Microsoft Corp. last week reported record quarterly profits of $2.44 billion and revenue of $6.11 billion, but sales of its Windows operating system didn't grow as much as the company and Wall Street predicted.
And they won't be stellar next quarter either, Chief Financial Officer John Connors said.
Indeed, this is a critical year for Microsoft. On the eve of the release of its next operating system, Windows 2000, it also must grapple with the rise of the application hosting market, a change in leadership and legal issues that could literally tear the company apart.
"This is a time when the company is going to battle," said Michael Gartenberg, an analyst at Gartner Group Inc. in Stamford, Conn.
"Microsoft has a new vision, [it has] the ongoing fight with the [Justice Department] and competition is stronger than ever in every segment," he said.
Steve Ballmer acknowledged as much when he took over as Microsoft's CEO two weeks ago. "It's a challenging time. But the time Microsoft is faced with challenges is the time we do our best work," he said.
Perhaps the most pressing challenge is the movement in the industry to offer software via online subscriptions rather than shrink-wrapped disks. This application hosting model has Microsoft in a hard spot.
The most valuable company in the world got that way by selling prepackaged software. The concept of pay-as-you-use subscriptions is "a very, very different model" from what Microsoft is used to, said Dwight Davis, an analyst at Summit Strategies Inc. in Seattle.
Microsoft has partnered with several application hosting companies, but questions remain, Davis said.
For example, technologically, Microsoft must decide how to split its products for users who don't want to subscribe to large bundles. A user might want to run the Word word-processing program but not the spreadsheet, database and other software that comes with the Office suite. Likewise, pricing is an unknown, Davis said. Start-up companies and established players such as Sun Microsystems Inc. offer subscription software at low prices - and sometimes for free, he said.
"Microsoft, which has had great market power to set prices and undercut competitors' prices, is suddenly coming up against a new breed of competitors willing to cut prices to the bone," he said. "If you're Microsoft, it's tough to compete with that when you have revenue goals and a stock price to grow."
Windows 2000 will be a marketing challenge. Microsoft hopes to erase its reputation for server operating systems that can't support hundreds of users in business-critical applications.
In addition, Microsoft must provide more help for customers looking to rewrite key applications for Windows 2000, users and analysts said. The vendor claims that more than 7,000 off-the-shelf programs will be available for the new operating system, but that doesn't address custom software that large information technology shops often run. Except in special cases with its very biggest customers, Microsoft refers users seeking such help to integrators and consulting firms such as Computer Sciences Corp. and Unisys Corp.
Meanwhile, Microsoft has from now until a self-imposed April deadline to devise a detailed schedule for a set of new products called Next Generation Windows Services. Chairman Bill Gates said he will be leading this charge to infuse all Microsoft products with Internet capabilities.
Larry Andrews, manager of the network operations center at a large entertainment company in California, said he's concerned that Next Generation Windows Services will too tightly couple operating systems with applications.
Microsoft continuously blurs the line between the two, Andrews said.
"That's a good part of where their reliability issues come from," he said.
"Windows is the only software I know of where you can get a corrupted word-processing document that will crash your system."
Microsoft declined to make executives available to be interviewed about application hosting or Windows 2000 for this article.