on the Net?

Well, obviously computer manufacturers, software manufacturers, but also people like financial services.

It’s a natural. Their customers are on the Net. So what you’re seeing is a lot of financial services advertising. You’re also seeing high end automobile advertising. So it’s a classic media buy. The demographics are: they skew high in income, they skew high in education, and you ask the question
“Do my products have that kind of target audience?”
. Here are the people that are saying yes. If you looked at the spending in the third quarter of 1997, 28% of the advertising on the Internet was from computer manufacturers. The rest break down as Web tools – 9%, financial services – 8%, telecommunications – 7%, media services, automobile, and consumer products. Actually consumer products is low even though they’re big spenders in advertising broadly. The reason why they are low is that there are many categories in the consumer products business that are very broad in terms of their demographics. So the Web is really not a smart buy for them with that kind of a target audience.

One of the things that’s really important here is to understand what is driving that growth. For a number of tasks the Web is simply superior. For people who want financial services information and they match those demographics, clearly they’re using the Net. Why? It’s more timely information. For people who want to get an airline reservation who don’t want to go through the process of working with a human being, obviously, it’s a better way to go. So with most things the users figure it out as to whether there’s an advantage for them or not. That’s really about it.

News services are very hot, especially when a big event occurs because people can get at detailed information to a much greater extent on the Web than waiting for a newspaper or waiting for a news show on the television. In fact, it’s just amazing what big events do to the use of the Internet. I’ve got a chart here that lays out the month of January. What happens is when you get one of these big events, Internet news services skyrocket in terms of their usage. After the event is over it doesn’t go back to normal. What happens is a lot of people have used that event to try these kind of news services and then they’re converted in regard to the use of the Internet on an ongoing basis to get news. So if you look at the month of January, and this is for MSNBC, I’ve got a base level there. Then Michael Kennedy runs into a tree skiing and what happens. So if you look at the average usage of MSNBC prior to that event and then look at it during the two days around this particular incident, what you see is a 140% increase in the average numbers of distinct users per day for that particular news service.

Now after the event, what happens? It went back to a level that was 30% higher than when it started during the month of January. Then what happened? Well, we had another accident in regards to Sonny Bono. People wanted to go to the Internet to get information, to get up-to-date information, to get detailed information in regard to what exactly happened. So now usage is at the 180% level compared to that base during the beginning part of January. After the event, what happened? It went down, but it went to a level that was much, much higher than the particular level at the beginning of the month. Then what happened? The Paula Jones depositions, you know what’s coming. The blockbuster 220% increase versus the start of the month. It was incredible. Where did it go down to? Well, it went down to now at a level that was double the beginning of January. Then it hit January 21 and the Monica Lewinsky event- 280% versus the base. Actually, then it went down a bit, and we’re still now way up compared to that base. Believe it or not the really gigantic event will surprise you. There was incredible interest in what was going on in Texas, the execution of a female that had not occurred in the State of Texas for a long, long time. Very much interest in that particular case. So, all kinds of things are buried in this chart, but the most important thing is the fact that people love to get detailed information about news events and the Internet is emerging as an incredibly powerful tool to do that.

If we do our job relative to making the hardware a lot easier to use and making hardware devices that really represent a full spectrum of price and capability, plus if we can make the software much, much easier to use, and much more reliable, then we really do have a shot, coupled with this great conductivity, of making a new mass media represented by the Internet and all the tools that we will have available to get at those incredible capabilities.

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

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