Microsoft’s Mobile Crisis
Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The Windows on ARM Initiatives Falter
Windows RT and Windows Phone 8, which both run on ARM processors, were released along with Window 8 Pro for Intel systems. Windows on ARM (NASDAQ: ARMH) was the heart of Microsoft’s thrust into Mobile, designed to take on Apple's iOS and Google's Android smart phones and tablets, all of which run on ARM processors. Although investors may take some comfort from the announcement that 40 million Windows 8 (for Intel) licenses have been sold, conspicuously absent was any hard data on Windows RT, Surface RT, and Windows Phone 8 sales.
The Weight of the Evidence
My readers may well question if 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 its partners. Microsoft's (NASDAQ: MSFT) 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 the 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.
HP’s (NYSE: HPQ) recent earnings conference call on Nov. 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% year over year, with total unit shipments down 12% and notebook and desktop revenue down 15%. The CEO did say that they were "happy with Windows 8 inventories," and she 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 the Surface. Following the announcement on Nov. 13, 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.” 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. 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 million 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 the Windows division in the calendar third quarter (ending Sept. 30, 2012) has been attributed to anticipation of the Win 8 launch.
Using its latest 22 nm process, Intel is able to squeeze the power of a desktop into a tablet only a little larger than an iPad or Surface RT, 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 hopes to energize their base of support.
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 Apple (NASDAQ: AAPL) iOS ecosystems is mostly a matter of numbers: they have more. Both Android and iOS each have about 400 million users worldwide, and both support robust ecosystems of apps, games, and digital content.
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 the Online Services Division, home of Bing, which has been a steady money-loser. Not included in the Q2 2012 results for OSD is the $6.2 billion goodwill impairment charge Microsoft took to devalue OSD.
The Future of Microsoft: Opportunities and the Threats
Mobile devices have been widely regarded as the Next Big Opportunity, with many companies 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 (NASDAQ: INTC) devices such as tablets, convertibles, and ultra-light notebooks. 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 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 search and smart phones, Microsoft has lost money big time. The danger 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.
MarkHibben has a position in Apple. The Motley Fool owns shares of Apple, Intel, and Microsoft. Motley Fool newsletter services recommend Apple, ARM Holdings, Intel, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!