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4/19/2013
09:26 AM
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Microsoft Office, Server Sales Fuel Strong Earnings

Microsoft's financials showed a strong, diversified company. Windows 8 concerns aren't going away, though, and neither are questions about the company's long-term influence.

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Microsoft announced Thursday that its third-quarter profits were up 19% relative to the same period last year. The uptick beat analyst expectations and was propelled not only by lower-than-anticipated expenses but also strong server and Office sales. At face value, the numbers seem like a solid rebuttal from Microsoft to its critics; the company, already burdened with Windows 8's cool reception, has been a media punching bag over the last few weeks, with blows ranging from the PC's continued decline to Goldman Sachs downgrading Microsoft's stock.

The earnings report shows that Microsoft is a strong and diverse company, but it doesn't fully silence doubts. Windows 8 and the scope of Microsoft's influence are two of the open questions. What does Redmond's financial health mean for the future of personal computing?

As a whole, Microsoft's Windows division rose 23% to $5.7 billion, slightly below analyst projections. Given how much criticism Windows 8 has absorbed, that might seem like a vindicating number. This isn't the case.

Microsoft predictably declined to break down Windows revenue. It didn't explore how Windows 7 sold relative to Windows 8, for example. Surface sales were likewise unaddressed. Even so, there are many reasons to doubt that Windows 8 has performed well.

For one thing, the seemingly healthy numbers include deferred revenue from previous quarters. When this sum is removed, Windows earnings were essentially flat. There's also evidence that Windows 8 has struggled to gain market share, suggesting that even within the adjusted earnings, Microsoft's newest OS was not a strong performer.

[ Not sure about Microsoft's video calling software? Read 6 Skype Alternatives Worth Considering. ]

In an email, Gartner analyst Carolina Milanesi said she suspects "most of the revenue comes from software upgrades." Indeed, with PC sales down, it's unlikely that Windows revenue is coming from new machines. But Windows XP will lose support next year, and scores of businesses are still in the process of upgrading. Most of them have opted for Windows 7, resulting in the Windows division posting a strong quarter, even as its newest offering continues to flounder.

Though Windows 8 might not have been a standout performer in Q3, Gartner analyst David Cearley believes the OS can still turn things around. In an interview, he stated that whereas Windows 7 was a refined product, Windows 8 has "rough edges." He lauded Microsoft's bold moves, such as kernel-level unity across its various Windows platforms, but predicted Redmond will need one or two update cycles to add polish.

Indeed, with Windows Blue, a Win8 update expected later this year, Microsoft is accelerating its update schedule, demonstrating the urgent pace necessary to improve its products. The strategy makes sense but it remains to be seen whether Redmond implements the features users want, or if it simply offers uninspiring updates more regularly. Recently rumored tweaks include resurrecting the Start button, a move that would address one of Win8's most persistent UI complaints. It's a good start -- but how much more will Windows Blue need to effectively woo consumers?

Microsoft CFO Peter Klein, who announced alongside the earnings that he will step down as the end of this quarter, said Thursday that "small" touch-enabled Windows devices will arrive in coming months, a near-confirmation that 7-inch tablets, much-rumored in recent months, will soon join the Redmond stable.

Klein also revealed that the devices will have competitive price points, a key factor that could not only stimulate Windows 8 adoption but also cut into the iPad Mini's dominance of the mini-tablet market.

Still, many questions remain. What does "competitive" mean? And will these devices run Windows 8 or Windows RT? Intel's Bay Trail Atom processer will allegedly bring tablet form factors and battery life to devices that can run the full OS. If the cheapest models are RT-only, will consumers care? Windows Blue will have some say in this, and Microsoft could make up lost ground by targeting this budget-friendly market segment. Still, until the devices are in users' hands, it will remain difficult to handicap Redmond's chances.

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Michael Endler
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Michael Endler,
User Rank: Author
4/19/2013 | 8:18:10 PM
re: Microsoft Office, Server Sales Fuel Strong Earnings
Thanks for reading, jabberwolf.

Apple's actually an interesting case. IDC pegged Mac sales as down, whereas Gartner said Apple actually increased sales in the US market. Cupertino took the unusual step of slashing prices on the 13-inch Retina MacBook Pro, which suggests sales aren't where the company wants them-- but it also looks like Apple is outperforming the Windows-centric parts of the PC market. Apple also enjoys favorable margins on its computing products, somewhat insulating its Mac offerings from declining hardware sales. Throw in the fact that Apple's overall revenue is less tethered to OS X than Microsoft and its OEM partners' respective earnings are to Windows and you have a pretty solid outlook for Apple. Can it stave off Android? No, probably not, but if Apple really sells 75 million iPhones in developing markets once the rumored low-cost model hits, Cupertino could be sitting pretty.

As for the one device idea-- I think a lot of people would like one device that can do almost everything, but form factors (e.g. screen size, ease-of-use with legacy keyboard-and-mouse applications) still get in the way of a true "one-size fits all" solution. The first round of Windows 8 devices were too compromised to live up to this ideal, but If Windows Blue brings some unity to the two side of the OS, Microsoft could make up some ground. Even so, many people will require more than one device simply because no one has found a way to make one form factor that adequately addresses all major use cases.

Also, while some people would value an all-in-one device, there's also evidence that consumers actually prefer the mutli-screen experience. Microsoft would still be wise to cram as much functionality into its tablets as it can, if for no other reason than to carve out an identity that offers value not found in iOS or Android. But it also needs a range of devices, from cheap (hopefully sub-$300) tablets to powerful Utralbooks and Surface models to giant 30-inch tablet/monitor hybrids designed to be communal household devices. I think a single form factor could come to be the most popular option but the market will nonetheless demand a variety of options, and, as the Forrester analysts predict, perhaps different versions of Windows tailored for each one. I see a lot of people continuing to haul around tablets and smartphones for certain use cases while turning to more traditional devices for others. Success will involve not only compromise-minimizing hybrid tablets but also software that embraces a multi-screen lifestyle, seamlessly moving online experiences from one device to the next.

A lot of this is reading into tea leaves, but one thing is clear: Windows 8 adoption is stagnant right now, meaning Microsoft faces two particularly important and foreseeable tests: 1) Windows Blue and the upcoming Intel chips (both Haswell and Bay Trail) need to deliver not only meaningful improvements but also branding differentiation that consumers care about; 2) As Windows 7 migrations concludes and businesses, probably between 2014 and 2016, start buying new computing products, Microsoft needs to find a way to both serve its install base while also making inroads with consumers. I think June should be a big month for Microsoft, with both the BUILD conference for developers and its TechEd conference in New Orleans. I've been told Redmond's evolving corporate strategy will be an emphasis in New Orleans, and BUILD seems like it has to be all about Windows Blue. So we'll have a better idea soon.

Michael Endler, IW Associate Editor
midmachine
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midmachine,
User Rank: Strategist
4/19/2013 | 4:00:35 PM
re: Microsoft Office, Server Sales Fuel Strong Earnings
Yup - that sums it up nicely. I have no problem with the OS on a desktop - I actually love it. The regular user and Enterprise usage won't be able to so easily adapt. The final goal of interoperability between all devices is the game changer here as far as the success that MS could achieve in the market.
jabberwolf
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jabberwolf,
User Rank: Apprentice
4/19/2013 | 2:44:55 PM
re: Microsoft Office, Server Sales Fuel Strong Earnings
As soon as MS puts the smart button back and a few other tweaks - they will have Windows 8 sales and tablets booming. Apple has shrinking sales because people cant afford all the difference devices. MS has an opportunity to do this right and show people they just need to purchase 1 device and thats all.
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