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Sunday, November 19, 2006 - Page updated at 04:06 PM

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Information in this article, originally published November 19, 2006, was corrected November 19, 2006. A previous version of this story incorrectly stated that Microsoft launched the original Xbox game console just before Windows XP in 2001. The Xbox was launched about three weeks after Windows XP on Nov. 15, 2001.

Microsoft counts on Vista to recharge stagnant stock

Seattle Times technology reporter

There was a time in the 1990s when shares of Microsoft stock seemed to double every couple of years. 1996: college for the kids. 1998: a place on Whidbey. 1999: early retirement.

Times have changed.

An investment made in Microsoft in October 2001 — when Windows XP, the last version of the company's top product, was released — is up a meager 8.6 percent today. The rest of the stock market has gained more than a third in that time.

"I don't consider it a growth stock any more," said Claude Foutch, a Clark County retiree who has a small stake in Microsoft. "I'm hoping I'm dead wrong."

Microsoft's leaders do, too.

The company is counting heavily on Windows Vista — the new version of the operating system, five years in the making — along with a parade of product launches beginning this month. That could give Microsoft's long-stagnant stock a boost; already, shares have been growing since hitting a low point in June.

Vista trivia


Lines of code: More than 50 million, a figure not confirmed by Microsoft.

Computer servers: Some 350 were used to perform billions of tests meant to simulate user behavior. That was in addition to extensive human testing of Vista.

Power failure: The buildings where Vista developers work lost power on the Friday before they were to release the finished product for manufacturing. They managed to complete the final testing despite the setback.

Beverage: Health-conscious Microsofties working on Vista sipped lemon-lime Talking Rain. The company's famous beverage coolers were stocked with customized cans of the bubbly water bearing the Vista logo.

Tattoo: One Vista program manager got a tattoo of Vista's logo on his left shoulder at Slave to the Needle.

But beyond Microsoft's financial fortunes, Vista and the other versions of Windows that came before it are the heart and soul of the company. As the software that runs more than nine of 10 computers in the world, Windows also has unparalleled influence over the broader technology industry.

Vista prices and versions


Microsoft will make Windows Vista and Office 2007 available to business customers Nov. 30. They will be broadly available Jan. 30. The company is offering five versions, including one sold to large businesses. Most people will buy Vista pre-installed on a new computer.

Business: $299 (meant for small and medium businesses)

Home Basic: $199

Home Premium: $239

Ultimate: $399

Upgrades: Upgrading from Windows XP or 2000 is a third to a half off new purchase prices.

Source: Microsoft

That's why Vista will draw so much attention between now and when it's available to businesses Nov. 30 and consumers Jan. 30.

At its essence, an operating system links software with hardware to make a PC useful. Over the years, Microsoft has periodically upgraded Windows to include more functions and use the growing processing power of the machines. Vista represents the latest, most ambitious effort so far.

But the Windows business has become so large that even the $1.3 billion in new sales it's expected to generate this fiscal year would amount to only a 10 percent growth rate.

In search of faster growth rates, like the ones investors enjoyed in the 1990s, Microsoft is building on its expertise with Windows and other widely used, highly profitable products to enter new markets such as entertainment and online services.

"To stay relevant in the technology world, you have to continue to pursue the things that are at the leading edge of the industry," Microsoft Chief Executive Steve Ballmer said at a conference in Seattle last week.

Microsoft has come a long way in the five years since it celebrated completion of its last operating system — Windows XP. The technology industry looks a lot different, too.

Microsoft's better defenses against hackers, much-reduced legal woes and improved reputation have helped set the stage for its entry into new markets. And success with things such as the Xbox and Microsoft's battle with Google will likely have as much, or more, influence on whether the company's stock gets growing again.

Five years after Windows XP, Vista takes center stage. Here's a look at how Microsoft and the technology industry have changed in the interim.

TECH ECONOMY

2001: In a slump

2006: Charging ahead

Microsoft is introducing Windows Vista in a dramatically different marketplace than the last time it released a new operating system.

Six weeks before Windows XP launched in 2001, the world changed. Among the tolls of the Sept. 11 terrorist attacks were Americans' sense of security and a heavy blow to an already declining economy.

The technology industry saw its first decrease in personal-computer shipments since the mid-1980s, a result of the dot-com bust and the hangover from a wave of PCs bought ahead of the Y2K scare that wasn't.

The "ecosystem" of computer makers, software developers and service providers that traffic in Microsoft's products looked to Windows XP for a lift.

"We are reclaiming the software industry's mojo," a Hewlett-Packard executive said in 2001 as Microsoft Chairman Bill Gates handed him a finished copy of XP.

Conditions today as Microsoft prepares to launch Windows Vista are decidedly better.

Computer sales, which have the biggest impact on the growth of Windows, have been up about 13 percent a year since 2002 and should increase 8 to 12 percent in 2007. Still, not quite the halcyon 1990s.

Also, computers in the guise of cellphones are spreading to our pockets and purses. More people are spending more time and money online. And a new crop of Internet companies has sprouted to serve them.

"Technology does not stand still," said Kevin Johnson, co-president of the Microsoft division responsible for Windows. "There are innovations and breakthroughs every day. ... At the foundation is how we weave that together in an operating system that delivers something for everyone."

SECURITY

2001: Achilles' heel

2006: Top priority

Among Vista's features, Microsoft gives top billing to its defenses against hackers and scammers that torment computer users.

Microsoft learned about this issue the hard way with XP.

Early in the decade, a series of viruses and worms with names such as Blaster and Sasser attacked PCs around the globe through holes found in XP and earlier versions of Windows.

"It wasn't that Microsoft products were inherently insecure; it's just that they didn't view security with the kind of importance that they needed to," said Matt Rosoff, an analyst with Directions on Microsoft, an independent market-research company in Kirkland. "They were still creating software ... that didn't assume attackers would use any avenue they could."

In 2004, the company's engineers introduced what was called XP Service Pack 2, an add-on designed to make the underlying operating system more secure. It was such a big project that some analysts considered it a new operating system. The work on SP2 was partly what delayed Vista, which is coming to market some two years later than expected.

Microsoft has made major adjustments to its security strategy since XP. In 2002, Gates delivered one in his culture-changing memos to employees. "Trustworthy computing" in the form of security, privacy protection, reliability and open business practices, he decreed, would be part of everything Microsoft did from then on.

Improvements in security have helped the company make big gains selling software to run the computer servers behind business databases and Web sites. That part of Microsoft has joined Windows and Office as a third multi-billion-dollar business, and it has room to grow.

Microsoft is telling customers that Vista is its most secure system yet.

"We've put a tremendous amount of energy into architecting and engineering the products with a view toward delivering a safe, secure computing experience," Johnson said.

The company touts controls that limit who can install software on Vista PCs and visit certain Web sites. A major problem with XP was that hackers could install malicious programs without the user doing anything.

Some analysts see these controls as an obvious fix Microsoft should have made long ago, and one found in systems from Apple Computer and Linux.

For all the work, however, company leaders don't go so far as to say Vista is impenetrable.

"The hackers are getting smarter," said Jim Allchin, the Microsoft executive who has led development of Windows for 16 years and is retiring with its completion. "There's more at stake. There's just no way for us to say that some perfection has been achieved."

ANTITRUST, REPUTATION

2001: Big challenge, big bully

2006: Still lingering, mending fences

Microsoft's antitrust battles, now fading into the background, reached a crescendo in the months leading up to the launch of Windows XP.

A federal court found in 1999 that Microsoft had stifled competition by using its monopoly in operating systems to bundle other products into Windows. But an appeals court turned back the Department of Justice's effort to break up the company, as Microsoft argued that the other products were part of Windows.

For a time in late summer 2001, the antitrust tumult threatened to delay XP as critics charged that it committed the same fouls as earlier versions.

The Justice Department and states suing Microsoft eventually reached a settlement that is overseen by a federal judge. But the products are still there: You'll find the latest versions of Internet Explorer and Windows Media Player, for instance, in Vista.

The litigation spotlighted competitor and customer bitterness toward Microsoft and its aggressive business practices.

Now, with the exception of a separate case brought by the European Union, antitrust has faded into the background and Microsoft has mended fences.

The company is adhering to settlement terms around competition and has pledged to do so after they expire in the next three years.

Chief Executive Ballmer, who assumed the title from Gates in early 2000, is halfway through "the largest rebranding task in history," said Mark Anderson, a technology analyst in Friday Harbor.

"He's right on schedule, by which I mean there's still a lot of fear and anger out there, but nothing compared to what was there five years ago," he said.

Gates' prominent role as a global philanthropist, which is growing as he transitions to work full-time with his foundation in July 2008, has helped Microsoft's image, too.

The result? Despite the scars of antitrust, Microsoft probably wields more power today than it did five years ago.

"They've extended power in terms of [market] segments, in terms of geographies, in terms of politics," Anderson said. "No one else in the world comes close. No one's even in the same game as Microsoft."

ENTERTAINMENT

2001: Xbox

2006: Zune

Microsoft is getting into other people's games.

The company is disappointing some shareholders by using the cash thrown off by Windows and Office to bankroll major investments in entertainment, online services, business applications, mobile devices and other markets where it's the underdog.

These moves have brought it head to head with competitors new and old.

Microsoft released the Xbox about three weeks after Windows XP. The video-game console is now a legitimate competitor to market leaders Sony and Nintendo. Its Xbox Live online service has become a solid fixture, and new video download functions of the Xbox 360 are designed to broaden its appeal in the living room.

But the Xbox business has yet to turn a profit. Microsoft says that will happen in its 2008 fiscal year, which begins next July.

Microsoft's latest foray into entertainment is Zune, the portable music player it launched last week. Zune is up against Apple's iPod, which came on the scene five years ago and owns three-quarters of the market.

While this is not a huge business, it is strategically important to the company's entertainment strategy, and also as a defense against a resurgent Apple.

"It's really the iPod that's helped turn Apple around and get it in front of everybody's eyes again," Rosoff said.

Since the iPod launched, Apple's Macs have gained some ground, though they still represent only about 5 percent of PC shipments.

ONLINE SERVICES

2001: Dot-com hype

2006: Google billions

The biggest opportunity, and challenge, for Microsoft is the emerging world of online services.

In this new business model for software — one that could lessen the importance of a feature-loaded operating system such as Windows — tasks such as managing photo collections or tracking customer relationships can be done over the Internet. The software, housed on computer servers in warehouses, can complement or replace software that resides on the PC.

It's not a new idea. Microsoft was talking about it in 2001. Since then, the world of Internet services has evolved from the hype of the dot-com bubble to the reality of billions in profits for Google and others.

Nearly three-quarters of American adults are online. They pay bills, watch videos, talk with friends — all made possible by widespread high-speed Internet access, cheaper data storage and better security.

Google, still an upstart five years ago, has risen to be the leader in Internet services. Half of all Internet searches are performed using Google, generating mounds of cash from advertisers. It also offers Web-based applications, some of which compete with parts of Microsoft Office.

"Microsoft is in the position of having to respond to more difficult challenges at this point," said Michael Cusumano, a Massachusetts Institute of Technology professor and expert on Microsoft and the software industry. "And it is responding."

The company has built a set of online services called Windows Live, as well as a new advertising platform to turn the services into cash. Another effort, Office Live, gives small businesses free e-mail and Web hosting.

Exactly how these services will fit with — or even change — desktop Windows and Office remains to be seen, but it may be the key to Microsoft's success from here.

"The whole Live program has been dancing around those flagship applications and not really discussing them," Anderson said.

In the coming years, Microsoft's ability to make the right connections between its core businesses and its new investments will have a great influence on its stock, and its leadership in technology.

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com

Copyright © 2006 The Seattle Times Company

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