Microsoft (MSFT) Has To Get Smaller

Microsoft’s (MSFT) revenue dropped 17% in the second quarter, and worse, sales dropped in all five of the firm’s operating units. The recession and the decline in PC sales are to blame for the largest portion of the trouble, but the software company’s inability to raise prices aggressively is combining with drop in units demand.

Operating income fell more than revenue, off 30% to just under $4 billion. Microsoft faces the fact that, if sales of Windows 7 and a recovery from the tough economy do not combine to sharply increase the size of the company’s sales, it is operating with an expense base that is much too large.
Microsoft continues to appropriately insist that the search business is essential to its future. Its new product, Bing, has had a successful debut. The firm’s online business is still in considerable trouble, so Bing has to make large financial strides along with strategic ones. Revenue from the Microsoft’s online operation dropped from $837 million in last year’s calendar second quarter to $731 million this year. The loss from the division was even more troubling. It went from $485 million last year to $732 million in the quarter of this year. Microsoft’s “appendix”, its devices business, which is dominated by its Xbox products, lost $130 million. Revenue at the division dropped from $1.59 billion to $1.19 billion, which raises the question, once again, of why Microsoft is in the device business at all.
Microsoft may be able to continue to hold its own selling software to businesses though its server and office divisions, but it faces strengthened competition from online based software models from operations like Salesforce.com and successful enterprise firms lead by Oracle (ORCL), which is growing rapidly in its core businesses through an aggressive series of acquisitions. For reasons that are hard to fathom, Microsoft has not used its large cash balance to make similar strategic purchases. The core of Microsoft remains its “client” operation, the Windows operating system. It has been hurt by Vista, the latest version of the product, and, combined with the affects of the recession revenue fell from $4.36 billion in the quarter last year to $3.11 billion, an extraordinary drop for the company’s core business. Microsoft’s new Windows 7 will have to be a huge success, an unprecedented success given how much of the global OS business it controls, to make the company viable at current cost levels. Customers may simply elect to keep older versions of Windows, which could hurt the Microsoft business model which is based on upgrades of software over time.
Microsoft may find, over the course of the next year that its cost base is too large for what remains of its businesses.

Douglas A. McIntyre