Why Microsoft doesn’t need your money: Business brings home the bacon

microsoft logo steve ballmer

Microsoft delivered a pleasant surprise to investors this week, revealing earnings of $5.1 billion for its third fiscal quarter of 2012. That’s down a bit from a the year-ago figure of $5.23 billion, but that was boosted by a one-time tax benefit. All told, the numbers were stronger than analysts and investors has expected, particularly since sales of its flagship Windows operating system ought to be lukewarm, as both consumers and business put off purchases of new software and new computers in anticipation of Windows 8.

The shocker: For all its name recognition among consumers, Microsoft generates surprisingly little money from its consumer offerings, including its Xbox 360 game console, Windows Phone, and Bing, it’s would-be rival to Google’s dominance of the Internet search market. In fact, if it weren’t for sales of Windows on consumer PCs, Microsoft arguably wouldn’t be making any money at all in the consumer market — a stark comparison to companies like Apple that derive nearly all their revenue from consumer sales.

How do the numbers stack up? And does Microsoft’s apparent failure to resonate with consumers derive from the fact that most of Microsoft’s spending money has nothing to do with consumers?

Where Microsoft’s money goes (and comes from)

Microsoft does not break down revenue across each of its products and services — and that’s probably a good thing, since the company offers hundreds of discrete products ranging from webcams and keyboards to games to operating systems to applications to systems geared at enterprises and even vertical markets like health care. Instead, Microsoft breaks revenue down into six basic areas:

  • Windows and Windows Live — As you might expect, this category includes Microsoft’s Windows operating system (all versions), but also gets a lot broader. It includes most of Microsoft’s consumer hardware products for computers (like keyboards and mice), as well as online services that are directly in support of Windows — think Windows Live Essentials, which includes Mail, Messenger, Photo Gallery, and Movie Maker, along with things like Windows Family Safety and Microsoft’s Silverlight technology. About three quarters of the revenue in this segment derives directly from sales of Windows — Microsoft does not break down how many licenses it sells to consumers versus corporate, enterprise, and site licenses. About one quarter of the segment’s revenue comes from sales of hardware devices and advertising on Windows Live services.
  • Business Division — It’s not quite accurate, but you can think of the Business Division as the Microsoft Office ecosystem: That includes not just the core Office applications (Word, Excel, PowerPoint, etc.) but also Exchange, Sharepoint, Lync, and Microsoft’s Office 365 Web-based applications. Another component is Microsoft Dynamics, a customer relationship management (CRM) and enterprise resource planning (ERP) system used by more than a quarter million businesses around the world. Microsoft actually earns more money from its Business Division than from Windows.
  • Server & Tools — Most consumers probably interact with companies using these products and services, but never see them directly. This encompasses products like Microsoft SQL Server, developer products (like Visual Studio) as well as Microsoft’s cloud services platform (Azure). Somewhat confusingly, it also includes server versions of the Windows OS: these are the ones designed to pump email, run databases, and host Web sites, rather than let people watch Netflix and play Crysis. About half the Server & Tools group’s revenue comes from volume license agreements with companies; the rest comes from retal products, transactional licensing (where Microsoft takes a cut from individual operations) and enterprise services.
  • Entertainment & Devices — Here’s the guts of what Microsoft makes for consumers that isn’t Windows. The Entertainment & Devices group includes the Xbox game console, Xbox Live services, Kinect and other accessories, and all of Microsoft Xbox games. It also includes all of Microsoft’s Windows Phone efforts, along with the recently-acquired Skype — Microsoft paid $8.5 billion.
  • Online Services — Think of Microsoft’s online services segment as MSN and Bing — although it’s important to note it also includes most of Microsoft’s online advertising business, including adCenter and advertiser tools. Bing and most MSN services are offered to consumers for free; that means essentially all the money earned by Online Services’ comes from display advertising — you know, the business where Google earned almost $5.5 billion during the first quarter of 2012.

If one were to order Microsoft’s revenue segments in the order in which consumers are exposed to them, the list might look something like this:

  1. Online Services
  2. Windows
  3. Entertainment & Devices
  4. Business Division
  5. Server & Tools

How well does that list line up with Microsoft’s revenue?

Entertainment and online services

None of Microsoft’s revenue segments are truly isolated from consumers: even the Server & Tools group derives some revenue from students and hobbyists doing some Windows programming. But Microsoft’s Online Services and Entertainment & Devices groups are distinctly consumer-slanted. How is their revenue doing?

Microsoft Entertainment and Online Operating Revenue 3Q2010 - 3Q2012

Microsoft introduced the Xbox 360 all the way back in 2005, and its Xbox Live platform has been widely heralded as one of the success stories of digital media. Microsoft is earning money from it: The figures above represent net revenue: the total amount of money Microsoft took in for the division, minus the expenses of running the group. Although the net income for the Entertainment & Devices group is actually negative this quarter (Microsoft attributes the slump to a “soft gaming console market” and market watchers seem to agree) the Xbox 360 has been the top-selling console to the last 15 months, and Xbox Live boasts 40 million members. In the last nine quarters, Microsoft’s Entertainment & Devices segment has generated almost $1.92 billion in revenue Microsoft can put in the bank — that’s a business many companies would love to call their own.

Halo 4 showcase

Online Services… not so much. In purely revenue terms, Microsoft has lost almost $5.4 billion in the last nine quarter pushing Bing, MSN, and related free online services. Sure, launching a service that competes with Google is no small feat, and Microsoft has had to fork over some cash to Yahoo to serve as the back end for its Web search. But that revenue agreement with Yahoo is over, and Microsoft’s Online Services group is staying right on trend, losing on the order of half a billion dollars every quarter. Bing is coming up on its fourth birthday.

Operating income across all segments

How do Microsoft’s other businesses compare?

Microsoft Operating Revenue (all segments) 3Q2010 - 3Q2012

Not so great. Microsoft’s by-any-measure successful Entertainment & Devices group can’t hold a candle to the revenue generated by Servers & Tools, Windows, or the Business Division — which is actually the biggest of them all. I’ve emphasized the online and entertainment businesses so they’re easy to pick out.

Microsoft’s Entertainment Group earned a little over $1.9 billion in the last nine quarters. Microsoft’s Windows, business, and tools groups earned nearly $73.6 billion over the same time period. And that’s actually earnings that can be put in the bank, after subtracting out costs. Microsoft Xbox, entertainment, and mobile efforts amount to about 2.6 percent of the company’s total bankable revenue over the last nine quarters. If you add in the Online services group — or rather, subtract it out, since it’s done nothing but lose money so far — Microsoft is piddling away nearly 5 percent of its cash money trying to make devices and services for consumers.

steve balmer office 365

Of course, those back-of-the-envelope numbers for consumer products do not include Windows, and Microsoft obviously sells millions of copies of Windows to consumers, both as a retail product and as an OEM bundle with new PCs. Consumers also buy plenty of licenses for Office applications, too.

So far as I can determine, Microsoft does not break down Windows and Office sales in any meaningful way that shows the proportion of operating system sales that are direct to consumers (whether retail or on new computers) versus volume licensing to corporations, schools, governments, and other organizations. I also haven’t been able to find any substantive third-party analysis breaking down sales along those lines. For now, just bear in mind that those figures above are skewed.

But even if we leave Windows revenue out of the figures entirely, Microsoft’s overall efforts in entertainment and devices (Xbox, Windows Phone, etc.) and online services (Bing, MSN) still amount to the company piddling away about 7.5 percent of the money it brought in over the last nine quarters. On a company-wide basis, that’s not a formula for success.

Bottom line

microsoft steve ballmer fisticuffs

Over the years, much ink has been spilled over Microsoft’s seeming inability to resonate with consumers. For every success Microsoft seems to have had — the Xbox ecosystem, and (arguably) Bing — the roadside is littered with failures like the Zune, Soapbox, MSN Music, and Urge.

But remember that list, above, ordering Microsoft’s divisions roughly in the order in which consumers are exposed to them?

  1. Online Services
  2. Windows
  3. Entertainment & Devices
  4. Business Division
  5. Server & Tools

Here’s how that list looks in Microsoft’s bank accounts:

  1. Business Division
  2. Windows
  3. Server & Tools
  4. Entertainment & Devices
  5. Online Services

It’s almost the opposite.

Ultimately, Microsoft doesn’t answer to consumers. It can’t. They aren’t who pays the bills. Microsoft’s principle customers — by a wide, wide margin — are corporations, enterprises, governments, schools, computer makers, and other big accounts that engage in high-volume licensing for Microsoft products. Everything else is just a nice side-dish for Microsoft — including its efforts to make products and services for everyday people.

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