Microsoft Internal Memo Points to Cost-Cutting, but Says No Layoffs

First, plenty of little companies beat mighty Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks) to the Internet. Then they started another trend it's finally following -- cost-cutting.

Microsoft CEO Steve Ballmer has asked his executive team to "significantly reduce" some expenditures planned for this fiscal year, which ends in June, according to an internal memo, which was first reported Tuesday by The Wall Street Journal.

Of course, Microsoft makes money -- tons of it -- and has so much cash it could get Internet companies through one miserable business plan after another. But it, too, sees the new market realities, many of which became even more apparent after the company's warning last week.

"We all have a big incentive as shareholders to reignite the kind of cost-conscious culture that marked Microsoft's earlier years," Ballmer wrote in the memo, a copy of which was obtained by TheStreet.com.

A Microsoft spokeswoman said, "The memo was really just a year-end report explaining strategies and priorities for next year. Steve routinely communicates with all employees here to make sure we all have the same goals."

Microsoft management distributed the memo to employees last Thursday, the same day the company announced that it would fall short of revenue and profit expectations for the December quarter and the fiscal year. It was the company's first warning since 1989.

Since the warning, the stock has fallen 19%.

John Connors, the company's chief financial officer, mentioned cost-cutting on the conference call last week, but he said Microsoft wouldn't touch its research and development budget, an indication that its product pipeline should remain strong. But the comments set off speculation that the company might look for savings by laying off employees.

Ballmer negated that notion. "To be clear, resource reductions don't translate into employee layoffs," he said in the memo. Indeed, to attract and keep the most talented people, Ballmer said the company will "invest significantly" in base salary raises for some high-performing employees, the memo said. Middle managers and lower-level employees will be reviewed next month.

"Microsoft has a history of being conservative on salary and cash compensation," said Carl Schmidt, vice president of the WestWard Pay Strategies consulting firm. "But it could only afford to do that when the stock was increasing. The previous use of stock options [in compensation] covered up a lot of sins in terms of what Microsoft was paying." (Microsoft isn't a WestWard client.)

Microsoft in April tried to cheer up employees with stock options after Judge Thomas Penfield Jackson announced his decision to split the company in two. The company doubled the number of performance-based options that each employee received in the previous performance review. It also announced it would start offering more competitive salaries.

But since then the stock has fallen further.

The chief executive himself admitted that the most recent stock drop "makes employees, new and old, more sensitive to cash compensation. Stock options remain a great long-term opportunity. But reality has set in -- here and industrywide."

As a follow-up to the memo, Ballmer and his boss, Chairman Bill Gates, held an internal Webcast Tuesday, said Microsoft product manager Dave Mendlen.

Meanwhile, some Microsoft employees refuted the idea that they were worried about layoffs. But the memo did catch many by surprise. They weren't even aware the company had warned, said Mendlen, who didn't know until he saw the seven-page memo in his email inbox.

"For the first five or 10 minutes after a memo like this, everyone runs to the water cooler to talk about it and then has to get to work on their next project," he said. "Some people are focused on the stock price, but it's definitely not the norm.

"So far there's no formal cost-costing. They're just reminding everyone to be vigilant about spending, and not always go for the lobster dinner."

But the Redmond, Wash.-based company already has cut back on some real estate plans. It canceled leases or sublet more than 300,000 square feet of office space in Bellevue, Wash., according to The Seattle Times.

The memo also reiterated seven business priorities that Ballmer had detailed at a board meeting last October. They are meant as focal points for the company's near future. They include its Windows operating systems, productivity programs such as Office, enterprise server products and tools, the MSN Internet service, applications for small businesses, products for non-PC devices and the company's Internet technology initiative known as .Net.