Steve Ballmer On Microsoft's Future

How the CEO is directing the company's growth -- and dealing with the threats to it

While William H. Gates III's name is almost synonymous with Microsoft Corp. (MSFT ), his longtime friend, Steven A. Ballmer, has been CEO of the software giant for more than three years. BusinessWeek Editor-in-Chief Stephen B. Shepard spoke with Ballmer in New York on Nov. 13 as part of the Captains of Industry series at the 92nd Street Y. Here are excerpts:

On working with Gates.

Bill and I have been friends for 29 years. We were friends in college. When I first got to Microsoft, frankly, we had a difficult period. We had to sort through exactly what the working dynamic would be. It took us about a year. When Bill asked me to take over as CEO, it was clear that he really wanted me to be CEO. It was also clear shortly thereafter that neither he nor I really understood what that meant. How were we going to change our working dynamic? It took us almost a year to sort that through. We now have a new way of interacting with each other. I know when to defer to him. He knows when to defer to me. We continue to work together in a super, incredible fashion.

On attempting to create a kinder and gentler Microsoft.

When you have gone through the kind of experience that we went through with government authorities, it really does cause you to step back and reflect: Who are we, what are we doing? The expectation bar, be it from government, be it from customers, be it from industry partners, is different, and the bar is higher. How do you hit the balance between being forceful and aggressive and still [having the] right level of cooperation [with our industry and] with government? We have worked hard on that theme of responsible leadership.

On how far Microsoft is in the process.

We're farther than 20% and less than 80%. I think we've made appreciable progress, yet I would be the first to say that I know our customers and our industry would want us to still do better.

On being a gentler Steve Ballmer.

I have worked hard on it. I am still every bit as energetic and able to get pumped as I ever have been. But just as I have had to understand what my role is in Microsoft as CEO, I also have to recognize that the role I have to play externally as a leader of the company is different. I can bring all the excitement and all the enthusiasm and all the passion to the job, but I have to bring it in a different way.

On whether a gentler Ballmer is reconciling with rivals.

Certainly we have reached out. I went down shortly after I became CEO to visit with Larry Ellison [CEO of Oracle Corp. (ORCL )] and talked about how we could work cooperatively on things that are important to our customers. I hadn't seen Scott [G. McNealy, CEO of Sun Microsystems Inc. (SUNW )] in years. We played in the same golf tournament a year and a half ago -- very amicable. It's tough when you're in a lawsuit with somebody, I have to say. It doesn't sort of flow naturally for me. But yeah, that is part of the deal, trying to figure out how do you resolve matters.

On what Microsoft has learned from the antitrust battle.

It doesn't matter how we may have seen ourselves, we have to see ourselves as others see us. That, by far, is the biggest lesson.

On the antitrust case before the European Union.

Our great desire would be to resolve the matters in a way that will work for our customers and will work for the commission. Even while the hearings are ongoing, we look forward to constructive dialogue that hopefully results in some kind of a reasonable settlement for all parties.

We think our job is to take new ideas and integrate them in a way that makes them super-easy, super-useful. We think that's what customers appreciate. So it's [not about us being arrogant about] our own product design. No, it's about our fundamental value proposition. That was the process that we went through with the U.S. government -- a painful process. The key thing for us is that even under our settlement with the Justice Dept. we accepted many new responsibilities, but we continue to have the ability to serve our customers in the ways they expect, which would be important in Europe, too.

On Microsoft's growth prospects.

Ten years from now, will the world of technology be: A) largely the same, or B) largely evolved and different than it is today? I think the answer is clearly B. Things will change. New value will be added. That means there is opportunity. Exactly how you convert that change, that dynamism, that additional value -- that's not 100% clear. Whether that creates 5%-a-year or 10%-a-year or 15%-a-year opportunity for our company, I don't know. The fact is that the opportunity is there, so we're investing $6.9 billion in R&D to positively change the world.

On the threat to Microsoft from Linux.

It's a weirdo competitor. There is no company behind it. You don't know exactly who builds it. It's free. I prefer to say: "Look, what we have here is a small price disadvantage." It's the first time we've had a price disadvantage.

Most analysts think the price of Windows to our hardware customers, people like Dell Inc. (DELL ), is about 50 bucks. If you stop and think about it, most people are going to own their PCs for four years. So do we offer $12 a year of value where you can run tremendously more applications, it's tremendously easier to take care of? It's $12 a year when people are spending $90 to $100 a month on cell-phone bills, and we're talking about saving you hours and hours of time. I think it's a pretty good value proposition, myself.

On the threat of PC viruses and worms.

There is a lot we're doing, and a lot we have to do. The first thing that everybody says is: "Why don't you just make your software all better?" The truth is, it's a reasonable starting point for people to say. I think it would be unwise for us or anybody to assume about any product that it will be perfect. But the first thing you have to do is up the quality level. The second thing you have to say is: "O.K., if there is a problem, how do you help your customers fix that problem?" If you don't have this thing called Windows Update turned on, I recommend it. It automatically will come and take care of your computer. You can set it up so it installs critical security patches.

On spammers and hackers.

Unless bad guys are being punished, there is not enough of a deterrent. If somebody bombs an empty building and nobody dies but there is huge damage, everybody thinks that person is really not a very good person. If somebody spams you or if somebody does hundreds of millions of dollars of damage by sending out a virus, people say: "Oh, they are cute kids. They are hackers." The truth is, you can do just as much or more damage nowadays in the world of the Internet as you can in the physical world. I think it's important that we and other companies in our industry really do the right partnership with law enforcement to make sure there is enough deterrent.

On the threat to U.S. tech jobs from Indian and Chinese labor.

People focus oftentimes on the labor rate differential. But the thing that's most troubling is the graduation rate of technical graduates. The U.S. is No. 3 now in the world and falling quickly behind No. 1 and No. 2 [China and India] in terms of computer-science graduates. In the U.S., we have fewer computer-science graduates today than we did five years ago. The bigger issue is what kinds of things do we need to do to encourage more American kids.

On Microsoft's decision to keep most of its engineers in Redmond, Wash.

I like to have people physically close together. R&D is a large number for us. The critical issue for us is: Do we have the right product? Are we in the market at the right time? Do we have the innovation? I will trade off a number of things on the cost side to make sure that we have that. And it's not that Indian people can't figure that stuff out. But it helps to not only be in the maelstrom of activity, it helps to be close to the biggest market in the world. You've got to try things out on customers.

On his decision to expense stock options.

There are times in a company's evolution where I think stock options are a perfect way to compensate people. But stock options' value comes largely from volatility. You can make a lot of money on an option even if your stock really never goes up. Now the long-term shareholder is making nothing. So it's not very well aligned with shareholder interests. It's kind of a crazy way to pay your people. You should want to pay your people based upon success. We moved to stock awards, which are clearly more valuable if the stock is worth more and less valuable if the stock is worth less. We have tied the interests of shareholder and employee better.

On his future if Gates hadn't urged him to join Microsoft in 1980.

I probably would have taken a job as the assistant to the president of an [auto-insurance] company called Progressive Insurance in Cleveland....If it hadn't been for Bill's persistence and encouragement and advice, I would probably be selling auto insurance right now.

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