Microsoft bent, but not broken

Microsoft, once seemingly immune from economic turmoil, is undertaking an historic resetting of its business starting with staff and cost reductions as it hunkers down to weather a downturn CEO Steve Ballmer predicts won't come with a quick rebound.

To emphasize the point, the company Monday cut 1,400 employees and said the number of lay offs could go as high as 5,000 over the next 18 months. Microsoft also is freezing pay raises for the next fiscal year.

It was the first time in its history that Microsoft had made wholesale cuts across the company. Microsoft also said it would cut a chunk out of its pool of outside consulting contractors that could go as high as 15% more than the internal staff cuts.

The layoffs came as a surprise to many inside Microsoft even though predictions from analysts and press have been flying for the past month.

Microsoft did not provide such dire predictions during its fiscal first quarter earnings report in October other than to say it would adjust downward its guidance for financial analysts.

But infamous internal blogger Mini-Microsoft wrote on his blog Monday: “Don't go asking your manager many questions today: this is news to 99% of us.”

But make no mistake, the company with more than $23 billion in cash is resetting and not reeling. In fact, the company in the second quarter grew 2% over the same quarter last year.

“They are not on the ropes,” says independent consultant Dwight Davis, who has followed Microsoft for more than 15 years. “Microsoft is a very diversified company in terms of geography and products and markets, including consumer, small and medium sized businesses, and the enterprise. This is a worldwide economic problem and Microsoft is exposed on about every front.”

And Davis says Microsoft has to keep dumping financial resources into businesses where it is losing badly, including online search and advertising.

Davis says one change for Microsoft could be a measured retreat from its strong spending on research and development and more of a focus on mergers and acquisitions to provide technology it needs to compete.

In 2008, the company spent more than $8 billion on R&D.

“They might feel they can acquire more people and technology more efficiently by acquiring companies,” Davis says. “With the economy you see a lot of cheap property on the market.”

Microsoft CFO Chris Liddel said in Monday's earnings call that mergers and acquisitions would slow during the second half of the year.

Another strong indicator that Microsoft is just regrouping is that Wall Street firms such as Goldman Sachs and Oppenheimer and Co. have been sending signals that a layoff would be good for Microsoft. Their predictions, however, were aimed somewhere near 10%, which is much higher than Monday's count.

And Liddel in October said that unearned revenue and plentiful cash on hand, both of which remain strong, would “allow us to weather any economic recession in relatively better terms than most.”

Even stealth Mini-Microsoft wrote Monday that what he wanted was “intelligent, well-thought-out leadership to have seen long ago that we've doubled our ranks far too fast and exceeded our ranks beyond what we can sustain (let alone need). And he added, “Yet here we are now, in the choppy waters of the global economic crisis, being reactive rather than opportunistic.”

Microsoft reported to the SEC in December that operating income decreased partially because of “headcount-related expenses” that were up 12% based on a “14% increase in headcount during the past 12 months.”

Despite the number of employees, Microsoft said cost cutting and the setting of strict limits in other parts of the business is how the company will buffer itself against the foul winds of the economy.

Liddel said during Monday's fiscal second quarter earnings call, which was moved to the start of the day from its typical spot at the close of the market, said staff and other cuts would amount to a $1.5 billion savings in annual operating expenses this year.

He said expenses would be reduced by cutting travel expenditures, reducing spending on vendors and contingent staff, reducing marketing spending, and scaling back capital expenditures.

Ballmer was quick to qualify the number of layoffs, saying the company in the same 18-month period planned to hire as many as 3,000 people to plug into strategic areas. A portion of those jobs will be added in research and development, which is one area that was hit today with layoffs. The others were marketing, sales, finance, legal, HR, and IT.

Given Ballmer's qualification, the total staff reduction will amount to no more than 3.3% of the more than 90,000 Microsoft workforce.