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Microsoft loses grip on Christmas shoppers... despite XBox boost

Windows Phone = loser. Budget Surface RT slab = saviour?!

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Analysis Microsoft's second quarter results, posted on Thursday, reveal that the software giant struggled in the sexy world of devices during the all-important Christmas shopping period.

These are the first numbers indicating how the battle between PCs and smart devices played out over the battleground for consumers' wallets that is Christmas.

What Microsoft’s results showed was consumers turning away from MS when it comes to smartphones – but jumping in where it dropped prices on certain tablets.

We expected the consumer PC business to take a hit, as consumers have generally stopped buying PCs and started buying tablets instead. Microsoft’s PC OEM business duly took one for the team. Windows OEM non-pro revenue, which meant consumer sales, were down 20 per cent year on year.

Neither were the public buying Office – sales on that are down 24 per cent, which Microsoft attributed to people taking out subscriptions to Office 365 Home Premium. But what really hurt was the lost of business in tablets and smartphones – two areas it has invested in.

Microsoft is so invested in them, in fact, it completely re-organised its corporate structure last summer, supposedly to make it more of a devices firm.

The software company is such a believer in smartphones, it’s buying Nokia’s handset business to pump out more Windows Phone handsets.

Microsoft did, however, do well in one area of consumer activity. Yes, you guessed it: Xbox.

The company’s other big success story was the enterprise. It was sales of Windows Servers, Dynamics, Office for business and unified communications that pushed Microsoft towards yet another quarter of “record” growth. These are now in Microsoft's consumer licensing unit, a unit that grew 28 per cent.

But let’s talk consumers first, and what it means.

Microsoft claimed that over Christmas revenue for Surface “more than doubled” compared to the previous quarter, from $400m to $893m. The company told Wall Street: "For Surface, we saw improved sales of Surface RT and also introduced Surface 2 and Surface Pro 2 into the market."

Surface is part of the Microsoft group called devices and consumer hardware, which is also home to Xbox and Xbox Live.

That group’s revenue grew 68 per cent, but given Surface is still such a tiny business it was Xbox in the driving seat. Microsoft sold more than 7.4 million Xbox One and Xbox 360 consoles during the quarter. Redmond did not break out exact revenues.

The other big driver of consumer revenue? Discontinued and heavily discounted Surface RT tablets.

Microsoft called out Surface RT during its conference call to discuss the results, talking of “improved sales.” The company’s execs didn’t provide unit shipment numbers, either for Surface RT versus its successor Surface 2, or on Surface 2 and Surface Pro 2 as a whole.

Even though Microsoft whistled through on Surface RT, things bode ill for its future.

Surface RT is now discontinued, having been replaced by the Surface 2 – also ARM-based and also running Windows RT, but a different product.

Further, it was heavy discounting that drove Surface RT sales. In the second half of 2013 Microsoft cut the price of Surface RT and began heavily discounting for schools.

US mega retailer BestBuy slashed Surface RT prices by 75 per cent in November, taking them below the psychologically and commercially important $200 barrier.

You can get a flavour of how much Microsoft was selling at a loss from the margins of the Surface group, that devices and consumer hardware unit, for the second quarter: they were down 46 per cent (to $411m) compared to a year ago.

Microsoft permitted the fire sale because it had to claw back money. In the summer Microsoft wrote off nearly $1bn on Surfaces that had not sold.

The worry for Microsoft is two fold.

One, is that Surface RT’s successor, Surface 2, along with its companion Surface Pro 2 are all over priced. It’s low-priced Android tabs that are shipping in volume. The fact Surface RT only began moving in big numbers once it was cut by 75 per cent was telling. Microsoft, though, has not learned: Surface 2 – the successor to Surface RT – starts at $359 and it doesn’t even have apps. Even Apple is lower, with an iPad Mini starting at $299.

This creates a second problem: what does Microsoft fill the gap if/when Surface RT is sold out? And, further, will it have to discount the Surface 2 and Pro 2?

“Next quarter we expect they will run out of Surface RTs,” Canalys senior analyst Tim Coulling told The Reg. Coulling tracks tablet and PC shipments. “Can Microsoft plug that unit shipment hole with new Surface products? That’s a big challenge because the price points they sell at.”

Over to phones, Microsoft’s other big-ticket re-invention item.

Windows Phone is housed in the devices and consumer licensing unit with Windows, Office Consumer and revenue from Android royalties. Revenue for that group fell 5.5 per cent, with group margins falling three per cent.

Microsoft blamed the tanking PC sales, but the results from Nokia that were announced on the same day suggest this was not the case for Windows Phone.

Nokia and Windows Phone

Net sales for Nokia's phone business in the fourth quarter dropped 29 per cent to €2.63bn ($3.6bn) and fell five per cent from the earlier quarter. After four consecutive gruesome quarters, net phone sales for the full year were likewise down 29 per cent, to €10.74bn ($14.71bn).

As The Reg notes here: “This was no mere bad patch.”

Comment

Nokia is the single largest maker of Windows Phone by a country mile, so if Nokia can’t sell the phones then Microsoft’s plans for Windows Phone look like they are in real trouble. The numbers mean you really must challenge everything you’ve read in the past few weeks about Windows Phone out-selling Apple’s iPhone in “certain” geographies as either badly compiled data or a shift away from Nokia as Microsoft’s primary phone maker.

This is a critical time for Microsoft. The world's largest software maker, married to the PC, is trying to become become the largest provider of software and hardware that lets you compute from the palm of your hand or using your finger tip.

Despite what Microsoft says, it's simply not there yet. Judging by its Christmas sales, it won't be there for some time. In the meantime, there's the enterprise. ®

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