Speech Transcript – Bob Herbold, Hambrecht and Quist Technology Conference

Remarks by Bob Herbold

Hambrecht and Quist Technology Conference

April 28, 1998

MR. HERBOLD: What I’d like to do is cover a variety of subjects this morning and really give you what the title suggests, which is an update. First of all, let’s start from the most exciting perspective, which is the product perspective. We really think about Microsoft as four different businesses at this juncture. Three of them are very fundamental. They absorb the large majority of our R & D investment. Then the fourth one, we hope, someday will also be fundamental and we hope that we can eventually come up with a model that suggests how, over the long term, we will make some money. There won’t be any surprises to what I’m referring to.

But first of all, let’s talk the three fundamental areas. Desktop operating systems, that’s the oldest part of our business, goes way back from the standpoint of Microsoft to the early days of the desktop operating system. Today a very exciting world for us in that we just passed over 120 million users on a 32-bit desktop. So that’s a good milestone for us. We continue to make progress. Clearly, the 32-bit operating system has been broadly accepted.

One thing that is also encouraging for us is that Microsoft Windows NT Workstation is now up to 10% of Windows PC shipments. We watch that figure carefully. Obviously, we’re steering Windows NT Workstation toward large accounts so this truly does represent an industrial strength desktop and a lot of companies are treating it thus. In terms of recrafting their key applications for the future, companies are, in many cases, going the Windows NT route.

We’re about to launch Windows 98, an exciting product that I’ll talk a bit about in a moment. But this part of our business remains very vital. It remains extremely healthy and one that we put the large majority of our research and development against. The secret to this business is to constantly listen to the key trends, to the customers, and constantly build in features that people want, that make the PC hopefully easier and easier and easier to use. That’s what we’re about in regard to operating systems.

The next part of our business, desktop applications. In terms of its growth prospect, you see that I don’t put it as high on that dimension as I do desktop systems. In terms of market share, it is also high. This is a funny business in that often people will look at it and say, wow, you’re currently a tower of strength in that area and that is true. That’s not always been the case. Some of you folks have been in this industry long enough to remember Microsoft Multiplan. Multiplan was a spreadsheet by Microsoft. In the late 1970s and early 1980s, it had a very high market share. Microsoft took a lot of pride in Multiplan because it had so many features crammed into just 64 K. So this thing would run on anything with 64 K…it would run on a Commodore. There was great pride that that code was so efficient that you could build all those features in.

Now, what happened, at the same time Microsoft was working on the operating system for the IBM PC, Lotus came in, looked at the new IBM PC, realized, man, you can be incredibly sloppy with your code, build in all kinds of new features. Microsoft sat there, continued to be convinced that that code had to be very efficient. So what happened is Microsoft got wiped off the face of the earth and that very, very high market share within 18 months went to zero. So what did we do? We missed the technology window. Shame on us. That’s the nature of this business. Share points, once you start winning reviews, can fly away very, very quickly and it’s a great lesson to learn. Naturally, the good news, from a Microsoft standpoint, was that Lotus looked at the graphical user interface, particularly the early versions of Microsoft Windows, and said, well, they have a lot of work to do there. Consequently, they didn’t move to the Windows platform very quickly. We did in terms of launching Microsoft Excel. So they faced the technology window problem at that juncture, leaving us today with a high market share for Microsoft Office 97 and the components of Office 97.

We’re now over 35 million licenses. When we say license, we’re including full package product that you might buy in a box in a retail outlet. We’re including also the licenses that you would get if you were to sign a Microsoft Select agreement, etcetera. So looking across all of those agreements, that’s where you get the 35 million. This product is rated extremely high by the trade press. Winning the reviews in the trade press is what it’s all about in this industry. When the third party objective folks look at your products and rate them better than competition on a regular basis, the share points come your way. That’s a clear norm in this industry. It also really gives the signal as to how to run your company in this environment, which is keep very close to the customers, understand what they want, build it into the products, and watch those reviews.

The third part of our business you’ll notice I rated higher in terms of growth prospect, but not quite as high, not nearly as high in terms of market share. In fact, you could claim that, relative to servers and Microsoft BackOffice systems, that we’re the new kid on the block. Microsoft Windows NT goes back to the early 1990s, when David Cutler was hired from Digital Equipment Corporation, and he focused on the server and what an operating system would look like, assuming the servers become big and powerful, which at least Bill Gates believed that they would. So David and his team worked from 1990 to 1995, finally put the Windows NT product out on the market, did not get good reviews and proved it to the point where, in 1996, Windows NT Version 3.51 started to be a force in terms of competition and started to win some of the reviews. The current version, Windows NT 4.0, clearly does win the reviews versus competition. So our Windows NT operating system business is very healthy at this juncture.

Also, this is the part of the business where Microsoft SQL Server sits. SQL Server is our database product. We’ve been investing in database personnel for the last four or five years, trying to hire the very best and the very brightest, and continuing to work on Microsoft SQL Server. We think we’re on the verge of a fantastic product with version 7.0, but I must tell you that the sales for Microsoft SQL Server 6.5 are also very robust as well. If you listened to our earnings call last week as far as reporting the first quarter of the calendar year, you heard that Windows NT Server, in terms of new servers, is up 40%.

The new servers and client access licenses are absolutely roaring with Microsoft Exchange, which also fits into this grouping of BackOffice products. This is a business that is very hot right now and Microsoft Exchange seats are now over 13 million. Microsoft Exchange is truly an industrial strength messaging system that has good workgroup characteristics as well. Consequently, particularly when a company is looking at that mishmash of mail systems that they may have had in the past, typically Microsoft Exchange emerges as an incredibly important tool for the future as far as basic infrastructure. It has a long sales cycle because when you make a messaging decision, it’s a big important decision that you’re likely to stay with for a long time. So, consequently, we’re just beginning to learn how to sell Microsoft Exchange. We’re just beginning to really see the kind of momentum that it takes with one of these BackOffice products to build a substantial business over a long period of time. There’s an awful lot of momentum in these products, in that, as I mentioned before, once the sale is made, it’s basically an infrastructure sale, so it’s likely to stay there for a while and it’s likely to build with time.

Microsoft SQL Server new server growth is up 80%. Client access licenses are three times what they were a year ago. Microsoft SQL Server 6.5 is a terrific product. A growing percentage of SAP, PeopleSoft and the like are using Windows NT and Microsoft SQL Server as the fundamental tools because of, number one, the tremendous cost advantage for a customer to go that route and, secondly, the fact that from the standpoint of processing their business, they get the performance they want. So this BackOffice area is one of very high growth for us.

Now, let’s talk about the fourth area of our business which, you wouldn’t call it fundamental now, but you would certainly call it exciting in terms of where it can take us. One of the things that’s so important about interactive media is that we constantly are learning, constantly changing, incorporating that learning and in many cases, you look at Microsoft and say, what are you doing? There’s so many activities, some of them being scaled back, some of them being ramped up very quickly, get experience and then change completely the approach.

What’s really happening is that we’re in the very early stages of the launch of what we hope will become the next mass media. We hope that the PC itself will become a device that will have a full spectrum of tools, with very inexpensive tools, very portable tools, and high-end tools and that whole spectrum will be filled out. Secondly, we hope that the software can become friendly enough that people who don’t use these kinds of online services and capabilities and the connectivity of the Internet day in and day out will become comfortable enough to take advantage of these tools. Thirdly, naturally, you’re betting on connectivity. You’re betting on bandwidth. So that’s why you see Microsoft make investments in things like Comcast and the like, to encourage bandwidth in general throughout the globe. So if there are a lot of convenient hardware devices that are very simple to use and very reliable because of great software and if the connectivity is what it should be, there’s no reason why this whole area of online capabilities, the access of the Internet shouldn’t emerge as the next mass media, where advertising will be important, tremendous content. There will be a blurring in regard to digital television and the Internet and the PC and you’re already beginning to see signs of that. It’s an exciting area, but in participating in this part of the business, you’d better be ready for change. You’d better be ready for constant learning, cashing in that learning in terms of putting aside certain things, modifying other approaches, and constantly keeping at it.

We have successes. We have our failures. I’m not going to mention the failures, because those get reported usually in detail in the press. But in terms of successes, there are some beauties right now. Age of Empires happens to be a CD-ROM product. It’s a game. It’s a fabulous game. It was in the top 10 over the holiday season as a new game last fall. So we’re beginning to get some confidence and some capabilities with respect to the game business.

More importantly, relative to the Internet, we’re beginning to really isolate some things that people are very excited about. The Internet Gaming Zone. I don’t know if any of you have ever been there, but if not, you should go, because if you play Microsoft Golf, for example, you can go there tonight and sign up for a foursome from people from all around the world. The other three people can be from who-knows-where. You pick your favorite golf course–maybe it’s Pinehurst–and you all play Microsoft Golf and away you go! You play a round of golf on Pinehurst this evening with three other people who can be anywhere around the world. It’s a fabulous tool. That’s why over 1.4 million people have registered for this service. This area is really hot.

From the standpoint of CarPoint, over 1.2 million monthly unique users, tremendous amounts of information in regard to automobiles. Hotmail, a recent acquisition. We’re now over 15 million in terms of registered users for that e-mail system. So we feel pretty good about this whole venture, which I put in the bottom right corner in terms of having great growth prospects, but obviously very low market share right now. In fact, it’s even difficult to gauge where you stand in this particular business at any particular juncture because there’s so much change going on.

Okay. We spent a few moments on Windows 98, a fabulous new product that we’re on the same schedule in regard to rolling this out that you have seen before. So mid-May or so it should go to manufacturing, an June 25th is the date that we have published in regard to kicking off the campaign for Windows 98. As far as its characteristics, I’m going to try to simplify it to the best of my ability. Improved performance and reliability. The reliability part of this system is very impressive. If you read the reviews, as far as what impresses the writers about this thing, this thing just runs really well. It’s also got some great characteristics like On Now, so you don’t have to waste as much time waiting for the system to come up. It’s got an integrated shell, so that front end of Windows 98 is going to be very Web like. In fact, you’ll feel very much like you’re on a browser rather than an operating system. Now why is that? Because people feel more comfortable with that kind of interface, and consequently, most of the interface aspects of this system capitalize on that key learning. Also, in terms of tools like Microsoft NetShow and Microsoft NetMeeting, for people who have the right kind of connectivity, great tools to enable them to do their job better than ever.

There’s a lot of ease of use and Internet capabilities in this system. It’s got an HTML-based help system that is very visual and we think really meets the needs of users in a very unique way. It’s got a Windows maintenance wizard that helps you in terms of maintaining your hard drive, maintaining your system in general, doing the things that you should be doing on an ongoing basis to keep that system properly maintained. There’s also an ability, in terms of Internet integration, to participate in things such as the Windows Update, which is an Internet-based service that will send you reminders of things, send you fixes as they come down the pike and the like, and a great way to have a dialog with the user on an ongoing basis. So advanced browsing capabilities has the Internet so integrated into it that you’re going to feel almost as if you have a brand new kind of tool here that capitalizes on the characteristics of the Web as far as its ease of use and point-and-click mentality, but on the other hand is an incredibly rich operating system.

Unlocking a new generation of hardware, this thing can hook up to a variety of new devices, so you can do multiple monitors in regard to this system. It also has Web TV characteristics embedded right into it so that, in fact, you can hook this up to a television set, and with a cable coming in the other end, the thing acts like a full Web TV. So it’s got some great characteristics that anticipate where the world is going in the future.

Here are some quotes in regard to what some of the key publications are saying. As I mentioned before, we focus very strongly on what these third party objective folks have to say about our products. That’s one of the key objectives we hold in front of our people. This is the quote from Computer World, “ease of installation, better performance, improved reliability, reduced cost of ownership. Your need for help desk activities from people who are operating on Windows 98 is significantly reduced.”

Here’s a quote from CRN. “Seriously upgrade to Windows 98” is their recommendation. “It’s not merely”–and this is important–“it’s not merely Windows 95 with I.E. 4 integrated. There are a whole bunch of other characteristics, some of which I just mentioned, so make sure that you properly check this system out.”

The bottom line to Windows Magazine is “just plain runs better than Windows 95”. So we’re very bullish about Windows 98. We think it’s got a lot of characteristics that users will want and so we’re anxious to get rolling.

Okay. I want to change gears briefly and talk about the Windows Terminal Server, often referred to as the Hydra project. What we’re talking about here is getting the full capabilities of what was previously called the network computer. I say previously because it has run into some heavy weather recently, but we certainly want to capture some of those great characteristics, while also not requiring a lot of investment on the part of customers to take advantage of these capabilities. So, management, in terms of administration and support that is as central as possible. Security, in terms of the tools that are handing that particular terminal. Performance, you want it remote-based. It’s great for things like branch offices. In access, you want to be able to plug a diverse set of hardware into this particular configuration. This is the spectrum that we see in terms of hand-held devices, Windows-based terminals and Net PCs, all the way up to clusters of servers.

What we’re trying to do is to bring the Microsoft Windows NT experience to desktops that that can’t run Windows NT today. So this facilitates the Windows desktop operating system upgrades, and that that’s all done centrally and the user has no knowledge of what’s being done there, which is good because it eliminates a lot of cost in terms of visiting that desktop, or of somehow involving that human being in that change. Low cost, easy to use, flexible terminal upgrade solutions. So if you’ve got PCs that, in fact, have been passed by the technology waves, they can potentially have a second life as a Windows-based terminal. Easy access to 32-bit Windows applications for these legacy desktops, so it’s a great way to put together a configuration for your organization that takes advantage of the fact that some people aren’t nearly as computing intensive as others. This enables you to match up those characteristics of the users with their particular needs without changing your applications, and that’s so core to this premise here. The feedback from the NC was absolutely clear. There’s no way people are going to take key applications and make massive modifications for pieces of hardware that don’t fit into basic infrastructure.

As far as product plans for Terminal Server 4.0, you’ve got complete Windows-to-Windows solution.

Now, if you look out to Microsoft Windows NT 5.0, again, you’ll have complete Windows-to-Windows solution, but you’ll see a further integration into the Microsoft architecture. Obviously with Microsoft Windows 5.0, Active Directory becomes a reality, so these things plug in in a way that it’s very convenient for the network as far as running that directory. You got multimedia capabilities and a very rich remote display protocol. So Microsoft Windows 5.0 really takes a giant step forward with respect to the Windows terminals.

This is the configuration as the typical organization could potentially look. You could have a Windows-based terminal, like you see in the upper right of this slide. A Net PC, where you’ve got intelligence on that machine, but basically no way for the user to insert any kind of software at all. Once again, the intent is to keep the cost down, to make it a basic utility. But in this case, this is a PC for a group of workers that, in fact, have a lot of computing intensive activity at the desktop, but they don’t need a lot of creativity in terms of modifying their software. Those folks who need that kind of ability to modify software, a workstation or a desktop PC is perfect, which you see in the lower right part of this slide. Over there, you see the MS-DOS, UNIX, Mac clients that can connect to that Windows NT Server, obviously with the Citrix product called Picasso. So from the standpoint of talking to accounts who have a multi-faceted organization, and most do, in terms of both hardware, as well as different types of users, where they want to try to minimize that cost that is incurred both from a capital standpoint and an expense standpoint, this is a great new tool.

The clear advantages are consistent user interface for those applications that have become your standard Windows applications, low cost hardware, starting as low as $500. You get a true Windows-based appliance that requires continuous connection to Windows Terminal Server for this thing to operate, but that is what gives you the advantage of the low cost of the device itself. So we’re very high on the Windows Terminal, in terms of the schedule today.

With Microsoft Windows NT 4.0, you get the kind of characteristics that you see on the left in terms of multi-user add-on for Microsoft Windows NT. Windows clients, non-Windows clients from Citrix, and then Windows-based terminals can all connect today to Microsoft Windows NT 4.0.

When you look at the world of Microsoft Windows NT 5.0, you get the same characteristics, but you then also get integrated NT administration, much improved scalability and a whole sort of other capabilities that I don’t list here. So this thing is off and running. We believe we’ve got a great tool here for users in facing up to the cost of ownership issue, which is obviously a very important issue.

I now want to change gears for a moment, because something very creative is happening with respect to the supply chain. So let’s talk about this typical company out there that obviously has suppliers of raw materials, and they take those raw materials, convert it into product. They then have to get that product into a distribution chain to eventually get it to the end customer. Literally everybody’s business is like that in some way, shape, or form. What has been difficult in the past is coordinating all of the activities right from start to finish, all the way from raw materials, tracking those raw materials as they become finished product, moving that finished product into your own inventory or the inventory of your channel, and then watch that channel take that finished product inventory and actually move it to customers. The goal is to deliver a dynamic data stream that connects the partners that make all that happen for a particular company with real-time data.

Now, in today’s world, what you typically have are relationships one at a time–a relationship between suppliers and manufacturers, another relationship, electronically, between manufacturers and distributors, and then distributors and retailers, and then retailers and consumers. All of that tends to be one step at a time and no amount of Internet or EDI connectivity alone can solve that problem. It’s an architectural problem. Data is being handed one step at a time down the sequence and companies have a very difficult time stepping back and saying what’s really going on with the complete channel. There’s a ton of money to be saved if you can view this problem in its totality.

Microsoft is very anxious to tackle this problem, along with literally hundreds of independent software vendors that we are working with. We’re calling this total initiative the Value Chain Initiative. So what is it? It’s literally hundreds of software vendors plus Microsoft, agreeing that the goal is that data will be exchanged between the VCI applications, or Value Chain Initiative, this group of software vendors, using Microsoft Windows NT as the core components of communications between all of this software.

Now, from the standpoint of what this looks like, here’s a slide that basically is the new architecture, where in the middle, you will have shared applications and obviously shared databases. All the different players, then, are around the peripheral aspects of this design, with a capability of reaching in and getting the data that they need for their particular aspect of this task. But most importantly, with all that data residing in one place and all of the compatibility that comes with these ISVs committing that they’re going to use the standard kinds of communications capabilities via Microsoft Windows NT, so that you can see all aspects of what’s going on in the organization, you’ve got a real powerhouse for analyzing where all you cash is being tied up, where the bottlenecks are occurring in regard to your aspects of the business. So it truly is an end-to-end approach, from raw materials, manufacturing, transportation, distribution, retail and consumer–looking at all aspects of your business at once. The platform is Microsoft Windows NT Server. What you get from the Value Chain Initiative is software vendors who are agreeing to make their off-the-shelf software completely compatible via Microsoft Windows NT, so that an organization can take off-the-shelf software in the order management area from a different vendor in regard to warehouse management, yet another vendor in regard to transportation management, and focus it all together via Microsoft Windows NT and be basically assured that this is all going to work together.

It’s a fabulous project. We have a proof of concept, with over 100 vendors right now participating, demonstrating how this works. This is a very hot idea. Why? Because it makes life simpler for people. First of all, it’s off-the-shelf software. Secondly, there’s a built-in agreement amongst all these companies that they’re going to work together to make sure that they take the burden off of the shoulders of the individual organization in terms of coordinating how all of this gets put together.

So here is a list, which you won’t be able to read, but there are literally at this juncture well over 100 software vendors that are part of the Value Chain Initiative. This is simply a great idea for the customers. The customers win big here because of simple implementation. In the past, people have dreamed about the notion of being able to track all this information about their business from start to finish. Here’s a quote from Fortune magazine, “For the first time, Windows NT promises to connect a factory’s diverse computer operations.” So all of this software is going to connect quite easily. So this is a picture of the future in terms of how software is going to assist an organization in being able to take a snapshot of all aspects of their business at one time.

Now I want to shift gears a moment and talk a legal issue. In fact, this is the issue of Microsoft Windows as an operating system and what you’re reading about in the press as far as the potential intervention of the government into the development of software. Stepping back, this is probably the healthiest industry in the world. This is an industry that spawns incredible creativity on how to run an organization. The principle that we’re fighting for at Microsoft is that each and every company needs to have the ability to innovate. They need to have the ability to listen to customers, understand what they think that customer wants, build that into their product, and sell their product versus their competition and may the best product win. That’s usually described as the free enterprise system and that’s the principle we’re fighting for with respect to this issue around the Microsoft Windows operating system.

If you were to take the clock and wind it back to 1990 and think about all the different aspects of performance that have been integrated into this operating system called Windows, but actually integrated into a lot of other software products as well, it’s awesome. How would you like to face the world today where you have to worry about loading all these different capabilities in some unique way in order to create a system for yourself that, in fact, works well across all these new capabilities?

What the world wants is simplicity. The way to get that is take new features and embed them so finely in your software products, that they’re almost invisible to users, so that the ease of use goes up, but the power of the system goes up significantly. That’s what this industry is all about, that’s what it’s been good at and that’s what Microsoft believes should continue in a way that there isn’t government intervention. Usually industries that need government intervention have characteristics like slow innovation rates, costs being held up at fictitious levels and the like and we don’t think those are characteristics of this industry. So, consequently, that’s why we’re fighting so hard for this principle.

If you look at Internet integration, you go back to the early days of 1994-95 and our arrangements with Spyglass. As far as Internet capabilities for the operating system, we made it public at that juncture, as did Spyglass. Spyglass’ statement is, “It’s natural that we do an arrangement with Microsoft since this Internet capability, often referred to as browsing, is fundamentally operating system functionality. So it’s natural that we would do a deal with Microsoft.” So early on, we had every intent of once again taking new capabilities and building them into the products in a way that made it much, much easier for the user to take full advantage of those capabilities. Today developers require Internet services for their applications. Well over 80% of them–85% in a recent survey–support the fact that they want their lives to be simpler. They want all that stuff integrated in a very natural way. Competitors, naturally, have done the same thing. So from the standpoint of building features in the products so that you serve the customer better, that’s what this issue is all about.

Let me spend just a few moments on what’s going on in the upstream research area. Natural language, vision, and speech is a very hot area. You’re going to see speech recognition tools emerging regularly over the next two years. I can also assure you that that technology will be commonplace enough that literally every software vendor will want to incorporate those kind of capabilities right into their particular tools. So speech integration will emerge, become very commonplace, and get integrated into all the major tools in this industry.

You see other areas where we’re putting our research money. The large majority of our research and development money goes toward the shorter term development of key aspects of existing products, but we do have a rather large organization doing some of the upstream research, which we think is valuable investment for Microsoft and, in fact, for the industry. We invest for the long haul. The research budget, the R & D budget, is a large one at this juncture. We also do a lot of work in regard to partnerships, both with companies as well as with a variety of people in the channel.

One thing I want to end with is talk just a few moments about the basic principles that we use to run the company, because I think it’s important to understand that this is actually a very simple operation and we focus on a few vital things that we think are the keys to our success. Number one, recruiting. Recruiting is a core competency at Microsoft. We recruit really smart people who are incredibly passionate about this industry and wanting to see good things happen to users via software. Secondly, as I’ve mentioned several times in this presentation, we really do focus strongly on technical reviews in the press. Third, efficiency and speed in communications. You have to make decisions in a very rapid manner in this business. Last but not least, operational excellence is very important in this industry.

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

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