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Is Microsoft heading the way of the dinosaur?

Nortel Networks, Remington, Eastman Kodak: The list of once-thriving and now-defunct or moribund technology companies reads like the stops on an abandoned railway line. You can add Microsoft to that list. It's well on its way to obsolescence. Nothing can be done. It'll take a long time - decades - but this $200-billion (U.S.) company is finished.

The problem is that Microsoft is utterly incapable of innovation. Over the past three years the company has spent about $25-billion on research and development. What do shareholders have to show for that investment? Vista, an operating system that users were frantically uninstalling within days of loading the cumbersome beast onto their laptops? Zune, the supposed competitor to Apple's iTunes and iPod? Kin One and Kin Two, Microsoft's answer to the smart phone? Two intense years in the making before they hit store shelves, they were pulled after two months and scrapped.

The stark truth is that Microsoft has rarely invented anything that mattered. It didn't invent the operating system. It didn't invent the graphical user interface. It didn't invent the spreadsheet or the word processor or the Web browser.

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It didn't invent the gaming console or the search engine or the tablet PC or server software. It has, in short, invented nothing - or at least nothing of consequence. What other technology company in the history of business has invented nothing and survived for long? Many of them invented very cool things and still didn't last.

Why can't Microsoft innovate? And couldn't that change? No, because no one wants to work there. It has become like working for a large bureaucracy - stifling and sterile.

The secret to Microsoft's success and longevity is part luck, part brains and large parts brawn - the bullying for which it got its wrists slapped repeatedly over the years.

Microsoft owns the desktop operating system business with a roughly 90 per cent market share. It also owns the productivity software market with Microsoft Office. And it's a dominant player in server software. These are the main sources of its prodigious revenues. Pretty much everything else it touches loses money. Even the Xbox, which earns lots of praise, will probably never earn a decent return, given how much it cost to develop and market in the early years. It only earns kudos because it's a rare technological hit.

To be inept at innovation doesn't necessarily condemn the company to death. Microsoft's revenue fell for the first time ever last year but it still earned $20-billion in operating profit. That's $2-billion less than the year before but it doesn't screech bankruptcy.

Neither does the balance sheet, which has barely any debt and $31-billion in cash and investments. But we're not talking about the company going belly up. We're talking about a gradual decline and irreversible decline into irrelevance, with all the hallmarks that this entails: shrinking revenues, desperate attempts to replace them and staggering failures piling up on one another. In fact, it's already started, as mentioned above. The Xbox cost billions to get going. Last year, the entire entertainment division posted revenue of $7.7-billion (down from a year before) and operating profit of $170-million. At that pathetic rate it's doubtful this unit will ever make any money over all.

Worse is that all of these marginal attempts at making money are dilutive. Windows and Office have profit margins of nearly 70 per cent. Even the server and tools segment makes 33 cents on the dollar.

But why can't Microsoft innovate? And couldn't that change? No, because no one wants to work there. It has become like working for a large bureaucracy - stifling and sterile. More important: no one's getting rich off Microsoft stock options any more. Everyone wants to work at Google or Apple. Microsoft has no history of innovation, and therefore no culture that the innovative find attractive.

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That's fatal in technology even if you do own the desktop. Gradually, everything is moving away from the desktop and to smart phones, tablets, or to "the cloud," as they call cloud computing. Microsoft has little to offer. Even its desktop dominance is assailable, in the long run.

The company should stop messing around and behave like a utility: Cut costs, including R&D, focus on what it does reasonably well and give all the money it can back to shareholders to maximize their returns.

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More

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