What Warren Buffett Can Teach Microsoft

Both Windows and Office face formidable competition -- from themselves. The latest versions of both products aren't revolutionary relative to their previous versions. There simply aren't substantial differences between Office XP, Office 2000 or Office 98. Despite repeated upgrades, my user experience with Word and Excel has remained unchanged for the last five years. And the $300 that Microsoft charges for the Office upgrade makes it a significant buying decision. Similarly, one would be hard-pressed to find meaningful differences between Windows XP and Windows Me for the typical user.

Over the last 27 years, Microsoft has undertaken hundreds of major endeavors and projects. Only two of these have yielded great results. The rest have either lost money or are insignificant in the broad scheme of things. Both the successful endeavors borrowed heavily from the products of other companies -- Windows from Apple and components of Office from the likes of Lotus and Word Perfect.

Microsoft has never created a large scale, profitable innovative product. Today the company is investing billions into next generation Windows -codenamed Longhorn. Longhorn is expected to be released in 2006 and is supposedly a quantum leap forward from Windows as we know it. But based on Microsoft's past record on innovation, the odds of Longhorn's being a runaway success are slim.

Product Cycles

Should Longhorn fail to capture our imagination, Microsoft would have no good upgrade story for its installed base for years to come. Microsoft would face the real possibility of declining revenue and possible losses -- even as the company continues to own the installed based of Office and Windows.

Thus Gates' fixation on keeping boatloads of cash is fully justified. Microsoft's cash reserves are critical for the company to survive a single missed upgrade cycle in order to be around to capture the next cycle.

---

Mohnish Pabrai is the managing partner of Pabrai Investment Funds, an Illinois-based value-centric group of investment funds. At time of publication, Pabrai was long Berkshire Hathaway, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He appreciates your feedback at [e-mail]. You can access his Web site at www.pabraifunds.com.