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Surface damage mounts at Microsoft as red ink reaches US$1.7 billion

Gregg Keizer | Aug. 5, 2014
The tablet business has lost money each quarter, and each fiscal year.

Surface red ink
(Dawson's numbers for annual revenue and annual cost of revenue were identical to Computerworld's.)

The total loss for FY2014 was then $680 million ($2.192 in revenue minus $2.872 in cost of that revenue).

But that was small potatoes compared to what Microsoft lost on the Surface the previous fiscal year. Using Microsoft's stated revenue of $853 million and some arithmetic to backtrack to the FY2013 cost of revenue, Computerworld concluded that the cost of revenue for the 12 months starting July 1, 2012, was $1.902 billion.

The total loss for FY2013 was thus $1.049 billion ($853 million minus $1.902 billion in cost of revenue and adjustments).

Since Microsoft started selling the Surface nearly two years ago, it has lost $1.7 billion on the line. (Microsoft, SEC filings.)

Most of the FY2013 loss was attributed to the massive $900 million write-off Microsoft announced in July 2013. That write-off, the first of two the Redmond, Wash. technology company has been forced to take on the Surface, accounted for a glut of Surface RT tablets Microsoft couldn't sell.

So, since the Surface's sales debut, Microsoft has lost $1.73 billion ($680 million plus $1.049 billion) on the new hardware.

While that loss may not pose an existential threat to Microsoft's finances -- it represented just 3% of the company's FY2014 gross margin, and less than 9% of the year's gross margin for the Devices and Consumer division, of which Surface is only one part -- it's certainly real money.

If Microsoft had managed to just break even on the Surface in FY2014, for instance, it would have boosted its year-over-year revenue growth by nearly one percentage point, from 11.5% to 12.4%.

In an analysis published last week, Dawson put the Surface debit into context. "Continued losses will make it harder and harder for Microsoft to keep the Surface project going, so a good performance in the next quarter or two will be critical to justifying its continued existence," he wrote.

In the interview today, Dawson elaborated. "You can accept some losses for a while, but how sustainable is that in the long term?" he asked. "Can you run [into the red] indefinitely?"

Dawson didn't think so, especially now with Satya Nadella as CEO.

"My sense is that Nadella is less willing to accept losses than was [Steve] Ballmer," Dawson said, referring to the former CEO. "Ballmer was willing to make decisions that involved heavy losses," Dawson added, citing both the Surface and the Nokia purchase.

One hint of Nadella's unwillingness to pour resources into a money-losing business came from his comments on the July 22 earnings call with Wall Street. "At times, we will develop new categories like we did with Surface and we will responsibly make the market for Windows phone," Nadella said then. "However, we are not in the hardware for hardware sake, and the first-party device portfolio will be aligned to our strategic direction as the productivity and platform company."

 

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