I was recently at Web 2.0 and I heard Ev’s conversation with John Battelle. Not much has changed. He seemed very coy about his plans to figure out a business model or solve Twitter’s scalability issues. Even during his talk I could see several people in the audience getting the Twitter Fail Whale trying the access Twitter. But one of Ev’s problems might be solved sooner rather than later. The two search titans Microsoft and Google struck deals with Twitter to get access to its valuable real time data. Both Microsoft and Google most certainly had to pay for it. Sheryl Sandberg made it a point to say she didnt believe in charging for data. Early this year Ev closed another round of financing putting the total at $100 million with a whopping $1 billion valuation. With all this hype Twitter is seeing their growth plateau  and they are getting more and more competition from Facebook.

The T-Mobile Sidekick disasteris turning into one of the biggest train wrecks in recent years. In the era of cloud computing and people dependent on their mobile phones Microsoft is in the middle of  a PR disasters.

Its not everyday Perez Hilton breaks a tech story wide open by ranting on his blog how for seven days he has not been able to access email or contacts on his T-Mobile Sidekick. He immediately ignited the twitt-o-sphere by telling all his loyal fans to tweet #TmobileStillSucks. What came next was so unbelievable it had to be considered a sick joke to Sidekick customers. T-Mobile issued a letter to all of its Sidekick customers saying that based on Microsoft/Danger’s recovery assessment, they basically lost all of peoples’ data. And to make matters worse they have no backup.

Update: T-Mobile halted selling Sidekick devices. T-Mobile is now saying that “Recent efforts indicate the prospects of recovering some lost content may now be possible.” CNet reported that those who do suffer permanent data loss will get a $100 “customer appreciation card” good toward T-Mobile service or products.

Microsoft launch an advertising campaign called Laptop Hunters where they give people a set amount of money to find a laptop to meet their needs. If they get it for less they keep the cash. The recent commercial has a kid and his mom shopping for a new laptop.

This marketing campaign does get enough credit for being smart and effective. Microsoft’s response to Apple’s commercials has been direct and bold. Given the current economic environment, people are much more focused on making every dollar count. And these commercials hit and the heart of Apple’s premium pricing which has helped them amass a war chest of cash. Now that premium pricing will be under pressure.

For Wall Street, this was a big surprise given IBM and Apple had strong quarters. People were expecting Microsoft to perform well given its diversified business. I think Microsoft performance is a result of a broader economic downturn that could become much worst before  it gets better. And a growing problem with the effect of netbooks and losing share to Apple. With the economy in more of a reset mode than a recession I think we are in for a long downturn and IT spending will be impacted broadly.

 With this news Steve Ballmer announced that Microsoft would cut 5,000 jobs and reduce other costs across the company. You can read his whole email below.

From: Steve Ballmer
Sent: Thursday, January 22, 2009 6:07 AM
To: Microsoft – All Employees (QBDG)
Subject: Realigning Resources and Reducing Costs

 

In response to the realities of a deteriorating economy, we’re taking important steps to realign Microsoft’s business. I want to tell you about what we’re doing and why.

Today we announced second quarter revenue of $16.6 billion. This number is an increase of just 2 percent compared with the second quarter of last year and it is approximately $900 million below our earlier expectations. 

The fact that we are growing at all during the worst recession in two generations reflects our strong business fundamentals and is a testament to your hard work. Our products provide great value to our customers. Our financial position is solid. We have made long-term investments that continue to pay off.

But it is also clear that we are not immune to the effects of the economy. Consumers and businesses have reined in spending, which is affecting PC shipments and IT expenditures.

Our response to this environment must combine a commitment to long-term investments in innovation with prompt action to reduce our costs.

During the second quarter we started down the right path. As the economy deteriorated, we acted quickly. As a result, we reduced operating expenses during the quarter by $600 million. I appreciate the agility you have shown in enabling us to achieve this result.

Now we need to do more. We must make adjustments to ensure that our investments are tightly aligned with current and future revenue opportunities. The current environment requires that we continue to increase our efficiency.

As part of the process of adjustments, we will eliminate up to 5,000 positions in R&D, marketing, sales, finance, LCA, HR, and IT over the next 18 months, of which 1,400 will occur today. We’ll also open new positions to support key investment areas during this same period of time. Our net headcount in these functions will decline by 2,000 to 3,000 over the next 18 months. In addition, our workforce in support, consulting, operations, billing, manufacturing, and data center operations will continue to change in direct response to customer needs.

Our leaders all have specific goals to manage costs prudently and thoughtfully. They have the flexibility to adjust the size of their teams so they are appropriately matched to revenue potential, to add headcount where they need to increase investments in order to ensure future success, and to drive efficiency.

To increase efficiency, we’re taking a series of aggressive steps. We’ll cut travel expenditures 20 percent and make significant reductions in spending on vendors and contingent staff. We’ve scaled back Puget Sound campus expansion and reduced marketing budgets. We’ll also reduce costs by eliminating merit increases for FY10 that would have taken effect in September of this calendar year.

 

Each of these steps will be difficult. Our priority remains doing right by our customers and our employees. For employees who are directly affected, I know this will be a difficult time for you and I want to assure you that we will provide help and support during this transition. We have established an outplacement center in the Puget Sound region and we’ll provide outplacement services in many other locations to help you find new jobs. Some of you may find jobs internally. For those who don’t, we will also offer severance pay and other benefits.

The decision to eliminate jobs is a very difficult one. Our people are the foundation of everything we have achieved and we place the highest value on the commitment and hard work that you have dedicated to building this company. But we believe these job eliminations are crucial to our ability to adjust the company’s cost structure so that we have the resources to drive future profitable growth. I encourage you to attend tomorrow’s Town Hall at 9am PST in Café 34 or watch the webcast.

 

While this is the most challenging economic climate we have ever faced, I want to reiterate my confidence in the strength of our competitive position and soundness of our approach. With these changes in place, I feel confident that we will have the resources we need to continue to invest in long-term computing trends that offer the greatest opportunity to deliver value to our customers and shareholders, benefit to society, and growth for Microsoft. With our approach to investing for the long term and managing our expenses, I know Microsoft will emerge an even stronger industry leader than it is today.

Thank you for your continued commitment and hard work.

Steve

We have seen the netbook PC category explode over the last two years and Microsoft was forced to make a key decision. Give up market share to Linux or lower the price of Windows. With the average price of a netbook selling for around $400 Microsoft made a smart business decision and sold Windows XP at a discount. Microsoft now has over 80% of the netbook running Windows. But Windows Vista would never be a credible alternative on netbooks. It required too much hardware to run optimally and Microsoft was worried about cannibalization.

 In comes Windows 7, when I first booted Windows 7 the first time I could tell something was different. It was snappier and more responsive. Applications loaded fast and even with the minimum hardware requirements the Windows Aero interface was enabled and performed like my desktop running Vista. After using it for a while I can only describe it with one word, solid. There are not any flashy features but several enhancements that you quickly become accustom to. Microsoft has clearly taken a different approach with the design of Windows 7 and it shows running on netbooks. Windows 7 is by far the best Windows beta I have ever seen come out of Redmond. It looks like Microsoft is starting to get its mojo back.

In a new booked called The Race For A New Game Machine, he describes how the project went off the rails, ending up with IBM engineers creating the processing chips for two rival video game consoles. In the process IBM sold parts of the cell processor design to Microsoft for their Xbox 360 and Microsoft benefited from over $400 million in R&D funded by IBM, Sony, and Toshiba. The R&D teams worked in the same building and in some cases Shippy met with Microsoft engineers right after meeting with Sony engineers. Ultimately Microsoft benefited a great deal from Sony’s work on the cell processor. Microsoft launched their Xbox 360 a year before Sony launched their PlayStation 3 and the rest is history.

Last October Microsoft solidified Facebook’s value to the world, $15 billion. Microsoft got a paltry 1.6% stake in the company for $240 million.  Some thought that Steve Ballmer had lost his mind. But what people didn’t realize is how smart he really was. To Microsoft, $240 million is a rounding error, so if they were really crazy they would have bought more of Facebook at an insane valuation. What was brilliant about this move was it established a public valuation for Facebook that was so high and unjustified no one on the planet would touch them. Unless you are Li Ka-shing the Chinese billionarie that put up $60 million at that valuation. Essentially it was a poison pill for anyone that would try to acquire them. (hint, hint, Google)

Even Facebook internally didn’t believe the $15 billion valuation. According to inside sources they were offering employees options at $10 billion and some employees got options at $5 billion. Mark Zuckerberg recently canceled a employee stock buying program when no company would agree that Facebook was worth $4 billion. So what is it worth now? Valleywag was reporting rumors of of people willing to sell their stock at $2.50-4.00, that would put Facebook’s valuation at $1.3 billion. If you look at the numbers Facebook is worth much less. 

They are buring a ton of cash adding new employees and increasing CAPEX spend on new servers to support their growth. Michael Arrington highlighted there burn rate back in October but matters get even worse with their valuation plummeting. Facebook has raised around $500M in funding. They probably have only about 100-150M still in the bank. Their global expansion could easily get more pricey and put them in a cash crunch. Facebook will be forced to do a down round in financing or raise debt. And in this market unless maybe Microsoft or Google would be Facebook’s bank to bootstrap their growth they are going to run out of options fast. Here is my take on their 2009 outlook.

Facebook’s 2009 Projections:

• 250M users
• 1B page views
• $.40 revenue per thousand page views
• $400M revenue – (Microsoft contributes 80% of revenue)
• $200M COGS
• $250M OPEX
• $-50M contribution margin

The key question for Facebook is will they have a breakthrough on the business model. Because right now that are just building a social portal business which will never scale and be as profitable as search. All of their previous attempts to add “the social” to advertising have backfired. Facebook’s Beacon product was a PR disaster.

The other big impact this will have on Facebook is recruiting. Hundreds of the best and brightest people bailed from their day jobs at Yahoo, Google, and other tech companies in the valley to ride the Facebook wave in hopes to get rich. With the valuation plummeting and fear that Facebook might run out of cash it is certainly a riskier option now. Several key people have already left the company including Adam D’Angelo co-founder and CTO, Jeff Hammerbacher, and Matt Cohler. The future does not look bright for Zuckerberg and team.

Apple had launched the iPod Nano a year earlier and the game was over. Apple’s unit volumes went up exponential and in no time,  everyone that was ever going to own a music device on the planet had an iPod. In Zune’s 2nd generation Microsoft started to get the software right and in many ways its superior to the iPod software but it seems too little too late. The puck is already shifting away from pure play music devices. 

At first you would think that this is a razor blade business. Sell the razor (hardware) for little to no profit and make all the money on selling razor blades (content and services). Except the paid content business is a horrible business. There is no money in that business, it just adds value to the device you are using. Apple makes all their profit selling hardware. So what is the future of Zune?

There has been a lot of specualtion that Zune will become a Microsoft phone. All of these rumors could not be farther from the truth. Zune is about the software. Its more of a strategy to compete with the growing dominance of iTunes than it is anything else. Microsoft needs a simple way to distribute software and services across the PC, phone, and TV. Right now Microsoft’s strategy for delivering digital content is extremely fragmented. For example, I cant get the same content on my Zune as I can on my Xbox 360. I also can’t easily share that content across other devices like my PC or phone. Microsoft has to fix this or they will never be able to compete with Apple for the consumer.

For the past two years they have been trying every strategy in the book to try and get traction in the market. First it was consumer free then it was an enterprise paid model. With all the P/R hype, all the data points to Google Apps being an utter failure. According to Compete, Google only gets 4M unique vistors to their Google Docs & Spreadsheets Web sites. Still the irony is while jouranlists were busy predicting web based apps would make Microsoft Office obsolete, they were busy typing away using Microsoft Word. Google even got on the feature treadmill and started banging out must have features like “print” and “charting”. Still no one is showing up to their party.

Microsoft has not been sitting still. They launched Office Live Workspace in March 2008 and later in October announced Office Web apps at their professional developer conference. People have also not been shy about buying Microsoft Office 2007, it doubled sales over the 2003 version. Even still Microsoft Office 2007 is a hot product this holiday season topping #2 on Amazon’s best seller list. Who says paying for software is a dead business?

With all the hoopla about Google Apps so far its really not been a threat to Microsoft Office. The future also does not look bright. Microsoft has a history of being a fast follower and closing the gap quickly. Once people have both a rich client and a web based version of Office at an affordable price, Google really has no chance. It seems like Microsoft finally got their act together just in time to suck the wind out of Google’s sails.

What is interesting about this move is Microsoft is making Seadragon Mobile available on Apple’s iPhone even before you can get it on the Windows Mobile platform. Is this a change of heart for Microsoft? Probably not. Seadragon Mobile uses graphics accelerated hardware and there are not many devices on the market today that take advantage of those capabilities. Microsoft is probably using this as an opportunity to test some technology early and also doing a little bit of hedging.