PART I
ITEM 1. Business
GENERAL
Microsoft Corporation was founded as
a partnership in 1975 and incorporated in 1981. Our mission is to enable people
and businesses throughout the world to realize their full potential, and our
vision is empowering people through great software - any time, any place, and
on any device. We develop, manufacture, license, and support a wide range of
software products for a multitude of computing devices. Our software products
include scalable operating systems for servers, personal computers (PCs), and
intelligent devices; server applications for client/server environments;
information worker productivity applications; business solutions applications;
and software development tools. We provide consulting services and product
support services and we train and certify system integrators and developers. We
sell the Xbox video game console, along with games and peripherals. Our online
businesses include the MSN subscription and the MSN network of Internet
products and services.
Microsoft also researches and
develops advanced technologies for future software products. A significant
portion of our focus is on our .NET architecture. Using common industry
standards based on Extensible Markup Language (XML), a universal language for
describing and exchanging data, our goal is to enable seamless sharing of
information across many platforms and programming languages, and over the
Internet, with XML Web services. In addition, we have embarked on a long-term
initiative called Trustworthy Computing that aims to bring an enhanced level of
security, privacy, reliability, and business integrity to computer systems.
PRODUCT SEGMENTS
We revised our product segments for
fiscal year 2003. Our seven product segments are Client, Server and Tools,
Information Worker, Microsoft Business Solutions, MSN, Mobile and Embedded Devices, and Home and
Entertainment.
Changes in our segments are designed
to provide management with a comprehensive financial view of our key businesses;
promote better alignment of strategies and objectives among development, sales,
marketing, and services organizations; provide for more timely and rational
allocation of development, sales, and marketing resources within businesses;
focus strategic planning efforts on key objectives and initiatives; and give
business owners more autonomy in detailed planning.
See Note 21 of the Notes to Financial
Statements for financial information regarding segment reporting. Prior year
segment information has been restated to conform to the seven new segments.
Client
Client segment includes Windows XP,
Windows 2000, and other standard Windows operating systems. Windows XP extends
the personal computing experience by uniting PCs, devices, and services, while
enhancing reliability, security, and performance. Windows XP Home Edition is
designed for individuals or families and includes capabilities for digital
photo, music, video, home networking, and communications. Windows XP
Professional includes all the features of Home Edition, plus remote access,
security, performance, manageability, and multilingual features to help users
improve productivity and connectivity. Windows XP was the successor to Windows
2000.
Client has overall responsibility for
product delivery, engineering and technical architecture for the Microsoft
Windows operating system, and new media technology, as well as our
relationships with manufacturers of personal computers and non-PC devices,
including multinational and regional original equipment manufacturer (OEM)
accounts. The segment includes sales and marketing expenses focused on business
development efforts for the Windows platform, as well as integration of our
technologies and products into non-PC devices.
Server and Tools
Server and Tools segment consists of
server software licenses and client access licenses (CALs) for Windows Server,
SQL Server, Exchange Server, and other servers. It also includes developer
tools, training, certification, Microsoft Press, Premier product support services,
and Microsoft consulting services. Microsoft server products offer a
comprehensive range of solutions designed to meet the needs of developers and
IT professionals, and are designed to flexibly run the programs and solutions
that enable information workers to obtain, analyze, and share information
quickly and easily. Microsoft servers provide capabilities ranging from
messaging and collaboration to database management and ranging from e-commerce
to mobile information access.
Windows Server 2003 is a multipurpose
operating system capable of handling a diverse set of server roles in either a
centralized or a distributed fashion. SQL Server is a Web-enabled database and
data analysis package, providing core support for XML and the ability to query
across the Internet. Microsoft Exchange delivers a reliable, scalable, and
manageable infrastructure with 24×7 messaging and collaboration. Systems
Management Server delivers cost-effective, scalable change and configuration
management for Windows-based desktop and server systems. Small Business Server
is a network solution that includes the Windows 2003 Server network operating
system and is designed to help small businesses. Developer tools focus on
coordinating the overall programming model for the client and server, creating
tools for the .NET platform, and fostering synergies between Windows and the
Windows Server System offerings.
Server and Tools segment includes the
integrated product development and marketing that delivers Microsoft Windows
Server System products. In addition, the segment provides information about the
extended Microsoft platform through a variety of content offerings, such as
web-based training for developers and IT managers. Through this segment, we
offer a broad range of consulting services for advanced technology
requirements, including custom solutions services, enterprise application
planning, architecture and design services, and proof-of-concept services. We
also provide product support services aligned to our enterprise customers. The
Server and Tools segment includes our Enterprise and Partner Group, which is
responsible for enterprise sales strategy, enterprise sales learning and readiness,
enterprise solution selling, enterprise partner sales strategy, and enterprise
field communications. This group is also responsible for technical selling,
field competitive strategy, and all competitive sales engagements.
Information Worker
Information Worker segment is
responsible for developing and delivering technologies that focus on improving
productivity for information workers in corporations. It consists of the new
Microsoft Office System of programs, servers, services, and solutions.
Microsoft Office System is the successor of Microsoft Office XP and is expected
to be released to market in the first half of fiscal 2004. The Microsoft Office
System includes the Microsoft Office 2003 Editions, which include (depending on
the edition): Microsoft Office Outlook 2003, Microsoft Office Excel 2003,
Microsoft Office PowerPoint 2003, Microsoft Office Word 2003, and Microsoft
Office Access 2003. Other products in the Microsoft Office System include
Microsoft Office Visio 2003, Microsoft Office Project 2003, Microsoft Office
Project Server 2003, Microsoft Office InfoPath 2003, Microsoft Office OneNote
2003, Microsoft Office Publisher 2003, Microsoft Office FrontPage 2003, and
Microsoft Office SharePoint Portal Server 2003. Microsoft Office has evolved
from a suite of personal productivity products to a more comprehensive and
integrated system of products for information work designed to increase
personal, team, and organization productivity. The Microsoft Office System
features integration with Microsoft intranet collaboration technologies,
Information Rights Management, and support for industry standard XML. The
Information Worker segment also includes Microsoft Office Live Meeting,
resulting from our acquisition of PlaceWare, Inc., Microsoft Office Live
Communications Server 2003, and an allocation for CALs. The segment also
includes professional product support.
The segment includes the Small and
Mid-Market Solutions & Partners (SMS&P) organization, which is
responsible for sales, partner management, partner programs, and customer
segment marketing for the small and mid-market businesses. In fiscal year 2004,
SMS&P group will integrate the sales and marketing assets of the Microsoft
Business Solutions segment with the existing Worldwide Small and Medium
Business groups. We believe this combined effort will lead to expanded
opportunity for Microsoft and our customers and partners by making available
the complete range of Microsoft products and services to small and mid-market
businesses, creating increased growth opportunities for the independent
software vendor (ISV) community.
Microsoft Business Solutions
Microsoft Business Solutions segment
includes the businesses of Great Plains, Microsoft bCentral, and Navision. Microsoft Business
Solutions develops and markets a wide range of business applications designed
to help small and mid-market businesses become more connected with customers,
employees, partners, and suppliers. Microsoft Business Solutions applications
provide end-to-end automation for financial reporting, distribution, project
accounting, electronic commerce, human resources and payroll, manufacturing,
supply chain management, business intelligence, sales and marketing management,
and customer service and support. Microsoft Business Solutions products are
designed to meet the broad spectrum of business application needs of small to
mid-market businesses, a group that generally consist of businesses with $1
million to $800 million in annual revenue. The business solutions are fully and
seamlessly integrated across the application areas of enterprise resource
management (ERM), customer relationship management (CRM), supply chain
management (SCM) and business intelligence. These business solutions are sold,
implemented, and supported through a partner network consisting of more than
4,500 value added resellers, systems integrators, consultants, ISVs, accounting
firms (national, regional, and local), application service providers (ASPs),
and eBuilders. Microsoft Business Solutions partners provide strong
distribution, marketing, training, and support in the business application
customer segment.
MSN
MSN segment includes MSN
Subscriptions and MSN Network services. MSN Subscription services include MSN
Internet access and premium services such as MSN Extra Storage, MSN Bill Pay,
MSN Radio Plus and MSN Mobile, which are offered to consumers regardless of
their Internet Service Provider. The MSN Network delivers online communication
services such as email and online instant messaging through its MSN Hotmail and
MSN Messenger products. It also delivers popular information services, such as
MSN Search and content from top partners like MSNBC, ESPN, Expedia, and Access
Hollywood.
The segment is responsible for
building and operating the MSN Network and for delivering MSN Subscription
services. Revenue is principally generated from subscribers to MSN's Internet
access and premium services and from advertisers on the MSN Network. MSN
delivers its services direct via its MSN Network and through partnerships with
network operators such as Verizon, Qwest, Charter Communications, and Bell Canada.
Mobile and Embedded Devices
Mobile and Embedded Devices segment
consists of Windows Mobile software, Windows Embedded device operating systems,
MapPoint, and Windows Automotive. Windows Mobile software powers Pocket PC,
Pocket PC Phone Edition, and Smartphone products. Windows Embedded, including
Windows CE.NET, Windows XP Embedded and Windows NT Embedded, is a family of
operating system software used in non-PC computing devices. Windows Embedded
software is used widely in advanced consumer electronics devices including
digital televisions, IP-based set top boxes, network gateways, and portable
media players, as well as in enterprise devices including industrial
controllers, retail point of sale systems, and voice-over-IP phones. The
MapPoint family of location-enabled products and services includes the MapPoint
Web Service, a hosted programmable XML web service that allows developers to
integrate location intelligence in applications, business processes and web
sites, and business and consumer oriented mapping CD-ROM products. Windows
Automotive is an automotive grade software platform that provides developers
with the building blocks to quickly and reliably create a broad range of
advanced telematics solutions.
Mobile and Embedded Devices segment
develops and markets the product lines described above. Further, the segment
manages relationships with device manufacturers and with network service
providers, including telecommunications, cable and wireless companies and host
and network equipment providers.
Home and Entertainment
Home and Entertainment segment
includes the Microsoft Xbox video game system, PC games, the Home Products
Division (HPD), and TV platform products. Microsoft Xbox, released in fiscal
2002, is our next-generation video game console system that delivers high
quality graphics and audio experiences. We offer several types of entertainment
products, including classic software games, online games, simulations, and
sport and strategy games. HPD includes Microsoft's line of consumer hardware
and software products, such as the Encarta line of learning products and
services, the Picture It! consumer publishing and productivity line of products
and services, the Macintosh applications business, and the Microsoft hardware
products.
Home and Entertainment segment
oversees development and business strategy for the Microsoft Xbox video game
system, including hardware, third-party games development, games development
published under the Microsoft label, Xbox and Xbox Live operations, marketing,
research, and sales and support. The segment leads the development efforts of
our HPD product lines. The segment also carries out all retail sales and
marketing for Microsoft Office, the Windows operating systems, Xbox, games, and
HPD products. The segment is responsible for the development, sales, and
deployment of Microsoft's TV platform products for the interactive television
industry.
INTERNATIONAL OPERATIONS
Microsoft develops and sells products
throughout the world. Our three major geographic sales and marketing
organizations are the Americas Region, the Europe, Middle East, and Africa Region, and the Japan and Asia-Pacific Region. Pressure to
globalize our pricing structure might require that we reduce the sales price of
our software in the United States and other countries. A number of
other factors could also have a negative effect on our business and results
from operations outside of the United States, including changes in trade
protection laws, policies and measures, and other regulatory requirements
affecting trade and investment; unexpected changes in regulatory requirements
for software; social, political, labor, or economic conditions in a specific
country or region, including foreign exchange rates; difficulties in staffing
and managing foreign operations; and potential adverse foreign tax
consequences. A portion of international revenue is hedged, thus offsetting a
portion of the currency translation exposure.
EQUITY METHOD INVESTMENTS
We have entered into joint venture
arrangements to take advantage of creative talent and content from other
organizations. For example, we own 50 percent of MSNBC Cable L.L.C., a 24-hour
cable news and information channel, and 50 percent of MSNBC Interactive News
L.L.C., an interactive online news service. National Broadcasting Company (NBC)
owns the remaining 50 percent of each of these joint ventures.
PRODUCT DEVELOPMENT
During fiscal years 2001, 2002, and
2003, research and development expense was $4.38 billion, $4.31 billion, and
$4.66 billion, respectively. Those amounts represented 17.3%, 15.2%, and 14.5%,
respectively, of revenue in each of those years. During fiscal year 2001, $272
million of goodwill amortization was included in research and development
expense. No goodwill amortization is included in fiscal years 2002 and 2003, in
accordance with Statement of Financial Accounting Standards (SFAS) 142, Goodwill
and Other Intangible Assets. We plan to continue spending significant
amounts for research and product development.
Most of our software products are
developed internally. We also purchase technology, license intellectual
property rights, and oversee third-party development and localization of
certain products. We do not believe we are materially dependent upon licenses
and other agreements with third parties relating to the development of our
products. Internal development allows us to maintain closer technical control
over our products and gives us the freedom to designate which modifications and
enhancements are most important and when they should be implemented. We work to
devise innovative solutions in computer science, such as making computers
easier to use, designing software for the next generation of hardware,
improving the software design process, and investigating the mathematical
underpinnings of computer science. We have created a substantial body of
development tools and have evolved development methodologies for creating and
enhancing our products. These tools and methodologies are also designed to
simplify a product's portability among different operating systems,
microprocessors, and computing devices. Product documentation is generally
created internally. We strive to obtain information at the earliest possible
time about changing usage patterns and hardware advances that may affect
software design. Before releasing new software platforms, we provide to
application vendors a range of resources and guidelines for development,
training, and testing.
Microsoft .NET is our strategy and
implementation of connecting people, information, systems and devices through
the use of Web services. It includes everything needed to develop and deploy a
Web service-connected IT architecture: servers to host Web services (Windows
Server System and Windows Server 2003), development tools to create them
(Microsoft Visual Studio .NET 2003 and the .NET Framework), applications and
smart devices that use them (Microsoft Office System, smart phones, Pocket PCs
and PCs), and a worldwide network of more than 35,000 Microsoft Certified
Partner organizations - people whose skills and experience can help businesses
get the most from their IT investments. Built on industry standards, Web
services enable applications to communicate and share data over the Internet or
an intranet, regardless of operating system or programming language.
We believe that establishing trust in
computing will be critical to our future success. Trustworthy Computing means
helping ensure a safe and reliable computing experience that is both expected
and taken for granted. Achieving Trustworthy Computing will require the
collaboration of hardware and software companies, academic and government
research institutions, and policy leaders. For us, Trustworthy Computing is a
company-wide initiative aimed at changing how we do business that will take
fundamental research and advances in engineering, as well as changes to
business culture and business processes to accomplish. We think there are four
factors that affect the level of trust that people place in computing:
Security, Privacy, Reliability, and Business Integrity. Security means the
customer can expect that systems are resilient to attack, and that the
confidentiality, integrity, and availability of the system and its data are protected.
Privacy means the customer is able to control personal information and feel
confident it is not only safe and used appropriately, but in a way that
provides value. A reliable system or service is one the customer can
depend on to fulfill its functions. Business Integrity involves being
responsive to customers, addressing problems effectively with products or
services, and being transparent and responsive in customer interactions.
To serve the needs of users around
the world, we "localize" many of our products to reflect local languages and
conventions and to improve the quality and usability of the product in
international markets. Localizing a product may require modifying the user
interface, altering dialog boxes, and translating text.
MANUFACTURING
We contract out most of our
manufacturing activities to third parties. Outside manufacturers produce the
Xbox, various retail software packaged products, and hardware. Our products may
include some components that are available from only one or from limited
sources. Key components that are currently obtained from a single source
include the Xbox central processing unit (CPU) from Intel Corporation and the
Xbox graphics processing unit (GPU) from NVIDIA Corporation. With the exception
of the Xbox CPU and GPU, we generally have the ability to use other custom
manufacturers if the current manufacturing vendor becomes unavailable. We
generally have multiple sources for raw materials, supplies, and components and
are often able to acquire component parts and materials on a volume discount
basis.
OPERATIONS
We have regional operations centers
in Ireland, Singapore, and the greater Seattle area. The centers support all
operations in their regions, including information processing and vendor
management and logistics. The regional center in Dublin, Ireland supports the Europe, Middle East, and Africa region, the center in Singapore supports the Japan and Asia-Pacific region, and the
center in the greater Seattle area supports North and South America. Microsoft Licensing, Inc., a
wholly-owned subsidiary in Reno, Nevada, manages our original equipment
manufacturer (OEM) and certain organizational licensing operations.
DISTRIBUTION, SALES AND MARKETING
We distribute our products primarily
through the following channels: OEM; distributors and resellers; and online
services and products. Our three major geographic sales and marketing
organizations are the Americas Region; the Europe, Middle East, and Africa Region; and the Japan and Asia-Pacific Region.
OEM
Microsoft operating systems are
licensed primarily to OEMs under agreements that grant the OEMs the right to
distribute copies of our products with their computing devices, principally
PCs. We also market and license certain server operating systems, desktop
applications, hardware devices, and consumer software products to OEMs under
similar arrangements. We have OEM agreements covering one or more of our
products with virtually all of the major PC OEMs, including Acer, Actebis, Dell,
eMachines, Fujitsu, Fujitsu Gateway, HP, IBM, NEC, Samsung, Siemens Computers,
Sony, and Toshiba. A substantial amount of OEM business is also conducted with
system builders, which are low-volume customized PC vendors.
Distributors and Resellers
We distribute our finished goods
products primarily through independent non-exclusive distributors, authorized
replicators, resellers and retail outlets. Organizations license our products
primarily through Large Account Resellers (LARs), Direct Market Resellers
(DMRs), and value added resellers. Many organizations that license products
through Enterprise Agreements (EAs) now transact directly with us with sales
support from our Enterprise Software Advisor channel partners. These Enterprise
Software Advisors are also typically authorized as LARs and operate as
resellers for our other licensing programs. Although all of our types of
reselling partners reach organizations of all sizes, LARs are primarily engaged
with large organizations and value added resellers typically reach the breadth
of small and medium sized organizations. Some of our distributors include
Ingram Micro and Tech Data, and some of our largest resellers include Software
Spectrum, Software House International, Dell, CDW, and Insight Enterprises.
Individual consumers obtain our products primarily through retail outlets
including Best Buy, Wal-Mart, and Target. We have a network of field sales
representatives and field support personnel who solicit orders from
distributors and resellers and provide product training and sales support.
We license software to organizations
under arrangements that allow the end-user customer to acquire multiple
licenses of product. These arrangements are designed to provide organizations
with a means of acquiring multiple licenses, without having to acquire separate
packaged product through retail channels. In delivering organizational
licensing arrangements to the market, we use different programs designed to
provide flexibility for organizations of various sizes. While these programs
may differ in various parts of the world, generally they are as follows:
Open. Targeted at small to medium organizations, this
program allows customers to acquire perpetual licenses and, at the customer's
election, rights to future versions of software products, over a specified time
period (generally two years). The offering that conveys rights to future
versions of software product is called Software Assurance. Software Assurance
also provides support, tools, and training to help customers deploy and use
software efficiently. Under the Open program, customers can acquire licenses
only or licenses with Software Assurance. They can also renew Software
Assurance upon the expiration of existing volume licensing agreements.
Select. Targeted at medium to large organizations, this
program allows customers to acquire perpetual licenses and, at the customer's
election, Software Assurance, which consists of rights to future versions of
software products, support, tools, and training, over a specified time period
(generally three years). Similar to the Open program, customers can acquire
licenses only, acquire licenses with Software Assurance, or renew Software
Assurance upon the expiration of existing volume licensing agreements.
Enterprise Agreement. The
Enterprise Agreement is targeted at large organizations that want to acquire
perpetual licenses to software products for their entire enterprise along with
rights to future versions of software products over a three year period.
Enterprise Subscription Agreement. The
Enterprise Subscription Agreement (ESA) is a time-based, multi-year licensing
arrangement. Under an ESA, customers acquire the right to use the current
version of software products and the future versions that are released during
the three year term of the arrangement. At the end of the arrangement term,
customers may either renew their ESA arrangement or exercise a buy-out option
to obtain perpetual licenses for the latest version of the covered products. If
they do not elect one of these options, then all covered software must be
uninstalled.
Online Services and Products
We distribute online content and
services through MSN Subscription services, MSN Network services, bCentral
small business portal, and other online services. MSN Subscription services
deliver Internet access and other premium services and tools to consumers. MSN
Network services deliver online email and messaging communication services as
well as information services such as online search and premium content. The
bCentral portal provides tools and expertise for small business owners to
build, market and manage their businesses online. Other services delivered
online include Microsoft Developer Networks (MSDN) subscription content and
updates, periodic product updates, and online technical and practice readiness
resources to support our partners in developing and selling Microsoft products
and solutions.
CUSTOMERS
Our customers include individual
consumers, small- and medium-size organizations, enterprises, governmental
institutions, educational institutions, Internet Service Providers, application
developers, and OEMs. Consumers and small- and medium-size organizations obtain
Microsoft products primarily through resellers and OEMs. No single customer
accounted for 10% or more of revenue in 2001, 2002, or 2003. Our practice is to
ship our products promptly upon receipt of purchase orders from customers;
consequently, backlog is not significant.
COMPETITION
The software business is intensely
competitive and subject to rapid technological change, evolving customer
requirements, and changing business models. We face significant competition in
all areas of our current business activities. The rapid pace of technological
change continually creates new opportunities for existing competitors and
start-ups and can quickly render existing technologies less valuable. Customer
requirements and preferences continually change as other information
technologies emerge or become less expensive, and as emerging concerns such as
security and privacy become of paramount concern. We face direct competition
with firms adopting alternative business models to the commercial software
model. Firms adopting the Open Source model typically provide customers with
Open Source software at nominal cost and earn revenue on complimentary services
and products, without having to bear the full costs of research and development
for the Open Source software. Additionally, global software piracy - the unlawful
copying and distribution of our copyrighted software products - deprives us of
large amounts of revenue on an annual basis. Further, the existing versions of
our products licensed to our installed base of users compete with future
versions. This means that future versions must deliver significant additional
value in order to induce existing customers to purchase a new version of our
product.
Our competitive position may be
adversely affected in the future by one or more of the factors described in this
section.
Client
Although we are the leader in
operating system software products, we face strong competition from well
established companies and entities with differing approaches to the market.
Competing commercial software products, including variants of Unix, are
supplied by competitors, such as IBM, Hewlett-Packard, Apple Computer, Sun
Microsystems and others, who are vertically integrated in both software
development and hardware manufacturing and have developed operating systems
that they preinstall on their own computers. Personal computer OEMs who
preinstall third party operating systems may also license these firms'
operating systems or Open Source software, especially offerings based on Linux.
Variants of Unix run on a wide variety of computer platforms and have gained
increasing acceptance as desktop operating systems, in part due to the
increasing performance of standard hardware components at decreasing prices.
The Linux open source operating system, which is also derived from Unix and is
available without payment under a General Public License, has gained increasing
acceptance as its feature set increasingly resembles the distinct and
innovative features of Windows and as competitive pressures on personal
computer OEMs to reduce costs continue to increase. The Microsoft Windows
operating systems also face competition from alternative platforms such as
those based on Internet browsing software and Java technology promoted by Sun
Microsystems, as well as innovative form factors that may reduce consumer
demand for traditional personal computers. We believe our operating system
products compete effectively by delivering better innovation, overall value, an
easy-to-use interface, compatibility with a broad range of hardware and
software applications, and the largest support network for any operating
system.
Server and Tools
Our server operating system products
face intense competition from a wide variety of competing server operating
systems and server applications offered by firms with a variety of market
approaches. Several vertically integrated computer manufacturers, such as IBM,
Hewlett-Packard, Apple Computer, Sun Microsystems and others offer their own
variant of Unix preinstalled on server hardware, and virtually all computer
manufacturers offer server hardware for the Linux operating system. IBM's
endorsement of Linux has accelerated its acceptance as an alternative to both
traditional Unix and Windows server operating systems. Linux's competitive
position has also benefited from the large number of compatible applications
now produced by many leading commercial software developers as well as Open
Source community developers. A number of companies supply versions of Linux,
including Red Hat and VA Linux.
We compete in the business of
providing enterprise-wide computing solutions with several companies that
provide competing solutions as well as middleware technology platforms. IBM and
Sun Microsystems lead a group of companies focused on the Java 2 Platform
Enterprise Edition (J2EE). Commercial software developers that provide
competing server applications for the PC-based distributed client/server
environments include Oracle, IBM, Computer Associates, Sybase, and Informix.
There are also a number of Open Source server applications available.
Numerous commercial software vendors
offer competing commercial software applications for connectivity (both
Internet and intranet), security, hosting, and e-business servers.
Additionally, IBM has a large installed base of Lotus Notes and cc:Mail, both
of which compete with our collaboration and email products. There are also a
significant number of Open Source software products that compete with Microsoft
solutions, including Apache Web Server.
The Open Source model of Linux and
other server programs enables both services and hardware companies to provide
customers with Open Source software at nominal cost and earn revenue on
complimentary services and products, without having to bear the full costs of
research and development for the Open Source software. For example, IBM, with
the largest hardware and services businesses in the industry, promotes Linux
extensively and seeks to earn revenues and profits on the sale of its
consulting services to implement the Linux server solution as well as related
hardware and commercial software products that run on Linux.
Our developer products compete
against offerings from BEA Systems, Borland, IBM, Macromedia, Oracle, Sun
Microsystems, Sybase, and other companies.
We believe that our server products
provide customers with significant advantages in innovation, performance (both
relative to total costs of ownership and in absolute terms), productivity,
applications development tools and environment, compatibility with a broad base
of hardware and software applications, security, and manageability.
Information Worker
While we are the leader in business
productivity software applications, competitors to the Microsoft Office
System include many software application vendors, such as Apple, Corel, IBM,
Oracle, QUALCOMM, Sun Microsystems, and local application developers in Europe and Asia. IBM and Corel have significant
installed bases with their spreadsheet and word processor products,
respectively, and both have aggressive pricing strategies. Also, Apple and IBM
preinstall certain of their application software products on various models of
their PCs, competing directly with our applications. Corel's suite and Sun
Microsystems' Star Office are aggressively priced and attractive for OEMs to
pre-install on low-priced PCs. The OpenOffice.org project provides a freely
downloadable cross-platform application that is gaining popularity in certain
market segments. In addition to traditional client-side applications, web-based
applications hosting services such as SimDesk provide an alternative to
Microsoft Office and are gaining some support. We believe that our products
compete effectively by providing customers significant benefits, such as
easy-to-use personal productivity, support for effective teaming and
collaboration, and better information management and control.
Microsoft Business Solutions
The small and mid-market business
applications market globally is highly fragmented and is intensely competitive
in all sectors. We face competition from a large number of companies in this
business. Well-known vendors focused on small and mid-market business, such as
Intuit and Sage, compete against us for a portion of this segment. In addition,
large-enterprise focused vendors, such as Oracle, Peoplesoft and SAP, also
compete against us for a portion of this segment. However, the competition for
a significant majority of the total business applications market includes
thousands of much smaller vendors in specific localities or industries who offer
their own enterprise resource planning, customer relationship management,
and/or analytic solutions.
MSN
MSN competes with AOL-Time Warner,
Google, Yahoo!, and a vast array of Web sites and portals that offer content of
all types, such as email, instant messaging, calendaring, chat, search, and
shopping services. As the broadband access market grows, we expect to have
increasing opportunity to deliver premium subscription services for consumers.
AOL and Yahoo! are both pursuing similar strategies and will be competitors in
this emerging category. While the movement to broadband access may cause our
Internet Access dial-up business to continue to decline, we will strive to
convert customers to MSN premium subscription services via partnerships with network
providers and Internet software services offered directly from MSN. We believe
our strengths are our heritage of technology innovation, particularly in
communication services, distribution partnerships, and the large base of users
of our free MSN Network. Additionally, while our advertising business has grown
considerably over the last year, evolving market conditions, particularly paid
search, will impact our strategy over the next year. We currently are building
our own search engine and investing to support the continued growth of our
advertising business.
Mobile and Embedded Devices
Windows Mobile software faces
substantial competition from Nokia, Openwave Systems, PalmSource, QUALCOMM, and
Symbian. The embedded operating system market is highly fragmented with many
competitive offerings. Key competitors include IBM, Wind River, and versions of embeddable Linux
from commercial Linux vendors, such as Metrowerks and MontaVista Software.
MapPoint competitors include DeLorme, MapInfo, Mapquest.com, Rand McNally,
Webraska Mobile Technologies, and Yahoo!. The telematics market is also highly
fragmented, with competitive offerings from IBM and automotive suppliers
building on various real-time operating system platforms from commercial Linux
vendors, QNX Software Systems, Wind River, and others.
Home and Entertainment
The home and entertainment business
is highly competitive and is characterized by limited platform life cycles,
frequent introductions of new products and titles, and the development of new
technologies. The markets for our products are characterized by significant
price competition, and we anticipate continued pricing pressure from our
competitors. These pressures have, from time to time, required us to reduce
prices on certain products. Our competitors vary in size from very small
companies with limited resources to very large, diversified corporations with
substantial financial and marketing resources. We compete primarily on the
basis of price, product quality and variety, timing of product releases, and
effectiveness of distribution and marketing.
Our Xbox hardware business competes
with console platforms from Nintendo and Sony, both of which have a large
established base of users. In addition to competing against software published
for non-Xbox platforms, our games business also competes with numerous
companies that have been licensed by Microsoft to develop and publish software
for the Xbox console. These competitors include Acclaim Entertainment, Activision,
Atari, Capcom, Eidos, Electronic Arts, Sega, Take-Two Interactive, Tecmo, THQ,
and Ubi Soft, among others. Success in the games business is increasingly
driven by hit titles, which are difficult to develop and require substantial
investments in development and marketing. In addition, other forms of
entertainment, such as music, motion pictures, and television, compete against
our entertainment software for consumer spending. Our PC hardware products face
aggressive competition from computer and other hardware manufacturers, many of
which are also current or potential partners.
EMPLOYEES
As of June 30,
2003, we
employed approximately 55,000 people on a full-time basis, 36,500 in the United States and 18,500 internationally. Of the
total, 23,200 were in product research and development, 25,100 in sales,
marketing, and support, 2,400 in manufacturing and distribution, and 4,300 in
finance and administration. Our success is highly dependent on our ability to
attract and retain qualified employees. Competition for employees is intense in
the software industry. We believe we have been successful in our efforts to
recruit qualified employees, but we cannot guarantee that we will continue to
be as successful in the future. None of our employees are subject to collective
bargaining agreements. We believe that our relations with our employees are
excellent.
AVAILABLE INFORMATION
Our Internet address is
www.microsoft.com. There we make available, free of charge, our annual report
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
any amendments to those reports, as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the SEC. Our SEC
reports can be accessed through the investor relations section of our Web site.
The information found on our Web site is not part of this or any other report
we file with or furnish to the SEC.