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Where's Microsoft?

By Larry Dignan Print this article Print

Microsoft was sitting on an ungodly amount of cash. The cash is held in the bank but doesn't add to productivity.

In 2003, Microsoft had too much of a good thing—cash.

Greenbacks are one of the biggest reasons Microsoft failed to crack the Baseline 500, a metric that measures information productivity. Isn't cash a good thing? Not when you don't do anything with it.

Microsoft earned an Information Productivity rating of -8% and failed to make the Baseline 500 list. The bright side? Few technology companies made the cut. Of the big-name technology providers, only Dell (No. 423) and Oracle Corp. (No. 477) placed in the top 500 with Information Productivity returns of 34.5% and 30.9%, respectively. Only 21 tech companies overall made the list.

Microsoft didn't make the cut because it fell short on two key indicators in the formula that underpins the Baseline 500 (see "Do It Yourself," p. 10): transaction costs and the money it stashed away from its highly profitable software business.

For starters, the operating system giant's transaction costs—the direct costs of generating the information it needs to manage its business—were $12.3 billion.

By comparison, household goods maker Procter & Gamble had transaction costs of $13 billion. How productive is that? Procter & Gamble had 98,000 employees in 2003, far more than Microsoft's 55,000. Microsoft's transaction costs per employee were $223,636; Procter & Gamble's were $132,653.

Microsoft, for its part, is bent on driving those costs down. In a widely publicized memo on July 6, CEO Steve Ballmer said one of Microsoft's biggest goals for the 2005 fiscal year is to cut $1 billion in costs. This is key, since sales and marketing and general administrative costs have grown from $8.09 billion for fiscal 2002 to $9.99 billion in fiscal 2003, or 23.5%, while revenue has only grown from $28.4 billion to $32.2 billion, or 13.4%, in the same period. That trend continued in fiscal 2004, which ended June 30.

But the biggest problem for the company in the ratings, which were for fiscal years ending in 2003, was its $49 billion cash hoard.

A key component of the Baseline 500 formula is the expected rate of return on money that shareholders possess. This is captured in the Capital Asset Pricing Model, a key component of the calculation for how well companies manage what they know about their business, or Information Productivity.

The Capital Asset Pricing Model assumes shareholders can expect to earn at least as much as a Treasury bond on the money they invest. Last year, such bonds paid an average interest of 4%.

Then, the model adjusts for the risk of investing in a particular firm. If its stock is going up, the risk is going down and the expected return can be high. By contrast, holding cash says the company can't find good ways to put it to use.

Last year, Microsoft's stock only gained 2.8%. And it held onto $10.4 billion more cash than at the end of June 2002. Not productive.

"The bottom line is Microsoft's transaction costs increased and the company was sitting on an ungodly amount of cash," says Paul Strassmann, creator of the Information Value-Added formula. "The cash is held in the bank but doesn't add to productivity."

Of course, Microsoft could improve the return to shareholders by giving them a cash dividend—which it announced this year.

On July 20, the company said it would give shareholders $3 out of that cash stash for each share they held. That will reduce the hoard by about $32 billion, and show that Microsoft has found a productive use for its cash.

The payout should help Microsoft move up in the 2006 Baseline 500 rankings. The one-time dividend will be paid on Dec. 2, Microsoft's second quarter of its 2005 fiscal year.

Microsoft, of course, earns interest on that cash. So reducing cash on hand will reduce earnings. That, in turn, will diminish a key component of Information Productivity, the Information Value-Added gained by managing well, notes Strassmann.

And then there's the big problem: The company's growth has stalled, indicating that it is not able to manage the information it has about its customers, its markets and its businesses to good advantage. The best example: Microsoft is taking longer and longer to release a significant new edition of its fundamental growth platform, the Windows operating system.

On Aug. 27, the company said its next edition of Windows, dubbed Longhorn in company parlance, won't be out until 2006, and even then will be lacking one of its three key selling points, the WinFS feature that would help users scour their hard drives for lost information.

Even then, it will be five years between major releases of Windows, where it used to be three. And if Longhorn's remaining new features aren't as attractive as hoped, the company could find itself facing more risk.

As Strassmann points out: "Microsoft could be in a position where the revenue just isn't coming in."