Microsoft's cash versus Google
The software giant's plan to build datacenters the size of 10 Costcos, complete with electrical substations, signals a major shift in the industry's fundamental economics.
NEW YORK (FORTUNE) – The software industry is changing by the minute. This once-ethereal, all-intellectual property business is starting to seem like old industry, where advantage will come from physical assets and capital spending.
Consumer software is increasingly taking the form of Internet services, like Google (Research), and being paid for with advertising. Microsoft (Research) has recently changed its strategy accordingly, as I described in a recent story in Fortune.
Its main growth plan now revolves around garnering more advertising - where it badly lags Google. Its ad revenues are only about one-sixth those of the search engine company.
But in order to deliver your software as a service, and thus be able to display ads, as Google does, you have to spend unprecedented amounts of money. Software is becoming a capital-intensive business.
The money must be spent to buy, build and manage the data centers that are the heart of the Internet economy. Microsoft's Ray Ozzie told me that the company would spend "staggering" amounts on these centers.
I believe Microsoft's strategy will increasingly be to seek to outspend Google. Since Microsoft has $35 billion in cash, that may not seem too difficult. But at the end of the first quarter Google had $8.4 billion of its own. Then it raised another $2.1 billion in a secondary stock offering. It is clearly concerned about having sufficient financial resources. With each of its recent stock offerings, people have asked why Google could possibly need so much money. The answer is becoming clear.
If you take the long-term view, as Ozzie is now tasked to do at Microsoft, you can envision a world where most of the planet's 6 billion people are online most of the time. And we will all likely be communicating and being entertained with bandwidth-intensive video.
Vast data centers
In such a world, the data centers will be vast, many in number, and loaded with servers, storage and switches. Such facilities will be so energy-intensive that the primary cost of operating them will probably be electricity. They thus will be, as Ozzie explained, located as close as possible to inexpensive power sources like dams.
In the wake of the FORTUNE story, people starting putting two and two together. The Seattle Times's Brier Dudley wrote, "A few weeks ago, Microsoft paid $1.08 million for 75 acres, where it's building three structures totaling 1.4 million square feet. That's about the size of 10 Costcos."
The site of those structures is not far from the Grand Coulee Dam, the third largest hydroelectric dam in the world. The Quincy Valley Post-Register reported last year that Microsoft said it could need 48 megawatts of power for the facility, and will build its own electrical substation and transformer on site.
In Tuesday's New York Times, Steve Lohr and Saul Hansell wrote that there is an arms race, evidenced by the unexpectedly higher capital spending both Microsoft and Google announced in their most recent earnings reports. Microsoft's estimated spending this year will be about $2 billion more than analysts expected, and Google will spend at least $1.5 billion this year. The Times story had a fascinating quote from Google CEO Eric Schmidt: "Those machines are full. We have a huge machine crisis."
But it's a crisis the company is clearly working quickly to resolve. Google itself last fall bought about 34 acres in The Dalles, Oregon, with an option to buy 80 more. Nearby is The Dalles Dam, like Grand Coulee a major power source on the Columbia River.
The changes Microsoft has to make to compete with Google are neither easy nor certain to succeed. I recently spoke with Dan Scheinman, Cisco's (Research) senior vice president for corporate development. Regarding Microsoft, he said "You've moved from the tyranny of the application to this massive scale of infrastructure - this is a disruptive change in the computer industry.
"Microsoft has to be willing to throw out everything they've done and change religion from Catholic to Protestant. If they're willing to do all these things, good luck."
It's unclear whether infrastructure alone will be enough to give any one of the giant Internet companies advantages over another. But this is an arms race. Other companies could end up being left behind as the giants battle for supremacy in the race for Internet infrastructure.
Fast Forward is a weekly column by FORTUNE's David Kirkpatrick.
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