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Microsoft’s Declining Mobile Expectations

by Mark W. Hibben
11/19/11

Aiming for Third Place

It was perhaps the most telling statement uttered by any Microsoft executive at the recent earnings conference call on 10/20/11: “. . . we are well-positioned to become the third mobile ecosystem.”  Thus CFO Peter Klein summarized Microsoft’s recent Windows Phone initiatives, and it’s indicative of how far their expectations have fallen in the past year that Windows Phone 7 has been on sale.  Even third place will be a stretch, given that Microsoft has fallen to 6th place (ranked by OS market share) in worldwide smartphone sales to end users in calendar Q3 2011, according to a report released by Gartner Research on 11/15/11.  Although Microsoft posted solid earnings for the quarter, the lack of traction in the mobile device space does not bode well for the future.  Can Microsoft recover?

Failure to Engage

Not only is Microsoft losing the War for Mobile Internet Supremacy, it hasn’t been able to get into the fight.  According to Gartner’s 11/15/11 report, there were only a total of 1.7 M Windows Phone 7 devices sold in calendar Q3 2011.  That put Microsoft behind even Bada, Samsung’s in-house mobile phone OS, and far behind RIM, Apple, Nokia Symbian, and Google, as the table on the next panel shows.

Operating System

3Q11 Units in thousands

3Q11 Market Share (%)

3Q10 Units in thousands

3Q10 Market Share (%)

Android

60,490.40

52.5

20,544.00

25.3

Symbian

19,500.10

16.9

29,480.10

36.3

iOS

17,295.30

15

13,484.40

16.6

Research In Motion

12,701.10

11

12,508.30

15.4

Bada

2,478.50

2.2

920.6

1.1

Microsoft

1,701.90

1.5

2,203.90

2.7

Others

1,018.10

0.9

1,991.30

2.5

Total

115,185.40

100

81,132.60

100

 

I don’t necessarily take Gartner on faith, but the above table appears reasonably accurate, Apple announced that they had shipped 17.07 M iPhones in calendar Q3, and Gartner’s number of 17.295 M agrees fairly well.  Agreement with Google’s activation number is not quite as good with Google reporting 55 M Android device activations in Q3 versus Gartner’s estimate of 60.5 M sales of Android OS smartphones to end users.  Obviously, activations and sales are not quite the same thing, but I would have expected better agreement.  Gartner’s error is potentially worse for the fact that Google’s activation number is for all Android devices, not merely smartphones.  Nevertheless, Microsoft is so far behind even fourth place RIM that the broad trend is clear.  Since WinP7 was introduced in October 2010, Microsoft’s smartphone OS market share has actually declined.

 

Consumers have rejected Windows Phone 7.  It may be that WinP7 is a little too innovative, having departed so far from the touch-icon-to-launch-app paradigm of iOS and Android.  But I also think that WinP7 comes across as too complicated.  Tiles are multifunctional and display more information, but that also makes them potentially more confusing.  Data overload is not something people want from a phone.  Apple’s home screen may seem a little primitive compared to WinP7, but it has elegant simplicity and intuitive ease of use.  Apple realized a simple truth: people don’t want to have to think about how to use their phones, they just want to use them.

 

In the world of consumer tech, a year is a long time, and certainly long enough to discern whether a product is going to be successful.  WinP7 was a flop from the beginning, and a year later there’s no sign of recovery.  The Nokia partnership has yielded nothing remarkable, a pair of phones based on the single core Qualcomm MSM 8255 second gen Snapdragon.  They’re nice phones, but nothing that’s going to win over tens of millions of new customers.  Consumers can buy dual core phones running iOS or Android with better screens, thinner form factors, etc.  The miniscule size of the ecosystem, the lack of apps and content, just the fact that if you actually bought a Windows Phone, almost no one else you knew would, all these factors worked against WinP7 adoption. 

If this sounds like I’m advocating pulling the plug on WinP7, I am.  I believe that Microsoft eventually will do so, but they’ll probably wait another year.  What are they waiting for?  Well, they’re waiting to see if Nokia can deliver some Symbian converts as well as some phones, and they’re waiting to see what other partners like Samsung can do with the OS.  Most importantly they’re waiting for a hoped for synergy with Windows 8 Metro.  The Metro touch interface is so much like WinP7 that Microsoft hopes that if people use and like Metro, they’ll be more inclined to buy a phone that works the same way.  In fact, I expect Windows 8 to help with Windows Phone adoption, but not enough to make a real difference.  Win 8 is still months away, and in the meantime WinP7 market share will continue to dwindle. Does this mean I think Microsoft is dead in the water for mobile devices?  Not entirely.  The strategy they recently outlined at the 2011 FAM shows great promise in a key area: Intel powered tablets.  Intel tablets running Windows 8 (in Metro mode) will be slightly more bulky than their ARM based counterparts, but will be able to do much more.  I believe they’ll completely take over the Windows laptop space, since they can be used with keyboards (either detachable or wireless), and they can be used as desktop replacements with a dock and external monitor.  More importantly, this is a space that Apple have for the time being elected not to exploit, leaving themselves wide open.  Apple may only realize belatedly that touch screen enabled Mac portables would be a good thing, so insistent are they on maintaining touch screens as the exclusive province of iOS.  Windows 8 Intel tablets will put Microsoft back into the mobile Internet fight, as well as stimulate sales of Windows 8.  Notice I said Intel tablets.  Windows 8 on ARM processors will have much more difficulty initially, given the lack of compatibility with Windows legacy apps, as well as the relative lack of horsepower compared to Intel.  Until there are enough native ARM apps to attract users, Windows on ARM will be a niche, a very small niche.

Mixed Bag Financials

Microsoft’s earnings conference calls have largely become exercises in obfuscation, in which Microsoft’s on-going problems are largely ignored.  As shown in the SEC 10Q filed on 10/20/11, Microsoft’s revenue was up a paltry 7% y/y for its fiscal Q1 2012 (ending September 30, 2011) to US$ 17.37 B, virtually unchanged from the previous quarter.  Year over year operating income growth was almost non-existent at 1.2% to US$ 7.203 B, and would have declined y/y had it not been for cutbacks in Sales and Marketing for the quarter, as the chart on the next panel shows. 

 

Despite this mediocre performance (relative to Google and Apple), Peter Klein chose to characterize this as “good momentum” going into Microsoft’s new fiscal year.  I would hardly call this momentum, given that three of the five Microsoft divisions suffered revenue declines compared to the previous quarter, as the table on the next panel shows.

Division Q1 2012 Revenue US$ Q1 2012 Operating Income US$ Q4 2011 Revenue US$ Q4 2011 Operating Income US$ Sequential Revenue % Change Sequential Op. Income % Change
Windows and Windows Live 4.832E+09 3.219E+09 4.695E+09 2.866E+09 2.9% 12.3%
Server and Tools 4.251E+09 1.605E+09 4.646E+09 1.716E+09 -8.5% -6.5%
Online Services 6.420E+08 -4.940E+08 6.620E+08 -7.550E+08 -3.0% 34.6%
Microsoft Business 5.606E+09 3.648E+09 5.812E+09 3.624E+09 -3.5% 0.7%
Entertainment and Devices 1.855E+09 2.480E+08 1.396E+09 -5.300E+07 32.9% 567.9%

 

As was the case in last quarter’s review of Microsoft’s financials, this table is derived from the SEC 10Q filing and is non-GAAP, since Microsoft often only states division operating income non-GAAP, as they did last quarter.  Usually the differences between GAAP and non-GAAP revenues and operating income are small, so I feel the non-GAAP numbers usually reflect the performance of the various divisions.  Year over year comparisons are summarized below.

Division Q1 2012 Revenue US$ Q1 2012 Operating Income US$ Q1 2011 Revenue US$ Q1 2011 Operating Income US$ Y/Y Revenue % Change Y/Y Op. Income % Change
Windows and Windows Live 4.832E+09 3.219E+09 4.705E+09 3.206E+09 2.7% 0.4%
Server and Tools 4.251E+09 1.605E+09 3.961E+09 1.584E+09 7.3% 1.3%
Online Services 6.420E+08 -4.940E+08 5.270E+08 -5.790E+08 21.8% 14.7%
Microsoft Business 5.606E+09 3.648E+09 5.097E+09 3.321E+09 10.0% 9.8%
Entertainment and Devices 1.855E+09 2.480E+08 1.769E+09 3.600E+08 4.9% -31.1%

Microsoft Business division (home of Office) is the most profitable in terms of operating income, and managed the best year over year growth in revenue and income, excluding Online Services, which continues to lose money, although less than in the past (which is why I show positive per cent changes in operating income for the division).  Microsoft’s expressed strategy is simply to keep growing revenue for Online Services until some unspecified time in the future when they finally turn a profit.  However, Bing US market share is only up 3.5 % y/y to 14.7 %.

How Much of a Loss? 

After Microsoft's last quarter earnings report, I discovered from their SEC filings that the Entertainment and Devices Division had lost money, and in my article on Microsoft’s Q4 results I had speculated that this fiscal first quarter might also be a money loser for the division, considering the burden placed on it by Windows Phone 7.  Xbox has been a hit, and the platform has generated US$ 1.74 B of the US$ 1.855 B in division revenues for fiscal Q1, or 88% of revenues.  I estimate that Windows Phone 7 only generated about US$ 54 M in revenue in the quarter, hardly enough to recover development costs, let alone marketing and partner support.  Therefore I’m a little suspicious of the positive income for the quarter.  It appears to me that Microsoft have pushed much of the WinP7 development and related marketing cost into their catch-all corporate level activities, which cost the company US$ 1.164 B, a 16% cost increase year over year for the quarter.  Thus, we may never know exactly how much money WinP7 is actually losing. 

  • 1.
    Aiming for Third
  • 2.
    Gartner Data
  • 3.
    Mobile '11 OS Pie
  • 4.
    Mobile '10 OS Pie
  • 5.
    Mixed Bag
  • 6.
    Financial Summary
  • 7.
    Division Data
  • 8.
    How Much Loss?
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