Steve Ballmer: Commonwealth Club of Silicon Valley and Churchill Club

RAYMOND NASR: Good afternoon, everyone, and welcome to today’s program of the Commonwealth Club of Silicon Valley and the Churchill Club, brought to you from the Hyatt Regency Hotel in Santa Clara, California.

My name is Raymond Nasr, president of the Churchill Club, and I’ll be your chairman for today.

It’s my distinct pleasure to introduce Steve Ballmer, the CEO of Microsoft Corporation. Mr. Ballmer joined Microsoft in 1980 as the first business manager hired by Bill Gates, and has headed a number of divisions within the company, including operations and sales. He was promoted to president in 1998, and two years later assumed the position of CEO, where he now helps create the strategic business planning of the company, while remaining responsive to evolving customer needs, and emerging technologies.

Mr. Ballmer graduated from Harvard University with a bachelor’s degree in mathematics and economics, and before joining Microsoft attended Stanford University’s Graduate School of Business.

Joining us today as moderator is a great friend of the Churchill Club, Roger McNamee. Roger is co-founder and managing director of Elevation Partners, where he joined with, among others, U2’s Bono to launch the first private equity firm targeting media and entertainment content. He is also a co-founder and general partner of Integral Capital Partners, and Silver Lake Partners, and in 2004 authored the book, “The New Normal.”

Ladies and gentlemen, please join me now in welcoming Steve Ballmer and Roger McNamee. (Applause.)

ROGER McNAMEE: It’s been more than three years since Steve was here in Silicon Valley, and I think the world has changed dramatically.

Steve, get us started by giving us a little perspective on the business trends and technology trends that you think are most important in the industry right now, and what you want to do about them.

STEVE BALLMER: Just a small correction: I actually have been to Silicon Valley, just not to the Churchill Club. I don’t want people to think I’ve lost my mind, Roger. (Laughter.)

ROGER McNAMEE: I want you to understand that if you’re not at the Churchill Club, it doesn’t count, Steve. (Laughter, applause.)

STEVE BALLMER: OK, let me talk about two or three things that I think are very big. The first thing is obvious but worth repeating, which is we do actually live in a world today where the notion of having users embrace kind of digital technologies, what we like to call digital lifestyle, we’re there, we can count on that as developers, as entrepreneurs, as businesspeople, and that’s a very good thing; and not even true four or five years ago, frankly, that you could count on people looking to digital techniques as a fundamental way of a lot of things that they did. That’s No. 1.

The second thing that I think is a very big deal is that Moore’s Law is mostly alive and well; that is, things are going to get smaller, cheaper, faster. I only say mostly because power consumption and heat have become a real problem in terms of just dialing up clock speeds on chips, and that does mean we’re going to need a new round not only of chips but software architectures, development tools and a new set of skills that we’ll have to build amongst people in order to really learn how to take advantage of some of the increased processing power that’s going to come to us.

No. 3, software really is evolving to be software and service as opposed to software as some kind of standalone entity. And whether that’s monetized through licenses or transactions or subscriptions or advertising, whether that appears software in the classic form that we love, or the future of the media industry, I think it is very fair to say that all forms of software are going to have a very important service component behind them, which brings additional value, community, new capabilities, and is extremely, extremely important.

Last but certainly not least, I would probably just remind everybody that we still have the ongoing process of digitizing many things which are not digital today. This lady is writing on a piece of paper, I noticed; Roger’s got paper in front of him; we have these old analog cameras around; I’m glad this is being podcasted, but still there’s video, which probably nobody will ever see. You really would want to sit here with an electronic device, make a note, have it be synchronized to what we were saying, “Hey, Steve made no sense here,” boom, e-mail it out, get an immediate response. We’re not fully digital. There are so many things, whether it’s the way we read, the way we take notes, the way we write, the electronic transactions. We all say, oh, the world is a world of e-business. I was meeting with the folks who run Mersk, which is the largest container-shipping company in the world, and they were saying their big problem is still when you want to land a container in a port or pick one up, it’s mostly a paper, manual-based process.

So the increased digitization of business transactions, media, reading, writing, that phenomenon will be very important for accelerating this sort of digital my style, work style, lifestyle we talk about.

ROGER McNAMEE: So when you think about that whole issue, it seems to me that one of the problems we all face is our ability to absorb the digital lifestyle, right? I mean, you think about this notion, why are we using paper, well, it’s convenient; why are people using older cameras, because they already have them. Quite clearly from Microsoft’s perspective you have a huge interest in moving people forward into that digital lifestyle. How do you do that?

STEVE BALLMER: Well, in a sense everything – what’s the old expression, to a man with a hammer everything looks like a nail. Everything you list to me just sounds like a software problem. We need to make hardware and software that’s as convenient as the paper. We know we can add value beyond whatever you can get out of paper, the question is can we get you the convenience factor that you expect. You talk about being deluged, and many people do, with too much information. Can we give you the tools that let you screen and filter, not shut yourself off from this world of digital information, but better manage and control it? So in a sense to, I guess, a software company these all just look like a set of software and sometimes software and hardware innovation challenges.

ROGER McNAMEE: Well, so, if you sit there, and I think from the perspective of a lot of people in this room, I think the things that we’re dealing with day-to-day don’t feel like software problems, right, that, in fact, the issue is the Blackberry is buzzing too much, the phone is ringing too much, that, in fact, this notion that somebody sends us an e-mail, we have to respond instantaneously, that’s a mixed blessing, right? And help us – I mean, you’re Microsoft, right, for years everything really was a software problem, but if you sit just as a consumer today, not all these things actually from our perspective, right, the user problem, and, if you will, the infrastructure problem are two different things. Where does that leave you? Do you feel like that’s a big – is that an opportunity for you or a problem?

STEVE BALLMER: Let me talk first about the social problem, but then I actually do want to make it back into a software problem. You know, you could say when should you send somebody a piece of e-mail –

ROGER McNAMEE: Anybody have a nail? (Laughter.)

STEVE BALLMER: When should you send somebody a piece of e-mail? When is it a disruption, when is it an annoyance, when is it helpful? In a sense that is partly a technology problem, and it is in large measure kind of a what’s the appropriate societal norm. Do you copy your boss on every piece of e-mail you send? Unwise at our place, but it could be wise in many other places. And so there really are a set of issues which I think over time we will develop norms, norms may be different in different societies, different companies, et cetera.

At the same time, I do want to come back to this issue that says technology helps. Is your phone ringing too much? Then, darn it, we didn’t give you the software that helps you manage and control. If it’s my spouse, please let it ring; if it’s anybody else, turn it off, to describe a richer set of rules and do that in the right way. A lot of e-mail doesn’t flow anymore, at least at Microsoft, because we have these kind of team-collaboration sites. And so things that would have generated e-mails and distribution lists go away and get replaced by convenient collaboration sites. So I do think it involves tools that help people better deal with the issues that you’re talking about, as well as let’s say ever improving societal conventions.

ROGER McNAMEE: So let’s leave that as a business problem, right, you’ve spent 20-some odd years as one of the most dynamic growth companies in the entire economy. And the Web has, in effect, made both the opportunities and the challenges much more diverse, you have to be good at a lot more things than you used to have to be good at.

How do you feel about that? I mean, from Microsoft’s point of view are we emerging from a period where you’re kind of repositioning and consolidating, or, you know, do you sort of sit there every day just going, you know, where the heck did MySpace and all these other things come from and grrr?

STEVE BALLMER: No, I’d say very excited about the future. I mean, look, if you want to, anybody can get, “Oh, geez, the world is changing,” and nobody should get in the technology business if they’re not prepared to live with, “Oh, geez, the world is changing,” Of course, the world is changing; embrace it. How do we drive growth, how do we embrace the next trend, how do we be a leading edge innovator?

And I’m excited about the stuff we have going. Do you want to know the best community site on the Internet today? The best in terms of business model, user interaction? I’d point to our Xbox Live site, frankly. The way people can communicate with each other, share, watch each other’s activities, and particularly with the improvements we’ve made. So we’re embracing as much as anybody out there some of these new phenomena.

ROGER McNAMEE: So can you move the needle, can you actually be a growth company again?

STEVE BALLMER: Whenever anybody asks me that, the first thing I ask them is, “What is a growth company?”

ROGER McNAMEE: I have no idea, you tell us. I mean, you’re the CEO.

STEVE BALLMER: I think a growth company is a company that grows. (Laughter.)

ROGER McNAMEE: Everybody write that down with your analog pen and paper, OK?

STEVE BALLMER: And I’ll give you two ways to think about growth, two easy ways: percentage, percentage of – three ways: how much percentage growth do you have is always an interesting question, how much absolute growth do you have I think is also a very interesting question, and I think you can say and how are you growing relative to the other guys that you compete with. I mean, frankly speaking, five years ago or so we were probably 18 percent of the profits of the top 25 companies in our industry, today we’re 23 percent of the profits of the top 25 companies in our industry. I think that means we’ve grown. Over that period of time our profits are up 80 percent. Whoo, I think that means we’ve grown.

Sure, at $20 billion, which is about where we are, plus or minus, $20 billion of pre-tax profit, we’re not going to do a 20 percent a year deal, that’s probably unlikely to happen, but we guided for next year to 8- to 10-percent growth. I think that’s pretty good.

If you leave the financial realm, how do people define growth, it’s about are you embracing and innovating in new spaces, in our case are we driving our Live stuff hard, are we going to be a leader in software as a service platform technologies or are we going to be only what we’ve growth up with with Windows and servers. Are we getting into new areas? This year alone we have significant new offers in security, management, business intelligence, search, unified communications, workflow, document management. None of these are areas where Microsoft, quote, grew up. Some of them live in corporate environments, some of them live in the consumer’s home, some of them are hosted, but these are all areas in which I would say we’re driving very hard.

So I think certainly our innovation agenda qualifies as a growth company innovation agenda, and I think our numbers have been pretty darn good.

ROGER McNAMEE: So imagine, if you will, we’re all looking at the company, obviously Microsoft for the longest time was the environment we lived in, and now you’re just one of the biggest guys in the environment because there’s so much going on. And alternately we’ve seen statements from you talking about IBM as the principle competitor, Oracle being a big competitor, Google being a big competitor; you know, the competition looks and feels different today than it did ten years ago. And give us some perspective on, again, we’re all down here in Silicon Valley, so maybe it’s the air we breathe or something, but, you know –

STEVE BALLMER: That beautiful eucalyptus.

ROGER McNAMEE: It must be that. And – yeah, or the nails we hammer. But give us a little perspective; I mean, who is your competitor?

STEVE BALLMER: We have many different – this is truthful, and then I’ll give you a more sort of general purpose answer. We have many different competitors in many different parts of our business. We have guys who come and work every day and say how do we do more innovative, more exciting, more appealing work than Blackberry, how do we compete versus Sony in the videogame business, what does it take to compete in the database business. So we have – hold on, I want to give you – the truth is we have many competitors across the spectrum of what we do.

In a more abstract way you could say the two big phenomenon that are going on that we have to look at and say how does it affect us, the two big – well, maybe even three, three big phenomena, number one, will software – and they all relate to business model changes. You know, people talk a lot about Open Source; well, Open Source is more about whether there’s a business model or a non-business model, whatever it happens to be, that will deliver superior innovation, more important innovation than the commercial business model. That actually affects all kinds of companies who develop software, but we happen to be on the leading edge of that. So there’s the competition with the new business model.

There’s the competition with new advertising type business models. We can’t embrace the Open Source business model, that’s inconsistent with being a commercial company, but we certainly have embraced the advertising business model. We’re the third largest seller of Internet advertising in the world. I’d like to be number two and then number one, but right now we’re number three. But it’s a big space and a big sphere, and we’re going to continue to grow. So there’s competition from that business model.

The third is what I would call the hardware embedded business model where software gets effectively embedded in hardware, it’s been happening for years, but will that business model trump a software independent business model.

So when you ask at the CEO level who’s your biggest competition, I think our biggest competition is our ability to either embrace and/or compete with alternate business models to our own.

ROGER McNAMEE: So let’s just run through them. What’s the strategy for competing with IBM?

STEVE BALLMER: IBM or Open Source. They’re different, which one, you pick. IBM is an interesting –

ROGER McNAMEE: Whichever one you spend more time worrying about, because IBM –

STEVE BALLMER: No, then I won’t talk about IBM. (Laughter.) No, that wasn’t –

ROGER McNAMEE: You were quoted less than a year ago as describing that was your biggest competitor.

STEVE BALLMER: That was not a lack of humility, he said I had to pick. I don’t know what I might have said that somebody quoted me as saying a year ago, and it partly depends on the forum, because the truth is when we meet competition in the enterprise, it’s almost always brought through IBM, even if it’s not IBM technology. IBM is a service company, largely, that is largely trying to propel forward ideas that were coming from outside IBM.

In the case of Open Source I would say, you know, we said, look, is this a religious competition, and eventually what we said, no, this is a good old fashioned engineering competition. Where we don’t have market share it’s because we need to innovate. So you take a look at file service, e-mail, we have very strong market share. In e-science and technical computing we need to have a better high performance clustered technology than Linux does; we’re hard at work at it. You take a look at what’s going on in security appliances, we need better technology.

So there are two or three areas where Linux has really developed a position, and the key is the key in any other competition, better products at a better total cost of ownership. It’s hard to beat Open Source on initial cost of procurement, it’s not hard to beat Open Source on total cost of ownership.

ROGER McNAMEE: So do you feel you’re gaining or losing ground right now?

STEVE BALLMER: Right now on the desktop we are – our position remains good, and on the server we’re gaining share, Linux is gaining share, Linux frankly has gained a little bit more share than we have on the server, but I think by and large you’d have to argue we’re doing well, and this is a year where we have big innovations in clusters, we’ve got big innovations in Web servers, and we have big innovations in security, which are the three areas where we need to sort of up our game versus Linux at the server level.

ROGER McNAMEE: So do you think of Oracle as being part of that Open Source competition as well? They’re really a competitor to you in the traditional enterprise software.

STEVE BALLMER: Well, they’re in a traditional way in the database business, and with the PeopleSoft acquisition to some extent in the business applications area with Dynamics, but they have a business model like our business model. IBM sort of has a services-based business model, but Oracle is not a change to business model.

ROGER McNAMEE: So you feel like you’re gaining or losing ground against those guys?

STEVE BALLMER: Against which guys?

ROGER McNAMEE: Oracle.

STEVE BALLMER: Against Oracle we’ve gained quite a bit of share. We have by far the No. 1-selling database in the world, we outsell IBM and Oracle combined, and every day we come to work and we’re moving up market, we released a fantastic new version of SQL Server the end of last year, and now we just keep going up the enterprise and building revenue share as well as unit share.

ROGER McNAMEE: So we’ve taken care of the old guard, let’s move to the new guard.

STEVE BALLMER: OK.

ROGER McNAMEE: So, Google, I understand perhaps they are a competitor as well. (Laughter.)

STEVE BALLMER: I think they would be one of the two guys who are ahead of us in advertising revenue, yes, you’d be correct about that, Roger, way to go.

ROGER McNAMEE: I thought that was an incredibly insightful question. (Laughter.) If you sit in my seat as an observer of the industry, you guys appear to be incredibly focused on Google. And in some ways I find that both surprising and disappointing, and I’m curious, you know, to me Google is doing something, what they’re doing is really, really interesting, but in other ways what they’re doing isn’t what Microsoft does, and so I’m surprised to see you putting so much energy behind it, and I’d just like to get your perspective, and I think everybody would.

STEVE BALLMER: Advertising – actually, let’s not focus on Google, because that’s actually not where I would say we’re competing, we’ve got focus. But the key is what about the advertising business model. I ask myself have we done everything we need to do to embrace advertising as a business model, to drive technology behind advertising as a business model, to have a market position that will let us and our partners, because in some senses the advertising business is about having an ecosystem of partners, are we putting ourselves in a position to be successful with advertising as a business model. And on that topic we have an incredible amount of focus.

Now, of course, a lot of that has to do with how we compete with the likes of Google and Yahoo! and others, but advertising as a business model is fundamental not only for us, but there will be an ecosystem of people around that, just as there has been an ecosystem of people around Windows, and it’s our kind of business and it’s key to the future of other Microsoft business.

ROGER McNAMEE: So give us some perspective. You have a vision; first describe it, and then show us the contrast from the other guy’s vision.

STEVE BALLMER: Well, the thing I would say primarily is the way advertising gets bought and sold will be fundamentally different in the future than it is today, and on that I think we all agree. The importance of technology in the sale of advertising will go up. And there are many issues to confront, privacy issues –

ROGER McNAMEE: Is this with respect to the purchase of the advertising, that is to say the advertisers, the way they acquire the space that they’re going to be on?

STEVE BALLMER: The purchase of – it would be the purchase of advertising, and the number of businesses which can thrive on advertising-based business models.

ROGER McNAMEE: OK.

STEVE BALLMER: In some senses the way to think about what we’re doing with our Ad Center service or what some of the other guys, Overture, Google are doing, is creating – think of it as like an eBay for advertising, how do you bring buyers and sellers of advertising together, how do you do that in a way that creates value for both of those, and gives the consumer an advertising experience that is not disruptive but is tailored and additive to the end user experience, while retaining appropriate respect for end user privacy, and that’s a set of technology issues.

The advertising industry is one of the biggest industries in the world, it will have more disruption from technology frankly than many of the other businesses that have gotten a lot of the attention. And that will affect the future of media companies, that will affect the future of software companies and a variety of others.

OK, we think we have a lot of ideas around that topic, but in a sense we’re a Johnny-come-lately, and really the guys you have to say who came first were Overture, then Google, and we’re a little bit later to the game, but I think we really grok what’s going on.

In order to get that kind of marketplace to critical mass, you have to have applications yourselves. Just like you could say we needed an Office to bootstrap a Windows, you need some applications to help bootstrap that marketplace, but its ultimate success is going to be not just based on your own applications. Google has bootstrapped their marketplace with search, we are bootstrapping our own marketplace with search, Hotmail, IM, a lot of things which have ad inventory. But at the end of the day it’s going to be the ability to really create a mass marketplace that’s going to give value to buyers of ads, sellers of ads, and the consumer. So we think we’ve got some strong ideas in there.

ROGER McNAMEE: So amplify a little bit, because that whole environment that we live in, I think we all see down here the importance of advertising as an economic model for the Web, and I think it seems that every three to six months somebody comes along with a new idea that suddenly captures tens of millions of people. Is your plan to try to get into innovating around the services that people provide, and therefore creating that inventory that way, are you going to acquire? What’s the strategy for creating inventory that’s really valuable?

STEVE BALLMER: We will do three things. We will create our own services, like Windows Live, Office Live, like Live Search that have valuable inventory; that’s number one. Number two, we will do business partnerships and business development deals with companies large and small that provide incentives and reasons to help bootstrap the marketplace and go to market together. And from time to time, we will also do acquisitions that help bootstrap that advertising marketplace.

ROGER McNAMEE: But pardon me for being persistent on this, but I think this is – correct me if I’m wrong, in the audience, but I think this is a really important issue. We look at Microsoft’s efforts around MSN in particular, and clearly there have been some reboots along the way, and some efforts to sustain critical mass that I think, I suspect you would have viewed as less successful than you would like. What is it about what you’re doing now that’s suddenly going to cause you to be more attractive to all of us as end users and suddenly spend our time inside your environment rather than inside somebody else’s?

STEVE BALLMER: Well, if you look today, we have the arguably either No. 1 or No. 2 environment where people spend time. That doesn’t necessarily lead to an environment where people spend money. More people are actually spending money with – not spending much time but spending money, that is looking at advertising in Google’s environment than either ours or Yahoo!, despite the fact that we have captured people’s time. So partly it’s a question of time and value to the people, partly it is the value that the people’s time have to the advertiser – this is an important part of the mix. Obviously commercial interests at the time that people are spending with you is important to advertisers, because the best advertisers are the ones that have something that they really want to sell.

You know, if you take a look at it today, less so in the United States frankly than outside the United States, we have a lot of traction with our Hotmail, IM and MSN assets. The United States happens to be one of the big countries where we have a little less presence, primarily because of AOL’s presence, and some things that I would say Yahoo! has done right. So we are hard at work on our own core services, with really a philosophy that says we want to let the user be in control. We’ll drive MSN hard for a produced kind of let me say newspaper experience to the Internet, but at the same time in Windows Live the goal is to really allow the user to have a very customized, personalized view, being very creative in the way we’re allowing people to manage RSS feeds, create their own custom portal, use search and search tools, not just the stuff that we write, but we’re creating an ecosystem system around search where third parties can write their own customized views of the Web using our own live search technologies.

So there’s a whole set of things that we’re doing to try to allow the user to be in control, kind of consistent with the first discussion we had, that we think is going to be pretty interesting for people.

ROGER McNAMEE: So for you to define your success in this space, is there a timeframe that you think about, or does somebody have to lose for you to win, or is this a plus sum game?

STEVE BALLMER: Well, I mean, at the end of the day if there’s only one advertising marketplace in the world, I think there are going to be a lot of people who have to deal with an unfortunate environment. And so I think we have to really work hard to build that ecosystem of participants in our ad marketplace, lots of partners, media companies, small publishers who want to participate and play in our ecosystem. We have to have experiences that people are interested and want to extend in valuable ways, and I think the next several years are critical.

Some might argue so were the last several years, and, you know, it would have been nice to have even more progress the last several years, but there’s so much more innovation still to come both in advertising and in some of these core services – 50 percent of searches don’t actually lead to an answer. And so I think the amount of innovation left to come, the worst the innovation which has preceded it.

ROGER McNAMEE: So if we were to think about where you are allocating your R&D dollars, what are the priority – if we sit there in dollars, priority things within Web?

STEVE BALLMER: Within which?

ROGER McNAMEE: Within the whole Web universe?

STEVE BALLMER: Oh, what would I say the priority, the priority you’d say is on the platform.

ROGER McNAMEE: And is –

STEVE BALLMER: The platform for letting us and partners build exciting applications of all kinds. What’s in that platform? Cloud storage, cloud database, the ability to find and rendezvous users in the cloud is certainly important, programming platform that can be run at scale with low cost in the cloud, the advertising platform, the payment platform; that infrastructure and then you get end user experiences like search, like Office Live – I’m really excited about what we have going on with Office Live, which is sort of in beta form on the Internet today, in terms of what it lets people do in kind of a business and commercial setting. But I would say the No. 1 investment area is let me say on the platform itself.

ROGER McNAMEE: So one of the things I think is really interesting is you’re describing the infrastructure in a way that to me is very consistent with the experience that’s been on the Web so far. The people who have done the best job creating supply into marketplaces have generally been most successful at building marketplaces. Yet there are things going on right now that we can see with community based things that are clearly about building the end user experience as well. Talk a little bit about that, because to me when you talk about Office Live and some of those other things, I cringe at the notion of an ad showing up in a PowerPoint slide.

STEVE BALLMER: And that’s why we’re glad to sell you a subscription-based offering so you don’t have to look at any of those ads. (Laughter.)

ROGER McNAMEE: My relief is palpable. (Laughter.)

STEVE BALLMER: No, that’s a big issue. Whenever anybody says to us, “Oh, yeah, word processing is moving to the Web and it’s all going to be ad-funded,” I mean, can you imagine sort of writing kind of a letter to somebody and say, “Yeah, hey, mom, you know, I really am upset with the gun policy,” and then you get an ad that pops up, “Oh, want to buy a gun: available today at such and such.” I mean –

ROGER McNAMEE: The problem is I can imagine it, and I wake up in a cold sweat every night thinking about it.

STEVE BALLMER: But that’s why I don’t think everything will move – the whole world is not going to move to be ad-funded, but as we know, consumers will put up with a lot in order to have businesses pay for what they do. I mean, we’ve been all putting up with 30-second and 60-second ads, at least Roger and I both just turned 50 recently, 50 years of 60-second TV commercials hasn’t dissuaded me, it’s still better than paying for TV. (Laughter.)

ROGER McNAMEE: So how do you think about the end-user side of it, right? Because clearly you’re an incredibly credible player on the supply side. How do you make yourself a credible player on the end user – or maybe it doesn’t matter in your mind?

STEVE BALLMER: No, it matters a lot. I mean, at the end of the day people now think of us as some kind of infrastructure company. I grew up with the Microsoft whose sort of core business was end-user software, and that’s how I think of us, focused in on Windows and Office, end-user experience. And yes it was extensible, and it was a platform, and now it’s mission critical and enterprise ready and blah, blah, blah, blah, blah. But at the end of the day the core kind of soul of our upbringing is really in doing great end-user experiences, whether that’s in the Xbox, whether that’s with Windows, whether that’s with Office, new user interface we’ll be pioneering in the new version of Office, our new Windows Mobile stuff. I was showing Roger; I have one of the new Motorola Qs running the Windows Mobile software. The stuff is really very, very good, and driving a set of service-based end-user experiences, including Office Live, including Windows Live, including MSN, including some of the things we’ll do for business customers is very important.

ROGER McNAMEE: So when you think about the next five years, do you have a target of where you’ve got to be, marketshare-wise, scale-wise with the advertising stuff to feel like it’s been successful?

STEVE BALLMER: Yes, I do.

ROGER McNAMEE: And you would like to share it with us now?

STEVE BALLMER: No, I would not. (Laughter.)

ROGER McNAMEE: Oh, come on, Steve. Well, it’s either I think the choice here is you either give us the number or we do a monkey dance, your choice.

STEVE BALLMER: Monkey dance, baby.

ROGER McNAMEE: Excellent, excellent. That will play really well on radio.

So when you –

STEVE BALLMER: Let me say the following, though, this is important. I have very clear targets that I think we need to meet, should meet and can meet. On the other hand, I think it is also important for us, probably important for a lot of other people that there been good, healthy competition in the advertising marketplace business. If there’s only one healthy advertising marketplace, there’s a whole lot of things – believe me, as many people have said to me for many years, everybody deserves good competition. People have been telling that to me and I’d tell you that’s true of all industry participants. And we want to make sure that there’s good healthy competition in the advertising marketplace arena.

ROGER McNAMEE: But does it give you pause that technology markets have had positive returns and, in fact, consumers have typically aggregated around a single guy? And here you are in third place, and more than half the dollars are going to somebody else.

STEVE BALLMER: I don’t like being in that position, but I think we have shown many times in the past that we have a tenacity and persistence and patience and willingness to get after something, and stay after it and stay after it and stay after it that often has proven itself in the long run. I mean, people point out, you know, there are people who say you’ll never get the browser right; well, when we got the browser right, we took share. People said you wouldn’t get Windows right, people said we’d never make it in the enterprise, people said we’d never take care of Novell and compete successfully. You could say whatever you like; we will show our usual innovation but also our patience, which I think distinguishes us from many technology companies, which do get impatient.

ROGER McNAMEE: So if you’re not going to give us a number, give us a timeframe for how you think about success.

STEVE BALLMER: I think in a sense it probably makes sense to talk about kind of give years, it doesn’t make sense to talk about – you know, you make progress in five years, kind of one year at a time, so you’ve got to continuously make progress, but I don’t think you’ll see some overnight transformation. Our actions, the other competitors’ actions aren’t going to lead to an overnight transformation, it’s going to have to be kind of a longer term campaign.

ROGER McNAMEE: Is there anything about Google that you see that you look at and go, “My God, they’re nuts, that’s just crazy”? (Laughter.)

STEVE BALLMER: Yes. (Laughter.)

ROGER McNAMEE: I’m patient, Steve, I’ll wait you out here. (Laughter.)

STEVE BALLMER: It’s not my job. I mean, come on, everybody can – everything is a double-edged sword. I was with a group of our employees today, you know, somebody will ask a question about Google or another competitor, and what do you think about what they’re doing here. And one can argue with a lot of the things that they’re doing that are different, somebody could say, “Hey, that’s a real advantage for them,” and somebody else can say, “Hey, I’m not sure.”

I didn’t listen to their whole press day yesterday, but I understand that they did say that they’re getting a little bit too much cacophony in their development process, and they’re going to have to work harder to not have that kind of cacophony in their development process. Well, as a guy who’s been dealing with this kind of engineering at scale for a long period of time, I won’t say I’m surprised, it is important – while in any large company it’s important to have a lot of flowers blooming for innovation, but some coherence is also a requirement. So I think only time will tell, only time will tell.

ROGER McNAMEE: So let’s move on to the area in which you really are very end-user focused, which is videogames. You compete obviously head to head with Sony and I’d say Nintendo as well. Tell us a little bit about what that feels like, and what that experience – you know, because clearly that is a very different kind of product than you have historically shipped.

STEVE BALLMER: You know, I think we’ve done a fantastic job with our new release.

ROGER McNAMEE: Is anyone surprised that he said that? (Laughter.)

STEVE BALLMER: No, but, you know, in a sense this is one of these things where v.1 we clearly didn’t have the formula right. That doesn’t mean we didn’t do pretty well, we took – you know, for a new guy to come into the market and take 20-odd percent of the share, not bad, but we clearly lost money, we clearly didn’t have the kind of hardware design, economics, we didn’t have a product that played that well in Japan, which is the second biggest market in the world, and I think what we did with the second generation with Xbox 360 is really get things right. I think we’ve got the right product, we have superior pricing, at least to what we’re hearing Sony will come out with, we’ve got the ecosystem of game developers and partners excited. We have a software-as-a-service strategy that I think is unparalleled, as I said, in Xbox Live. Sony is still only sort of talking about where they add service-based aspects to their platform. And so I think we’re actually sort of in a very good position.

With Xbox 360 we have the opportunity to broaden out the demographic from the hard-core gamer, which has been generally sort of both Sony and our purview. Certainly when people see this “Viva Pinata” game that we have coming out, I think we’ll start to see more attraction for younger people, for girls, for women. And I feel like we’re well positioned, shall we say.

ROGER McNAMEE: Does that mean that this cycle you anticipate that the household penetration and unit volume, which are two separate issues, of videogames will continue to rise, peak to peak?

STEVE BALLMER: I do believe that that’s the case. The broadening demographic should lead to let’s say greater lifetime market sales of consoles this generation than last.

ROGER McNAMEE: Because it’s a tough call, right, this is the first time that videogames have been competing really against text messaging in North America, against things like MySpace. So there are – you know, almost every other form of media is losing share because of the proliferation of media types. So what’s your sense about from a long-term evolutionary point of view, at some point we reach saturation in this category as we have with others, and have to do it totally off of software?

STEVE BALLMER: Well, the real question is over time will people want to spend more of their time rather than less in what I would call entertainment experiences. Some might be on the PC, we announced a strategy to sort of bridge PC and Xbox, some of it might be on mobile devices. We are certainly betting that the amount of time and the ways in which the – the amount of time that people want to spend entertaining themselves will increase, and I think over time you have to bet that the difference between in the longer time what’s a movie and what’s a videogame, even that barrier will somehow blend. An interactive movie, a videogame, today we could think about those things as being very different, tomorrow they may be a lot less different.

ROGER McNAMEE: So there was a time I think in the version 1 of the Xbox where you really thought of it as an extension of the PC architecture. Is it really now more independent in your mind and in your strategic planning? Does it get to stand on its own and become its own platform and evolve at its own pace?

STEVE BALLMER: I think developers want it to be technically – it’s better for developers if it’s technically closer to the PC. The fact that it may not look at all like a PC to the end user is interesting, but I think the underlying technology, and that’s partly why we are an integrated software company. There’s really no reason for us to develop two graphics packages, one for videogames and one for PCs.

ROGER McNAMEE: But there may be an argument that Xbox Live as an environment develops a culture around the console that is independent of one that might develop in the PC gaming world.

STEVE BALLMER: Again we would say, hey, look, let’s say you happen to be on the – you’re an Xbox kind of guy, but you happen to be on your PC, and your friends are playing. Do you want to see that they’re online or not? We would hazard a guess the answer is yes. Might you want to be able to be a spectator from your PC, even if you can’t fully participate?

So I’m not saying everything just collapses into one, but I do think we have to think about those living room scenarios, the PC scenarios, the mobile scenarios, and not just say that people want to have multiple worlds and multiple lives. Some people will and some people are going to want to get a level of integration, and I think we’re uniquely positioned to offer that.

ROGER McNAMEE: So last competitor question, do you still think of Apple as a competitor, how do you feel about them?

STEVE BALLMER: Sure, sure, Apple is absolutely a competitor. You could say who does desktop operating systems, it’s Apple, Microsoft and the Open Source community. And Apple has been a remarkably resilient company coming up with innovations that have continued to give them lift. But every day we have a bunch of guys who come in and say, okay, what are they doing, what are we doing, where are we better, where are they better, how do we improve. We have been fortunate to continue to have very strong market share, and I think part of that, a large part of that comes if we continue to have a much bigger ecosystem of hardware providers, device makers, application vendors, and it is more fundamental to our strategy. Apple has tended to take a more we do things end-to-end, there’s less opportunity for third parties to participate in the Apple ecosystem. I think our ecosystem choice has benefited us.

ROGER McNAMEE: Well, it’s interesting though, because when we look at the Xbox, the Xbox actually looks a lot more like Apple’s world than it looks like your traditional ecosystem.

STEVE BALLMER: That’s right.

ROGER McNAMEE: And it seems to me that one might reasonably conclude that each of those has a place in certain parts of the market.

STEVE BALLMER: Each of them has a place. In the PC world clearly by volume we’ve benefited. Why does the Xbox have an ecosystem that’s more managed, if I could say it that way? Answer: Because the hardware needs to be – because the competition set the metronome that says the hardware essentially needs to be subsidized to break even, and so you need to have an integrated hardware/software-style business model, you need a managed ecosystem, it drives you instantaneously.

I mean, in these devices, mobile phones, you can ask should it have a PC style approach, which is the one we’re taking, where software and hardware are really independent businesses, or will it be more of a managed ecosystem, which is kind of the approach I would say that Nokia is taking, or very closed and end-to-end, which is the approach RIM is taking. And I don’t use those words pejoratively, the question is which of those models will create more end user value through the work not only that a company like we do, but the work of software development partners around this. I think we’ve made the right choice.

ROGER McNAMEE: So as you think about the products, you’re over the next year going to ship some really, really big things and you’re talking a lot about Vista, about software as a service, give us a sense of why any of us who use PCs should upgrade to version. What’s the – I mean, it’s such a pain in the ass to upgrade, why do it?

STEVE BALLMER: A) in Vista – not that this would give you a reason to do it, but just for the record, in Vista we actually make it easier to upgrade. That is an important aspect of getting people to upgrade.

ROGER McNAMEE: Would you say that’s the leading feature of why we should upgrade?

STEVE BALLMER: No, no. (Laughter.) No, but I thought I should nip that one in the bud before I blew you away with the magnificence of Vista. (Laughter.)

ROGER McNAMEE: I sense a monkey dance coming.

STEVE BALLMER: It is important that we continue to work to make it easier for people to move their programs, their settings, their data; we’ve done a lot of work.

Why would somebody upgrade? I think there are really three reasons. No. 1 is security and privacy. These are not necessarily in priority order, but I’ll tell you at the Ballmer household the work that we’ve done to enhance parental controls, to enhance anti-phishing, the work that we’ve done on anti-spyware, the work that we’ve done to harden the environment, build in the firewall, that in and of itself will appeal to my wife. We’re not talking about me now, we’re talking about my wife in this case.

ROGER McNAMEE: So is all that work taking place inside the Ballmer household? I mean, I think that’s high-value engineering at Microsoft. (Laughter.)

STEVE BALLMER: And my wife wants it to be high-value engineering at Microsoft, not high value engineering that she feels compelled to do.

So the integration of a more secure world I think I would list.

No. 2 is the new visuals. Frankly, and it’s not just the new visuals for Vista itself, it’s the new visuals, new user interface that’s available to all software developers. I think that’s a big deal. That includes the new integration of search throughout the experience. People do still have a very hard time kind of finding, using, taking advantage of their PCs, and the way we’ve pervasively integrated, and we’re just talking about desktop search here, you can use whatever Internet search, whatever corporate search you want, but the way we’ve pervasively integrated search I think will improve the basic experience quite a bit.

ROGER McNAMEE: So give us a sense of on the security side, are we going to be done with the current generation of worms and viruses, the things that use the memory management issues in the current versions of Windows? Are those sort of all done and we get to look forward to a period of peace and quiet while the hackers figure out the next opportunity?

STEVE BALLMER: Subject to the tolerance levels of the fact that there might still be a small amount of human error, we will have eliminated the known attack vectors that people use against us today. You’ve got to understand today we’re the world experts in how hackers attack. I’m not sure I should be boastful about that, but when you get the most popular system, you get the most data on how these guys come after you. And we’ve done a lot of work that I think is incredibly impactful against those guys.

But will there be new attack vectors, undoubtedly there will. I think actually the thing that’s most concerning is the next generation of attack vectors are more likely to be insidious in the sense that instead of just trying to – sort of the fun of disrupting people, it will get down to how do I steal your identity, how do I steal your money, things – let me just call those more insidious. And that’s why I think the battle moves out more to malware, to phishing than just to good old-fashioned virus attacks.

ROGER McNAMEE: So what’s Microsoft’s current thinking on the whole spam, phishing? You know, those things kind of overlay each other and there has been some confusion about where you guys stood in terms of both wanting to enabling a free marketplace relative to people pushing advertising to people versus the implications of what may come with that. Where are you on that?

STEVE BALLMER: I think what we want to do is put the – like I said earlier, put the user in control. We really need to put the user in control; that is, what are their privacy preferences, what do they want, what do they not want. You don’t want ads in your PowerPoint, you should be able to buy PowerPoint without ads. Somebody else says, “Hey, look, I don’t have any money, invade me, take my privacy, but give it to me for free.” And there will be people who will say that, “I will take more advertising, you can know more about me in order to charge me less.” We want to make sure we enable that. And so in a sense it’s about enabling these experiences flexibly.

ROGER McNAMEE: So will I be able to buy versions of Outlook that are just – you know, guaranteed against today’s spam things, that I in effect can pay you to protect me against that?

STEVE BALLMER: We will sell you that. What is the challenge? The challenge is in understanding what is spam and what is not spam. And there are still challenges. I’ll give you from personal experience. And it’s a funny one, so I’ll pick it. McNealy and I, you know, we’re good friends again, and – (laughter) – no, you can laugh, but I’ve known the guy since high school, and we actually kind of grew up as friends, and we had a little bit of a patch there where we didn’t talk much, and now we exchange hockey jerseys together and stuff.

But when Scott first sent me a piece of e-mail as we were sort of reconnecting, his piece of mail wound up in my junk mail folder. Every now and then I’ll go through my junk mail and look and just try to see what’s in there. And it had the characteristics of a piece of spam. It was short, it was a one liner, it wasn’t sent through a rich text editor, da-dah, da-dah, da-dah.

ROGER McNAMEE: Open Source, Silicon Valley; yeah, no. (Laughter.)

STEVE BALLMER: No. No, you said that, not me. And I had to go mark it “safe sender.” So there still is a level of analysis required.

I give out my e-mail address frequently to people to invite customer feedback. How do you know whether – when somebody in an audience sends me a piece of e-mail, good question, is it spam or not. It wasn’t generated by a computer but it sure might feel a lot like spam. And so really being able to distinguish these things, filter them accordingly, we still need a lot more intelligence.

ROGER McNAMEE: So this whole notion of software as a service, we’re going to get to make the choices around this. When does that start to really roll out as a customer experience?

STEVE BALLMER: Well, for us it really comes with Windows Live that we have both models, not just the traditional portal view which we give you in MSN, but really user in control services, which we will launch beginning of next year.

ROGER McNAMEE: OK. And so if I sit there, can you give us some sense on –

STEVE BALLMER: Sorry, later this year.

ROGER McNAMEE: OK, what the premiums are that we’re going to pay for the various things? Pricing we’ve heard on Vista a little bit higher than on Windows, pricing on Office all over the place.

STEVE BALLMER: We jumped there, didn’t we? Were we just on Windows Live and we jumped to the price of Windows and Office?

ROGER McNAMEE: We’re talking about the whole experience of, you know, there’s a package of things I have to own in order to –

STEVE BALLMER: No, I think – well, you don’t have to won Vista and you don’t have to own the new Vista to participate in Windows Live.

ROGER McNAMEE: OK, good answer.

STEVE BALLMER: Thank you. Windows Live has to be able to extend to customers who have old Windows, who have old Office.

ROGER McNAMEE: Well, this is a huge change for you. I mean, one of the biggest support problems that we all have is version control and version currency, and so –

STEVE BALLMER: No, there are things that will still prereq new versions. Our service offerings, MSN and now the Live stuff have taken a basic viewpoint that says it’s going to work down level because it’s important to get to critical mass. The same thing with the new Office, the new Office does not require the new Windows, because we think it’s important to be able to go do that.

You did make a couple comments I just want to disabuse.

ROGER McNAMEE: Please.

STEVE BALLMER: I don’t understand this Vista costs more. We think of Vista as costing about what prior releases of Windows have cost. Office comes in many flavors these days. We have a Student and Teacher Edition, we’ve got a Basic Edition, we’ve got Office Standard, we’ve got Office Professional. So I would say a little bit if you want what you’ve always wanted, you’ll probably pay what you’ve always paid. We have a number of users though who want new capability and certainly our Student and Teacher, which will be replaced by a home edition of Office, carries a much lower price point than earlier versions of Office did for those home users.

ROGER McNAMEE: So when you look out in Silicon Valley and other places, you see a lot of startups doing a lot of interesting things. Are there companies out there in the startup world that you really admire?

STEVE BALLMER: Yeah, there are actually, I think there are companies that are doing great stuff. Most of the companies, even if they’re doing great stuff, will probably never break through let me say into the stratosphere of companies in this business, as Yahoo! has or Cisco has or Microsoft has. I mean, statistically the odds are against it.

And so it’s easy for people to say after the fact when somebody broke through, say, oh, I really admired them when they were a startup, and maybe they did and maybe they didn’t.

In the last year we’ve acquired 22 companies, most of which you would characterize as startups, early-stage-type deals. And in every case there was something about one of those companies that we really admired: technology, people, founders, in some case business models. And so we found 22 that were actually worth and we wanted to buy, but I’m always meeting these companies that excite me.

I have a new thing I do three times a year, I spend a day in different parts of the world just meeting every 40 minutes or so a new CEO of a new startup company, learn what they’re up to, what they’re doing, what their interests are with us, where they think we can help. Some of them are built on our technology, many of them are not built on our core technologies, so a little bit of selling for me back to them. But I did a day here in the Valley about, oh, a month or two go, and I probably met CEOs from eight or 10 startups down here, and we wind up in some cases I think we’ll do some acquisition, in some cases we’ll do business development deals, and in some cases I have respect for them but we probably won’t do much together.

ROGER McNAMEE: So I’ll give you a few names then. How about BitTorrent? Interesting, not interesting.

STEVE BALLMER: Interesting, very interesting, not sure exactly where it goes as a business but very interesting technology and approach.

ROGER McNAMEE: Architecturally interesting to you?

STEVE BALLMER: Yes.

ROGER McNAMEE: OK. YouTube?

STEVE BALLMER: Interesting. Again, anything that can capture consumer imagination is very interesting. Where they go, how things pan out, I think the future is yet to be written.

ROGER McNAMEE: Facebook?

STEVE BALLMER: Facebook, fascinating. I’ve spent a lot of time studying Facebook. There’s probably something we all can learn about community, not just – I mean, we have to admit university is kind of the weirdest place in the world that we spend our time. We all do it for four years, it’s bounded, sort of your time is your own in a very unique way. When you work your time is not that your own. Even when you’re a kid in high school your time is probably not as much your own as when you’re in college. But if you ask what’s the Facebook equivalent for many other communities, I think there’s a lot we all can learn from the Facebook concept.

ROGER McNAMEE: So when you think about content then, one of the big debates has been whether at the end of the day the content that’s going to matter is the stuff that already exists, movies, television, music, whatever, versus stuff created by end users. When you’re sitting there in the strategic planning, how do you think about those things?

STEVE BALLMER: The stuff that we all like to call the tail, the stuff created by end users I think is very important, very, very important. I think that because all analysis says that’s where most of the content is going to come from. Some of the most interesting content we’ve all looked at has come from end users who did the best video, for example, of the tsunami in Southeast Asia. Of course, it was so-called tail video. So I think it’s going to be very important.

The problem people are going to have is talking about its business, does it have a business model, what does it look like, what does it look like from an infrastructure perspective. But me personally, I’m a big tail video guy.

ROGER McNAMEE: So when you think about that cell phone and the stuff that you’re creating for it, how much of the time do you wind up spending courting Hollywood versus thinking about the issues that you need to do to make that user interface more effective for the end user?

STEVE BALLMER: You know, we know we – I mean, I know you’d like me to say A is more, B is more. We can’t punt either one of them. At the scale at which we want to operate, we want the professionally produced content, but I also want the basketball game from Detroit Country Day School, my alma mater, I really want it on the darn cell phone. And everybody has got their own issue, their own alma mater, their own kid’s game, their own whatever it is that they want to see up on the Web, and that stuff is as important as let’s call it the head of the curve.

ROGER McNAMEE: There is some talk that perhaps the wireless infrastructure will develop an Internet like or Open Source-like model in terms of WiMAX, Wi-Fi and particularly metro area stuff. Where do you guys come down on all that, and frankly where do you come down on the whole issue of the relationship between the established carriers and new communication models?

STEVE BALLMER: Well, I think if you take a look at it and say is the Internet sort of an Open Source model or not an Open Source model, I think you’d say it’s a commercial model that has interesting attributes around it. I mean, nobody owns the Internet but there are definitely people who get paid to hook you up to the Internet, and they afford their capital equipment consequently.
So when people talk about Mesh Networks and where wireless is going, I actually believe that there will be definite commercial business model involved, and yet I think it will be an evolved model of how connectivity happens.

We’re getting WiMAX to the home at our house in the next month. Living next to Craig McCaw, who’s starting one of the first WiMAX companies, is helpful in terms of being an early pioneer on some of this stuff. And certainly the guys who are going to make the capital investment to make this happen need to seek some kind of return, and it may be that they only provide so-called backbone and less of the meshing out the further houses, but there will definitely be a business model around it.

ROGER McNAMEE: So we need to wrap. Is there anything you’d like to tell us about Microsoft and the relationship it would like to have to Silicon Valley?

STEVE BALLMER: If you take a look and you say, okay, what is our relationship, it’s really quite broad. We’ve got almost 2,000 people down here doing software development, software and hardware development; that’s a big deal for us. Of the 22 companies we’ve acquired, about four [Editors’ note: number misstatement corrected] of them are here in the Valley, and in a sense then you could say an important source of technology and talent. If you look at our very large partners, people like HP and Intel, of course, a number of them, of our biggest partners are down here in the Valley. You look at our biggest competitors, a number of them are down here in the Valley. You look at the important ecosystem partners, the startups, the software as a service companies, I will go from here back to our venture capital summit, and we’ll have about 200 venture capitalists talking about what their portfolio companies are doing and what we’re doing, and where the business development opportunities and partnerships are.

So I’d say it’s a very broad and rich relationship where most of it has a lot to do with how we and partners and talent and startups go forward and help do great things together, and I think as one of the arguably two or three biggest forces and leaders of the industry, I think we benefit immensely from our relationship with Valley companies, and we certainly take our responsibilities as a leader in that context super seriously, and really look for a lot of win-win situations, even if there’s a few folks down here we seem to compete with pretty hard.

ROGER McNAMEE: Excellent, and I want to thank Steve Ballmer, the CEO of Microsoft, for having been such a patient and great guest today, want to thank the Churchill Club and the Commonwealth Club for hosting this event, and want to thank all of you for being part of it.

STEVE BALLMER: Thank you all very much. (Applause.)

Let me also – one other thing. We will take all the questions people submitted that we didn’t get, we’ll get some answers, I’ll get some answers out for people to look at, and I’ll be there’s some Churchill Club Web site or something where we can post them, and if that’s okay, we’ll get them back to you. And again thanks everybody very, very much.

RAYMOND NASR: Thank you, both. (Applause.) Now this meeting of the Commonwealth Club and the Churchill Club is formally adjourned. Thank you, everyone.