Microsoft is still an enterprise software company (And that's ok.)

Microsoft is still an enterprise software company (And that's ok.)

Summary: Microsoft's enterprise software sales are still carrying the devices and services company, as the company's latest earnings report makes plain.


What is Microsoft these days?


Microsoft officials, first and foremost, want to position the company as a devices and services power house, or at least well on its way to becoming one. 

The reality, as the company's Q2 FY 2014 earnings made plain is Microsoft is still a software company. And a primarily enterprise software company, at that.

There's nothing wrong or shameful about this fact. But it's not the message Microsoft wants to convey, given management is heavily focused on growing the company's consumer market share. Microsoft doesn't want to be IBM. But it's still a lot more like IBM than it's like Apple or Google. 

Figuring out where Microsoft is making money is a bit tricker than it used to be. Gone are the familiar, old Windows/Office/Online/Entertainment/Server & Tools groupings us Microsoft watchers had come to know and sort of love. Microsoft made over its reporting categories a few months back.

New segmentation not withstanding, it's apparent that Microsoft's strong second fiscal quarter for fiscal 2014 was powered by enterprise software more than devices or services -- regardless of any headlines one might see to the contrary.

Using the new reporting structure, here were the top three segments, revenue-wise, for Microsoft in Q2 FY 2014:

1. Commercial licensing, meaning Windows Enterprise, Server Products, Office Business, Dynamics and Unified Communications: $10.9 billion
2. Devices and consumer licensing, meaning Windows OEM, Windows Phone, Office Consumer and IP licensing: $5.9 billion
3. Devices and consumer hardware, meaning Surface, Xbox/Xbox Live and other hardware: $4.7 billion

And here are the top three Microsoft business segments, as measured by gross margins, for Q2 FY 2014:

1. Commercial licensing (a k a the enterprise software mentioned above): $10.8 billion
2. Devices and consumer licensing (more software, including Windows, Windows Phone and Office client, as noted above): $5.0 billion
3. Commercial "other," meaning Enterprise Services, Office 365, Azure and Dynamics CRM Online: $415 million

Yes, it's still early days in Microsoft's transition to a devices and services company. But it's still worth noting what's missing from both the top revenue and top margin lists -- specifically, hardware (Surface, Xbox) and consumer services (Bing, MSN, Office 365 Home Premium).

While Microsoft shared specific unit and/or license numbers for several of its consumer offerings -- Xbox, Office 365 Home Premium -- as part of its latest quarterly earnings release, company officials were not willing to share sales figures for the company's less sexy and more enterprise-focused software products. There were no dollar or license breakouts for products like System Center, SQL Server, Visual Studio, Lync, Exchange, Windows Server, SharePoint Server and the like. Instead, Microsoft offered basically meaningless measurements, given there was no baseline, such as "double-digit growth" (System Center and SQL Server) and "seats more than doubling" (Office 365 commercial and Azure).

Xbox consoles sold well during the holiday, as did Office 365 Home Premium, which is Microsoft's subscription-based version of Office for consumers. Windows Phone revenues increased by $340 million, or 50 percent, in the quarter, according to Microsoft (though this total hides how much the company made from licensing the Windows Phone OS vs. how much it made by licensing mobile-phone patents).

But make no mistake: It's still Microsoft's enterprise software that powers Microsoft. Ten of the company's self-proclaimed 16 billion-dollar businesses were business-focused ones as of the last time Microsoft shared information on its billion-dollar business club. And five of the remaining six all had enterprise components. (The one exception is Xbox.)

Enterprise software is king at Microsoft. At least for now....

Topics: Enterprise Software, Cloud, Microsoft, Tablets, PCs, Windows


Mary Jo has covered the tech industry for 30 years for a variety of publications and Web sites, and is a frequent guest on radio, TV and podcasts, speaking about all things Microsoft-related. She is the author of Microsoft 2.0: How Microsoft plans to stay relevant in the post-Gates era (John Wiley & Sons, 2008).

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  • Of course

    Microsoft software is everywhere, and millions of people and businesses depend on it for their livelihood. Database, eCommerce, Web Servers, Office software, and millions of business apps use Microsoft technology to make the world go round. In contrast Apple and Android stuff are just consumer toys, barely used for real work.
    Sean Foley
    • For now...

      Microsoft isn't what it used to be. It now faces real competition both in the consumer space and in the enterprise. And in some instances it's getting it's behind kicked.

      One instance is in the development space. I know of at least two shops that have dumped MS technologies completely in favor of open source solutions. Their reasoning was things move faster in the OSS realm, and there's lots more options available without restrictive EULAs that smother them. Drop linux, java, php, postgres, etc on some VMs and go to town.

      It's not about the software any more. MS needs to wake up and change their antiquated licensing model if it's going to want to compete.
      • Follow the money. They just posted a record quarter.

        You think they are hurting in the development space? The data doesn't reflect that. The data shows they are doing very very well. Over 7B in profit for the quarter.

        When AMD was super hot and Intel's products were lagging behind, I predicted Intel's victory because Intel made more money on each processor sold than AMD and even during the very worst Intel was dominating AMD financially. That's the key.

        Microsoft is actually growing in the Enterprise. A lot of the pundits seem to indicate Microsoft's decline, but they are actually growing and have been. They did shrink in Windows department but Microsoft is way more than Windows or Office. Financially they are doing better than ever despite the decline of Windows OS. I suspect that is temporary as well but if not Microsoft seems to be doing quite well!

        Are you kidding or what? Software is what powers all hardware whether it's biz or consumer. Software is the key to everything!
        • That's right

          It's funny to see the disconnect that people immersed in the MS eco-system have.

          Most software is a commodity now. Just like hardware has become. It's written to get things done, not to be some kind of product that generates revenue on its own. True, some specialized software still is, but more and more revenue streams are generated selling services and support around software that's given away.

          Linux, for example, is free like air. You don't need to think about buying licences. None of that matters. It's not some sort of "product", it's a tool like a hammer or screw driver.

          Why do you think MS is transitioning to be a services company?
          • Not in the enterprise

            IT departments continue to spend vast sums on software, in addition to services (which are sometimes substitutes, e.g. Windows Server licences from Microsoft, or Linux support contracts from IBM). That’s what keeps not only Microsoft going, but also Oracle, SAP, even to some extent IBM. It’s also generally the most cost effective solution for IT departments.

            What IT managers recognise that the average end user doesn’t is that ‘expensive’ software licences are a drop in the bucket next to staff costs. Switching from expensive software backed by a large firm to free software that requires additional staff to manage can lead to much higher costs, at least in the First World. In the Third World, even skilled labour is cheap, so things are a bit different. (Compare, say, Northern Europe, where vast sums are spent on software because of high labour costs, with, say, India, where it’s often free software combined with cheap labour.)
          • One more thing

            You can think of enterprise software licences as being similar to any other capital good, and capital goods markets are very different from consumer goods markets. Capital goods often remain high-margin rather than becoming commoditised, because firms can substitute them for (expensive) labour, so small improvements can give high rewards. A large share of German exports, for example, are capital goods, and they’re competitive despite high wages and high margins for the firms that produce them. They’re competitive because they add much more value than cheaper capital goods from elsewhere.

            The central task of managers is to choose how much capital and labour to employ, and both have diminishing marginal returns. In terms of IT software, if you spend more and more on software licences, you’ll eventually reach the point where spending on IT staff instead would lead to lower costs. Conversely, if you spend more and more on IT staff, you’ll eventually reach the point where spending on software licences instead would lead to lower costs. IT managers are just like managers anywhere else.

            The optimal capital/labour ratio, or software-licence/it-staff ratio in this case, depends on the economic structure. More developed, high-wage countries tend to spend relatively more on software licences, and less developed, low-wage countries relatively more on IT staff. As countries develop, they use relatively less labour, which implies higher output per worker and is more or less synonymous with becoming richer. As a result, continued development in countries like China and India could be very beneficial for enterprise software firms over time, provided the client firms in those countries can be convinced (or prodded) to respect intellectual property rights.
      • @ spackle

        I don't think that is an accurate description of Microsoft's business model.

        There must be atleast 1000 to 2000 large Enterprises in America if you forget rest of the world (ROW). And most of these Enterprises are multi-national. Except for companies like Genentech which use Google Apps, not many have moved outside of Microsoft enterprise ecosystem let alone examine alternatives. A lot of these cover different DOW and F1000 and F2000 and SP500 verticals like telecommunications, transportation, oil and gas, food and beverages, tourism and hospitality etc industries. It will takes ages for these companies to just dump their existing software and hardware infrastructure and move to all encompassing Google Apps or iCloud Pages or Linux ecosystem. It is just not gonna happen.

        There is a reason why HP, Dell, MSFT, IBM etc pull in cash flow. Their technologies are sticky. And let us not even add in contractors for defense, government, healthcare etc verticals. Those are super sticky technologies including all sorts of client, server, middleware, mainframe etc hardware and software technologies.

        All said and done, Cloud will replace on premises platforms very slowly. And Microsoft will show Enterprises how to do it in a seamless and non-disruptive manner.

        Again, all said and done, Mobile will not replace Desktop platform on the client side. It will not happen because Mobile does not spell productivity well enough.

        Of course, the only real contender to existing desktop client platform is from Apple. And the Mac is already a tiresome device. It has run its course over the past 10 years (from 2003 till 2013). And Chromebooks are largely educational industry vertical specific. So they are a niche that does not grow outwards.

        Which means Microsoft is looking at Enterprise dominance for a long time to come. And so is Oracle looking at Enterprise dominance for a long time. So will SAP and VMware do well. But I doubt that HP, DELL, IBM and EMC will continue to do good. Enterprise hardware is getting commoditized faster than Enterprise software. Add in Cloud as a threat. And consumer Mobile as a threat. And you can see the Enterprise hardware companies have 3 technology trends as short-run and long-run business threats versus 1 (Mobile) which is the only real threat to Microsoft.

        Ultimately, Microsoft appears to have changed strategy seamless enough to ride the threats of Cloud and Mobile disruptions to its business model. But it has its work still cut out in Mobile area. And it is set for growth in both consumer and enterprise Cloud areas.
        • I think there’s still a lot of money in enterprise hardware

          The tricky bit is that the money is in specific components, like high-margin, server-grade CPUs, and not in the assembled servers themselves. There’s no reason to believe Intel’s high margins in server CPUs will fall, but the servers themselves are typically very low-margin products, because it’s hard to differentiate beyond the key hardware components (e.g. CPUs). The only other way to differentiate is the software, and again that’s typically provided by a third party (e.g. Microsoft, Oracle, IBM, SAP), so the server vendors are left with no way to differentiate, leading to razor-thin margins.
          • @ WilErz

            I do not deny that hefty profits come from server products.

            HP still rakes in a ton of margin from its Proliant server products and its attendant customer support contracts. But the writing is on the wall for x86 servers.

            If IBM made a decision to exit the x86 server market, then its System-X margins must have declined and finally so did its earnings. The rackmount and blade server is no longer a margin maker. People can now buy it directly from Taiwanese ODMs.

            But the ramp down will not occur fast. IBM exited the PC market in 2005. The PC market started to tank in 2011. Which is like 6 years later.

            The pending commoditization is a long road ahead for x86 server makers all though I still expect HDD, SDD and CPU makers to still make profits. Seagate and Intel will be the beneficiaries. I do not expect either of them or even LSI to see any decrease in profits in the next 10 years on the server front. But HP and Dell have burgeoning competition from Lenovo. Lenovo is now an almost end-to-end systems maker except for networking hardware. They make servers and business computers and have reseller relationship with EMC for storage solutions.

            And of course, Cisco Sys is a formidable competitor to all of the above especially with their integrated FlexPod systems. I actually think this is the only area that will grow like hell in the future. Customers want to buy integrated enterprise hardware and not pieces from different vendors that they themselves have to assemble into a solution for their data centers.

            The one company which I see as losing the enterprise hardware space completely is Oracle. The Oracle Sun Sparc servers will die completely. There is no other way will the market function. Except for their Exalogic machines.
          • Yes

            Oh yes, I agree with what you’ve written. My point is simply that the industry will remain highly profitable. The profit, however, will go to producers of R&D-intensive components, like CPUs, and not to assemblers of servers. That’s more or less what happened with PCs, and will (maybe is already starting to?) happen with tablets and smartphones.

            I agree that Oracle’s Sparc will probably die, but so too may HP’s Itanium, and IBM’s Power and z/Architecture. The development of the server market will probably resemble the earlier development of the desktop market, where x86 drove out all of the other architectures (many of the same ones, e.g. Sparc, PowerPC, and also Arm), before price wars wiped out margins on assembled systems (but components like CPUs and software remain high-margin). The wild card is Arm, which could turn the market into a two-horse race for a while, but in the end there will probably be convergence on either x86 or Arm, with manufacturing technology (traditionally Intel’s biggest strength) playing an important role in deciding which one wins.
          • I also agree ...

            ... that IBM’s choice is the right one, but its other server businesses (Power and z/Architecture) may not last much longer either.

            A key issue is that Lenovo is not constrained by market pressure, so can operate with razor-thin margins, which Western competitors answerable to shareholders can’t do. Lenovo is essentially a national champion for China, so its objective is to showcase China’s emergence as a modern, high-technology economy, and not to maximise profit.

            A vaguely similar example is Airbus, which is Franco-German but has always been strategically guided by Paris rather than Berlin, and is become more market-driven over time. Airbus will probably never recover the investment costs of the A380 project, but Airbus had a political mission to break the dominance of Boeing in the market for very large commercial aircraft, just as it had an earlier political mission to break the Boeing/McDonnel-Douglas duopoly (which it did). In both cases, state backing (e.g. loan guarantees) made possible what pure market forces would not have permitted. In Airbus’s defence, the state support (military contracts) of McDonnel-Douglas and Boeing played a big role in their rise as well, and the demise of the once-leading European aerospace firms.
      • @ spackle

        Of course, the other way to look at it is to examine the SMB market. That has been ignored a bit by Microsoft recently. Which is where new enterprise Cloud solutions or OSS solutions will play better.

        What you refer to as two shops must be small businesses. But if they could untether their existing small-scale IT infrastructure to move away from Office to Google Apps or Open Office, then what makes you think they will not come back to Microsoft with Office 365, especially with the right discounts and deals?
    • Absolutely

      Large organisations tend to move slowly, but with a few exceptions, most notably web servers, Windows is deeply entrenched in most IT departments, and continues to gain share in key enterprise software categories. That’s also where you can sell high-margin products, and where you can sell on technical merit rather than fashion.

      Given Microsoft’s enterprise strength, If I were running the firm, I’d have used a different strategy to attack the post-iPhone smartphone and post-iPad tablet markets. When faced with BYOD consumer smartphones/tablets, Microsoft chose to try and break into the consumer markets directly, and almost forgot about the corporate ones. It may have looked attractive, given Apple’s margins, but those margins probably can’t be sustained in the long run (look at margins on Android devices), especially without Apple’s consumer brand recognition. Microsoft should expect much lower future (and even current) margins on consumer hardware than Apple’s.

      Instead of trying to break into the consumer market head-on, I’d have played to Microsoft’s strengths. Most IT managers have been less than thrilled with BYOD, and for good reasons (security, manageability, many others). Consumers, however, like their simple, easy to use consumer devices that they can use for personal and simple professional tasks. (The situation with cloud services is much the same, with a struggle between IT departments and, for want of a better term, 'use-your-own-cloud'.) My approach would have been to focus on building smartphones and tablets (and cloud services) that provide everything IT managers want in terms of security, manageability, features, compatibility, etc. IT departments would pay high prices for such devices (and services). However, the devices (and services) would also need the features necessary to wean consumers away from their consumer devices (and services) and towards the corporate/organisational standards.

      Attacking the consumer markets from the enterprise stronghold is exactly what IBM, and later Microsoft and Intel, successfully did in the PC market against much cheaper, and for a time technically better, consumer PCs. High corporate margins fuelled investment in R&D that rapidly improved Windows/Intel PCs, whilst dominant consumer PC producers struggled to even cover production costs. In the end, the leading firms in the consumer PC market simply vanished, and the corporate standard defined the consumer standard. If Microsoft can create corporate standards in smartphones and tablets, combined with good consumer experiences (they don’t have to be as good as Apple’s, but they have to be good enough), it will be much better placed to challenge Android and Apple in the consumer markets (and can even sacrifice margins for market share in consumer markets, provided margins in the corporate markets remain high).
  • Apple would gladly take the enterprise if they had the chops

    They don't and there isn't a credible threat in their bag. Google? Nope.
    • Apple has fatal flaw in terms of enterprise

      Apple will never get a grip in enterprise as long as they continue to use proprietary adapters, and refuse to offer long term support. Enterprise IT moves at a much slower pace than the consumer space so while Apple keeps zipping ahead with a new OS iteration every year, enterprise has no time to test, or even overcome obstacles to adoption before there's a new group of changes in a new OS flavour to start the process all over again. Heck, even basic things like smart cards are unsupported in OS versions higher than 10.6 without third party support.
    • I think they have the chops just not the will.

      Why should they, they are making way more money doing it the way they are. Remember Apple is now a much larger company than Microsoft and they've done it through consumer products.

      Microsoft is doing very well, but Apple is doing better (financially).
      • Apple's mobile reign is already slipping a bit

        On top of that OEMs won't be able to continue charging $600-$700 for phones. These prices are bound to drop as tech evolves and eventually stalls. Much like we saw with the PC industry over the last decade. You get to the point where speed and power all look about the same year after year. I'm only speculating but I think we're getting to that point now.
        • I agree

          Apple’s margins may be sustainable for a while, but probably not indefinitely. Consumer hardware is a very different business to software (e.g. Microsoft), especially enterprise software, or advertising (e.g. Google). If fashions change or Apple’s ability to differentiate weakens, margins could rapidly erode.

          In the pre-Windows era, Apple sold very expensive, high-margin PCs, and was much larger than Microsoft. When Apple’s technical lead and ability to differentiate slipped (because of Microsoft Windows and the Intel 386), and Apple management made the wrong bet on CPUs (PowerPC instead of x86), margins collapsed, R&D became weak and the firm nearly failed. With modern manufacturing flexibility/outsourcing, falling margins would be less dangerous today than they were in the 90s, so Apple would be unlikely to face collapse again. Even so, the better part of its market capitalisation could easily be wiped away.

          The whole point of Android is to destroy Apple’s margins, and mobile hardware margins generally, so that advertising will become the only way to make money, playing to Google’s (only) strength. If margins are destroyed, Apple and other vendors will be bled of the profit they need to fund R&D, and product development will stagnate, except for development funded by advertising revenue (e.g. Google, and possibly Microsoft Bing).
    • There's more money in the consumer space

      Why do you think MS is so desperate to break into it?