Surface Write-Off Dampens Microsoft Profits

Microsoft Surface

Microsoft Surface

Seems like a steady drumbeat at this point about the woes related to Surface, but Microsoft profits missed quarterly expectations mostly because of an RT tablet inventory write-off and sagging Windows operating system sales.

Microsoft Corp. reported annual earnings of $73.7 billion with $21.8 billion in profit. The fourth quarter, which ended June 30, missed profit expectations by the biggest margin in a decade as Microsoft was forced to write off $900 million in Surface RT inventory.

Additionally, sales in the Windows division came in at $4.4 billion in the latest quarter, down from the quarterly average of $4.8 billion. Analyst firm IDC said PC shipments were down 11 percent in the most recent quarter, but Microsoft said it saw demand fall 20 percent, which hurt sales of Windows and the Office productivity suite.

“While our fourth quarter results were impacted by the decline in the PC market, we continue to see strong demand for our enterprise and cloud offerings, resulting in a record unearned revenue balance this quarter. We also saw increasing consumer demand for services like Office 365,, Skype, and Xbox LIVE,” said Amy Hood, chief financial officer at Microsoft, in the earnings statement. “While we have work ahead of us, we are making the focused investments needed to deliver on long-term growth opportunities like cloud services.”

Microsoft is operating under steady criticism for its go-to-market strategy and products. While Windows 8, launched October 2012, finally brought Microsoft into the touch-screen interface market, it arrived when tablets and smartphones were peaking and Google and Apple had already established market superiority.

Microsoft and others had high expectations that Windows 8 would revive PC sales, which fell nearly 9 percent in 2012 and projected to fall as much as 11 percent in 2013. Typically, a new version of the world’s most widely used operating system would spur upgrades and new adoption. Instead, the market – consumer and commercial – continued to extend the life of their existing Windows 7 machines and adopt new iPad, iPhone and Google Android-based devices.

Microsoft Surface, also introduced October 2012, is seen as an interesting entry in the tablet market. Its two versions, Windows RT and Windows 8, offer similar and, in some cases, superior capabilities to an iPad or Android tablet. Nevertheless, Surface isn’t a best seller; analysts say Microsoft shipped just 900,000 in the first two quarters of the tablet’s availability and has sold probably 1.5 million. By comparison, Apple sold 23.5 million iPads in the fourth quarter of 2012 alone.

Partners have been clamoring to sell the Surface tablet to their accounts. But Microsoft has been approaching the channel with a slow rollout. It was only after sales bottomed during the 2012 holiday season that Microsoft added Best Buy and Staples to its Web direct and retail store sales strategy. Earlier this month, Microsoft authorized a dozen direct market resellers, such as CDW, to resell the tablet.

At the recent Worldwide Partner Conference, Microsoft offered partners deeply discounted Surface tablets; the RT version selling for just $99. The discounted sale, which drew long lines, and the limited channel strategy did irk solution providers. As one Microsoft partner told Channelnomics, “If you can’t sell them to real customers, sell them to partners who can’t sell them to their customers because you won’t let them.”

Hurting Windows RT further is the defection of Microsoft OEM partners from the operating system built for low-power ARM mobile processors. Lenovo is the latest PC company to announce it will stop offering its popular Yoga notebook running RT. Hewlett-Packard and Acer both toyed with producing RT tablets, but since abandoned their plans.

Solution providers say Microsoft would have been better of giving the channel the Surface tablet to sell, broadening its potential distribution across the total addressable market. Instead, Microsoft has been wading into the channel with its first computing device. When asked by Business Insider why Surface isn’t available to all reseller partners, Microsoft said, “This first phase of authorized resellers were selected because of their extensive knowledge, services and support they’re able to bring to the Surface family. We’ll sign up more resellers and reach more countries in the coming months, but have nothing further to share at this time.” Noncommittal and undefined timelines have become the standard Microsoft response.

While Microsoft is under pressure in Windows and PC-related products, its other divisions are either holding their own or growing. The Business Division, which includes the Office suite, grew 14 percent in the fourth quarter and 3 percent for the full year. Server and Tools grew 9 percent on the full year on increasing sales of SQL Server and System Center. Online Services, which includes Windows Azure, grew 9 percent. And the Windows Division, the company’s cornerstone, grew 5 percent year-over-year, despite the market pressures.

“We continue to see strong demand for our enterprise products and services, with more and more customers making long-term commitments to the Microsoft platform,” said Microsoft COO Kevin Turner. “The growing adoption of our cloud services, including Office 365, Windows Azure and Dynamics CRM, continues to demonstrate our leadership position in the cloud.”

Earlier this month, Microsoft announced a sweeping reorganization that will consolidate different business units into four operating groups and focus all products and services into a single go-to-market strategy. The intent is to break down walls that prevent collaboration and innovation. Microsoft has acknowledge that its 18 months behind the market in mobility solutions. Reading between the lines, Microsoft is looking to not just leapfrog competition, but fill holes that will prevent being caught behind the market again.