Why Microsoft loves us

[Nerdy Woman]

After reading through all the conjecture about the future of Windows phones and Xbox, I decided to offer up a few facts. This information is from Microsoft's 2013 Annual Report (remember their fiscal year ends June 30, so this is a year old. The 2014 report is not out yet). I created a pie chart so you wouldn't all go crazy reading financial info. BTW, Xbox and Phones are the big purple slice at the top, Entertainment and Devices Division. Surface devices are part of the Windows Division. As you can see, Xbox and Windows phones are not an insignificant slice of this pie.



Now, what do each of those divisions sell?

Windows Division

operating systems for computing devices, related software and online services, Surface RT and Pro devices, and PC accessories
approximately 65% of total Windows Division revenue comes from Windows operating systems purchased by original equipment manufacturers (?OEMs?) and pre-installed on devices they sell. The remaining Windows Division revenue is generated by commercial and retail sales of Windows, Surface, PC accessories, and online advertising
​

Server and Tools

product and service offerings include Windows Server, Microsoft SQL Server, Windows Azure, Visual Studio, System Center products, Windows Embedded device platforms, and Enterprise Services. Enterprise Services comprise Premier product support services and Microsoft Consulting Services. We also offer developer tools, training, and certification. Approximately 80% of Server and Tools revenue comes from product revenue, including purchases through volume licensing programs, licenses sold to OEMs, and retail packaged product, while the remainder comes from Enterprise Services
​

Online Services Division

include Bing, Bing Ads, and MSN. Bing and MSN generate revenue through the sale of search and display advertising, accounting for nearly all of OSD?s revenue
​

Microsoft Business Division

include the Microsoft Office system (?Office,? comprising mainly the core Office product set, Office 365, SharePoint, Exchange, and Lync), which generates over 90% of MBD revenue, and Microsoft Dynamics business solutions
​

Entertainment and Devices Division

products and services designed to entertain and connect people. EDD offerings include the Xbox entertainment platform (which includes the Xbox 360 gaming and entertainment console, Kinect for Xbox 360, Xbox 360 video games, Xbox LIVE, and Xbox 360 accessories), Skype, and Windows Phone, including related patent licensing revenue

EDD revenue increased, due to higher Windows Phone and Skype revenue, offset in part by lower Xbox 360 platform revenue. Windows Phone revenue increased $1.2 billion, including an increase in patent licensing revenue and sales of Windows Phone licenses
​

Any questions?

 

[Chregu]

Any questions?

Yes, what's about profit?

 

[Maaz Mansori]

Windows Phone licenses are now free, and much of the entertainment such as original TV shows are being cancelled. I would assume Windows Phone software would be rolled into the Windows division, and maybe Xbox as well.

 

[Nerdy Woman]

Yes, what's about profit?

Since you asked... Here's a chart showing the NOI. Although the NOI from Entertainment and Devices is only $848 million, that's still better than the $1.28 billion loss in the Online Services Division (Bing, MSN).

Windows Phone licenses are now free, and much of the entertainment such as original TV shows are being cancelled. I would assume Windows Phone software would be rolled into the Windows division, and maybe Xbox as well.

Much of the entertainment? Do you think they would have canceled the original content if it would have provided a profit instead of just an additional expense? Quality television-type shows are expensive to produce. Could Xbox studios have created shows on par with Netflix original offerings, in quantities sufficient to compel people to buy an Xbox controller and sign up for a gold subscription? Reality check.

 

[Maaz Mansori]

Much of the entertainment? Do you think they would have canceled the original content if it would have provided a profit instead of just an additional expense? Quality television-type shows are expensive to produce. Could Xbox studios have created shows on par with Netflix original offerings, in quantities sufficient to compel people to buy an Xbox controller and sign up for a gold subscription? Reality check.

That depends. I'm not saying it was a bad decision. However, you can't assume that one additional expense in one division can't be made up with ad revenue or sales of devices in another division. They could have allowed Windows and WP devices to access the content as well, instead of just limiting it to Xbox. If they did it right, it could have offered a good incentive to sell more Microsoft products and subscriptions, then being able to charge more for ads because of more customers. However, I think it's more along the lines of them just not wanting to be in the business because they want to streamline what their company focuses on as a whole.

 

[a5cent]

Hey! Thanks for that nice summary!

Although I understand the difficulties involved in large scale software and operating system development, the money that must be spent to make our gadgets a reality never ceases to amaze me!

You already mentioned that IP licensing profits from Android are factored into the 'Entertainment and Devices' division's numbers. Last I heard they were estimated at around $2 billion. Excluding those profits would put NOI at the same level as their online services.

I'm not trying to spoil the fun, but just wanted to point out that consumer entertainment/hardware is a tough as nails business. The good news is that WP is on the right trajectory.

 

[VS729]

Well, nicely put, ty, but surely the Xbox tv news has spoiled many relationships and the image if ms....i mean advertising is only wat makes the money...its something the world runs on.imho...lets see how things unfold though...

 

[Nerdy Woman]

That depends. I'm not saying it was a bad decision. However, you can't assume that one additional expense in one division can't be made up with ad revenue or sales of devices in another division. They could have allowed Windows and WP devices to access the content as well, instead of just limiting it to Xbox. If they did it right, it could have offered a good incentive to sell more Microsoft products and subscriptions, then being able to charge more for ads because of more customers. However, I think it's more along the lines of them just not wanting to be in the business because they want to streamline what their company focuses on as a whole.

You're probably right about them not wanting to be in the movie production business. That is not their core competency. Would it have made a significant difference to the bottom line? Probably not.

Compare Netflix. I became a Netflix subscriber because House of Cards looked like must see TV to me. I'm sure others were drawn to Breaking Bad or another Netflix original. I'd originally planned to do the 30-day trial and be done. But at $8/mo, there are enough classic movies that my daughter and I enjoy watching and the investment is insignificant, so I'm still a Netflix subscriber. Making their own makes sense for Netflix. I don't know what the numbers look like, but I'm sure they pay licensing fees for every movie they offer (either PPV or periodic payments). Eliminating that expense offsets the cost of homegrown + increases revenues because of viewers like me.

Given the fact that no one show is going to attract the majority of users, how many shows will Microsoft have to make and at what cost to make that profitable? Would it be monetized solely through advertising, added as an additional feature to xbox gold, or a separate subscription like xbox music? Again, video production is not Microsoft's core competency. The only compelling reason would be if there was a lack of things to do and watch with an xbox device or something so irresistible that people raced out to buy an xbox just to watch that show (yeah, right).

The entertainment division is profitable and not an insignificant piece of the revenue stream for Microsoft, but the way business works? Each product has to pull its own weight unless it is absolutely necessary. ie., the Bing search engine. Although Bing only has 20% market share, dwarfed by Google's 67%, it is necessary to other products such as Windows 8.1 search everywhere functionality and Windows Phones (Cortana). The alternative would be to use Google for Microsoft searches. Yeah, no. The worst thing Google ever did was to require users to register to use most of their services. Now, the last thing Microsoft wants to do is send users to Google's search engine.

Homegrown movies on Xbox doesn't enjoy that lofty status. It would have to pull its own weight and apparently, Microsoft doesn't see that happening.

 

[Nerdy Woman]

Hey! Thanks for that nice summary!

Although I understand the difficulties involved in large scale software and operating system development, the money that must be spent to make our gadgets a reality never ceases to amaze me!

You already mentioned that IP licensing profits from Android are factored into the 'Entertainment and Devices' division's numbers. Last I heard they were estimated at around $2 billion. Excluding those profits would put NOI at the same level as their online services.

I'm not trying to spoil the fun, but just wanted to point out that consumer entertainment/hardware is a tough as nails business. The good news is that WP is on the right trajectory.

Not quite as bad as online services... 2013 saw a $375 million increase in payments to Nokia related to joint initiatives over 2012 numbers (another day I might undertake a year-to-year analysis). So with Nokia hardware now MS hardware, those payments might disappear into the purchase cost and Microsoft, having already killed all non-Windows Nokia devices, might be able to focus on making the division more profitable.

Q4 2014 numbers come out on Tuesday. If I can carve out some time, I might just post a pic-summary...

 

[rodan01]

Microsoft redefined the segments in the last reorg.