Microsoft’s Mobile Crisis
by Mark W. Hibben
The Windows on ARM Initiatives Falter
Windows RT and Windows Phone 8, which both run on ARM processors, were released coincident with the release of Window 8 Pro for Intel systems. Windows on ARM was the heart of Microsoft’s thrust into Mobile, designed to take on iOS and Android smart phones and tablets, all of which run on ARM processors. Although investors may take some comfort from Microsoft’s recent announcement that 40 million Windows 8 (for Intel) licenses have been sold, conspicuously absent from the announcement were any hard data on Windows RT, Surface RT, and Windows Phone 8 sales.
The Weight of the Evidence
My readers may well question whether a crisis actually exists, but here I’m just siding with the preponderance of the evidence. Perhaps the best evidence of the Windows on ARM flop is the lack of specific information, either from Microsoft or from partners such as Dell, Asus, Lenovo, or Nokia. Microsoft management haven’t missed a chance to brag about sales numbers, so the lack of numbers for RT licenses, Surface and Windows Phone 8 isn’t a good sign. And Ballmer is widely reported to have told a Paris newspaper that sales of Surface were “modest”. There is also anecdotal evidence provided by Philip Elmer-DeWitt in his Apple 2.0 blog from Gene Munster of Piper Jaffray. Munster’s team staked out the Apple and Microsoft stores at the Mall of America for a couple of hours on Black Friday. During the observation, the Apple store sold 11 iPads/hour vs. 0 Surfaces/hour.
Even Microsoft’s announcement about Windows 8 sales bears further consideration. Microsoft has historically lumped license sales to consumers and PC OEMs together, with OEMs accounting for about 75% of sales. This means that about 30 million licenses went to OEMs in order to build inventory with about 10 million to consumers and retailers. In either case, there’s no real way to tell how many Windows 8 licenses have actually been bought by consumers in form of new PCs, standalone licenses, or upgrades. This is important because the Microsoft marketing push for Windows Phone is now based on “completing” the Windows 8 experience. Microsoft evidently hopes to kick start Windows Phone 8 sales based on linkage to Windows 8, a strategy that may backfire.
HP’s recent earnings conference call on November 20 would have been an opportune time for a major partner of Microsoft to say something nice about Windows 8. That was made difficult by the fact that HP Personal Systems (PCs) quarterly revenue was down 14% y/y with total unit shipments down 12% and notebook and desktop revenue down 15%. Meg did say that they were happy with Windows 8 inventories, which is putting the best possible face on slow sales that I can imagine. Meg also blurted out during Q&A that she didn’t expect Windows 8 to “gain traction” until the middle of 2013, a further indication of slow initial sales.
Not that all Windows 8 devices are selling poorly. There is also anecdotal evidence provided by Trip Chowdhry of Global Equities Research that two touch screen devices by Acer and Sony are selling well, although specific numbers were lacking in his report, described in a recent Forbes article by Louis Bedigian. But this basically confirms my expectation that Intel based portable systems with touch screens will do well with Windows 8. As I stated in my Windows 8: a Competitive Assessment, it is sales of conventional non-touch screen PCs that I expect to be hurt by Windows 8. The Forbes article also confirmed my expectation that Windows RT Surface sales would be slow, with most potential customers preferring to wait until the Windows 8 Pro version comes out, since it is equipped with an Intel Ivy Bridge processor and can run all Windows 7 apps.
And then there is the matter of Mr. Sinofsky’s sudden departure. Sinofsky, as head of the Windows Division, oversaw the development of Windows 8 and its ARM variant, as well as Surface. Following the announcement on 11/13/12, the tech media bent over backwards to avoid the implication of failure at Microsoft.
Instead, writers such as Nick Wingfield of the New York Times preferred to focus on Sinofsky’s alleged personality deficiencies, describing him as “polarizing” and “territorial”. Such journalistic contortions simply strain credulity to the breaking point, and a few moments’ reflection is sufficient to dismiss such claims. If Sinofsky’s personality issues were sufficient to get him fired, he would never have risen to the position he held in the first place, since these issues surely would have been manifest long before now. Here, the simplest explanation is almost certainly the correct one. Someone had to take the fall for Windows RT and Surface RT, and it wasn’t going to be Ballmer.
Crisis is not Necessarily Disaster
For this SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis of Microsoft, I’ve chosen to call the Mobile situation a crisis because such crises present opportunities as well as threats, and test the strengths and weaknesses of the organization and its leadership. Make no mistake. Microsoft’s test is just beginning, and it will be long and grueling. But first, let me in good SWOT fashion enumerate Microsoft’s strengths and weaknesses.
Strengths: Microsoft’s great competitive strength lies in its huge installed base of Windows users worldwide, which includes about 670 M Windows 7 users. Most of these people use other Microsoft products as well, especially some version of Office, either at home or at work. Windows 7 is without a doubt the best OS Microsoft has ever produced, and I consider it on a par with Mac OS X. Microsoft’s strength in operating systems and business software is reflected in the three divisions that continue to perform reasonably well, Windows and Windows Live, Server and Tools, and MS Business Division (home of Office). As can be seen in the following chart, they all make money, although not always as much as in the previous year.
The decline in revenue and operating income for Windows division in the calendar third quarter (ending September 30, 2012) has been attributed to anticipation of the Win 8 launch. Although we hear endlessly about the “death of the PC”, in fact, the Intel powered desktop or laptop is still very compelling for users. They are inherently more computationally powerful machines than ARM based devices. Desktop PCs are the platform of choice for photo-realistic games such as Modern Warfare, simply because PCs have developed to the point that they easily outperform consoles, not to mention mobile devices of all types. For demanding tasks such as 3D modeling or digital video editing, there simply isn’t a better solution than a system based on the latest Intel Sandy Bridge E or Ivy Bridge processors.
Using its latest 22 nm process, Intel is able to squeeze all that power into a tablet only a little larger than an iPad or Surface, which is why so many people are waiting expectantly for the Ivy Bridge based Surface Pro. The Intel PC isn’t dead, but it will continue to shrink and become more energy efficient. In Windows 8, Microsoft clearly needed to energize their base of support, but it remains to be if they have succeeded.
Weaknesses: Mobile devices, phones and tablets, remain the major weakness of Microsoft, despite credible efforts in Windows Phone 7 and now Windows RT and Windows Phone 8. As IDC’s August report showed, Windows Phone 7 had only a 3.5% worldwide smart phone market share in Q2 2012, putting it in fifth place behind Symbian, which it was supposed to replace at Nokia. Microsoft’s failure to make much headway against the Android and iOS ecosystems is mostly a matter of numbers: they have more. Both Android and iOS have about 400 M users worldwide, which support robust ecosystems of apps, games, and digital content. Being so late to the game just gives consumers the impression of cluelessness, and indeed Microsoft management has been consistently clueless about iPhone and iPad.
The weakness in Mobile devices is reflected in the poor performance of the Entertainment and Devices division, home to Xbox and Windows Phone. Despite relatively strong sales of Xbox (currently the best selling console in a declining market), the division has been weighed down by losses due to Windows Phone. As the chart below shows, ED lost money in Q1 and Q2 of 2012 and barely eked out a profit in Q3.
Also included as a non-Core business is Online Services Division, home of Bing, which has been a steady money-loser. Not included in the Q2 2012 results for OSD is the US$ 6.2 B goodwill impairment charge Microsoft took to devalue OSD.
I personally believe that the true cost of Windows Phone is not fully reflected in the ED results. Starting in 2012, corporate costs took a big jump, from about US$ 1B to 1.4B suggesting that some of the Windows phone burden was being borne by corporate in the form of R&D and Sales and Marketing costs, which are booked at the corporate level.
The Future of Microsoft: Opportunities and the Threats
Mobile devices have widely been regarded as the Next Big Opportunity, with companies such as Google anxious to sell smart phones to “the next billion”. Insofar as ARM based devices, I believe that the opportunity has already passed Microsoft by. Microsoft simply started too late. The other ecosystems are too well developed and entrenched. Microsoft will probably soldier on with Windows Phone and RT for another year, however, before finally giving up. After all, the major investment in developing the OS and developer tools is mostly behind them, so they might as well reap whatever they can.
The real opportunity for Microsoft is in ever smaller and more portable Intel devices such as tablets, convertibles, and ultra-light notebooks. In the end, I believe Microsoft will be forced to realign itself with its natural ally, Intel. Although Intel processors are somewhat disadvantaged compared to ARM when it comes to power consumption, Intel may be able to brute force a competitive Intel processor through their superior process control. Intel Atom processors based on the 22 nm process will be coming out next year, and these promise to be as low or lower in power consumption while providing more computing power than current or foreseeable ARM processors.
The great threat to Microsoft’s future is in the great diversity of its businesses and initiatives. Microsoft is trying to be the dominant platform for ARM and Intel systems, as well as the dominant server platform, as well as the dominant search engine, as well as the dominant cloud services provider, as well as the dominant game console provider. In the areas where it has launched frontal assaults on competitors such as in Online Services (home of Bing) and Windows Phone, Microsoft has lost money big time. The danger to Microsoft is that in pursuing these money losers, Microsoft will lose focus on its core business, Windows, and its core platform, Intel. Assuming that the loss of focus has not already occurred.