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7/23/2014
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Microsoft Earnings: 3 Big Takeaways

Microsoft's cloud business is booming, but devices and consumer mindshare remain problems.

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Apple-IBM Deal: 9 Moves Rivals Should Make
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Microsoft on Tuesday announced strong but slightly mixed earnings for its fiscal Q4, which ended June 30. The company's cloud businesses continued to blossom, with revenue expanding almost 150% to an annualized run rate of more than $4.4 billion. But its device efforts -- particularly the Nokia acquisition, which closed during the quarter -- continue to pose challenges.

Overall, the company's revenue reached $23.4 billion, a year-over-year increase of almost 18%. That exceeded the expectations of Wall Street analysts, who forecast closer to $23 billion. With net income of $4.6 billion, or 55 cents per share, Microsoft came in below profit estimates, however. Analysts had expected per-share earnings closer to 60 cents. In the year-ago quarter, the company's net income was $4.9 billion.

Given that CEO Satya Nadella's just-launched restructuring plan involves the biggest round of layoffs in company history, he faces pressure to accelerate the strong spots while quickly addressing weaknesses. Is Microsoft on the right track heading into its fiscal 2015? Here are three essential takeaways.

1. Microsoft's cloud services are growing rapidly.
Nadella's strategy relies heavily on personalized productivity experiences that follow users via the cloud from one device to the next. On the enterprise side, these services -- which include Office 365, Azure, Exchange Online, SharePoint Online, Dynamics CRM, Lync Online, and Intune -- drove terrific business during the quarter, and, as mentioned, are now on pace for more than $4.4 billion annually. Consumers are embracing Microsoft's cloud services as well. During the quarter, the company benefited from not only Office for iPad, but also Office 365 Personal, a new low-cost option. It also aggressively bundled OneDrive storage with Office 365 plans. Thanks to these efforts, Office 365 Home and Personal subscribers now total more 5.6 million, up from 4.4 million in the previous quarter.

[Say goodbye to the old days. Microsoft Shows Tech 'Monopolies' Don't Last.]

2. Device sales are still a black hole of profit.
Nadella said Tuesday that his "mobile-first, cloud-first" mantra goes beyond mere devices, and is more about the digital experiences mentioned above. That's probably a wise way to spin his strategy, given that Microsoft's first-party device efforts are still hurting. Nokia, for example, added $2 billion in revenue to Microsoft's books, but still posted such poor margins that Microsoft ended up with lower overall profit. Similarly, the company conceded it took a charge when it decided not to release a new Surface form factor, presumably the much-rumored Surface Mini. On the bright side, company execs said the Surface Pro 3 is outselling previous models. It was released late in the quarter, however, and had only a minimal impact on the quarter's overall numbers.

During Tuesday's earnings call, Nadella spoke with an awareness of these challenges, and stressed that devices will have a smaller role in his strategies than they did in predecessor Steve Ballmer's. He talked about inventing new device types that highlight Microsoft services and set an example for partners and about responsibly building the Windows Phone businesses via a scaled-down Nokia. Microsoft said demand had been relatively decent for low-cost, low-margin Lumia smartphones, and that it plans to attack the higher end of the market with upcoming devices.

3. Windows posted a decent quarter, but long-term prospects are still unclear.
Microsoft's Windows cash cow has looked vulnerable over the last year, as PC sales have slid and Windows 8 and 8.1 have flopped. But in the most recent quarter, Windows OEM revenue increased 3%, boosted by an 11% surge in Windows OEM Pro revenue. Microsoft conceded that the uptick was tied at least in part to business upgrades prompted by Windows XP's end-of-service deadline. This makes it unclear how much of the growth is sustainable. Moreover, consumer Windows revenue is falling.

Nadella offered two points of optimism for the long term. He noted that free and low-cost OEM licenses are helping device partners bring sub-$200 Windows laptops and tablets to the market, which should help Microsoft's consumer market share. He also said the next version of Windows would scale across all device types, replacing Windows 8.1, Windows RT, and Windows Phone with a single, unified OS. He didn't go into much detail, but with Windows 8.1 considered a bust, the next version needs bold changes.

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Michael Endler joined InformationWeek as an associate editor in 2012. He previously worked in talent representation in the entertainment industry, as a freelance copywriter and photojournalist, and as a teacher. Michael earned a BA in English from Stanford University in 2005 ... View Full Bio

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Lorna Garey
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Lorna Garey,
User Rank: Author
7/23/2014 | 11:14:04 AM
No surprise
Hardware margins are always thin -- seems like the point is the linkage and driving adoption of your OSes and software. Oh, and your cloud services. As long as MS isn't actively losing money on phones and tablets I can't see the downside to being in the hardware game.
melgross
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melgross,
User Rank: Ninja
7/23/2014 | 11:56:12 AM
Re: No surprise
Lorna, what do you mean by "thin"? Yes, it's true that manufactures with poor products, as we see for most of the Windows industry, the margins are thin. But for companies that make better quality products, that's not so. I would imagine that no matter what Microsoft may say, they expected big demand for their various Surface models, and correspondingly good profits. After all, they were targeting the iPad and iPhone, not cheap Android devices. The fact that people, and organizations, simply weren't interested in Microsoft's efforts, is what has resulted in their losing so much money in these areas. It's not that hardware has thin margins. But it would be true that software does have usurious margins. Why is it that companies that make good hardware margins are excoriated, while software companies that have absurdly high margins are not? Where does it say that over 75% margins in software is ok, when 40% hardware margins are considered to be almost criminal? Microsoft may have thin margins on their hardware, if not negative, because no one wants their products, so that marketing costs become the largest percentage of costs, right after R&D, making a profit impossible. Just curious. Do Apple and Cisco have thin margins, and are their margins fair? How about Microsoft's software margins?
Lorna Garey
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Lorna Garey,
User Rank: Author
7/23/2014 | 12:06:39 PM
Re: No surprise
I didn't say anything about huge software margins being OK (more on that in a bit). But to start, saying "no one wants their products" is patently incorrect. Surface may not be for everyone, but my college-age daughter bought one (with her own money) and likes it a lot. I've talked with business people whose companies support the devices, and they find them of good quality and suitable for work.There's a huge market globally for lower-end and midrange smartphones. Not everyone is an Apple fan.

And, frankly, in terms of huge margins, we're a market-driven economy. No one "deserves" any given profit margin by right. A company is in business to make as much profit as the market will bear. If Microsoft or Cisco or Apple can get people to pay X dollars for a product, hard or soft, that's exactly what they should be charging. "Fairness" has exactly nothing to do with it.
melgross
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melgross,
User Rank: Ninja
7/23/2014 | 1:10:37 PM
Re: No surprise
Of course, by saying no one, I don't literally mean no one. But a 2 or 3% marketshare is as close to no one as can be achieved for a major company. Without actually knowing how many of these have sold, and we all know how inaccurate both Gartner and IDC are. Without Microsoft giving us numbers, we may never know. And they don't tell if the numbers are bad. As for fairness, I'm not saying anything is fair or not, but a lot of people do.
TerryB
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TerryB,
User Rank: Ninja
7/23/2014 | 1:50:26 PM
Re: No surprise
@Mel, I'm not sure I understand your take on IBM/Apple impacting MS on phones. Are you saying you expect IBM to solve the problem of Apple devices not playing well in a MS environment like Active Directory? Or have seamless access to SQL Server databases? Exactly how/why would IBM do that?

Lorna is right, MS came late to party on smartphones and Android/iPhone both have good enough products that most people see little reason to switch. Not unlike a new car model introduced by GM not  taking all customers away from other models because they do same thing. Now, if the new car can fly, and costs the same, how many people flock to it then? Question is whether another killer use of smartphones is ever found. If MS produced phone which battery lasted 1 week between charges, how would you like there chances against Android/iPhone then?

Windows tablets, not just Surface but OEM devices also, have much more potential in enterprises than existing Android/Apple/ChromeBooks. And, again, reason is that is only tablet which plays well in an Active Directory environment. Active Directory will be the determining factor. If you start seeing some other technology displacing AD, then all bets are off on Win based devices. But I haven't read anything saying that is on horizon, short term or long term.

Kind of curious what you do @Mel. You know your stuff but you are always dogging on MS and I'm not sure why. How many companies would take $4.6 billion profit in one quarter as a "bad" period of time? Only on the Bizarro world of Wall Street is that a problem.
melgross
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melgross,
User Rank: Ninja
7/24/2014 | 8:56:45 AM
Re: No surprise
iPhones do just fine. If they didn't, then they wouldn't be the biggest choice for both business and government today. Do,you see Microsoft phones and tablets above the small single digit share there? Anywhere? No. Can Microsoft turn that around? Maybe. But people have to want the products first, and there's little evidence that they do. Of course, there is that low single digit share, but it shrunk this year, everywhere. I speak to business people too. Some in rather large businesses. There seems to be little interest in these Microsoft devices, despite the supposed advantages. They are indicated for some specialized functions, but overall, their maintenance is much higher than iOS devices, which is usual with Windows based machines. So until we see larger investments being made in these devices by large organizations, I won't be convinced. I was a principal in a large commercial photo lab for many years, until we sold it in 2004. I was one of the first labs around the world to go digital in 1988, when I bought the Crossfield system for editing and correcting photos. Then I retired from active business, though I do a lot of investing, and some advising to companies. I've been involved with computers since I took Fortran four back in high school in 1966. I designed equipment for companies such as HBO and Showtime. I did work for Microsoft, and they kept sending me tons of all their software for years, until I told them to quit. I've got a number of patents in speaker design, though most have expired. I was a partner in a professional audio electronics firm, where I designed analog and early digital equipment as well as the mentioned speakers. I used to teach PC DOS way back when, and before that, built my own S-100 bus computers, when building your own computer meant designing and building your own circuit boards, and writing your own basic, as well as converting old teletype machines to use as a printer. I programmed 3D software on VAX's. Basically, I did a lot of things, in the industry and out if it. I find it amusing that some still insist that only Microsoft's products are truly relevant to business, when it's become glaringly obvious that it's no longer true. Microsoft has been doing a very good job in some areas, but have badly fumbled in others, and are being pushed out. IT loves Microsoft, as it gives them job security, but many business people I know can't wait to get them out of the shop.
TerryB
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TerryB,
User Rank: Ninja
7/24/2014 | 10:42:43 AM
Re: No surprise
Very interesting background @Mel. Explains your very informed comments on a variety of topics.

I'm no MS lover, I program using IBM servers and support ERP systems since the 80's. So I tolerate MS as front end device. I also learned and implemented Sharepoint for our company. But other than some playing with VB 4 a long time ago, never developed in either COM or .NET. I consider that the most unproductive environment I've ever seen, all that GUID stuff.

But I see nothing Apple brings to table on either phones or tablets which is a game changer compared to MS devices. Since MS devices play well with Active Directory, Group Policy and our VPN appliances/clients, I'm not sure I agree that businesses using AD would go to Apple or Android. All those devices play well with HTML5 applications and products like Sencha Touch and Phone Gap can generate native apps for all devices.  As a developer, it doesn't make any difference to me. So decision would boil down to which is easier to integrate into our network, and now that MS devices by light years. Maybe that will change but, as I said before, I haven't seen anyone swapping out their AD for anything else.

But I do have an iPhone for work so I can get email and calls when I travel. But's all I do with it for work, and all I will ever need to do with it for work. Calling it a "business" device is pushing it. I don't see making our ERP apps run on a phone, or a tablet for that matter. What would be the business case for that?

 
melgross
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melgross,
User Rank: Ninja
7/28/2014 | 7:42:28 PM
Re: No surprise
Just look at the numbers. Unlike what happens in the consumer space, business and government are more selective of what they will support. The majority of phones bought in those spaces are iPhones. 70% of the tablets there are iPads. Obviously, those products do what is expected of them. Where are Windows tablets and phones?
TerryB
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TerryB,
User Rank: Ninja
7/29/2014 | 1:00:51 PM
Re: No surprise
>>Obviously, those products do what is expected of them.

I just wonder if those businesses expect same thing we do: phone calls and email. I know a few consumer facing, sales oriented companies are creating some iPad/iPhone apps but, in a broader business sense, these devices are not replacing the legacy Win desktops and laptops and their role in business. I'm sure you would not issue your A/P clerk an iPhone/iPad to do her job. And not likely a Mac either, just for cost reasons.

Granted, this a small sample size here (30-35 devices) but most of my users prefer Samsung Galaxy devices over iPhones. I have about 5 iPhone users (including me, I got one just because my wife had one and we could share accessories) and 25-30 Android users. You are correct not one person has even asked about getting Win phone, MS has a LOT of work to do.
Michael Endler
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Michael Endler,
User Rank: Author
7/23/2014 | 5:34:08 PM
Re: No surprise
It's true that hardware margins aren't as high as software margins, as a general rule. But Apple still achieves pretty extraordinary profit. So too, since it was brought up in some of the comments, does Cisco.

I sympathize with Mel's indicated point about double standards; it's almost like people expect healthy hardware margins to be definitionally short-lived, whereas software margins are seen as potentially eternal. I can see why that bias exists in the abstract, since it's easier to move quickly and adapt as a software-reliant company than it is as one that also relies on hardware. But if anyone has earned some respect in this regard, it's Apple. I still remember when everyone thought Apple was a short-lived "anomaly" during the height of the recession, when its stock price was half what the post-split price is now. Says something about what analysts know. Maybe Android's huge installed base will lead to future glory as users in emerging markets upgrade, but I can tell you right now, in the present-tense, all that market share doesn't mean squat compared to the real dollars and real user-investment iOS is achieving.


That said, I think Microsoft's problem is more complicated than "no one wants their stuff." That might have been, by and large, the case when Windows 8 and Windows Phone 8 both debuted. I used each OSes extensively, and speaking as objectively as I can, neither was nearly as satisfying as OS X or iOS. Windows 8.1 and Windows Phone 8.1 are better, however. I still prefer the Apple OSes, but I don't think Microsoft's UI is a reason to avoid the platform anymore. I once would have had trouble recommending Windows 8 devices to people, especially if I was talking to someone willing to shell out for an Apple product. But the newest Lumias and the Surface Pro 3 have legitimate merit. I don't think they beat Apple's products, per se, but Microsoft has closed some gaps, from a functional standpoint. From a PR standpoint, however, is another matter-- which is probably why Microsoft will ditch the "Windows 8.x" branding and move to "Windows 9" - or perhaps even just "Windows," to reflect the multi-form factor, rapid-release model Microsoft is going for - early next year.
Broadway0474
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Broadway0474,
User Rank: Ninja
7/24/2014 | 11:19:56 PM
Re: No surprise
MSFT pulled out all the stops on the marketing/ad campaign for Surface and the latest Windows --- conveniently, a commercial just came on my TV. Did they report in this latest quarterly call how much they've wasted on this campaign? Perhaps the dichotomy is between B2C and B2B, and Microsoft ought to just concede defeat in B2C (excepting gaming)? 
Shane M. O'Neill
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Shane M. O'Neill,
User Rank: Author
7/23/2014 | 11:43:13 AM
The device dilemma
Some good takeaways here to think about. Very surprised to hear that Nadella & Co "plan to attack the higher end of the [phone] market with upcoming devices." Why would Microsoft keep trying to push that boulder uphill? To say nothing of "inventing new device types that highlight Microoft services." Microsoft is not cut out to invent new devices. They've proven that it's not in their DNA. Cloud services and software are where Microsoft clearly excels. I agree with @Lorna that Microsoft should stay in the hardware game as long as it's not actively hurting the company. But if they keep treating devices as an afterthought, the hurt will come soon enough.
melgross
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melgross,
User Rank: Ninja
7/23/2014 | 12:08:15 PM
Re: The device dilemma
I think the problem is very simple. People don't want their mobile products. People include those running organizations. If people don't want your products, then it hardly matters what is being done. One major reason why people don't want their products is because they don't solve any problems that aren't being solved now. Something new must solve current problems that aren't being solved elsewhere. They must! If they don't, then why but them? Why leave a system that is already doing most (if not all) of what you want? This is a major problem for them. Nothing they've done is of any interest to the buying public. The second reason is that people, as a group, don't like the UI. Yes, I do know that some people do. But it's a small percentage. This is like digital cameras. In the beginning, manufacturers thought that they needed to come up with new forms, since there was no film chamber, or winding mechanism to contend with. They experimented with many form factors. Writers extolled these many, rather odd, factors as being the future. But what happened? All of those forms went to the dust bin. Why? Because over decades, camera manufacturers had already come out with the form factors that worked best. Now, digital camera resemble this old film counterparts. Why bother with all that exposition? It's simple, Microsoft tried a new form factor, and people don't like it. Their displeasure is echoed by sales numbers. This is true, as we know for their Desktop factor as well, something they are forced to back away from. But what about their mobile products? They can't go back. The total failure of Win Mobile shows that. What does this mean? Likely that Win Phone will never really make it, and that their tablets, won't do that well either. With Apple and IBM getting together on this, it makes any advantage Microsoft may have here, obsolete. Their chances are now less than they were before. And you just know that those at Microsoft, and possibly Google, are saying oops!
Lorna Garey
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Lorna Garey,
User Rank: Author
7/23/2014 | 12:48:57 PM
Re: The device dilemma
I'd argue that WinMobile failed mainly because Microsoft under Ballmer was hideously late to the mobile game, and the ecosystem is served by Android and iOS. 

As to no one wanting MS desktop products, apparently, businesses and consumers didn't get that memo. Take a look at the latest desktop OS numbers:

http://www.netmarketshare.com/operating-system-market-share.aspx?qprid=10&qpcustomd=0

As of June, all versions of OS X owned about 8%, Linux 1.74%. The rest is Windows.

Moreover, Android is doing just fine. It's even with iOS in the US and well ahead globally. I don't hear many uh-ohs coming from Google.
MDMConsult14
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MDMConsult14,
User Rank: Moderator
7/25/2014 | 4:53:18 AM
Re: The device dilemma
I still think Android is the market leader and will remain so. There are still nascent areas such as adopting tablets for disruption. Microsoft is also in good position to take over the market for these areas as well as consumer mobile platform. There are popular devices and with the right conditions, more growth should occurr as the economy improves.
melgross
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melgross,
User Rank: Ninja
7/28/2014 | 7:38:58 PM
Re: The device dilemma
You can't always just look at numbers and make assumptions about what people want. Consumers, in particular, buy what they think they must. If they think they need to buy Windows, they will. It certainly doesn't mean they like it. I've met a number of consumers bought a Win 8 computer, not knowing that they could, if they looked around, buy one with Win 7. Microsoft counts on this. As for Google, they aren't in the business space. Well, hardly, with Android. You also need to look at trajectory. Two quarter's ago Mac sales grew by 17%. This past quarter, it was 18%. I don't have the numbers for before that, but cook said during the financial conference that Mac sales out paced, in growth, Windows sales for 32 out of the past 33 quarters. You mentioned Mac marketshare. It was just 1.1% several years ago worldwide, and 2.8% domestically. How is the marketshare and sales growth of Windows doing?
Lorna Garey
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Lorna Garey,
User Rank: Author
7/29/2014 | 9:41:01 AM
Re: The device dilemma
Well, let's look:
Market Share of Windows 7 Windows 7 50.55%
Market Share of Windows XP Windows XP 25.31%
Market Share of Windows 8.1 Windows 8.1 6.61%
Market Share of Windows 8 Windows 8 5.93%
Market Share of Mac OS X 10.9 Mac OS X 10.9 3.95%

That's per: http://www.netmarketshare.com/operating-system-market-share.aspx?qprid=10&qpcustomd=0

So, let's say Mac OS grows by 20% this quarter. 20% of 4% is .8% So it's still less than 5%. 
melgross
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melgross,
User Rank: Ninja
7/29/2014 | 3:38:23 PM
Re: The device dilemma
Those numbers aren't quite right. First of all it only includes 10.9. A generally accepted number for worldwide share is closer to 7.5%. But, as I tried to point out, it the trajectory that matters. Mac is growing, Windows is shrinking. I certainly don't expect OS X to take the lead from Windows. That's not the point. But Mac share in the USA, if you don't use the incorrect numbers from Gartner and IDC, both of which were off by over 20% this past quarter, the one before, etc., Mac share is a good 14% here. It was down to 2.8% ten years ago. If that doesn't tell you something about what is happening, then nothing will.
Charlie Babcock
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Charlie Babcock,
User Rank: Author
7/23/2014 | 7:34:08 PM
Microsoft is a server company
This is the first quarter where it's been made clear that Microsoft is no longer a consumer device company. It's a server company, able to sell consumer services from cloud data centers. It has two sources of server strength: the enterprise data center and the Azure cloud.
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