Ballmer defends Microsoft's spending increase

Microsoft CEO Steve Ballmer is confident that the company's plan to invest more across several businesses is the right move in the long run.

But the news last week that the spending would likely be at the expense of higher near-term profits sent the stock on its biggest one-day plunge in five years, an investor reaction Ballmer described as "a lesson that the entire leadership team at Microsoft will learn from."

In a memo to employees Friday afternoon, Ballmer wrote that executives "are immediately going to redouble our efforts on business execution and financial discipline."

The memo, obtained by The Seattle Times, first emerged Monday on financial news wire Bloomberg News, perhaps in an attempt to present a more detailed vision of the spending plan to investors.

"Microsoft has a long history of publicizing its strategies by leaking memos judiciously, or not so judiciously," said Dwight Davis, a Kirkland-based analyst at Summit Strategies.

Some Wall Street analysts complained that Microsoft did not offer enough detail last week when it gave its first forecast for fiscal 2007, which included roughly $2 billion in unexpected spending and lower per-share earnings.

But the Friday sell-off, in which Microsoft shares lost $3.10, or 11 percent, and hit a 52-week low of $24.15, may have had more to do with investor expectations of share-price gains from the upcoming launches of Windows Vista and Office 2007 (the stock recovered 14 cents Monday, closing at $24.29).

"Investors were thinking that these new products were going to return Microsoft to the same levels of growth and profitability as it had in its glory days," said Brendan Barnicle, an analyst at Pacific Crest Securities in Portland.

That's not realistic, he added, "principally because Microsoft has competition now."

Ballmer put that competition — namely, Google, Sony and Nintendo — squarely in the crosshairs in his memo Friday, and he acknowledged it will take lots of money to pull the trigger.

Microsoft is making "heavy investments" in Internet search, advertising and data storage that will "show how serious we are about Live services." Live is Microsoft's name for a series of software services and platforms delivered over the Internet.

Advertising revenue is a critical part of the emerging Internet services market. Microsoft is hosting important advertising customers in Redmond this week for its Strategic Account Summit.

"[O]ur goal is to create the Web's largest advertising network, giving us an engine that will enable us to monetize our services and compete against Google," Ballmer wrote.

Microsoft chalked up a recent victory late last month when Amazon.com switched two of its Internet sites from Google to Windows Live Search technology.

Google also struck a blow with news that it has complained to antitrust officials about Microsoft's Internet Explorer 7, released to the public in a test version last week. The New York Times reported Monday that Google quibbles with the new Web browser's search tool, which is set to Microsoft's search engine when the program is installed. However, adding and using other search engines is a simple process.

In the video-game console market, Microsoft is striving to build on its head start over Sony and Nintendo, a sprint that has and will continue to cost it in the short term.

"[T]he cost of producing Xbox 360 consoles was higher than expected, while at the same time we decided to manufacture and sell as many consoles as possible to build on our lead in the race to be number one in the video game business," Ballmer wrote, adding that Microsoft will have 5 million consoles sold by July.

The company's growth strategy depends on its core businesses and the success of Vista and Office, Ballmer wrote.

"These will be the largest launches in company history by every measure and the first time since 1995 that we have launched these flagship products simultaneously. We are making a considerable marketing and sales investment for these launches," he wrote.

In the third quarter, Microsoft spent $292 million more on sales and marketing, related to product launches and Windows Vista pre-launch advertising and marketing programs.

"You can only imagine that they could end up spending an incremental billion to billion and a half [dollars] in the next fiscal year launching new products," analyst Barnicle said.

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com