Microsoft Gets Hit Where It Hurts: On the Desktop and Online

By now you’ve probably already heard that Microsoft missed analysts’ expectations and will cut up to 5,000 jobs. That’s painful, though less severe than had been rumored. But when you look at the financial results, they suggest that Microsoft’s real problem is on the desktop and online.

Look at the numbers below from Microsoft’s latest 10-Q.

Two divisions – Client and Online Services — really stand out. The former is the part of Microsoft that sells Windows for PCs, and both revenue and operating income were down significantly in both the three-month and six-month periods ending December 31, 2008. But what is really telling is how much of an impact the slowing economy has had. Revenue in the last calendar quarter dropped by nine percent. Look at the absolute dollar difference in both the six-month and three-month periods; they are $385 million and $384 million. That suggests the slowdown was virtually all during the last three months of the year.

Operating income drop, however, was more uniform. For the first six months, between 2007 and 2008 it dropped by $672 million, or by about 10.3 percent. For the last three months, between 2007 and 2008, operating income dropped by $481 million, or by over 14.7 percent. So, profitability was already starting to take a nose dive in the fall and the drop accelerated by the end of the year.

The online services business had fairly flat revenues between 2007 and 2008, but more than doubled its operating loss in the last six months of 2008. This is worse news for Microsoft than just missing Wall Street’s estimates, because the weak areas are in client operating systems — a traditional cash cow for the company — and in online services, which is supposed to represent the corporate future. But although laying people off can help boost earnings, it does nothing for revenue growth. This is one reason why the new version of Windows is going to be critical, to eradicate the bad taste of Vista from the mouth. But what is Microsoft doing that might aid on the online revenue front?

 On the gaming front, given that the company significantly dropped prices on the Xbox 360, with a drop in operating income as a result, revenue in the last three months shot up by about 3.4 percent, which suggests that the trade-off in pricing for units and market share worked.