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Earnings Redux: Microsoft Makes Less Money, But Why?

It's the incontrovertible rule of RCPU: No matter what happens, Microsoft makes more...Wait, what's this? Microsoft didn't make more money in its most recent fiscal quarter? Well, not compared to the year-ago quarter, it didn't -- but you know that by now.

Yes, by now, you've seen the results of Microsoft's third fiscal quarter of 2008 (but here they are again, in case you haven't). And, by now, you've read the news stories, the blogs and the commentaries about how the software industry's money machine, which had been racking up massive quarters as far back as we can remember -- or at least for the last couple of years or so -- finally hit a wall.

Profit fell 11 percent in Q3 '08 compared to the year-ago quarter, and although Redmond beat analysts' expectations, the first reaction the market had late last week was to punish Microsoft's stock price. Especially weak were the company's client division (basically Windows and Office) as well as -- to our surprise here at RCPU -- the Microsoft Business Division, which is mostly made up of the Dynamics enterprise software line. Both divisions reported revenue shortfalls year over year. Microsoft's beleaguered Online Services Business (search, MSN, various "Live" things and stuff like that) showed a bit of revenue growth but also reported a bigger operating loss than what it had racked up in Q3 '07.

The disappointing news unleashed a flurry of theories as to why Microsoft didn't, after all, make more money in Q3. (On top of everything else, a little helpful accounting actually gave the numbers a bit of a boost, something that suggests that they could have actually been worse.) After scanning a slew of online offerings, we found that most observers pegged Microsoft's shortfall on one (or several) of a few simple factors:

  • The end of Microsoft as we know it. Well, actually, maybe not; although we read a bunch of blog entries that referred to "reports of Microsoft's demise" and so forth being premature or inaccurate, we found that very few pundits, if any, actually reported Redmond's demise. Probably the closest thing we found to that sort of thing was here, and it's pretty innocuous. And, no, we didn't search the open source or Mac blogs. So, as often happens in the blogosphere, reports of the reports of Microsoft's demise were, um, over-reported. Or something like that.

  • Vista. The weakness in the Client division had a few commentators pointing the revenue-shortfall finger at Vista, which is still failing to impress in the enterprise. There might be something to this -- Microsoft keeps claiming that it has sold 140 million Vista licenses, but as one intra-Microsoft blogger mentions, we've been hearing that figure for a while now. Are Vista sales slowing or stalled? Everything we hear and read suggests that they are...and that could be a big reason why the client division's numbers fell.

  • Piracy. Microsoft has struggled to rein in piracy in developing markets such as China, and that semi-failure has led to all sorts of repercussions. For one thing, in an effort to fight both piracy and open source competition, Microsoft has been selling Windows and other software at discount rates in some foreign markets, meaning (duh) that it makes less money on those sales than it used to. Plus, Microsoft CFO Chris Liddell said himself that piracy is hurting Microsoft's sales worldwide. It seems to be playing at least some sort of negative role.

  • The economy. Could this be the first sign of the slowdown we've all feared and dreaded and assumed we were already in? Maybe. That would certainly make for a convenient explanation for Redmond, and IDC has been making noise about IT budgets dropping. Of course, we're not convinced that IT folks would spend money on Vista even in good times.

  • Yahoo. Mary Jo Foley cites a lack of focus on Windows and Office -- caused by Microsoft's obsessive-compulsive behavior toward Yahoo -- as a possible cause of Redmond's shortfall. This makes sense to us, not only because Mary Jo says it but because as followers of Microsoft news, we've been struck by how little Redmond has had to say lately that didn't have the word "Yahoo" in it somewhere.

Whatever Microsoft's problem was, or is, it's not time for partners or anybody else to panic. Some huge products are on the way -- think Windows Server 2008 and its buddies -- that should get everybody's cash registers ringing again. What will be interesting to track is the trend of Windows sales; did Microsoft have a revenue shortfall because of Vista or because Windows as an operating system really is going out of style? Or was there some other reason? Stay tuned; the next earnings report (Q4 and fiscal year 2008) is a big one.

Oh, and we're through making laws here at RCPU, just for the record.

Send your take on Microsoft's earnings, its future and all things Microsoft to lpender@rcpmag.com.

Posted by Lee Pender on 04/29/2008 at 1:21 PM


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