Peter Kafka

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Live from New York: Microsoft CEO Steve Ballmer

ballmer-mcgraw-hillThe Microsoft (MSFT) boss is sitting down with BusinessWeek editor Stephen Adler at the McGraw-Hill media conference. Expect at least some chatter about Yahoo (YHOO) and its new boss Carol Bartz, who just happens to be visiting New York this week as well.

Following is paraphrased live notes, unless in quotes. Please refresh your browser for updates.

Starting off with an economy question: Should be believe that recent rally means things are getting better?

SB: The principle we’re operating on is that the economy will contract, reset… and we’ll begin again what I call “regular growth”. We had had abnormal growth fueled by too much debt in the system. I don’t how long that will take. It could take, two, three, four years to get there.

SA: Back to MSFT business. Why don’t you dominate search?

SB: We had to start essentially from scratch about 6 years ago. Essential thesis: Most of the innovation is still come in search. Search hasn’t changed much in the last 5 years, 10 years. “It’s gotten somewhat better, but at the end of the day you search to do something, you don’t search to find links to web pages.” We think there’s a lot of innovation yet to come. We’ve learned that cost of just getting into the game – the table stakes – is a lot higher than we realized in R&D, capex. Google (GOOG) is making that investment, Yahoo can’t, we are.

SA: Isn’t much of this a marketing question, that no one visits you for search?

SB: Yes. But it means opportunity for us. Our brand will differentiate us, and if we can just get 15 or 20% in the next few years, that’s a big step up.

SA: Please tell us about Kumo, your new search product.

SB: Not really ready to talk about it. Need a new name. We update search every 9 months. Going still call it “Live Search” for now.

SA: So not a new product, just an incremental release?

SB: “I think we could use a “set change” as they say in organizational behavior classes, and when we’re ready to release one, we will”.

SA: What’s up with Yahoo talks?

SB: Principles first: “Whether or not there’s a partnership to be had with Yahoo, we think our own innovation… it’s not about Yahoo’s technology. It’s really about getting the pooled volume, because you actually can improve your product faster if you have more users.” If you have more advertisers, you can improve the product as well. “There are returns to scale. And putting the scale together is valuable.”

“With that as context, we’re largely on the same strategy, with or without a partnership with Yahoo.” I’ve talked with Carol briefly, over the phone. “I’m sure when it’s appropriate, we’ll have a chance to sit down and talk.” I’ve known her for years. She’s straightforward and friendly “and when she’s ready, we’ll have that type of discussion. Whether a deal gets done or not, who knows.” People at our two companies talk all the time.

SA: Will there be a deal?

SB: “There are a lot of things that are fairly compelling economically in trying to put our two search efforts together in a partnership.” I thought that last year, and “I got bailed out of this economy by Yahoo on that”. [Laughs].

SA: Do you own an Apple (AAPL) products?

SB: “No. I don’t. My sons don’t. My wife doesn’t.”

SA: Why does MSFT, which is so smart have so much trouble outside of Windows, Office. Why so difficult to expand beyond that (ie against the likes of Apple?).

SB: “Most people in our industry never expand beyond one thing.” So the fact that we have Windows, Office, business software…”So beyond those three, Mrs. Lincoln, or whatever, how was the play? I think I got that backward, but you get the point.”

Xbox doing great for us. Incredible asset, opportunity. We have areas where we have our work cut out for us. No doubt that Apple does a nice job in video and music services. We’ve talked about search… but if you were a shareholder, I’d also say, it’s great because there’s lot of opportunity.

SA: Whither Zune?

SB: “We’re going to keep going with Zune”. It’s two things: Service and a device. The Zune service, that’s going to fan out its footprint. Hardware will continue to improve. “The question is whether even if we flog them heavily, is their profit upside”. We’re going to keep going “I won’t say full steam ahead, because that implies acceleration of investment, but we’re going to sustain our investment.” We like it and the future may be the software/ecosystem on other devices.

On to smartphone market:

SB: Smartphones will go from 10% to 70 or 80% of market next few years. So what will people want? Good experience built in, w/out downloading stuff. You want good price range. iPhone is very expensive phone, without a keyboard. Some people can’t afford them. Sweet spot is phones that cost $150 to $200 to make — forget retail price. iPhone is about $500. We want to provide vendors with ability to make Windows phones up and down the price scale.

Unless you assume Apple and BlackBerry are going to sell the lion’s share of most phones, which I don’t, I think the play for us is to provide broad innovation at many price points.

A $500 phone is not going to work for everybody in every market. The most popular phones in China and India cost about $25 to build. We can’t get our software on that.

SA: Do you care about “touch” on phones? The blogs say you are.

SB: Windows Mobile 6.5 has touch on it. The way Apple does touch drives cost. They way they do it on the iPhone is not an inexpensive component. We’ll do it in a way that you can afford to do it on most phones.

SA: What are you thinking with these retail stores? How different than Apple?

SB: You have an interesting case in the US. Right now there’s a range in innovation, around, by our partners. Not selling software in stores, but hardware. It is a challenge today for our partners, who do the most innovative designs, to get them to market. Because it’s too high risk for the Best Buys of the world. So we need an outlet to champion that innovation. Showcase devices that are hard to get stocked in traditional electronics retailer.

Apple actually sells about half of all Apple machines through its stores or online. We’re not going to do that for PCs. But we don’t to show off interesting stuff. It’s sort of like our enterprise consulting services, which doesn’t really compete with the big consultants. It’s a place to showcase.

SA: Back to Windows/Office. How are you adapting the Cloud – Software as Service?

SB: I think we’re doing a good job. Rattles off series of vaguely cloud-related services – things that involve the Web. “We’re doing a lot of work in the area and I see all upside from the cloud.” Do we have competitors? Sure. Is Google going to compete with us? Sure. We try to compete with them, too. Everybody makes their software really run on the client. The truth of the matter is that nothing is really a Web software — even Google Apps. Everything really runs on the local device, because it runs better there.

SA: What do you think of IBM/Sun deal?

SB: “I don’t exactly get it, but it doesn’t exactly surprise me either.” Logical exit strategy for Sun shareholders. On IBM’s side. “I think you pick up a lot of stuff when you buy Sun” and you have to figure out if you want everything you’re going to get. “It doesn’t change our fundamental” economics, strategy. “I think it gives me a year or two where they’re digesting it. I relish that year.”

SA: Recently you promised to keep investing in R&D, etc and you got criticism for that. Please respond.

SB: The feedback we’ve gotten isn’t just about the R&D number. It’s “Cut costs. Cut them more.” But in R&D, when you’re giving someone some people today, you’re really, giving them more people tomorrow. So we need to flatten that curve a bit. There are plenty of areas where we spend less than the competition. Apple, for instance, spends much more (proportionally) on marketing than we do.

SA: Those layoffs you announced may have been the first major round you did. How are you absorbing that.

SB: We feel bad about the layoffs. Nobody wants a death by a 1,000 cuts. So we really thought it through beforehand. I “revectored” my Christmas and New Years to go over this. “While it’s not fun, they’re moving forward with good attitudes.”

SA: Talk about future markets, opportunities

SB: PC market will shrink nearterm, but when it turns around Windows/Office will go gangbusters. Cloud-based services has big growth. Big possibilities in servers/mainframes. On a percent basis, fastest growth will be in search, phones. Those things will grow quickly, but we’re still in investment mode. Xbox we’ve turned the corner on. We’ve paid our upfront costs. Have big base of subscribers, and a real opportunity for it to be “more than a console” and I think you’ll see that 12 months from now.

On convergence: Zune needs to come from the cloud and support the TV. It will support the phone/mobile device, and it has to run on the PC. Right now it’s on a device but it broaden from there. LiveMessenger will work the same way.

But the PC has real advantages compared to TV or mobile. TV has no intelligence. The phone today is pretty nascent. There will be about 300M PCs sold this year, compared to 20M iphones or Windows Mobile phones. PCs are open. PCs are compatible. So importance of PC-centered innovation…most of the new media creation, the PC will actually be the primary target device, for now, and eventually the same type of opportunities will be available on three screens, from the cloud.

SA: What about M&A?

SB: “We don’t have an acquisition strategy. We have a business strategy that might lead to acquisitions.” We did 20 deals last year. We’ll do about 20 this year. Most between $10M and $400M in value. “But will be buy many things things that are $2, $3, $4B and up? We could.” But I’m not sure we will. But integration is hard. And pricing is hard. “Nobody knows what asset values should be, at least until the economy finishes resetting”. I only get involved in deals about “a couple hundred million”.

[Missed some parts about evolution in Ballmer's management style. Apologies]

SA: Is it better now that Bill Gates is gone?

SB: “It’s different”. We’re growing, but “we miss Bill.” But everyone values what Bill is doing with this nonprofit, and everybody relishes the chance to grow. Windows 7 is a great product, that we’re building without Bill’s involvement.

SA: You recently called on government to invest in innovation. What should they be doing?

SB: “A lot of basic research in this country needs to be funded by government.” A lot of important research has come out of government, and I think it’s important that they understand it. GDP growth comes from basic transformations in science and the business cycle. “The most important thing is that the government says, he we believe , and we’re going to put our money where our mouth is” on the science side.

On the education side, anything we can do to shore up what is the best set of universities, I think the more we can keep that system healthy, the better.

“I’m not going to pretend to be the expert in how that happens.”

SA: You’ve made a lot of money [then a dig at Forbes]. What would you do if you weren’t running Microsoft?

SB: “I’m not really sure. I don’t really allow myself much time to think about it, because you might fall in love with it, if you think about it too hard.” I have kids who are 13, 14.

SA: So you’re saving for college?

SB: I mean that we’re not moving out of Seattle anytime soon. But if there’s one thing that captivates me, I think it’s education.

[Photo courtesy of McGraw-Hill]

Q&A finishes.

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I think the NSA has a job to do and we need the NSA. But as (physicist) Robert Oppenheimer said, “When you see something that is technically sweet, you go ahead and do it and argue about what to do about it only after you’ve had your technical success. That is the way it was with the atomic bomb.”

— Phil Zimmerman, PGP inventor and Silent Circle co-founder, in an interview with Om Malik