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Peering Through the Windows: A Conversation with Microsoft's John Connors

The software giant's finance chief talks about lawsuits, stock options, and life during recession.

1Dec

In December 1999 longtime Microsoft CFO Greg Maffei announced he was leaving the software giant to become CEO at Worldwide Fiber, a Vancouver-based communications company now known as 360Networks. While investors barely reacted to the departure of the high-profile finance chief — Microsoft's share price dropped a mere 12 cents that day — Maffei definitely got out of Redmond while the getting was good. Since his exit Microsoft has, in order: been nearly split asunder by the U.S. Department of Justice, sued for anti-competitive practices by about a third of states in the Union, and taken a $2.6 billion hit in investment losses. Oh yes, in that time the company has also come out with two major product launches (Windows XP and the X Box), watched its share price go up and down more than a Duncan Butterfly, and witnessed an overall sagging in purchases of computers and software.

Welcome to John Connors world. The 12-year Microsoft vet took over as company CFO in January 2000 — only the third finance chief in company history. Before assuming the top finance spot, Connors held a number of executive-level positions at Microsoft. He oversaw Microsoft's worldwide enterprise group and also served as company controller for two years. In addition, Connors ran Microsoft's information technology department.

In that time, Connors has earned a reputation as a steely pragmatist. As CIO, he ended Microsoft's expensive practice of developing its own in-house software, recommending instead that the company buy off-the-shelf applications for internal use. Connors also streamlined Microsoft's procurement system, saving enough in the bargain to pay for a worldwide rollout of SAP R/3.

In a recent interview with CFO's Kris Frieswick, Connors talked about corporate venturing, managing during a recession, and what it's like to run a finance department when the government is trying to bust up your employer.

John, how do you see your role as the Microsoft CFO versus what the role was previously?

I'd say my role is a much broader operating role than what it had been with Greg Maffei or [former CFO] Mike Brown. When Bob Herbold retired as COO, I assumed responsibility for our IT organization, plus all of our worldwide operations, manufacturing, distribution, and licensing programs that we run around the world. I also have responsibility for real estate, procurement, corporate security, and all corporate services, plus, of course, finance.

Corporate investing and corporate venturing have been in the news a lot of late. How does Microsoft run its venturing activities?

In terms of investments, we have a matrixed organization. Ultimately each group, each business unit, is responsible for deciding what investments they want to do. We also have a small corporate development group which works with business development people within those organizations to actually do the deals, negotiate them, and so forth.

Has Microsoft always done it that way?

We had a pretty small corporate development group until the last couple of years. That group grew, and Greg spent a fair amount of his time on investments. Once we make the investment, however, our treasury group manages it on an ongoing active basis, which is pretty consistent with what we've always done.

Then there's really not a formal venture capital group within Microsoft?

No, no. We've tried to steer away from the notion that it's venture capital. What we want to do is make investments that are consistent with the business plan of our operating units. What we look for is a business group to be a sponsor and ultimately be responsible for the success of the investment. Once we make the investment, the treasury guys manage the governance of it and work with those business units on an ongoing basis, in terms of changes in the investment structure, dispositions, and so on.

Did you make a conscious decision to recuse yourself from direct involvement in those activities, or do you still have some involvement?

Anything that is a major investment I'll get involved in. I'll go in and do a review, we'll go through the list of pros and cons, and the yea or nay recommendation is up to Bill [Gates] and Steve [Ballmer].

How has the economic slowdown affected your job as CFO?

By August 2000 it was pretty clear to us that the economy was going to slow. It was also pretty clear that the tech sector, and in particular the dot-com and telecom sectors, were going to face real tough times. So we began a process of managing our expenses much more closely and began to take down our expense growth rates. We've really focused the last year on managing our expense structure carefully.

The second key thing that we've had to do the past year is explain the business strategy of the company. We're on a fairly extensive diversification campaign, so it's important that Wall Street and big investors understand what we're doing, understand what the opportunities are. We try to be very realistic about where we see the economy going, where we see our growth going.

Back during the years when we had hyper growth rates, it was just "add it up at the end of the quarter." But now we look at what everybody thinks we're going to do, and we look to see if these guys are being too optimistic. If they are being too optimistic, then we examine what expense structure we need to come in at. There's been a much broader, companywide focus on forecasting in the last 12 to 18 months.

Where do employees fit in to the company's overall strategy?

One big initiative we've had over the past year is getting out and evangelizing to our employees about the role they have in helping to increase profits. We speak to all the administrators in the company, who really manage a lot of the procurement function on behalf of their groups. We also speak to the executive teams, to midlevel management, and to different business units about how much profit we have to grow to remain an interesting investment.

Because we have such a widely held stock option program, people really now understand what they can do to help grow profits. We get hundreds of ideas a month from employees about different ways to increase profitability — everything from "Here's a place where I see money can be spent more effectively" to "Should we buy this company?" The whole grass-roots evangelism has been a big part of what I've tried to do.

Having a highly subscribed employee stock option plan can be a great way to get workers to buy in to corporate strategy. But it can be tough on those employees when the options are under water. Are you looking at other incentives for employees — incentives that are not options-based?

Over the last two and a half years, we've made a conscious effort to give employees larger-than-average compensation increases. We feel like now, with both cash comp and bonus, we're competitive with the market.

We still have a lot of employee options outstanding. Realistically, because of the downturn in the economy and the severe reset in the stock market, I think employees' time horizon for creating equity wealth from their options is more realistic. Employees understand now that it's going to be multiple years before the equity value is realized, as opposed to 18 to 24 months. But I also think employees now feel pretty secure being at Microsoft in terms of our long-term strength and viability. People understand that now's a good time just to have a job.

To date we've been fortunate in that we're still hiring. We've had no layoffs. We haven't had to take draconian steps for expenses, and I think our employees are looking at us and saying, these folks managed us through this pretty well.

From a financing perspective, one of the most interesting things about Microsoft is you generally do cash deals. You sell something, you get the money. You don't rely on bank debt. On the other hand, the investment decisions that the company has made over the last two or three years have caused investors considerable pain.

We made several very large investments in cable and telecom in 1998 and 1999, and a little bit in early 2000. The valuations on those companies are down now, in some cases as much as 70 percent. Some of the companies we invested are bankrupt. It's been a painful — and expensive — lesson.

In hindsight, I think we should not have taken as large a position. Secondly, we didn't do as good a job framing the macro-economic environment of some of these sectors, and just how much growth and profit was realistic from those areas. On an individual investment basis, some of them looked really good and made a lot of sense. But if you lined up all the expectations that these upstart telecoms had, or the cable companies had, there was just never a basis for the valuations they reached. So fortunately for us, we do have a strong balance sheet, we have great cash flow, we'll recover from it. But, yes, it's been expensive.

Obviously, Microsoft has been involved in a much-publicized, protracted antitrust case. What do you think Microsoft can do to foster a more competitive environment, thereby avoiding similar litigation in the future?

The first principal is that we must retain the right to innovate in our products. I have yet to meet a customer who says, "I wish you wouldn't innovate and add more features and functionality to your products and services."

We've invested very heavily in our government-affairs capability. I think we can improve the number and quality and presence that we have in Washington, D.C. But most important, we've got to do a good job of getting the message out about just how large the IT ecosystem is, and what our percentage share of that ecosystem really represents. And we've got to do a good job of explaining just how many people and partners there are that work with Microsoft every day. I think we're making good progress on that front. We face intense competition, whether its Linux, IBM, AOL, Sun, Oracle, Sony, or Nintendo. There's a very large degree of competition, and we have to do a better job of getting that story out.

But if you buy a PC, it's pretty likely it's going to come with Windows. If you want something other than a Microsoft OS on a computer, well…that's going to be tough to make happen.

The majority of the case is clearly around the desktop. I think we've made good steps. In terms of the specific issues that the appeals court identified — with respect to our OEM contracts, with respect to our contracts with Internet service providers — we've made many of the changes that the appeals court thought were appropriate. And we'll work hard to adjust, based on what the ultimate settlement and ultimate court action says we should do.

But at the end of the day, we believe very strongly in the right to innovate in our products and our services.

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