Microsoft looks to cash in on the iPhone

March 25, 2008: 9:01 AM ET
Five iPhones
Microsoft has a profitable business building software for the Mac; now it has an eye on the iPhone, too. Image: Apple
Tom Gibbons
Tom Gibbons, head of Microsoft's Specialized Devices and Applications Group, said the focus would be on extending Office functions onto the iPhone and iPod touch. Image: Microsoft

Don't think for a minute that Microsoft is ignoring the iPhone. In fact, the software giant is probing the gadget for profit opportunities.

For a little more than a week, a team of the company's Silicon Valley software engineers has been examining the iPhone software development kit (SDK for short), a set of tools Apple (AAPL) released this month that let outsiders build software for the iPhone and the iPod touch. Microsoft (MSFT) executives aren't sure yet whether they'll find worthwhile opportunities to sell iPhone software – but they seem eager to find out.

"It's really important for us to understand what we can bring to the iPhone," Tom Gibbons, corporate vice president of Microsoft's Specialized Devices and Applications Group, told Fortune on Monday. "To the extent that Mac Office customers have functionality that they need in that environment, we're actually in the process of trying to understand that now."

Though it's typical to think of Apple and Microsoft as pure software rivals, their relationship is actually more complicated. For more than a decade, Microsoft has maintained a group of engineers whose sole job is to develop software for Apple's Macintosh operating systems. Most of the engineers in Microsoft's Mac Business Unit are based in Mountain View, Calif., a few miles from Apple's headquarters. (They also happen to be quite close to the headquarters of archrival Google (GOOG).)

The Mac unit's work certainly isn't charity – it delivers millions of dollars in profit for the company with its Mac version of the Office productivity suite. Microsoft doesn't break out exact numbers, but we can extrapolate: Gibbons said the Mac Business Unit provides about a third of the revenue for the Specialized Devices and Applications Group, which also includes Windows Embedded, Microsoft Hardware, the Automotive Business Unit and Microsoft Surface Computing; the whole group did more than $1 billion in sales last year. So it's reasonable to guess that the Mac unit provided about $350 million – and since Gibbons said the Mac group was one of the group's more profitable units, it's possible that Microsoft made somewhere in the neighborhood of $200 million in profit from Mac software.

Which brings us to the iPhone. With the Mac Business Unit, Microsoft has long prided itself on having one of the largest groups of Mac developers outside of Apple. With that expertise in Mac software, and knowledge of the Microsoft Exchange protocols the iPhone will use for business e-mail, the chances are good that Microsoft will be able to develop extra iPhone goodies.

"We do have experience with that environment, and that gives us confidence to be able to do something," Gibbons said. "The key question is, what is the value that we need to bring? We're still getting comfortable with the SDK, right? It's just come out. So we had a guess as to what feasibility would be like, now we'll really get our head wrapped around that."

The Mac Business Unit isn't the only Microsoft group eyeing the iPhone as an opportunity. Voice recognition unit TellMe, which Microsoft purchased a year ago, also sees potential in the device. Of course, TellMe now spends much of its time developing for Microsoft's own Windows Mobile operating system. But as long as the iPhone SDK will allow software to take advantage of voice recording and location-based information, said general manager Mike McCue, TellMe will be all over it.

"If the SDK supports these things," McCue told Fortune in February, "we're absolutely going to get a version out there as soon as we can, get TellMe out there on the iPhone."

The iPhone software update that opens the door to such third-party software is due at the end of June; that's also when owners of the iPhone and iPod touch will be able to purchase the new programs. Until then, you can bet that developers everywhere – even at Microsoft – are hard at work.

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