Microsoft's steady retreat from consumer products is nearly complete

Two intertwined stories define Microsoft's recent history with consumer products and services. One is about bets that never paid off. The other involves shifting resources to business units that are thriving: enterprise software and cloud services.

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In the Satya Nadella era, Microsoft is all business.

Well, almost all business. Microsoft's gaming division seems pretty healthy these days. Anchored by the Xbox console and some popular game titles, that division brought in nearly $4 billion in revenue in the quarter that ended on Dec. 31, 2017. That's about 13.5 percent of the company's overall revenue that can be attributed directly to customers in search of fun.

But the Xbox factor is the exception, not the rule. In recent years. Microsoft has aggressively reengineered its business, focusing on enterprise customers and (with the noteworthy exception of the gaming division) moving away from consumer products.

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To get a better idea of where Microsoft is allocating its resources in the Satya Nadella era, I took a close look at the company's most recent quarterly report, released in late January 2018 and covering the final calendar quarter of 2017 (that's Q2 of Microsoft's fiscal year 2018).

In that quarter, Microsoft reported $28.9 billion in total revenue. Of that amount, about $19 billion (more than 65 percent of the total) came from large corporations and government agencies purchasing on-premises desktop and server software licenses, cloud services, and enterprise consulting services.

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After accounting for the gaming and enterprise segments, that leaves another $6 billion and change coming from other lines of business. Most of that revenue, it turns out, comes from sales of business-related products and services through the consumer channel. Very little of it is tied to consumer products, designed for entertainment rather than productivity.

This chart shows a breakdown by product category. The tall blue columns represent revenue from business products and services, while orange represents revenue from consumer products.


In the core Office and Windows segments, consumer revenue is a fraction of the total.

Part of the story involves some very large bets Microsoft made over the past decade or more that simply didn't pay off. During the fourth quarter of 2017, the company officially gave up on two of those consumer bets, exiting the digital music business and pulling the plug on development of Windows Phone.

Microsoft has been persistent in its pursuit of the digital music market for most of this century. But its efforts have been spectacularly unsuccessful. The Zune player became an easy punch line for sitcom writers, and the company's music store and streaming service transmuted through a parade of brands, including Xbox and Groove, but never made a dent in Apple's iTunes juggernaut. Microsoft removed music from its online store and shuttered its Groove Music Pass streaming service at the end of 2017.

Earlier in the quarter, the company pulled the plug on Windows Phone, admitting that new features and new hardware aren't in the cards for the platform. It was an ignominious ending for one of Steve Ballmer's biggest bets, which already resulted in a writedown of $7.6 billion for the Nokia acquisition.

Other Microsoft-branded consumer products that have ended in the past few years include Windows Media Center, which was the defining feature of Windows Home Premium editions at the height of the PC era, and the Microsoft Band, a Fitbit competitor.

With the exception of Xbox, in fact, Microsoft's product lineup in 2018 is remarkably free of products built for fun. Outside of gaming, most of its revenue from consumer channels comes from people buying software and services to do work-related things.

Take the Office Products and Cloud Services category, for example, which brought in almost one-fourth of Microsoft's revenue last quarter. In its 10-Q report, the company provided enough detail to break down its mix of revenue in this category:

  • A little over $6 billion came from the Office Commercial segment, selling Office 365 subscriptions, perpetual licenses for Office on-premises software, and a slew of ERP and CRM software and cloud services under the Dynamics brand name.
  • Another $1.3 billion came from the recent LinkedIn acquisition, specifically from "talent solutions, marketing solutions, and premium subscriptions."
  • By contrast, the Office Consumer product line accounted for less than $1.5 billion in revenue for the quarter. That's a healthy chunk of incremental revenue, but it pales in comparison to the amount that enterprise customers pay.

Because of Microsoft's opaque financial reporting, it's not possible to break out similarly detailed figures for the Windows business. But I've studied this business for long enough to be confident that the same pattern holds. The Windows Commercial business (volume licensing of the Windows operating system, plus Windows cloud services and other Windows commercial offerings) brings in the vast majority of revenue. The non-Pro OEM licensing business is, by my estimates, well under a quarter of the commercial business.

In the Devices category, it's likely that most revenue comes from individuals buying Surface devices (along with premium keyboards and mice). The Surface line started with a consumer product, the Surface RT, which turned into yet another massive write-off. The Surface Pro line, despite a shaky start, has been the clear winner.

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Microsoft also has a healthy commercial channel for Surface devices, one that's likely to grow faster than the rest of the business.

And then there's Search Advertising, which accounted for $1.8 billion in revenue in the quarter. For the sake of this discussion, I've categorized all of that revenue as belonging to the consumer category. In reality, it's probably more accurate to call this business a pure defensive play, to keep Microsoft independent of Google in any activity that involves search.

All in all, the numbers tell a simple story: Microsoft has been steadily shifting resources toward successful markets and out of those where the overall business opportunity is too small to justify the ongoing investment. That means gaming is likely to remain the only pure consumer play in Redmond.

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