Microsoft Slams on the Brakes

Two days after President Barack Obama, in his inaugural speech, told the country to brace itself for tough times, the head of one of the most valuable U.S. companies echoed the sentiment. "We're certainly in the midst of a once-in-a-lifetime set of economic conditions," Microsoft (MSFT) Chief Executive Steve Ballmer told analysts during a conference call discussing fiscal second-quarter results. "The economy is resetting to a lower level."

In other words, we've entered a new paradigm. The mortgage-market collapse, financial market turmoil, and restricted lending have taken a big toll on demand for computers and other products that run Microsoft's software, and it's time to settle in for a long slump. There's no recovery on the horizon, Ballmer warned. The economy could remain in the doldrums for "a year, two years—I don't know what it will be—and then start to build back," Ballmer said.

As with other tech bellwethers including Intel (INTC), the "resetting" is hitting Microsoft hard. Second-quarter sales rose a mere 2%, to $16.63 billion, compared with analysts' already-lowered average forecast of $17 billion, according to the earnings report, which was released Jan. 22. Net income fell 11%, to $4.17 billion. And Microsoft said it lacked enough clarity to provide a forecast for the next two quarters. Microsoft's stock tumbled 11.7%, to 17.11, helping fuel a 1.94% decline in the New York Stock Exchange.

So what's a behemoth of a company like Microsoft to do in the midst of so great a downturn? Organic growth is hard to come by for the maker of software running more personal computers than there are cars in operation. And the company's biggest attempt to grow through acquisition, a proposed takeover of Yahoo! (YHOO) in 2008, foundered.

Slimming Down

Instead, Microsoft is slimming down more than ever. "We're significantly putting the brakes on," Ballmer said. In its first-ever broad-based layoff, the company is eliminating about 5,000 jobs, or 5.5% of its 91,000-person workforce. The net reduction will be less than 3,000 because Microsoft will keep hiring in key areas. But the move "shows they are serious about taking at least some initial steps to get their business model more aligned" with the economic conditions, says Technology Business Research analyst Alan Krans. Microsoft also plans to cut travel expenses by 20% and eliminate merit bonuses for the year that begins in August.

Diminished demand for PCs is taking the biggest toll on Microsoft's flagship Windows business, where sales fell 8% to $3.98 billion—far off the company's forecast for 10% to 12% growth three months ago. Executives said sales fell across the board, but especially in price-sensitive emerging markets and among corporate buyers. Many of the PCs that were sold were low-priced netbooks that tend to go for less than $300. For the version of Windows in those machines, Microsoft gets less than half as much as it does for the version in a full-blown PC.

Falling PC sales also hurt sales of the company's Office suite of productivity applications, which includes e-mail and spreadsheet creation tools. That's partly because most netbooks do not have the memory to run it, and because people who use these stripped-down devices do much of their computing on the Web.