Microsoft Partners Not Panicking Over Earnings

Hammered by weakness in the PC and server industries, Microsoft this week stumbled to its first-ever year-on-year quarterly revenue decline. But Microsoft partners are confident that when viewed through the lens of time, this will come to be seen as an aberration resulting from the most challenging economy in decades.

Still, there's no denying that Microsoft's Q3 results were grim: Profit fell 32 percent during the quarter, overall revenue fell 6 percent, and Microsoft's Client division revenue fell 15.4 percent year-on-year, the third consecutive decline for what had for years been a trusty revenue engine. Microsoft Chief Financial Officer Chris Liddell said the company expects the weakness to last at least through the next quarter, calling the situation "the most difficult economic environment the company has faced in our history."

Giddy with schadenfreude, Microsoft bashers hailed the revenue decline as a sign of things to come, and as just desserts to Microsoft for not adjusting its business model to meet the challenges posed by Apple and Linux.

But oddly enough, Microsoft shares closed trading Friday up nearly 11 percent and are now at their highest levels since January. That's because Microsoft actually did better than some Wall Street analysts had expected. Likewise, the prevailing belief in the Microsoft channel is that one bad quarter in 23 years is no reason to panic, and Microsoft's growth prospects in areas like virtualization and Windows 7 remain strong.

Microsoft's revenue shortfall during the third quarter was likely due to its focus on new products such as Windows 7, says Jennifer Mazzanti, president of eMazzanti Technologies, a Hoboken, N.J.-based Microsoft Gold partner. "Microsoft has been devoting more of its time and investment to future products, and less to sales and marketing of existing ones, and that has had a direct effect on revenue," she said.

Windows 7, Office 2010, Exchange 2010, and potentially a new search offering are all slated for release in the next year. CFO Chris Liddell said the company won't deviate from the planned release wave even though these products will most likely be launched at a time when companies are still operating under heavily constrained budgets.

Indeed, Microsoft sees great benefits in relying on its ability to weather economic storms like the one currently raging, a luxury that smaller companies simply don't have.

"At the moment, it's about surviving the economic reset, and going into the growth pickup with a very good set of new products. And the environment of one to two years out starts to look more interesting," Liddell said in the earnings call.

Lee Nicholls, global solutions director for Microsoft technologies at Getronics, a global Microsoft Gold partner, says many companies have decided to skip Vista, but there's a general sense of optimism about Windows 7.

Microsoft beta testers have praised Microsoft for streamlining Windows 7 and boosting its performance, and according to reports, the company is preparing to issue the Windows 7 Release Candidate to testers next month.

NEXT: Potential Impact Of Windows 7

The strong early returns on Windows 7 suggest a coming spike in demand from businesses looking to upgrade, and its momentum on other product releases will go a long way toward keeping confidence high in the channel, Nicholls said. "Microsoft could stick their head in sand and wait for things to blow over, but they're still forging ahead with products. We believe that's going to alleviate the effects of the economic climate down the road and offer some level of relief," he said.

However, Windows 7's success in the market is by no means a given, and the lingering negative perceptions of Vista that exist aren't just going to disappear overnight. According to beta testers, Windows 7 fixes the performance and compatibility issues that led to Vista being widely panned, but new features like multi-touch, which Microsoft has gone to great lengths to highlight, still don't have clear benefits for many businesses.

Microsoft's ability to get the legions of companies that still use XP to upgrade shouldn't be taken for granted, according to solution providers.

"Microsoft really hit a wall with Vista, and it's not yet clear that Windows 7 will reverse that," said Ron Herardian, president of Global System Services, a Mountain View, Calif.-based solution provider. Microsoft will have to prove that it's capable of developing an operating system in which businesses will see intrinsic value, he added.

Vista has painted solution providers into a difficult corner, since many companies are still standardized on Windows XP, an eight-year old operating system that can't take advantage of newer technologies. "The problem we face is that customers are now stuck on an aging corporate platform that still works, but has clear drawbacks," Herardian said.

Much has been made about the impact of open source on Microsoft's earnings shortfall. And while Linux adoption on the desktop remains sluggish, open source does pose a threat to traditional cash cows like Office. Stuart Crawford, business development manager at Bulletproof Infotech, a solution provider in Red Deer, Alberta, is seeing more businesses with mixed environments that include OpenOffice as a replacement for Microsoft Office.

"Price is definitely on people's minds, and if people can get free Office with basic functionality that does 80 percent of what they need, they're going to go in this direction," Crawford said.

Although Microsoft partners appear willing to give their vendor partner the benefit of the doubt in the worst recession in decades, Microsoft's coming product release wave is quite possibly the most important in its history. Its success will help determine whether the competitors currently nipping at Microsoft's heels continue to gain ground, or get left in the dust.