Microsoft Office's Flat Profits Show Tough Sales Job

Microsoft can't take market share from the competition because it has no competition.
Analysts pondering Microsoft's latest quarterly corporate earnings report said Friday the flat profits for Microsoft Office reflect Microsoft's problem in growing the sales of its market-dominate productivity suite.

Office is part of Microsoft's Information Worker division, which in fiscal 2005 delivered a whopping $11 billion in revenue and $7.9 billion in operating income. Although revenue for the group was up about 5 percent during the second quarter of 2006, operating income increased less than 2 percent, to $2.1 billion in 2006 from $2.07 billion in the same quarter the year prior.

"Frankly, there's very little upside for Office in developed markets," said Paul DeGroot, an analyst with Kirkland, Wash.-based Directions On Microsoft. "The market share [for Office] is so high, there's just not much room to grow."

This isn't the first time that the Office group's revenues have been flat. "They've been like that for the last several years," noted DeGroot. "My understanding is that revenues for Office itself has been very flat or even declining slightly, say about 1 percent per year," he added. The Information Worker division is responsible not only for Office, but also for Office-associated tools and software, including Visio, Project, and SharePoint.

"Microsoft has a special kind of problem with Office," DeGroot said in explaining the flat revenues. "In a competitive market, you can always take the other guy's share and go to the other guy's customers and pitch them your product. The sales staff has something to do." But when you own the vast bulk of the business application suite, as does Office, "there's nothing to take away [from others] since you already own everything.

"On top of that, Office is a fairly mature product."

That contrasts with the stellar seller in the second quarter, SQL Server, which grew sales by over 20 percent year-to-year on the back of the release of SQL Server 2005.

"There's still lots of relational database business Microsoft can still get," said DeGroot.

While DeGroot was confident that sales of Office would recover and be "reasonably healthy" in the ramp up to Office 12, scheduled for a late 2006 release, he also noted that most enterprises already have upgrade agreements in place, or if they have plans up for renewal in 2006, will probably sign up for just one year, not two.

Customers with upgrade plans in place are provided a perpetual license, which means they can activate and use any version introduced during the program's term.

"Microsoft is trying to put more emphasis [for Office] on small business, but it'll take a while to have the potential to boost revenues," DeGroot said.

Nor does he think that Microsoft will try to push Office sales in developing or emerging markets using the same strategy its Client group has with cheaper "Starter" editions of Windows.

"In the long run, I think Office will face serious competition" in those markets from locally-developed application suites, said DeGroot, but for now, "they want to maintain the Office price points. And they've been successful doing that."

Microsoft could compete with upstarts in huge markets like the ones developing in China and India, but to do so would wipe out the company's profit margins. For now, then, Microsoft is content to bank its 80 percent profit margin on Office.

"I think most of us would be quite happy with a $11 billion business with 80 percent margins," said DeGroot.

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