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Another Perspective


Microsoft's net income during its second fiscal quarter, the calendar's fourth, was up by a stunning 60 percent.  The company's revelation showed net income of $6.66 billion on sales of $19.02 billion; a third of Microsoft's intake went to the bottom line.  By way of comparison, IBM earned $4.81 billion, or 17.7 percent of its $27.23 billion in revenue, nearly half of it from software that accounted for a quarter of Big Blue's intake.  Microsoft's success was even more concentrated.  A third of its revenue and five-eighths of its profit came from Windows for PCs.

The good news is that Windows 7 is off to a superb start.  The bad news is that it looks like the operating system is not yet a big hit on corporate desktops, where it helps boost sales of Windows server software, Office, and other Microsoft offerings.  In fact, outside of the Windows segment, Microsoft's revenue was more or less flat: On a year-to-year basis Microsoft reported only a small gain in server software, a slight decline in sales of Office, and a bit of a drop in its online services business.  For Microsoft, services remains a loser; by contrast IBM, which talks cloud but walks glasshouse replacement, makes a nice piece of change providing services.  A very basic analysis of Microsoft's quarter, with some pretty graphs, was done by the company's hometown newspaper.

Steve Ballmer
Steve Ballmer
Like Windows, he has gained
a bit of weight lately

Microsoft said it has sold 60 million Windows 7 licenses.  Microsoft reported Windows revenue of $6.9 billion, a gain of nearly 70 percent from the prior year's quarter.  If half of Microsoft's Windows revenue was from Win 7 in the quarter (just a guess) then the average revenue per copy was around $55.  If Win7 brought in two-thirds of Microsoft's Windows take, the average was around $77.  I'll guess that Microsoft's intake on the new software was in the range of $55 to $77 per unit.

The reason only some of Microsoft's Windows revenue was from Windows 7 is because for part of the quarter Windows 7 wasn't available.  And even when it was a choice, plenty of users kept buying Vista or XP, sometimes with an upgrade option in mind.

Windows 7 was shipped to end users on October 22, but for a few months before that users buying Vista got tickets for a free ride on the upgrade train.  In most cases upgrading moving a PC from Vista to Win 7 is a job an end user or support geek can do without too many problems.  That's not the case with a machine running XP.  Basically, XP users are out of luck.

First, while most computers with hardware that supports Vista can run Win 7, not all XP boxes can.  And some XP machines can run Win 7 but only with restricted graphics support.

The easy way to find out if a computer is able to run the new OS is to let Microsoft tell you what it thinks.  However, even if an XP machine can support Win 7, the upgrade is still a job of work.  Windows 7 will require a clean install.  So corporate users who have new PCs running XP may well have suitable equipment but they are in a bind: The cost of moving from XP to Win 7 may be comparable to the cost of buying a whole new Win 7 computer with an OS preloaded.

And all that presumes a company is willing to try migration, which, far more often than not, it won't.

Microsoft may not be pleased with this situation but it readily admits that its success with the new operating system is based on sales of new machines (plus previously booked sales of Win 7 upgrades that occurred during the Vista generation that were not booked until this quarter).  From the comments made by analysts who study the PC business, a lot of Win 7 machines turn out to be netbooks, which have been hot, hot, hot--at least until the announcement of the Apple iNapkin.

It may well be that netbooks have been the camel's nose of Windows 7 in the business community.  I say this based on the Web site posture that Dell has taken.  If you buy a business computer from Dell (via the generic Web site or one of the special webs that Dell has built for many corporate accounts) there are deals that involve a regular laptop or a desktop machine plus a Dell netbook.  The netbook loaded with Win 7 can be almost free if the main machine is one of Dell's snazzier computers.  This stuff changes and you'll have to check for yourself if you really want to know, but I think that adding a basic Dell netbook to a deal on one or a few high end laptops or desktops might change the deal price by as little as 50 bucks.  In the netbook market, Dell probably comes out farther ahead on extended warranties and support than it does on the computers.  And Microsoft probably sells the puny version of Windows 7 that runs on netbooks for a lot less than it gets for the Professional version that goes on corporate PCs.  The Home versions of Win 7, the ones that are used on most consumers' PCs, are priced in between.

One indication that netbooks are a significant part of the Windows 7 market is the downturn in Office sales Microsoft reported in the quarter.  New laptops and desktops are often sold with a bundle of software that includes Office; netbooks aren't.  But there is more to that in this story.  The downturn in Office also is a reflection of the general state of the economy and the reduction in the workforce that uses Office in corporate settings.

Corporate buyers often have site license deals with office.  These deals are priced based on the number of client machines using the software.  User organizations can migrate to new PCs and just move the licensed Office from a de-installed box to a new one.  Microsoft would not see revenue growth unless a user organization increased its seat count and had to buy an expanded license.  In an economy with so many layoffs, there are plenty of user organizations with Office licenses that exceed their actual seat count.  There will have to be a lot of growth before the lost population is replaced, let alone increased.

Information on the actual state of the Office market may emerge later this year if Microsoft gets its next version of Office out the door as it says it will.  The company will undoubtedly provide data on the number of new packages and upgrades it sells.  And if the new Office requires Windows 7 (or at least Vista), Microsoft will probably be more transparent about sales than it has been about the current version of Office.

Still, even if there's more corporate action than is currently apparent on the surface, one more segment of Microsoft's financial map says that things have been tough: Server software revenue rose only marginally from last year.  Optimists believe that there is a lot of pent-up demand that will turn into sales of server hardware and software just as soon as business buyers feel that their enterprises are on firmer economic ground.  Skeptics think the economic conditions remain pretty severe and suggest that Microsoft will have to trim the prices of its server packages much the way hardware makers have had to improve the value of their offerings.  In the past, hardware usually got cheaper every year while server software became more expensive, but that may be changing.  Linux is a tempting alternative to Windows, and these days, with Oracle turning into a full-server vendor, both Microsoft and IBM may have to adjust to more competitive conditions.

IT managers in IBM shops will be under a lot of pressure.  They may have a hard time getting funds for technology upgrades.  Many of the attractive aspects of Windows 7 have a great deal of consumer appeal.  But Microsoft has not yet done as good a job getting business users to appreciate the improvements it claims it has baked into Windows 7.  Corporate buyers on tight budgets may defer migration to Windows 7 even though they know their end users will like the snazzy GUI.  Microsoft has yet to make a strong case for lower support costs that sticks in the market.  The cliché is that corporate users will join the rush to Windows 7 once Microsoft releases a bunch of fixes in the form of Service Pack 1.  That's the way it was with Windows 2000 and XP.  That is not what happened with Vista; it simply never caught on in corporate settings.

The situation is turning into a bit of an adventure.  Microsoft ought to be able to clear out those musty old XP machines sitting in office the world over, much the way it has clearly succeeded in winning the hearts, minds and charge cards of consumers.  But what it ought to be able to do and what it can actually accomplish might not be exactly the same.

The stakes are very high right now.  The success of forthcoming server software and the next generation of Office depend on the market's embracing Windows 7 for business settings with enthusiasm.  Microsoft can't just wait for the base of laptops and desktops to wear out, although that is an inevitability in its favor.  And Microsoft can't settle for a world in which only half the corporate users move to Windows 7 while the rest try to muddle through with XP.  If corporate buyers don't become more lively pretty soon the most recent quarter will be seen as an aberration, not part of a trend.  That would be detrimental to the whole computer industry, not just Microsoft.

— Hesh Wiener February 2010

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