Letter from Microsoft CFO Greg Maffei to Wall Street Analysts.
May 4, 1998.
Source: Microsoft.

A Letter From Greg Maffei
Chief Financial Officer
Microsoft Corporation
May 4, 1998

Recently, there has been extensive discussion about the investigations of Microsoft by the Justice Department and several state Attorneys General, but little has been said or written about the broader economic consequences of an action that might block or delay the launch of Windows 98. As you all know, Windows 98 is an important step forward in innovation for the personal computer industry, benefiting consumers of hardware, software, peripherals, games and other PC technologies.

It is always difficult to predict the economic impact of events, but should the DOJ or state Attorneys General seek to interfere with the launch of Windows 98, there are likely to be broad, negative consequences not just for Microsoft but for the entire PC industry. The impact would be felt by PC manufacturers, companies that develop software products (often called ISVs, or independent software vendors), companies that manufacture hardware peripheral devices supported by Windows 98 (such as digital cameras or digital video devices), resellers and retailers who sell computer and software products, value-added providers who provide service and support, and thousands of others whose success is tied to Windows. We are working very hard to ship Windows 98 on schedule, but in the event that we are not allowed to do so, I thought it might be useful to outline the possible financial ramifications of such regulatory action.

PC Manufacturers (OEMs)

Windows 98 is an important product for OEMs. It will give a significant boost to a PC market that depends on new innovations for growth. Much of the positive impact will be front-loaded: independent research suggests that of those consumers who plan to upgrade to Windows 98, 87 percent will do so in the first year, compared with an actual 68 percent for Windows 95. OEMs such as Compaq, Packard Bell and Dell have already geared up major Windows 98-based marketing and advertising campaigns to tap that early rush. These expenditures will be lost if Windows 98 is delayed or blocked, and they will also be wasted if the Justice Department attempts to remove Internet features from the operating system. Consumers may be unwilling to replace their PCs if they cannot be sure that all their software will run on their new machines.

Research that we have commissioned on the industry in Silicon Valley suggests that OEMs will be hit hard. The study indicates that almost a fifth of OEM revenues derive from products that are complementary to Windows. A delay in the launch of Windows 98 will leave OEMs with lost or deferred sales, wasted marketing and advertising, higher support costs (Windows 98 product enhancements should produce 20 percent support savings) and other substantial losses.

Independent Software Vendors (ISVs)

About 2.2 million independent software developers in the U.S., and 5 million worldwide, design products to work with Windows. Products designed for use on Windows make up about 30 percent of total packaged software revenues (Microsoft’s own applications account for only a fraction of that total).

National figures are hard to come by, but, in Silicon Valley alone, ISVs, system integrators, Web companies and computer training and education centers have total revenues of at least $25 billion a year, and employ 74,000 people. Almost 40 percent of these companies are engaged in activities related to Windows, a business that generates $6 billion in annual revenues and accounts for about a fifth of the sector’s employees.

If Windows 98 is delayed, ISVs may be harmed in a number of ways. ISVs look to new trends, technologies and standards to make their products more useful for their customers. For example, Windows’ built-in support for Internet standards permits ISVs to design software that allows users to download new features or information from the Internet, or to get data from the Web without starting another application. Without this, ISVs would have to add their own support for Internet standards to their software, a process that would consume significant R&D dollars. In a survey of 200 randomly chosen ISVs, 79 percent said that the integration of Internet technologies into Windows would help them develop new applications, and 85 percent thought it would positively impact their business.

Even now, ISVs are being hurt by the uncertainty surrounding the release of Windows 98. Many of them devote the lion’s share of their existing R&D funds to products whose success or failure depends on Windows – and on the smooth and scheduled launch of each new version of an operating system. They also spend heavily on upfront marketing and advertising for new Windows-based products and depend on the market excitement that a new version of an operating system can create. Our survey found that 91 percent of ISVs thought Windows had created a positive impact on their businesses.

Resellers and Retailers

Our resellers and retailers in states across the U.S. will unfortunately share the pain. A product release such as Windows 98 is a milestone for the reseller and retailer community, and for some it will likely be the biggest new product introduction of 1998. The launch of Windows 98 will help sell new PCs, new software, new peripherals such as printers, scanners and digital cameras, and even books and training courses. If Windows 98 is delayed, this huge opportunity could be lost. Moreover, prior to the release of a product such as Windows 98, leading resellers and retailers spend heavily on upfront advertising and marketing, and usually build large inventories of complementary products such as applications, memory upgrades, games and hard drives. This expenditure will be lost if Windows 98 is derailed.

Value Added Providers (VAPs) and Microsoft Certified Solution Providers (MCSPs)

Computer services is a $300 billion industry, and more than $40 billion of this is generated by business related to Microsoft’s software. Approximately 2.2 million people work in computer services, with more than 320,000 full- and part-time jobs related to our software – our products generate $16 billion in annual wages in the industry. There are more than twice as many job openings in computer services for Windows-based service jobs than there are for jobs based on Lotus/IBM, Novell, Oracle or Unix. And most of these openings are with small companies, many of which are dependent on a narrow range of services. They are the most vulnerable to government action.

Microsoft seeds the creation of immense value-adding opportunities. Commissioned research shows that every dollar of pre-packaged software we sell generates $7 in service revenues for MCSPs, and $3 in service revenues for VAPs. Last year, VAPs and MCSPs together added an estimated $173 billion in value to the U.S. economy – double the value added by the auto and truck industries combined. Together, VAPs and MCSPs now account for 2.1 percent of U.S. GDP.

While it is difficult to calculate an exact figure, a delay to Windows 98 will mean that these companies will lose business selling, installing, supporting and training their customers on both software and related products.

The U.S. Economy

During the past five years, the IT industry has generated a quarter of the U.S.’s real economic growth and now accounts for more than 8 percent of our national output, much of it for export. Microsoft has been a key contributor to this. A 1996 DRI/McGraw Hill study found that, during the past decade, every dollar spent on Microsoft software raised business productivity by an equivalent amount. This, in turn, improved the U.S. economy’s growth, investment and employment environment so significantly that it produced a cumulative net gain in GDP equivalent to more than $4 for every $1 spent on our software. It’s clear that this Microsoft growth dividend has not shrunk since 1996 – and it’s equally clear that action against Windows 98 will significantly reduce it.

The Justice Department (and the FTC) have dedicated eight years and enormous resources to examining our business relationships. We fully intend to comply with the laws of this land, and believe that we do, but regulatory authorities should not ignore the broad, two-way nature of the benefits that flow from our business relationships and the IT industry’s positive role in the nation’s economy.

It is for all the above reasons that we are asking for your patience and continued support. We understand the impact of regulatory action on us, but more important is the potential impact on you, our key partners. We will continue to inform public officials about the importance of our industry, the need for continual innovation for customers, and the positive benefits of products such as Windows 98 for both customers and the entire industry.

Thank you.

Sincerely,

Gregory B. Maffei
Chief Financial Officer