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Microsoft CEO Steve Ballmer comments on the Windows 8 operating system before unveiling Surface, a tablet computer to compete with Apple's iPad. http://media.npr.org/assets/img/2012/07/19/microsoft_earns_12600419_custom.jpg ?t=1342733984&s=51
We delivered record fourth quarter and annual revenue, and were fast approaching the most exciting launch season in Microsoft history, said Steve Ballmer, chief executive officer of Microsoft. Over the coming year, well release the next versions of Windows, Office, Windows Server, Windows Phone, and many other products and services that will drive our business forward and provide unprecedented opportunity to our customers and partners. The combination of solid revenue growth and rigorous cost discipline drove doubledigit operating income growth for the quarter, adjusting for the goodwill impairment and deferred revenue, said Peter Klein, chief financial officer of Microsoft. We are focusing our resources in strategic areas that will deliver shareholder value and long-term growth opportunities. From the FY12 Q4 Earnings Release.
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Table of Contents
No. 1. 2. 3. 4. 5. 6. Topic Summary Brief Introduction to Analysis Breakeven Model and the Simple Linear Law Microsoft Profits-Revenues Analysis Appendix I: Line of Excellence (LOE) for Microsoft Appendix II: Bibliography list of related articles Page No. 3 4 5 7 13 17
LOS ANGELES, CA - JUNE 18: Microsoft CEO Steve Ballmer shows the new tablet called Surface during a news conference at Milk Studios on June 18, 2012 in Los Angeles, California. Photo by Kevork Djansezian/Getty Images http://www.slate.com/content/dam/slate/blogs/moneybox/2012/07/26/microsoft_s_fall_the_r eal_lesson_is_that_innovation_is_hard/146537702.jpg.CROP.rectangle3-large.jpg
Note: Tables of all the raw data analyzed are provided to permit readers to do their own analysis and prepare their own plots to verify all the findings reported here.
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1. Summary
It has not been generally appreciated that all companies obey a simple universal law, y = hx + c, relating revenues x and profits y. A careful review of the historical profits-revenues data for Microsoft, for the last two decades (1993-2012), with the aid of the x-y profits-revenues diagrams, shows that Microsoft has been essentially operating along a series of parallels, y = hx + c = h(x x0), with a positive slope h and a negative intercept c. These are called Type I lines (h > 0, c < 0). Microsoft was first operating along Line A (1996-2000) and then made a transition to the parallel Line B (2007-2011). The slope h 0.50 for the two Type I parallels. During the transitional years, profits and revenues increased at a much lower rate as revealed by several transitional (x, y) pairs. The transitional line, called a Type II line, has smaller positive slope h and a positive intercept c (as opposed to the negative intercept for the Type I line). Exactly similar conclusions are also drawn from the cumulative profits and revenues data for a single year. There is a back-and-forth switch from Type I to Type II behavior and vice versa, but over the long term, the slope h has been decreasing slowly and the intercept c has also been decreasing, thus increasing the minimum, or cut-off, revenue needed to produce a profit. Thus, we can expect a transition back to the Type I operating line in 2013 or the establishment of a new Type I line with a higher x0 (smaller intercept c, more negative value).
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Slope h = 1 - (b/p) Determined by the unit variable cost b and unit price p Intercept c = - a Determined by the fixed cost, a
The linear law y = hx + c also suggests three different possibilities, depending on the numerical values of the constants h and c. This gives rise to what may be called Type I, Type II, and Type III companies. Examples of all three companies can be found in the real world (see www.scribd.com/vjlaxmanan). The three types can be described, briefly, as follows:
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1. Type I (h > 0, c < 0, positive slope, negative intercept which also means a positive intercept on the x-axis, or the revenues-axis). Both profits and profit margins increase with increasing revenues. This is usually the case for all companies in the very early stages of growth and emergence into profitability. (The most recent data for RIM, Limited, reveals an unusual INVERSE Type I; revenues and profits are both going down together yielding a positive slope h > 1.) 2. Type II (h > 0, c > 0, positive slope, positive intercept). Profits increase with increasing revenues but profit margins decrease with increasing revenues. Also, as we see with Microsoft, profits usually increase at a lower rate than in Type I stage. 3. Type III (h < 0, c > 0, negative slope, positive intercept, and yes, very rarely also with negative intercepts on both axes). Profits decrease with increasing revenues, or vice versa, i.e., profits can also increase with decreasing revenues. Correspondingly, profit margins can either go down with increasing revenues, or up with decreasing revenues. Further discussion of these points may be found in Ref. [1], the Fresh Look article on Microsoft, and in other articles cited. In this article, we will briefly reconsider the Microsoft profits-revenues data. While confirming the findings in Ref. [1], the analysis here also provides some additional insights about how costs have been rising, slowly, at Microsoft. (The same is true of ALL companies, if the data is analyzed over several years, as outlined here.) We see a back and forth movement from Type I to Type II behavior, when we consider the cumulative profits and revenues data for a single year. Also, we see a slow transition from one Type I line to another, with an interim Type II transition, when we consider the multim-year data for the last two decades. These transitions all lead to the conclusion that costs have increased gradually over the years. Even so, Microsoft is, perhaps, one of the most exceptional companies in that the numerical value of the slope h, as we see here and in Ref.[1], is among the highest that we can deduce for any large corporation with revenues approaching nearly $75 billion annually. Further improvements in profits and cost reductions can be achieved by gaining a deeper understanding of the fundamental (a, b, p) triplet
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which manifests as the slope h and the intercept c in the linear law. The analysis presented for Apple and Kia Motor Company is particularly noteworthy in this context; see Refs.[16, 17] in the bibliography. A simple methodology for predicting the revenues of a company can be developed, as discussed in these two articles, if one knows the number of units N sold to generate the revenues. In the case of an automotive company like Kia, the total number of vehicles sold (without regard to brands and sub-categories) can be shown to scale nicely as the revenues. A similar scaling law can be shown to apply for Apple Inc., if we simply add the units sold for the four main products (iPhones, iPads, iPods, and Mac computers) and create a composite count N, see http://www.scribd.com/doc/101503988/ThePerfect-Apple-II
Note: The profits and revenues data compiled here were obtained from Annual Reports at the Microsoft website. Multi-year data are available in several annual reports. There were some slight discrepancies between the figures here and in Table 2 of Ref. [1]. This does NOT affect the main conclusions. The discrepancies were cross checked carefully with multiple reports http://www.microsoft.com/Investor/EarningsAndFinancials/Financials/FY12/Q4/IncomeStateme nts.aspx . In 2002 Annual Report values are 28.365 and 7.829; in 2004 Annual Report the values for 2002 are given as 28.365 and 5.355. In 2002 Annual Report, profits for 1998 is 4.490; In 1999 Annual Report, the 1998 values are 15.262 and 4.490, and the 1997 revenue is 11.936. In 1999 Annual Report, the 1998 revenue is given as 15.262 and the 1997, 1996, and 1995 revenues are the slightly higher values. In 1998 Annual Report, the lower values are given for 1997 to 1994; the 1998 values are 14.484 and 4.490. In 1997 Annual Report, the 1993 revenue is given as 3.753. In 1996 Annual Report values for 1996 are 8.671 and 2.195.
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The graph of the cumulative profits-revenues data during a single fiscal year is often linear, as seen in Figure 1. Furthermore, with a company like Microsoft, we do not see much scatter in the data. The diamonds in Figure 1, joined by the solid blue line, represent the data for 2007 and the red squares, joined by the dashed blue line, the data for 2005. The equations of these lines were deduced by considering the (x, y) pairs for 1Q and 4Q for each of the years. When the data fall approximately on a straight line, this is the simplest method that can be used to determine the numerical values of h and c in the law y = hx + c = h(x x0). Both Type I and Type II behavior described in 2 are seen here. The subtle interaction of the constants h and c can also be appreciated. The figure caption includes some additional comments in this regard.
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The rate of increase of profits with increasing revenues, as measured by the slope h was actually higher for 2005 compared to 2007 although the cumulative profits and revenues at the end of the FY were higher for 2007. Notice that the small positive intercept means that 1Q07 profits were higher than for 1Q05 but the cumulative profits, as the months rolled by, were actually lower than the predicted by the dashed line for 2005 because of the lower value of h for 2007. Table 3: Operating lines for each fiscal year deduced from quarterly data Fiscal year 2005 2006 2007 2000 1999 1996 1995 2008 2009 Equation y = 0.32x 0.39 y = 0.27x + 0.47 y = 0.26x + 0.64 y = 0.41x - 0.02 y = 0.39x + 0.04 y = 0.25x - 0.015 y = 0.24x + 0.014 y = 0.339x + 0.287 y = 0.235x + 0.833 Slope h 0.3178 0.2738 0.2626 0.4114 0.3923 0.2548 0.2424 0.339 0.235 Intercept c -0.3928 0.4737 0.6387 -0.0242 0.038 -0.0148 0.0137 0.287 0.833 Comments Type I Type II Type II Type I Type II Type I Type II Type II Type II
y = 0.306x 0.385 0.306 -0.385 Type I 2010 y = 0.306x + 0.416 0.306 0.416 Type II 2012* y = 0.33x + 0.065 0.330 0.065 Type II 2011 * For FY2012, the slope h was determined between 1Q2012 and 3Q2012, because of the special write-off the resulting historic first ever quarterly loss. The operating equations for the most recent eight consecutive years (2005-2012) and for four earlier years (1999 and 2000) and (1995 and 1996), deduced as just described are summarized in Table 3. Notice the back-and-forth switching from Type I (small negative intercept c) and Type II (small positive intercept c) behavior. Also, a careful examination reveals a pattern. Besides the change in the sign of the intercept, Type I behavior is always accompanied by a higher slope than the Type II behavior. Profits increase much more rapidly when a company exhibits Type I behavior than when it exhibits Type II behavior, as confirmed by the plot prepared in Figure 1. Although, the absolute magnitude of the profits were higher
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in 2007, they were actually lower than the profits that could have been achieved if Type I behavior had continued in 2007 as in 2005. This rule is confirmed with the annual data plotted in Figure 2. Microsoft started operating on Line A (blue dashed line) in 1995, with profits increasing with increasing revenues. The profit margins also increased. This is Type I behavior as discussed in 2. This was then followed by a slow transition, over several years, to the second Type I Line B (solid blue line), the operating line established since 2007. During the transitional years, profits and revenues increased but at a much slower rate. The transitional years can be described by a Type II line, with the equation y = 0.165x + 5.636, deduced by joining the (x, y) pairs for 2000 on Line A and 2007 on Line B (see also Figure 6 in Ref. [1], which shows this transition, line joining 2005 to 2009 is used there, with the equation y = 0.124x + 7.31).
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loss). This joins the (x, y) pairs for 2007 and 2011. The slopes h are roughly the same and the lines are roughly parallel.
Notice again that the Type I lines (h > 0, c < 0) have a higher slope than the Type II lines. In the annual profits-revenues plot, the Type II line is usually a transitional line between two Type I behaviors (with a large change in the intercept), or even from Type I behavior to a Type III behavior (observed with some other companies, discussed in the reference list, a good example being Air Tran). In summary, although Microsoft has been a pre-eminent company since its founding in 1975, reporting record profits year-after-year, with ever increasing profit margins (due to the Type I behavior that we see here), a careful analysis of the profits-revenues (the cumulative quarterly data for a single year and the annual data for multi-years) shows a subtle increase in the costs as revealed by: a) The slowly decreasing values of the Type I slope for the last two decades. Since the slope h = 1 (b/p) in the simple breakeven model, this mean the unit variable costs b has increased and/or the unit price p has decreased (due to competitive pressures) or a combination of these two factors. b) The change in the intercept c, or the cut-off revenue x0 = - c/h. According to the breakeven model, the intercept c = - a, the fixed cost, for a company making and selling N units of a single product. For a real world company like Microsoft, the fixed cost is the cut-off revenue x0. The higher the value of x0, the higher is the minimum revenue required before profits are reported. When x > x0 profits increase at the fixed rate h, If revenues increase by a fixed amount x, profits always increased by the same fixed amount y = hx. c) As we see here, Microsoft has been able to convert nearly 50% of the additional revenue (over the minimum cut-off, or breakeven level) into profits. This is a very high rate of conversion of revenues into profits, unmatched by most companies in the modern corporate world.
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Line B: y = 0.483x 10.61 = 0.483 (x 21.98) The cut-off revenue was $4.33 billion on Line A and has increased to $21.98 billion on Line B and the conversion rate of revenues into profits has dropped from 50.6% to 48.3%. Again, what dictates the choice of h and c? The analogy drawn earlier with Einsteins photoelectric law, discussed in some detail in the Fresh look at Microsoft article, is worth recalling. Einsteins law can be written as K = E W = hf W = h(f f0) where the cut-off frequency f0 is exactly analogous to the cut-off revenue x0 in the financial analysis. When a photon with the energy E = hf strikes the surface of a metal, it will eject an electron from within the metal. The energy of the electron K < E since some of the photons energy must be given up to do the work W to overcome the forces that bind the electron to the metal. The graph of K versus f is thus a straight line with the slope h, the Planck constant, and a finite positive intercept f0 = W/h on the frequency axis and finite intercept Won the K-axis. The intercept W made on the K-axis equals the work function of the metal and is exactly analogous to the intercept c in the profits-revenues law. Now, Einstein also points out that in order to determine the correct numerical value of the slope h (Planck constant) of the K-f graph, it is important to determine the maximum kinetic energy K of the electron. Electrons are ejected with a range of energies. But, only those with the highest energies are of interest since this highest energy is a true manifestation of the energy E = hf of the photon and therefore the true value of h will be revealed in such experiments. Likewise, since many values of h can be determined, it seems appropriate to seek the highest slope h on the profits-revenue diagram since this represents the highest rate at which the company is able to convert revenues, in excess of the cut-off x0, into profits. Such a line will be referred to as the Line of Excellence (LOE) and was discussed in the article on Google (see Ref. [12] in Appendix II). In the case of Microsoft, we can deduce three Lines of Excellence, with increasing slopes h and successively higher values of x0 associated with each LOE. The increasing values of x0 imply that fixed costs have been rising but Microsoft is also able to convert the excess revenues into profits at a higher and higher rate (which implies lower unit variable costs and/or lower unit price for the products sold). It is clear,
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therefore, that more definitive conclusions can be drawn when we determine the LOE for each time period, starting with the earliest time period here.
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conclusion). Although the conversion rate of excess revenues into profits (75%) is high compared to the previous result (48.3%) in Figure 2, the cut-off revenue has also increased ($38.9 billion versus $21.98 billion). In summary, the idea of a Line of Excellence (LOE) suggested here, where we seek the highest slope h, is analogous to seeking the maximum kinetic energy of the electron in the photoelectricity experiment. Fixing the highest slope h during different time periods also permit a non-controversial interpretation of the rate of conversion of revenues (over and above the minimum cut-off revenue) into profits. The most important point to note is that while the cut-off revenue has increased over time, for Microsoft, the slope h has also increased over time (rather than decrease over time).
Courtesy: http://www.scribd.com/doc/65012321/Ordinary-and-Extraordinary Uploaded by Shannonplong, July 30, 2012. Microsoft certainly seems to have
that extra
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10.The Air Tran Story: An Important Link to the Future of Southwest Airlines, Completed June 27, 2012 (to be published). 11.Annies Inc. A Single-Product Company Analyzed using a New Methodology, http://www.scribd.com/doc/98652561/Annie-s-Inc-A-SingleProduct-Company-Analyzed-Using-a-New-Methodology Published June 29, 2012 12.Google Inc. A Lovable One-Trick Pony Another Single-product Company Analyzed using the New Methodology. http://www.scribd.com/doc/98825141/Google-A-Lovable-One-Trick-PonyAnother-Single-Product-Company-Analyzed-Using-the-New-Methodology, Published July 1, 2012. 13.GT Advanced Technologies, Inc. Analysis of Recent Financial Data, Completed on July 4, 2012. (To be published). 14.Disappearing Brands: Research in Motion Limited. An Interesting type of Maximum Point on the Profits-Revenues Graph http://www.scribd.com/doc/99181402/Research-in-Motion-RIM-Limited-WillDisappear-in-2013 Published July 5, 2012. 15.Kia Motor Company: A Disappearing Brand http://www.scribd.com/doc/99333764/Kia-Motor-Company-A-DisppearingBrand, Published July 6, 2012. 16.The Perfect Apple-II: Taking A Second Bite: A Simple Methodology for Revenues Predictions (Completed July 8, 2012, To be Published) http://www.scribd.com/doc/101503988/The-Perfect-Apple-II, Published July 30, 2012. 17.http://www.scribd.com/doc/101062823/A-Fresh-Look-at-Microsoft-After-itsHistoric-Quarterly-Loss Microsoft after the quarterly loss, Published July 25, 2012. 18.http://www.scribd.com/doc/101518117/A-Second-Look-at-Microsoft-After-theHistoric-Quarterly-Loss , Published July 30, 2012. 19.http://www.scribd.com/doc/100984613/Further-Empirical-Evidence-for-theUniversal-Constant-h-and-the-Economic-Work-Function-Analysis-ofHistorical-Unemployment-data-for-Japan-1953-2011 Single universal value of h for US, Canada and Japan in the unemployment law y = hx + c, Published July 24, 2012. 20.http://www.scribd.com/doc/100939758/An-Economy-Under-StressPreliminary-Analysis-of-Historical-Unemployment-Data-for-Japan, Published July 24, 2012.
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21.http://www.scribd.com/doc/100910302/Further-Evidence-for-a-UniversalConstant-h-and-the-Economic-Work-Function-Analysis-of-US-1941-2011-andCanadian-1976-2011-Unemployment-Data Published July 24, 2012. 22.http://www.scribd.com/doc/100720086/A-Second-Look-at-Australian-2012Unemployment-Data, Published July 22, 2012. 23.http://www.scribd.com/doc/100500017/A-First-Look-at-AustralianUnemployment-Statistics-A-New-Methodology-for-Analyzing-UnemploymentData , Published July 19, 2012. 24.http://www.scribd.com/doc/99857981/The-Highest-US-Unemployment-RatesObama-years-compared-with-historic-highs-in-Unemployment-levels , Published July 12, 2012. 25.http://www.scribd.com/doc/99647215/The-US-Unemployment-Rate-Whathappened-in-the-Obama-years , Published July 10, 2012.
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Planck, referred to here as the generalized power-exponential law, might actually have many applications far beyond blackbody radiation studies where it was first conceived. Einsteins photoelectric law is a simple linear law, as we see here, and was deduced from Plancks non-linear law for describing blackbody radiation. It appears that financial and economic systems can be modeled using a similar approach. Finance, business, economics and management sciences now essentially seem to operate like astronomy and physics before the advent of Kepler and Newton.
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