Microsoft Surface hits $1bn revenue: Mission accomplished?

Microsoft's Surface hybrid has broken though the $1bn revenue mark. Does this mean it can now be described as a success?
Written by Steve Ranger, Global News Director
Has Microsoft's tablet PC finally come of age? Earlier this week Microsoft said Surface revenue hit $1.1bn for the most recent quarter - up 24 percent year on year - driven by Surface Pro 3 and accessories. Microsoft CEO Satya Nadella said of the rise: "The value proposition of being the most productive tablet is resonating."

The company revealed that the third version of the Surface, the two-in-one device first launched two years ago, is selling faster than previous versions. "Surface Pro 3 volumes are pacing over three times the rate of what we saw with Surface Pro 2," said Microsoft CFO Amy Hood.

So can it be finally said that Surface is a success? It depends on which metrics you use.

Breaking through that $1bn revenue barrier is psychologically important and useful for Microsoft and its marketing, but that doesn't mean Surface is generating huge amounts of cash for the company. Until the last two financial quarters it had been costing more money to make and distribute the devices than Microsoft was making from selling them.

Revenue on the Surface range by Microsoft's financial quarter. Source: Microsoft filings.
Image: Steve Ranger/ZDNet

That has now changed. As Jan Dawson of Jackdaw Research noted, in Microsoft's latest financial quarter the gross margins on Surface were "not only positive for the second time, but significantly so", although he points out the Surface line still probably loses money overall because of all the marketing spend involved.

Still, he added: "I would guess it's not a million miles away from producing a positive contribution margin at this point, which is enormous progress from the early quarters."

According to Dawson's calculations, most of the revenue in the quarter came from Surface Pro 3. With the average selling price around $1,000, the quarterly revenue represents around a million unit shipments, with some accessory spending rounding out the rest. Dawson points out: "Chances are that's not much higher than previous quarters."

One million might seem good going - were it not for the fact that Apple sold 21.5 million iPads over the same time period (some may argue MacBook Air sales would make for a better comparison, of course).

So, if the device is not making lots of money for Microsoft and it's still a minnow compared to Apple's iPad, can Surface be seen as a success yet?

Perhaps. Surface has never been just about the revenue - it has also been a way of proving to consumers, business customers, and PC makers that a Windows slate could really work. Remember, it launched at a time when the PC appeared doomed and tablets were unstoppable.

In this case, Microsoft is maybe half (or, if you're being generous, two-thirds) of the way there. PC makers have finally been roused from their slumbers and are experimenting with some new form factors, of which Lenovo's Yoga series is probably the best known.

On this week's earnings call, Microsoft's Nadella was asked if Surface was cannibalizing PC sales. He responded instead that the device is instead expanding the market.

"One of the things that I feel very good about is the risk we took to introduce the two-in-one category. I feel now that we see that in fact [we] inspire a lot of activity in our own OEM ecosystem. We see many good designs coming, because it is viewed as a category that drives growth," Nadella said.

He added: "From that perspective, I feel good about leading, because that's one of our strategic goals, which is we want to create new categories, foster more demand for the entire ecosystem."

There's some truth to this - certainly the two-in-one is increasingly seen as a genuine PC category. It's also possible to argue that Microsoft doesn't want to be too successful with Surface Pro as the company still needs the PC makers on-side to keep generating profits from making Windows PCs: a delicate balancing act.

And for business customers the Surface Pro fills a handy niche as well, giving them the flexibility of a PC with the glamour of a tablet without the worry of supporting yet another operating system.

But for consumers there is still much to do: Microsoft has reportedly ended production of the consumer Surface model which ran on the unloved, stripped-down Windows RT operating system. This is no great surprise: for most consumers, an underpowered version of Windows on an unproven device was just too risky a concept.

It will be interesting to see if Microsoft takes another swing at the consumer tablet market itself - it has Nokia's device expertise onboard now, after all - or whether it feels the PC makers have got things under control now. I'd certainly like to see a new Lumia tablet coming down the line in time for the release of Windows 10.

Despite the eye-catching revenue number, Surface still remains a drop in the ocean of PCs, of which over 300 million were sold last year. But if the existence of Surface has forced PC makers to innovate, and as a result kept Windows PCs (whatever they look like) relevant to businesses and consumers - and it now even turns a profit, then it's probably done its job.

Further reading on Microsoft Surface

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