Job cuts show even Microsoft’s bubble can burst

Microsoft, the company whose name became a synonym for the boundless growth of the technology business, has finally come down to earth.

Signs of Microsoft’s incipient middle-age had been evident for some time – and not just because founder Bill Gates and Steve Ballmer, chief executive, have entered their 50s.

Larry Page and Sergey Brin, the Google founders long since took over as the tech world’s most envied Young Turks.

Yet psychologically, news on Thursday of Microsoft’s company-wide job cuts struck a deep blow. Even its financial might, which is still based on the underlying Windows monopoly, did not stop the software group from making the sort of job losses that had previously been a feature of other, older industries.

In its first, unfamiliar attempt to rein in spending in the middle of this decade, Microsoft provoked employee anger with small steps like withdrawing towels from company bathrooms.

This time, workers have something more serious to ponder: the loss over the next 18 months of up to 5,000 jobs, out of a current total of 96,000.

Along with that comes a pay freeze this year, a 20 per cent cut in travel budgets and a range of other measures designed to slice $1.5bn from operating costs to prevent further deteriorations in Microsoft’s profit margins.

These have already been slipping for some time, as shifts in the tech market have forced Microsoft to invest more heavily in new businesses like search, and it has also branched out into lower-margin areas like server software and video gaming.

Now, however, the company is facing a deeper problem. Its core Windows division, which still accounts for more than 40 per cent of its operating profits, has seen an erosion in its business.

The economic downturn has much to do with this. But with internet-based computing on the rise, and competitors like Apple and Google still performing relatively strongly despite the downturn, Wall Street has started to worry that the longer-term shift that is pushing the focus of computing away from Microsoft’s stronghold, the PC, is accelerating.

The fears sent the company’s shares down by more than 10 per cent in morning trading in New York on Thursday, to their lowest level in more than 10 years.

Microsoft’s client division, which sells Windows for PCs, suffered an 8 per cent drop in revenues in the final quarter of last year, undershooting both its own and Wall Street’s revenue and earnings forecasts. Overall revenues rose only 2 per cent to $16.6bn, while net income fell 11 per cent to $4.2bn, or 47 cents a share.

The slump in demand for new PCs had much to do with this. Compared with its own earlier expectations that the number of machines sold would rise between 10 and 12 per cent in the last quarter, Microsoft said sales had been flat.

One factor behind this has been a revived Apple, which earlier this week revealed that sales of its MacBook laptops had continued to do well despite the economic gloom. Mr Ballmer said on Thursday, that the 2.5m Macs that Apple sold in the last quarter compared with about 50m PCs, but conceded that Apple’s traditionally small market share had increased by a full percentage point. With consumers becoming far more price-sensitive, he predicted that that shift would not continue.

In a deeper sign of the difficulties for Windows, Microsoft also said that “traditional,” full-featured PC sales had dropped by 10 per cent in the most recent quarter, but that this had been partially made up for by higher sales of “netbooks”. These small, low-priced laptops generate far less revenue for Microsoft and could spell longer-term problems for the company, according to analysts.

Microsoft’s revenue for each netbook that is sold with its older Windows PC operating system is thought to be less than $20, said Roger Kay of Endpoint Technology Associates. That compares with average revenue of $56 for each copy of Windows that is sold. While the next version of Windows has been designed to work on netbooks – unlike the current Vista system – it will be a full year before the new software is launched and Microsoft could lose ground in the meantime, he added.

All of this has left the tech industry’s most feared competitor in an unfamiliar position.

Microsoft ploughed on through the last recession, which coincided with the tech industry’s historic bust at the start of the decade, with little noticeable effect, and has since seen its revenues grow by 150 per cent. The rebound this time will be more problematic.