Holiday Sales Help Push Profit Up at Microsoft

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Microsoft to Buy Nokia Units and Acquire Executive

Late Monday, Microsoft and Nokia said 32,000 Nokia employees would join Microsoft as a result of the all-cash deal, which is meant to turn the Finnish mobile phone pioneer into the engine for Microsoft’s mobile efforts.

Stephen Elop, the former Microsoft executive who was running Nokia until the deal was signed, will rejoin Microsoft after the transaction closes, setting him up as a potential successor to Steven A. Ballmer, Microsoft’s chief executive. Mr. Ballmer has said he will retire from the company within 12 months.

“This agreement is really a bold step into the future for Microsoft,” Mr. Ballmer said in a telephone interview from Finland. “We’re excited about the talent capabilities it will bring to Microsoft.”

The deal, which was first broached between Microsoft and Nokia executives in February, is the latest transformation of the 150-year-old Finnish company. Nokia began life as a conglomerate making products like rubber boots and car tires before reinventing itself in the 1980s as the world’s largest manufacturers of cellphones.

Nokia’s once mighty position in the mobile phone business has been lost, as the industry shifted to the era of the smartphone. Samsung and Apple divide nearly all of the profits in the global smartphone business now.

Nokia’s fall has been most spectacular in Asia, a region that its phones once dominated. As recently as 2010, the company had a 64 percent share of the smartphone market in China, according to Canalys, a research firm. By the first half of this year, that had plunged to 1 percent.

While Nokia phones used to be prized in Asia and other developing economies for their durability and value, the company was late to introduce innovations like touch screens. That left the high end of the market to brands like Apple and Samsung.

In the lower price ranges, smartphone makers from China have been more responsive to consumer demands, offering phones with features resembling those of their more expensive rivals at a fraction of the cost.

Risto Siilasmaa, Nokia’s interim chief executive, said on Tuesday that the sale of the handset business was the logical step in the company’s evolution but still pulled on his heartstrings.

“Selling a business is sometimes the right cause of action, but it’s emotionally complicated,” Mr. Siilasmaa said.

Consumers may be less concerned.

At a cellphone store in central London on Tuesday, Geoffrey Widdows, a 33-year-old engineer, said he had once been a devoted Nokia fan but now preferred Android phones because of the greater choice of apps available on phones from companies like Samsung and HTC.

“Everyone had a Nokia when I was growing up,” he said. “You just don’t see them around a lot anymore.”

A megadeal between Nokia and Microsoft is something that pundits and analysts have speculated about for years, after Mr. Elop joined Nokia and signed a pact with Microsoft in February 2011 to standardize the software company’s Windows Phone operating system.

The cellphone fortunes of the two companies have become closely intertwined since that agreement, but the relationship has done little to turn either company into a leader in the mobile business. Handsets running Windows Phone accounted for only 3.7 percent of smartphone shipments in the second quarter, according to the technology research firm IDC.

Nokia remains the second-largest shipper of mobile phones in the world, after Samsung, but that is largely because of lower-end feature phones, from which consumers are moving away. Nokia is no longer among the top five makers of smartphones.

A big question is whether Microsoft and Nokia will succeed as one company where they have not as close partners. Mr. Ballmer said Microsoft and Nokia had not been as agile separately as they would be jointly, citing how development could be slowed down when intellectual property rights were held by two different companies.

“There’s friction,” he said.

Mark Scott contributed reporting from London and Eric Pfanner contributed from Tokyo.

DealBook: For Microsoft, Nokia Deal Was Long and Arduous

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Needed at Microsoft: A Catch-Up Artist

About an hour into the conversation, someone asked about Microsoft. The company seemed to be treading water, the mantle of high-tech leadership had passed to Apple and Google, and investors were impatient with Microsoft’s stagnant stock price. The question: Would Mr. Gates, the Microsoft chairman, consider going back to run the company?

That question comes to mind again, after Microsoft announced on Friday that Steven A. Ballmer, the chief executive, would step down within a year.

The prospect of Mr. Gates’s riding to the rescue at Microsoft is intriguing but highly unlikely. Steven P. Jobs, the other celebrity entrepreneur of the early personal computer era, returned to Apple in 1997 and remade it. But in June, Mr. Gates brushed aside any suggestion that he would again lead Microsoft. The messiah option, he insisted, was not on the table. He had moved on, he said.

Mr. Gates stepped down as C.E.O. in 2000 after a bruising courtroom battle with the Justice Department. A federal court ruled that Microsoft had repeatedly violated the nation’s antitrust laws.

“Gates felt he was being penalized for success,” says Michael A. Cusumano, a professor at the Sloan School of Management at the Massachusetts Institute of Technology. “He left at a critical time, when Microsoft was facing new challenges, and he didn’t really look back.”

Mr. Ballmer was Mr. Gates’s old friend and chosen successor, but there is no obvious successor to Mr. Ballmer. One thing is clear: “Being the next chief executive of Microsoft isn’t going to be an easy task for anyone,” Mr. Cusumano says.

Mr. Cusumano is the co-author of two books about the company, “Microsoft Secrets” and “Competing on Internet Time,” which chronicled Microsoft’s assault on the commercial pioneer in Internet browsers, Netscape.

Mr. Cusumano and his co-author on the Microsoft-Netscape book, David B. Yoffie, a professor at the Harvard Business School, are now writing a book that examines the strategy and leadership lessons to be learned from three technology executives, Mr. Gates, Mr. Jobs and Andrew S. Grove, former chief executive of Intel.

There are examples for Microsoft to follow: a onetime technology leader has experienced a revival each decade since the 1980s. Back then, Intel was staggering under the Japanese challenge in the memory chip market. I.B.M. stepped in to make a 20 percent investment because Intel was a valued supplier, and the help gave the chip maker some financial breathing room. Intel then made the leap into microprocessors, the brainy chips that power personal computers.

In the 1990s, I.B.M. almost went under as the profits from its mainframe business were gutted by competition from low-cost PC-style computing. But I.B.M. retooled its mainframe business and moved into higher-margin software and services businesses.

In the 2000s, it was Apple’s turn. Under Mr. Jobs, the company first stabilized its desktop computer business with some nifty designs. Then Apple went on to transform the digital music business and smartphones, with the iPod, the iTunes store and the iPhone. And the iPad created the modern tablet market.

Can Microsoft pull off a similar revival act in this decade?

Microsoft is different from the other three companies in one important respect. It is facing a crisis of technology leadership, but not a financial crisis. Microsoft’s Windows operating systems and Office productivity software remain immensely profitable. By contrast, Intel, I.B.M. and Apple were fighting for survival. In each case, it was clear that drastic action was needed — and it was taken, successfully.

Microsoft’s seeming strength, according to George F. Colony, the chief executive of Forrester Research, has proved a weakness.

“I would argue Microsoft does have a financial problem, and it’s been the fear of losing those massive profits from Windows and Office,” Mr. Colony says. “By doing everything it can to try to protect those profits, Microsoft has taken a defensive position for more than a decade. And in technology, if you play defense you’re going to lose.”

Still, thanks to the success of its mainstay businesses, Microsoft has been able to afford multibillion-dollar investments in newer fields like Internet search, digital media players, smartphone software and, recently, tablets.

The problem for Microsoft has been that it has often been forced to make those investments while playing catch-up. In the search and smartphone markets, all the snowballing effects of leadership, brand recognition and consumer habits that helped Microsoft in the PC market are working against it as it tries to catch Google and Apple.

Past success can obscure new opportunities when emerging markets or technologies don’t operate by the same rules as a company’s tried-and-true products. And Microsoft has suffered from that kind of corporate myopia. In an interview with me in 2007, Mr. Ballmer acknowledged the problem.

“One of the biggest mistakes I’ve made over time is not wanting to nurture innovations where I either didn’t get the business model or we didn’t have it,” he said.

In his memo to Microsoft employees on Friday, Mr. Ballmer pointed to the challenge ahead for the company. At 57, he has decided to make way for a successor who can guide “our transformation to a devices and services company.”

No mention of software as such. But a big part of the job for Mr. Ballmer’s successor will be re-engineering Windows and Office for delivery over the Internet onto all kinds of devices including smartphones and tablets, according to Mr. Yoffie of the Harvard Business School.

Even if that is successful, the profit margins of the PC days will probably never return, especially when competing against free and low-cost alternatives, like Google’s Android operating system and Google Docs.

“But unless Microsoft makes that transition with its core products,” Mr. Yoffie says, “the company is in danger of heading into the kind of crisis it is trying to avoid.”

Microsoft Lifts the Dow; Other Indexes Also Rise

A big jump in Microsoft helped lift the Dow Jones industrial average on Friday.

Microsoft had its biggest gain in four years after its chief executive, Steven A. Ballmer, said he would retire. The surge for the company, part of the 30-member Dow, contributed more than a third of the index’s advance.

The Dow closed up 46.77 points, or 0.3 percent, at 15,010.51.

The stock market stumbled at midmorning after the government reported a plunge in new-home sales, then drifted steadily higher in the afternoon. Trading volume was very light.

The Commerce Department released data on July purchases of new homes, which showed that Americans had cut back sharply, a sign that higher mortgage rates may slow the housing recovery.

Sales of newly built homes dropped 13.4 percent to a seasonally adjusted annual rate of 394,000, the lowest in nine months. And sales fell from a rate of 455,000 in June, which was revised down from a previously reported 497,000.

The housing rebound that began last year has helped drive economic growth and create more construction jobs. But mortgage rates have climbed a percentage point since May. The increase has begun to steal some momentum from the market.

Sales of new homes are still up 7 percent in the 12 months ended in July. Yet the annual pace remains well below the 700,000 that is consistent with a healthy market.

July’s drop “may mark an ‘uh-oh’ kind of moment for the housing recovery,” said Mark Vitner, an economist at Wells Fargo Securities.

Homebuilder stocks declined sharply on Friday. Shares of Toll Brothers, D. R. Horton and Lennar — three of the nation’s largest builders — all fell more than 2.5 percent at the close of trading.

Traders reacted to the drop in home sales by buying bonds and gold, investments that become more attractive when the economy appears weaker.

In the market for government bonds, the price of the benchmark 10-year Treasury note rose 20/32 to 97 8/32, and its yield declined to 2.82 percent, from 2.89 percent late Thursday. The price of gold rose $25, or 1.8 percent, to $1,395 an ounce, the highest in two months.

Stocks have sagged in August on concerns that the Federal Reserve will start to pull back on its economic stimulus.

On Friday, the Standard & Poor’s 500-stock index edged up 6.54 points, or 0.4 percent, to 1,663.50. The Nasdaq composite index rose 19.09 points, or 0.5 percent, to 3,657.79. The Nasdaq exchange was closed for most of the afternoon Thursday because of a technical problem.

DealBook: Next Microsoft Chief Should Pare the Menu

Questions for Microsoft as It Nears a Crossroad

Justin Lane/European Pressphoto AgencySteven A. Ballmer, chief of Microsoft and a friend of the company’s chairman, Bill Gates, said he would retire in the next year.

Microsoft’s plan, announced Friday, to replace Steven A. Ballmer as its chief executive does not exactly follow — at least to people outside the company — the way they draft these things in business school.

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Steven Sinofsky
Left Microsoft last year amid friction and is seen as unlikely to return.

But Mr. Ballmer and Microsoft’s board have been considering the possibility of his retirement for some time. Still, because of Mr. Ballmer’s larger-than-life personality, the board’s reluctance to push back and the company’s recent product and financial problems, finding a new chief executive for Microsoft was never going to resemble a cut-and-dry, business-school case study, according to people with knowledge of the company.

“No one is an obvious candidate,” said Michael A. Cusumano, a professor of business and engineering at the Massachusetts Institute of Technology who studies strategy in the computer software industry. “All the really interesting people who were in the company over the last dozen years who might have been have left. I also find it hard to imagine they could bring an outsider in. Microsoft is known for having quite a lot of powerful groups within the company and they make life very difficult for anyone who tries to oversee them.”

Succession planning is a delicate issue for many companies, particularly one like Microsoft, where Mr. Ballmer has been a senior employee since 1980 and chief executive since 2000, and his longtime friend, Bill Gates, Microsoft’s co-founder, remains chairman.

“Particularly for a person like Ballmer, who really is one of the founders, leaving is almost like death, so it’s extremely difficult to have an orderly process,” said Joseph L. Bower, a professor at the Harvard Business School. “It requires a very grown-up relationship between the chief executive and his board.”

Industry insiders almost immediately began to place bets on which executives inside and outside Microsoft — and even outside the technology industry — could be tapped. The decision will go a long way to determining whether Microsoft will successfully transition to tech’s future of mobile computing and computing in a virtual cloud of data-storage devices.

But at the moment, at least, the betting cards are virtually empty.

Even though Mr. Ballmer had indicated he was going to retire when the youngest of his children went to college, which was in about two more years, “I think people thought Ballmer would maybe die with his boots on in that role,” Mr. Cusumano added.

Developing a succession plan is one of a board’s chief responsibilities, but only half of companies actively groom executives, according to a 2010 study by Stanford University’s Rock Center for Corporate Governance and Heidrick & Struggles, the executive search firm that is leading Microsoft’s search. Boards spend only an average two hours a year on succession planning, the study found.

“When you have such strong personalities as Gates and Ballmer, is the board really proactive with them, or is it more of a caretaker board?” said David Larcker, director of corporate governance research at Stanford University’s business school, who worked on the study.

Though it might not be obvious outside the boardroom, Microsoft’s directors have been planning the transition, according to a person briefed on the board’s meetings who was not authorized to speak about them publicly.

Discussions have been happening for a decade, the person said, and intensified in 2010. Several months ago, Mr. Ballmer suggested to the board that it was time to begin a formal succession process, the person said, and told directors on Wednesday that he would announce his retirement.

Mr. Ballmer and the board have discussed the attributes they want in the next chief executive and have been appraising internal and external executives who might be candidates. Over the last 18 to 24 months, Mr. Ballmer has personally met with several outside executives, including people outside the tech industry with experience transforming very large companies, according to the person knowledgeable about the board’s work.

Nick Wingfield contributed reporting.

Ballmer Exit Brings Microsoft a Chance for Reinvention

Ballmer Through the Years: Moments of Steven A. Ballmer from conferences, commercials and interviews over the years that he was Microsoft’s chief executive.

SEATTLE — Steven A. Ballmer announced on Friday that he was leaving the top job at Microsoft, paving the way for a generational change at the once-dominant technology company and giving it an opportunity to reinvent itself for a world dominated by mobile devices, social media and other technologies that have eluded its influence.

A number of powerful executives have departed Microsoft over the years. While some current executives have recently risen to prominence, here is a look at some who had been mentioned previously as possible choices to take over the company.

Mr. Elop was the head of Microsoft's business division from 2008 until 2010, when he left to take the chief executive job at Nokia. In 2011, Nokia announced a smartphone alliance with Microsoft.

Mr. Johnson worked at Microsoft for 16 years, running the company's online services group and its Windows division. He left to become the chief executive of Juniper Networks in 2008. In July, Mr. Johnson announced his retirement from Juniper.

Mr. Maritz was effectively the No. 3 executive at the company when he left in 2000. He later became the chief executive of VMWare, but he stepped aside last year. Mr. Maritz is now the chief executive of Pivotal, a cloud-based start-up.

Mr. Raikes spent 27 years at Microsoft, the last eight running the company's business division. He left in 2008 to become the chief executive of the Bill & Melinda Gates Foundation.

Mr. Sinofsky was both widely admired and considered abrasive as the head of Windows, and his exit from the company last year is said to have come after a string of run-ins with Microsoft’s leaders. On Thursday, he announced that he had joined Andreessen Horowitz, the venture capital firm, as a board partner.

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But with no clear successor to Mr. Ballmer lined up and a jumble of businesses that will require the skills of a polymath to run, the company still faces huge obstacles to reclaiming its former glory.

While Microsoft in Mr. Ballmer’s reign as chief executive has yielded the spotlight to more glamorous companies like Apple, Google and Facebook, it still makes some of the biggest money-gushers in the technology business, including its Windows operating system for personal computers and Office applications like Word. Its profit last quarter was nearly $5 billion, compared with $3.2 billion for Google and $6.9 billion for Apple. Anyone who uses a PC to create a résumé or a term paper or to do online banking is more often than not doing so on a machine running Windows.

But the PC business, which Microsoft has ruled for decades, is under siege by mobile devices like tablets, an area that Microsoft has stumbled in, and that Mr. Ballmer famously underestimated. Analysts say the company needs to act quickly to right itself.

“The walls are falling now,” said George Colony, chief executive of Forrester Research, a research and advisory firm. “They may fall very quickly. There’s not much time for the board.”

Nonetheless, it has given itself a year to choose a successor, and Mr. Ballmer, 57, will stay on until then. The company declined requests for an interview with him.

Some analysts have suggested that Microsoft could use a seasoned turnaround artist in the mold of Lou Gerstner, who rescued I.B.M. from irrelevance in the 1990s. Current and former Microsoft executives said the company would more likely turn to someone with a technology pedigree. Some pundits have called for Bill Gates, Microsoft’s co-founder and chairman, to return to the company, in a nod to how Steven P. Jobs revitalized Apple.

But people who know him said Mr. Gates has no intention of doing that because of his full-time focus on philanthropy.

Others believe Microsoft is not governable in its current form. Ben Slivka, a 14-year employee of Microsoft who left in 1999, said the company should split up into five independent companies he calls “Baby Bills” devoted to Windows client software, Office applications, servers, Xbox and the Web.

“Give each of them (say) $5B for a rainy day, but not much more,” Mr. Slivka wrote in a post on Facebook after the news of Mr. Ballmer’s retirement. “You want them to be hungry. Return most of the cash hoard to shareholders.”

That Mr. Ballmer announced his plans without a successor in place is puzzling and led to speculation among current and former Microsoft executives that Mr. Gates might have been losing patience with his longtime friend, whom he first met when they were students at Harvard University in the 1970s. A spokesman for Mr. Gates said he was not available for interviews.

While the board, Mr. Ballmer and Microsoft gave no public indication that he was pushed out, the disappointing stock price may have been a factor in his departure. Over Mr. Ballmer’s 13-year tenure at Microsoft, the stock has lost 36 percent of its value, if the dividends that Microsoft pays out are excluded. Apple, meanwhile, was up nearly 2,000 percent over the same period. With the announcement of Mr. Ballmer’s departure on Friday, Microsoft’s stock rose more than 7 percent, closing at $34.75.

“Microsoft will have to go through a very hard and painful transition,” said Joachim Kempin, a former senior Microsoft executive, who has written a book critical of the company under Mr. Ballmer. “I’m not very confident the next guy will be able to immediately turn the ship around.”

This year, ValueAct, a hedge fund known for behind-the-scenes shareholder activism, began acquiring a small stake in Microsoft. Some analysts say they believe other shareholders might have been willing to join with the fund in efforts to lobby for management changes at the company. Two years ago, the investor David Einhorn said Mr. Ballmer was “stuck in the past” and called for him to go.

Mr. Ballmer provided plenty of fodder for such critics over the years with his dismissals of technologies that turned out to be game-changers. At a forum in Seattle in 2007, shortly after Mr. Jobs introduced the iPhone, Mr. Ballmer said there was “no chance that the iPhone is going to get any significant market share.”

Wall Street Rebounds to End Three-Day Drop as Microsoft Gains

The three major U.S. stock indexes shook off early losses as Microsoft shares climbed. The stock closed up 2.6 percent at $32.89 in heavy volume. The S&P information technology sector index rose 0.4 percent.

Shares of Tesla Motors Inc jumped 14.3 percent to $153.48 a day after the electric car maker posted an unexpected quarterly profit. The stock has been a major momentum favorite this year, up almost 350 percent in 2013.

"There definitely seems to be some big runners. Microsoft was up quite a bit," said Peter Jankovskis, co-chief investment officer of OakBrook Investments LLC in Lisle, Illinois.

"It could be people decided there are some bargains out there. It's kind of odd that we had a fair amount of this tapering talk the past few days. So I'm surprised in that regard that people have decided to step back in."

Stocks had inched lower much of this week, pulling back from last week's record levels, on concerns that the Federal Reserve will start to reduce its stimulus efforts this year as the economy recovers. Gains in equities have been closely linked to the Fed's stimulative policy, and many investors are worried that economic growth may stall without the Fed's intervention.

In the latest comments from a Fed official, Richard Fisher, president of the Federal Reserve Bank of Dallas, reiterated that the central bank will probably begin cutting back on its massive bond-buying stimulus next month, as long as economic data continues to improve.

The Dow Jones industrial average rose 27.65 points or 0.18 percent, to end at 15,498.32. The S&P 500 gained 6.57 points or 0.39 percent, to 1,697.48. The Nasdaq Composite Index added 15.115 points or 0.41 percent, to 3,669.124.

Volume was once again light, with about 5.81 billion shares traded on the New York Stock Exchange, the NYSE MKT and the Nasdaq, below the daily average of 6.35 billion. Volume has yet to climb above 6 billion for any trading day this week.

Groupon Inc shares soared 21.6 percent to $10.60. Late Wednesday, the online coupon company reported revenue that exceeded expectations and named its co-founder as chief executive.

JPMorgan Chase & Co was among the Dow's worst performers. The stock fell 0.9 percent to $54.83. JPMorgan Chase, which is the biggest U.S. bank ranked by assets, faces a criminal probe by the U.S. Department of Justice over sales of mortgage-backed securities.

Data showed U.S. weekly jobless claims rose less than expected to 333,000 in the latest week, while the four-week average fell to 335,500, its lowest level since before the recession in 2007 through 2009.

Orbitz Worldwide Inc, an online travel agency, reported higher-than-expected quarterly earnings as it sold more hotel and vacation packages, and forecast full-year revenue above analysts' estimates. Orbitz shares surged 36.7 percent to $12.62.

After the closing bell, Priceline.com shares rose 5.1 percent to $981.46 after the online travel agency said quarterly profit rose on improved hotel and car-rental reservations. The stock had ended regular trading at $933.75, up 0.7 percent ahead of its earnings.

Of 442 companies in the S&P 500 that had reported earnings through Thursday morning, Thomson Reuters data showed that 67 percent topped analysts' expectations, matching the beat rate over the past four quarters. In terms of revenue, 53.6 percent exceeded estimates, more than the 48 percent rate over the past four quarters, but below the 61 percent average since 2002.

Advancing stocks outnumbered declining ones on the NYSE by a ratio of 2 to 1, while on the Nasdaq, three stocks rose for every two that fell.

(Editing by Jan Paschal)

Bits Blog: Is Google More Like Microsoft or Apple?

Weak PC Market Catches Up to Microsoft

On Thursday, the company missed Wall Street forecasts, blaming the declining PC market for the shortfall. Microsoft also acknowledged the disappointing sales of one of its most prominent products, its Surface RT tablet computer, by taking a $900 million charge to reflect unsold inventory of the device.

“It finally caught up to them,” said Colin W. Gillis, an analyst at BGC Partners. “We’ve been in a PC recession for five quarters.”

For the fiscal fourth quarter that ended June 30, Microsoft, which is based in Redmond, Wash., reported net income of $4.97 billion, or 59 cents a share, in contrast to a loss of $492 million, or 6 cents a share, in the period a year earlier. Last year, Microsoft took a $6 billion write-down on a soured acquisition, wiping out its overall profit.

In the latest quarter, revenue rose 10 percent, to $19.9 billion, from $18.06 billion a year earlier.

Those results fell well short of the average analyst estimates compiled by Thomson Reuters of 75 cents a share in earnings and $20.73 billion in revenue.

Revenue from Microsoft’s Windows business, which includes its Surface tablet computers, rose 6 percent, to $4.41 billion. But without including the favorable impact from an upgrade offer last year, Microsoft’s Windows revenue fell 6 percent in the quarter.

Last week, the research firm Gartner reported that global PC shipments declined 10.9 percent in the second quarter of the year, the fifth consecutive quarter of declining PC shipments, the longest ever.

Mobile devices have sapped much of the gusto out of the PC market. Many people are buying tablet computers, especially Apple’s iPad, instead of PCs to watch movies, surf the Web and write e-mails.

“We know we have to do better, particularly on mobile devices,” Amy Hood, Microsoft’s chief financial officer, said in an interview.

Ms. Hood said the company’s Windows business is a “tale of two markets,” one in which PC sales to businesses continue to grow modestly, while consumer demand for the machines is fizzling. She estimated that total industry PC shipments to the consumer market fell more than 20 percent during the quarter.

She said that a companywide reorganization that Microsoft announced last week was part of an effort to better position the business for big changes in technology, including the shift to mobile devices.

Until its most recent quarter, Microsoft showed a remarkable aptitude for finding ways to squeeze money out of its venerable business, despite the problems in the PC market. It did that through lucrative multiyear software contracts with corporate customers that tend to move far more slowly than consumers in adopting newer technologies.

Parts of Microsoft that cater more to businesses helped lessen the sting. Microsoft said revenue in its server and tools group rose 9 percent, to $5.5 billion. Revenue in its business division, dominated by the Office suite of applications, jumped 14 percent, to $7.21 billion. But the division grew only 2 percent without deferred revenue related to an earlier upgrade offer.

Office is under siege from a suite of online applications from Google and others, which has led Microsoft to adapt the software so it can be delivered as a service through cloud computing. Microsoft said that if Office 365, the version of its productivity applications that are offered as a service, were to perform for a full year at current levels, it would generate $1.5 billion in revenue.

“The consumer has voted,” said Barbara Coffey, an analyst at S&P Capital IQ. “I don’t know that enterprise has yet. We’ve seen such a big shift to tablets. Microsoft just doesn’t play in tablets at the same level that they do in PCs.”

Investors had become more bullish on Microsoft’s ability to navigate the disruption of the PC market, sending its shares up more than 32 percent this year. But after the release of its financial results, shares of Microsoft dropped more than 6 percent in after-hours trading. They ended regular trading at $35.44, down 30 cents.

Microsoft Profit Misses as Surface Tablets Languish; Shares Drop

The stock fell 5 percent after hours from 5-year highs.

The massive charge underlines the struggles of the world's largest software company, which last week announced a deep reorganization to transform itself into a "devices and services" leader, but is struggling to make mobile computing as attractive as Apple Inc or Google Inc.

"That's the biggest miss we've ever seen from Microsoft, the biggest that I could remember," said Brendan Barnicle, an analyst at Pacific Crest Securities. "It looks like everything was weak."

Before the sell-off late Thursday, Microsoft shares had risen 32 percent this year, beating a 19 percent rise in the Standard & Poor's 500 index.

Microsoft said the $900 million charge was related to its Surface RT tablet, the version of its tablet running on ARM Holdings-designed chips. The Surface was meant to challenge Apple's iPad when it was launched alongside Windows 8 in October, but has not sold well.

Earlier this week, Microsoft said it was drastically cutting prices and expanding distribution of the model to entice buyers, reducing the value of Surface devices in its inventory.

"We do know we have to do better, particular in mobile devices," Amy Hood, Microsoft's new chief financial officer, said in a telephone interview. "That's a big reason we made the strategic organizational changes last week."

Microsoft's biggest shake-up in five years, unveiled by Chief Executive Steve Ballmer last week, creates a single devices unit for the first time at the company, suggesting that it will double down on its so-far unsuccessful move into hardware.

Redmond, Washington-based Microsoft reported fiscal fourth-quarter profit of 59 cents per share, compared with a 6 cents per share loss in the year-ago quarter when it wrote off the cost of a failed acquisition.

Wall Street had estimated earnings of 75 cents per share, on average, according to Thomson Reuters I/B/E/S. Excluding the Surface charge, Microsoft reported 66 cents per share profit, a less drastic miss.

Revenue rose 10 percent to $19.9 billion, helped by sales of Microsoft's Office suite of applications, but fell short of analysts' average estimate of $20.7 billion.

Sales of Windows rose slightly, but only because of the inclusion of some deferred revenue, weighed down by an estimated 11 percent dip in PC sales in the quarter.

Microsoft's Windows 8 has sold more than 100 million licenses since launching in October, but is struggling to win over many consumers confused by the new design which is more suited to tablets than traditional PCs. Acknowledging this, Microsoft is releasing a revamped version of the system called Windows 8.1 later this year, which brings back the iconic 'start' button.

(Additional reporting by Liana Baker in New York; Editing by Richard Chang)

State of the Art: Microsoft Office for the iPhone Is Here. Yawn.

Office for iPhone is big news, but not because the software is earthshaking. No, it’s a big deal primarily because of the politics of the situation — the optics, as public relations people say.

Here is Microsoft — the once-mighty software global overlord, years into its repeated failures to produce a successful smartphone — creating an app that lets you edit Word, Excel and PowerPoint files on the gadget that defeated it, the iPhone. It’s as if somewhere along the line, Microsoft executives started wearing “If you can’t beat ‘em, join ‘em” T-shirts.

Microsoft, of course, doesn’t see it that way. The company reports tiny but measurable upticks in sales of its own Windows Phone (which actually is a terrific phone). So why, then, did Microsoft create Office Mobile for the iPhone?

Here’s a hint: You can’t buy the Office Mobile app outright. It’s free with your paid subscription to Microsoft’s Office 365 plan, which costs $100 a year. It’s a service that lets you download Word, Excel and PowerPoint to up to five Mac or Windows computers.

Since Office 365 arrived, Microsoft has been busily trying to sweeten the offer. Office 365 membership gets you one hour of free phone calls a month using Skype. It also gives you 20 extra gigabytes of storage on the SkyDrive, an online hard drive for backing up or transferring documents. (Nonsubscribers get 7 gigabytes free.)

And now it gets you this app for iPhone (iPhone 4 and later) and iPod Touch (5 or later). That’s why its impressively clunky full name is Office Mobile for Office 365 Subscribers. (Office Mobile is already available on Windows Phones, and doesn’t require any subscription.)

You can run the app on up to five iPhones. If you ever stop paying for your Office 365 membership, the app stops working. Your documents are safe in that case, however. They’re both on your phone (until you delete the app) and on your free SkyDrive.

To use the app, you enter your Office 365 name and password. Once you’ve signed in, you see a list of all the Word, Excel and PowerPoint files that you’ve stashed on your SkyDrive. When you select a document’s name, it rapidly downloads to your phone, and you can work on it without an Internet connection. Next time you’re online, the changes get sent back to the SkyDrive original. You can also use Office Mobile to edit documents that people sent to you as attachments in the iPhone’s Mail app.

But once you tap a document to open it, you quickly discover that this app isn’t anything like the full Microsoft Office — it’s more like the Microsoft Vestibule. It’s extremely stripped down. It offers only the features Microsoft thinks you’ll realistically use on a bus or in the doctor’s office with nothing but your phone in hand.

The miniature Word module, for example, offers comments, outline view, bold/italic/underline/strikethrough styles, font and background colors and highlighting. You type, cut, copy and paste using variations on the iPhone’s standard finger gestures. And when you open a Word document, it jumps to the spot where you were last reading on your computer. Slick.

Notably absent: style sheets (normal, heading 1 and so on). Spelling checker. An undo command. The ability to change the font or insert a graphic. You can make the type bigger or smaller, but you can’t specify a size by number. Layout-intensive documents — lots of boxes, embedded graphics and so on — sometimes don’t come through to the phone fully intact.

The Excel module is by far the most fully featured app. It displays most elements of a spreadsheet, including charts and graphics. You can scroll around with your finger, zoom in or out with two fingers, lock a row or a column so it doesn’t scroll, rotate the phone for a wider view, edit comments, flip into outline view, edit formulas, create graphs, change numbers, sort, find, filter and format text and numbers. If the sheet has multiple pages, you can switch among using bottom edge tabs, exactly as on a computer. There’s an undo command. (Why here, and not in Word?)

Notably absent: you can’t rearrange rows or columns (although you can adjust row heights and column widths), and you can’t insert new ones.

Bits Blog: Microsoft Names First Female Finance Chief

Microsoft Amy Hood, Microsoft’s new chief financial officer.

Microsoft named Amy Hood, an executive at the company, as its chief financial officer, the first woman to hold the top finance job at Microsoft.

Ms. Hood, 41, joined Microsoft in late 2002 and was most recently the chief financial officer of Microsoft’s business division, the unit that oversees its lucrative Office suite of applications. She replaces Peter Klein, Microsoft’s chief financial officer who announced recently that he was resigning to spend more time with his family.

A number of women have risen to Microsoft’s top ranks, but like most technology companies, its senior leadership is still dominated by men. One exception is Lisa Brummel, who, as chief people officer, runs the company’s human resources department. Late last year, Microsoft appointed two women, Julie Larson-Green and Tami Reller, to run the engineering and finance operations of the company’s Windows division, one of its most important units.

As chief financial officer, Ms. Hood will play a bigger role in helping Microsoft adapt to major changes in its business, most notably the shift to mobile devices from PCs and the transformation of traditional software into cloud services. In a sign of these changes, for the last six months, Steve Ballmer, the chief executive officer, has begun talking about Microsoft as a devices and services company.

Ms. Hood will also serve as Microsoft’s ambassador to Wall Street, which has for years looked skeptically at the company’s efforts to enter new businesses like Internet search. After a recent solid earnings report from Microsoft, investors have become more bullish on the company’s prospects. Its shares now trade near their 52-week high.

In an e-mail to Microsoft employees on Wednesday, Mr. Ballmer said Ms. Hood had helped lead the change of Microsoft Office into a cloud service. He said that he worked closely with her on two big acquisitions, that of Skype and Yammer, and that her critical thinking would be an important skill in her new job.

“Amy is a great collaborator with a history of successful cross-group projects, and I am looking forward to having her as a member of my leadership team,” Mr. Ballmer wrote.

U.S. Said to Look Into Microsoft Bribery Allegations

The United States Department of Justice and the Securities and Exchange Commission have both opened preliminary investigations into the bribery allegations involving Microsoft in China, Italy and Romania, according to the person, who declined to be named because the inquiry is a confidential legal matter.

Microsoft’s practices in those countries are being looked at for potential violations of the Foreign Corrupt Practices Act, a federal law that prohibits American companies from making illegal payments to government officials and others overseas to further their business interests.

In a blog post Tuesday afternoon, John Frank, vice president and deputy general counsel of Microsoft, said the company could not comment about continuing inquiries. Mr. Frank said it was not uncommon for such government reviews to find that allegations were without merit.

“We take all allegations brought to our attention seriously and we cooperate fully in any government inquiries,” Mr. Frank said in the blog post. “Like other large companies with operations around the world we sometimes receive allegations about potential misconduct by employees or business partners and we investigate them fully regardless of the source. We also invest heavily in proactive training, monitoring and audits to ensure our business operations around the world meet the highest legal and ethical standards.”

The Wall Street Journal first reported news of the investigations on its Web site on Tuesday.

Michael Passman, a spokesman for the Justice Department, said the department had a policy of not confirming or denying the existence of investigations. A spokesman for the S.E.C. could not be reached immediately for comment.

The allegations in China were first shared with United States officials last year by an unnamed whistle-blower, who had worked with Microsoft in the country, according to the person briefed on the inquiry. The whistle-blower said that a Microsoft official in China directed the whistle-blower to pay bribes to government officials to win business deals, this person said. After this incident, the whistle-blower had a business conflict with Microsoft, the person added.

In 2010, Microsoft itself conducted an internal investigation of the allegations, with the help of an outside law firm, that found no evidence of improper behavior, this person said.

The federal agencies are also looking at Microsoft’s relationship with outsiders in Romania and Italy, including software resellers and consultants, who are said to have bribed government officials to secure contracts for government business, this person said.

Edward Wyatt contributed reporting from Washington and Ben Protess from New York.

Microsoft Battles Google by Hiring Political Brawler Mark Penn

SEATTLE — Mark Penn made a name for himself in Washington by bulldozing enemies of the Clintons. Now he spends his days trying to do the same to Google, on behalf of its archrival Microsoft.

Since Mr. Penn was put in charge of “strategic and special projects” at Microsoft in August, much of his job has involved efforts to trip up Google, which Microsoft has failed to dislodge from its perch atop the lucrative Internet search market.

Drawing on his background in polling, data crunching and campaigning, Mr. Penn created a holiday commercial that has been running during Monday Night Football and other shows, in which Microsoft criticizes Google for polluting the quality of its shopping search results with advertisements. “Don’t get scroogled,” it warns. His other projects include a blind taste test, Coke-versus-Pepsi style, of search results from Google and Microsoft’s Bing.

The campaigns by Mr. Penn, 58, a longtime political operative known for his brusque personality and scorched-earth tactics, are part of a broader effort at Microsoft to give its marketing the nimbleness of a political campaign, where a candidate can turn an opponent’s gaffe into a damaging commercial within hours. They are also a sign of the company’s mounting frustration with Google after losing billions of dollars a year on its search efforts, while losing ground to Google in the browser and smartphones markets and other areas.

Microsoft has long attacked Google from the shadows, whispering to regulators, journalists and anyone else who would listen that Google was a privacy-violating, anticompetitive bully. The fruits of its recent work in this area could come next week, when the Federal Trade Commission is expected to announce the results of its antitrust investigation of Google, a case that echoes Microsoft’s own antitrust suit in the 1990s. A similar investigation by the European Union is also wrapping up. A bad outcome for Google in either one would be a victory for Microsoft.

But Microsoft, based in Redmond, Wash., has realized that it cannot rely only on regulators to scrutinize Google — which is where Mr. Penn comes in. He is increasing the urgency of Microsoft’s efforts and focusing on their more public side.

In an interview, Mr. Penn said companies underestimated the importance of policy issues like privacy to consumers, as opposed to politicians and regulators. “It’s not about whether they can get them through Washington,” he said. “It’s whether they can get them through Main Street.”

Jill Hazelbaker, a Google spokeswoman, declined to comment on Microsoft’s actions specifically, but said that while Google also employed lobbyists and marketers, “our focus is on Google and the positive impact our industry has on society, not the competition.”

In Washington, Mr. Penn is a lightning rod. He developed a relationship with the Clintons as a pollster during President Bill Clinton’s 1996 re-election campaign, when he helped identify the value of “soccer moms” and other niche voter groups.

As chief strategist for Hillary Clinton’s unsuccessful 2008 campaign for president, he conceived the “3 a.m.” commercial that raised doubts about whether Barack Obama, then a senator, was ready for the Oval Office. Mr. Penn argued in an essay he wrote for Time magazine in May that “negative ads are, by and large, good for our democracy.”

But his approach has ended up souring many of his professional relationships. He left Mrs. Clinton’s campaign after an uproar about his consulting work for the government of Colombia, which was seeking the passage of a trade treaty with the United States that Mrs. Clinton, then a senator, opposed.

“Google should be prepared for everything but the kitchen sink thrown at them,” said a former colleague who worked closely with Mr. Penn in politics and spoke on condition of anonymity. “Actually, they should be prepared for the kitchen sink to be thrown at them, too.”

Hiring Mr. Penn demonstrates how seriously Microsoft is taking this fight, said Michael A. Cusumano, a business professor at M.I.T. who co-wrote a book about Microsoft’s browser war.

“They’re pulling out all the stops to do whatever they can to halt Google’s advance, just as their competition did to them,” Professor Cusumano said. “I suppose that if Microsoft can actually put a doubt in people’s mind that Google isn’t unbiased and has become some kind of evil empire, they might very well get results.”

Nick Wingfield reported from Seattle and Claire Cain Miller from San Francisco.

Microsoft Battles Google by Hiring Political Brawler Mark Penn

SEATTLE — Mark Penn made a name for himself in Washington by bulldozing enemies of the Clintons. Now he spends his days trying to do the same to Google, on behalf of its archrival Microsoft.

Since Mr. Penn was put in charge of “strategic and special projects” at Microsoft in August, much of his job has involved efforts to trip up Google, which Microsoft has failed to dislodge from its perch atop the lucrative Internet search market.

Drawing on his background in polling, data crunching and campaigning, Mr. Penn created a holiday commercial that has been running during Monday Night Football and other shows, in which Microsoft criticizes Google for polluting the quality of its shopping search results with advertisements. “Don’t get scroogled,” it warns. His other projects include a blind taste test, Coke-versus-Pepsi style, of search results from Google and Microsoft’s Bing.

The campaigns by Mr. Penn, 58, a longtime political operative known for his brusque personality and scorched-earth tactics, are part of a broader effort at Microsoft to give its marketing the nimbleness of a political campaign, where a candidate can turn an opponent’s gaffe into a damaging commercial within hours. They are also a sign of the company’s mounting frustration with Google after losing billions of dollars a year on its search efforts, while losing ground to Google in the browser and smartphones markets and other areas.

Microsoft has long attacked Google from the shadows, whispering to regulators, journalists and anyone else who would listen that Google was a privacy-violating, anticompetitive bully. The fruits of its recent work in this area could come next week, when the Federal Trade Commission is expected to announce the results of its antitrust investigation of Google, a case that echoes Microsoft’s own antitrust suit in the 1990s. A similar investigation by the European Union is also wrapping up. A bad outcome for Google in either one would be a victory for Microsoft.

But Microsoft, based in Redmond, Wash., has realized that it cannot rely only on regulators to scrutinize Google — which is where Mr. Penn comes in. He is increasing the urgency of Microsoft’s efforts and focusing on their more public side.

In an interview, Mr. Penn said companies underestimated the importance of policy issues like privacy to consumers, as opposed to politicians and regulators. “It’s not about whether they can get them through Washington,” he said. “It’s whether they can get them through Main Street.”

Jill Hazelbaker, a Google spokeswoman, declined to comment on Microsoft’s actions specifically, but said that while Google also employed lobbyists and marketers, “our focus is on Google and the positive impact our industry has on society, not the competition.”

In Washington, Mr. Penn is a lightning rod. He developed a relationship with the Clintons as a pollster during President Bill Clinton’s 1996 re-election campaign, when he helped identify the value of “soccer moms” and other niche voter groups.

As chief strategist for Hillary Clinton’s unsuccessful 2008 campaign for president, he conceived the “3 a.m.” commercial that raised doubts about whether Barack Obama, then a senator, was ready for the Oval Office. Mr. Penn argued in an essay he wrote for Time magazine in May that “negative ads are, by and large, good for our democracy.”

But his approach has ended up souring many of his professional relationships. He left Mrs. Clinton’s campaign after an uproar about his consulting work for the government of Colombia, which was seeking the passage of a trade treaty with the United States that Mrs. Clinton, then a senator, opposed.

“Google should be prepared for everything but the kitchen sink thrown at them,” said a former colleague who worked closely with Mr. Penn in politics and spoke on condition of anonymity. “Actually, they should be prepared for the kitchen sink to be thrown at them, too.”

Hiring Mr. Penn demonstrates how seriously Microsoft is taking this fight, said Michael A. Cusumano, a business professor at M.I.T. who co-wrote a book about Microsoft’s browser war.

“They’re pulling out all the stops to do whatever they can to halt Google’s advance, just as their competition did to them,” Professor Cusumano said. “I suppose that if Microsoft can actually put a doubt in people’s mind that Google isn’t unbiased and has become some kind of evil empire, they might very well get results.”

Nick Wingfield reported from Seattle and Claire Cain Miller from San Francisco.

Microsoft Renews Relevance With Machine Learning Technology

SEATTLE — Eric Horvitz joined Microsoft Research 20 years ago with a medical degree, a Ph.D. in computer science and no plans to stay. “I thought I’d be here six months,” he said.

He remained at M.S.R., as Microsoft’s advanced research arm is known, for the fast computers and the chance to work with a growing team of big brains interested in cutting-edge research. His goal was to build predictive software that could get continually smarter.

In a few months, Mr. Horvitz, 54, may get his long-awaited payoff: the advanced computing technologies he has spent decades working on are being incorporated into numerous Microsoft products.

Next year’s version of the Excel spreadsheet program, part of the Office suite of software, will be able to comb very large amounts of data. For example, it could scan 12 million Twitter posts and create charts to show which Oscar nominee was getting the most buzz.

A new version of Outlook, the e-mail program, is being tested that employs Mr. Horvitz’s machine-learning specialty to review users’ e-mail habits. It could be able to suggest whether a user wants to read each message that comes in.

Elsewhere, Microsoft’s machine-learning software will crawl internal corporate computer systems much the way the company’s Bing search engine crawls the Internet looking for Web sites and the links among them. The idea is to predict which software applications are most likely to fail when seemingly unrelated programs are tweaked.

If its new products work as advertised, Microsoft will find itself in a position it has not occupied for the last few years: relevant to where technology is going.

While researchers at M.S.R. helped develop Bing to compete with Google, the unit was widely viewed as a pretty playground where Bill Gates had indulged his flights of fancy. Now it is beginning to put Microsoft close to the center of a number of new businesses, like algorithm stores and speech recognition services. “We have more data in many ways than Google,” said Qi Lu, who oversees search, online advertising and the MSN portal at Microsoft.

M.S.R. owes its increased prominence as much to the transformation of the computing industry as to its own hard work. The explosion of data from sensors, connected devices and powerful cloud computing centers has created the Big Data industry. Computers are needed to find patterns in the mountains of data produced each day.

“Everything in the world is generating data,” said David Smith, a senior analyst with Gartner, a technology research firm. “Microsoft has so many points of presence, with Windows, Internet Explorer, Skype, Bing and other things, that they could do a lot. Analyzing vast amounts of data could be a big business for them.”

Microsoft is hardly alone among old-line tech companies in injecting Big Data into its products. Later this year, Hewlett-Packard will showcase printers that connect to the Internet and store documents, which can later be searched for new information. I.B.M. has hired more than 400 mathematicians and statisticians to augment its software and consulting. Oracle and SAP, two of the largest suppliers of software to businesses, have their own machine-learning efforts.

In the long term, Microsoft hopes to combine even more machine learning with its cloud computing system, called Azure, to rent out data sets and algorithms so businesses can build their own prediction engines. The hope is that Microsoft may eventually sell services created by software, in addition to the software itself.

“Azure is a real threat to Amazon Web Services, Google and other cloud companies because of its installed base,” said Anthony Goldbloom, the founder of Kaggle, a predictive analytics company. “They have data from places like Bing and Xbox, and in Excel they have the world’s most widely used analysis software.”

Like other giants, Microsoft also has something that start-ups like Kaggle do not: immense amounts of money — $67 billion in cash and short-term investments at the end of the last quarter — and the ability to work for 10 years, or even 20, on a big project.

It has been a long trip for Microsoft researchers. M.S.R. employs 850 Ph.D.’s in 13 labs around the world. They work in more than 55 areas of computing, including algorithm theory, cryptography and computational biology.

Machine learning involves computers deriving meaning and making predictions from things like language, intentions and behavior. When search engines like Google or Bing offer “did you mean?” alternatives to what you misspelled in a query, they are employing machine learning. Mr. Horvitz, now a distinguished scientist at M.S.R., uses machine learning to analyze 25,000 variables and predict hospital patients’ readmission risk. He has also used it to deduce the likelihood of traffic jams on a holiday when it is expected to rain.

Mr. Horvitz started making prototypes of the Outlook assistant about 15 years ago. He keeps digital records of every e-mail, appointment and phone call so the software can learn when his meetings might run long, or which message he should answer first.

“Major shifts depend on incremental changes,” he said.

At a retreat in March, 100 top Microsoft executives were told to think of new ways that machine learning could be used in their businesses.

“It’s exciting when the sales and marketing divisions start pulling harder than we can deliver,” Mr. Horvitz said. “Magic in the first go-round becomes expectation in the next.”

As Microsoft Shifts Its Privacy Rules, an Uproar Is Absent

Microsoft instituted a policy on Friday that gives the company broad leeway over how it gathers and uses personal information from consumers of its free, Web-based products like e-mail, search and instant messaging.

Almost no one noticed, however, even though Microsoft’s policy changes are much the same as those that Google made to its privacy rules this year.

Google’s expanded powers drew scathing criticism from privacy advocates, probing inquiries from regulators and broadside attacks from rivals. Those included Microsoft, which bought full-page newspaper ads telling Google users that Google did not care about their privacy, an accusation it quickly denied.

The difference in the two events illustrates the confusion surrounding Internet consumer privacy. No single authority oversees the collection of personal information from Web users by Internet companies. Though most companies have written privacy policies, they are often stated in such broad, ambiguous language that they seem to allow virtually any use of customers’ personal information.

Web companies like Microsoft and Google have been moving aggressively to expand their abilities to gather and sort information about individuals’ habits and interests — even as Congress, federal regulators and the Obama administration have been seeking ways to protect Internet users against unwanted privacy incursions.

Microsoft’s policy, which it calls its Services Agreement, allows it to analyze customer content from one its free products and use it to improve another service — for example, taking information from messages a consumer sends on Windows Live Messenger and using it to improve messaging services on Xbox. Previously, that kind of sharing of information between products would not have been allowed under Microsoft policies, which limited the use of data collected under one of its products to that product alone.

Microsoft has promised, however, that it will not use the personal information and content it collects to sell targeted advertising. It will not, for example, scan a consumer’s e-mails to generate ads that might interest the user. Google does that, and expanding its ability to draw on that content was part of the reason Google changed its privacy policy this year.

But the new Microsoft policy does allow for such targeted advertising. Microsoft promised not to do so in blog posts and e-mails informing its customers about the change, but not in the formal policy. That has some privacy advocates nervous.

“What Microsoft is doing is no different from what Google did,” said John M. Simpson, who monitors privacy policy for Consumer Watchdog, a California nonprofit group. “It allows the combination of data across services in ways a user wouldn’t reasonably expect. Microsoft wants to be able to compile massive digital dossiers about users of its services and monetize them.”

Jack Evans, a Microsoft spokesman, says the company’s plans are benign. He differentiates between the Services Agreement, also known as the terms of use, that was changed on Friday and the company’s Privacy Policy, which was last updated in April.

“Over the years, we have consistently informed users that we may use their content to improve the services they receive,” Mr. Evans said in a written statement. “For instance, we analyze content to improve our spam and malware filters in order to keep customers safe. We also do it to develop new product features such as e-mail categorization to organize similar items like shipping receipts in a common folder, or to automatically add calendar invitations.

“However,” he added, “one thing we don’t do is use the content of our customers’ private communications and documents to create targeted advertising. If that ever changes, we’ll be the first to let our customers know.”

Microsoft’s new services agreement affects only its free, Web-based products, not the software programs that individuals and companies buy off the shelf for home or business use. It covers Hotmail, and its related e-mail service, Outlook.com, but not the Outlook e-mail and calendar program that is individually loaded onto computer hard drives and widely used by corporations. Bing, its search engine, is covered, but Internet Explorer, its browser, is not.

Microsoft’s pledge not to use the data from its Web services to target advertising has some credibility, given the company’s broader privacy initiatives. The company has said it will include a “do not track” feature in its new Internet Explorer 10 Web browser that prevents online advertising companies from monitoring the browsing habits of users so they can target promotions. Microsoft has made “do not track” the default setting on the new version of Explorer, a move that has caused a firestorm among online advertising companies.

Bits Blog: Microsoft Surface to Start at $500

David Mcnew/Reuters The Surface tablet, as displayed by Microsoft in June.

As the days tick down to Microsoft’s introduction of its Surface tablet, the company has revealed how it plans to price the product — more like Apple than Amazon.

Instead of adopting Amazon’s lower pricing on the Kindle Fire, Microsoft said it would sell Surface for a starting price of $500, the same starting price as the current generation of Apple’s iPad. People who buy that Surface model will get some extra perks though, including 32 gigabytes of storage — twice the amount of the cheapest third-generation iPad — and a 10.6-inch display, rather than the iPad’s 9.7-inch display.

Microsoft said it would sell a 32-gigabyte Surface bundled with a black Touch Cover, a keyboard that doubles as a protective shield for the tablet, for $600. A similar bundle with a 64-gigabyte Surface will cost $700. Microsoft will sell Touch Covers separately in a wider assortment of colors for $120, and a different type of keyboard cover with moving keys, called Type Cover, will sell for $130.

It’s clear Microsoft is aiming Surface at what is shaping up to be the premium portion of the tablet market, which Apple currently dominates. Amazon, in contrast, seems intent on using price as a weapon to gain market share against its rivals. The company recently introduced an 8.9-inch-screen Kindle Fire that starts at $300.

Microsoft has not yet said whether it will bring out a version of Surface that competes in the small-screen tablet category. Google’s Nexus 7 tablet starts at $200, while Amazon’s seven-inch Kindle Fire starts at $160. Apple is expected to announce a new, smaller iPad next week.

Surface will go on sale Oct. 26 in Microsoft retail stores in the United States and Canada. The company said the product would be sold online in Britain, China, France, Germany and several other countries. Microsoft said a limited quantity will be available for ordering on Tuesday at noon Eastern time.

The company also began showing a new Surface television commercial on Monday evening, featuring an odd collection of foot-stomping girls in school uniforms and dancers using their Surface tablets as percussion instruments.