Microsoft: Pivoting to a Communications-Centric Business

Introduction: From Monopoly to Disruption

For many years, Microsoft was an iconic monopolist, in much the same way as AT&T had been before divestment. Microsoft’s products were ubiquitous and often innovative, and its profitability enormous. It was familiar, yet frequently scorned as the creator of a dreary monoculture with atrocious security properties. Microsoft’s mission statement could not have been simpler: a computer in every office and in every home. This achieved, though, its critics have often seen it as an organisation in search of an identity, experimenting with mobile, search, maps, hardware and much else without really settling on a new direction.

Going to the numbers, for the last two years, there has been steady erosion of the once phenomenally high margins, although revenue is still steadily rising. Since Q3 2013, revenue at Microsoft grew an average of 3.5% annually, but the decline in margins meant that profits barely grew, with a CAGR of 0.66%. Telcos will be familiar with this kind of stagnation, but telcos would be delighted with Microsoft’s 66% gross margins. Note, that getting into hardware has given Microsoft a typical hardware vendor’s Christmas spike in revenue.

Figure 1: MS revenue is growing steadily but margin erosion undermines it

Source: Microsoft 10-K, STL Partners

Over the long term, the pattern is clearer, as are the causes. Figure 2 shows Microsoft’s annual revenue and gross margin since the financial year 1995. From 1995 to 2010, gross margins were consistently between 80 and 90 per cent, twice the 45% target HP traditionally defined as “fascinating”. It was good to be king. However, in the financial year 2010, there is a clear inflection point: margins depart from the 80% mark and never return, falling at a 3.45% clip between 2010 and 2015.

The event that triggered this should be no surprise. Microsoft has traditionally been discussed in parentheses with Apple, and Apple’s 2010 was a significant one. It was the first year that Apple began using the A-series processors of its own design, benefiting from the acquisition of PA Semiconductor in 2008. This marked an important strategic shift at Apple from the outsourced, design- and brand-centric business to vertical integration and investment in manufacturing, a strategy associated with Tim Cook’s role as head of the supply chain.

Figure 2: The inflection point in 2010

Source: Microsoft 10-K, STL Partners

The deployment of the A4 chip made possible two major product launches in 2010 – the iPhone 4, which would sell enormously more than any of the previous iPhones, and the iPad, which created an entirely new product category competing directly with the PC. Another Apple product launch that year, which also competed head-on with Microsoft, wasn’t quite as dramatic but was also very significant – the MacBook line began shipping with SSDs rather than hard disks, and the very popular 11” MacBook Air was added as an entry-level option. At the time, the PC industry and hence Microsoft was heavily committed to the Intel-backed netbooks, and the combination of the iPad and the 11” Air essentially destroyed the netbook as a product category.

The problems started in the consumer market, but the industry was beginning to recognise that innovations had begun to take hold in consumer and then diffuse into the enterprise. Further, the enterprise franchise centred on the Microsoft Business division and what was then termed Server & Tools[1] were both threatened by the increasing adoption of Apple products.

Microsoft had to respond, and it did so with a succession of dramatic initiatives. One was to rethink Windows as a tablet- or phone-optimised operating system, in Windows Phone 7 and Windows 8. Another was to acquire Nokia’s smartphone business, and to diversify into hardware via the Xbox and Surface projects. And yet a third was to embrace the cloud. Figure 3 shows the results.

Introduction
Executive Summary
From Monopoly to Disruption
The push into mobile fails…but what about the cloud?
Changing Platforms: from Windows to Office
The Skype Acquisition: a missed opportunity?
Skype for Business and Office 365: the new platform
The rise of the consumer cloud
Bing may just about be breaking even…but the real story here is consumer cloud
Scaling out in the cloud
Conclusions: towards a communications-centric Microsoft

Figure 1: MS revenue is growing steadily but margin erosion undermines it
Figure 2: The inflection point in 2010
Figure 3: Revenue by product category at Microsoft, last 2 years
Figure 4: Cloud and the Enterprise drive profitability at Microsoft
Figure 5: Cloud is the driver of growth at Microsoft
Figure 6: Internally-developed hardware and cloud services are improving their margins
Figure 7: The Nokia Devices & Services business slides into loss
Figure 8: In 2011, an unifying API appeared critical for Skype’s future within Microsoft
Figure 9: Cloud is now over $8bn a year in revenue
Figure 10: Spot the deliberate mistake. No mention of Bing’s profitability or otherwise
Figure 11: Bing was a money pit for years, but may have begun to improve
Figure 12: The app store and consumer cloud businesses are performing superbly

RIM: R.I.P. or ‘Reports of my death are greatly exaggerated’?

Summary: RIM’s shares have plummeted in value over the last four months, prompting an eruption of finger-pointing in the media and speculation of its demise or acquisition. In this analysis we examine whether the doom-mongers are right and what RIM’s recovery strategy might be. (July 2011, Executive Briefing Service)

Below is an extract from this 12 page Telco 2.0 Report that can be downloaded in full in PDF format by members of the Telco 2.0 Executive Briefing service here. Non-members can buy a Single User license for this report online here for £295 (+VAT) or subscribe here. For multiple user licenses or other enquiries please email contact@telco2.net or call +44 (0) 207 247 5003.

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Background – RIM’s share price disaster

RIM’s shares have plummeted in value over the last four months, prompting an eruption of finger-pointing in the media and speculation of its demise or acquisition. In this analysis we examine whether the doom-mongers are right and what RIM’s recovery strategy might be.

‘Reports of my death are greatly exaggerated’ – US writer Mark Twain, 1907, when he failed to return to New York City as scheduled and The New York Times speculated that he might have been “lost at sea.”

Figure 1 – RIM has obviously underperformed Apple, but incredibly it has also underperformed Nokia.

With its iconic Blackberry devices, RIM led the way in the mobile messaging era – first in corporate and then in consumer markets. But the transition to the mobile web has seen it surpassed by Apple and Google in consumer developed markets. In this respect RIM faces the same challenge as Nokia. And yet, despite facing the same challenge, RIM and Nokia have taken completely different strategic options for their future. When Nokia announced its partnership with Microsoft it pointedly talked about the creation of the third platform for the mobile web alongside Apple and Google – Nokia effectively discounted RIM from the game.

Previous Telco 2.0 analysis on RIM includes: RIM: how does the BlackBerry fit with Telco 2.0 strategies?; Mobile Software Platforms: Rapid Consolidation Forecast; and Nokia’s Strange Services Strategy – Lessons from Apple iPhone and RIM.

Current Position – on the surface, OK, but…

At first glance, RIM looks in a healthy position and its recent results show that both handset shipments (13.2m vs 11.2m) and revenues (US$4.9bn vs US$4.2bn) were up on the previous year. RIM is making reasonable profits (US$695m) and has a healthy cash position (US$2.9bn). But under the hood, life is not looking as rosy.

Profits: Under Pressure

RIM’s accounts show that its absolute profits are declining as growth in R&D and S&M costs are exceeding the slowing growth in revenues.

Figure 2 – RIM’s Profits are down against growth in R&D and S&M costs

Of course, rising R&D and S&M costs may ultimately result in new revenues, although at present the effects of this spending are not yet evident in overall performance.

Revenues: Squeezed out of Key Markets

RIM’s revenues are dropping in key markets, particularly the USA, and its growth in revenues is coming from emerging markets.

Figure 3 – RIM’s Changing Market Revenues

Market Share: Declining

RIM’s share of the overall smartphone market is declining.

Figure 4 – RIM’s Declining Worldwide Market Share

Core Product Advantages: Eroded

Core product advantages (e.g. Blackberry Messenger) are being eroded and surpassed as the competition (e.g. Apple iMessage) improves.

New Products: Late

New devices such as the updated Bold 9900 have missed planned release dates.

To read the rest of this report, including…

Outlook – a time of transition?
QNX & TAT – RIM’s saviours?
Playbook – A disappointing start
Coming: the Android / Emerging Market Crunch
Corporate Strength
Telco 2.0 Conclusions & Recommendations – Is there a recovery strategy?

…Members of the Telco 2.0 Executive Briefing Subscription Service can download the full 14 page report in PDF format here. Non-Members, please see here for how to subscribe, here to buy a single user license for £295, or for multi-user licenses and any other enquiries please email contact@telco2.net or call +44 (0) 207 247 5003.

Companies, technologies and products referenced: 7digital, Adobe Flash, Amazon, Android, Apple, Blackberry, BlackberryOS 8, Bold 9900, Carphone Warehouse, Google, Huawei, iMessage, iPad, iPhone, Microsoft, Nokia, Phones4U, Playbook, QNX Software Systems, RIM, The Astonishing Tribe (TAT).

Tablet Frenzy: Network Poison or Economic Palliative?

Summary: The success of the iPad2 has been seen by some as a sign of a paradigm shift in computing. With their theoretical appeal as a new portable medium for online video consumption could tablets have a significant impact on communications networks and economics? Here is Telco 2.0’s market outlook.

Below is an extract from this 18 page Telco 2.0 Analyst Note that can
be downloaded in full in PDF format by members of the Telco 2.0
Executive Briefing service using the links below.

‘Growing the Mobile Internet’ and ‘Fostering Vibrant Ecosystems: Lessons from Apple’ are also key session
themes at our upcoming ‘New Digital Economics’ Brainstorms (Palo Alto, 4-7 April and London, 11-13 May). Please use the links or email contact@telco2.net or call +44 (0) 207 247 5003 to find out more.

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Introduction: fearing the tablets’ effects?

The mobile device industry is currently awash with tablets. Catalysed by the iPad’s meteoric rise to prominence in 2010, the market has since been saturated with a broad range of similar devices such as Samsung’s Galaxy Tab. In early 2011, trade shows at CES in Las Vegas, and Mobile World Congress in Barcelona both saw the launch of countless Android-powered tablets, as well as others featuring RIM’s and HP’s own operating systems.

With the subsequent huge success and publicity of the iPad 2 launch (see iPad2: how Apple plans to dominate the ‘post PC era’), many in the technology industry are convinced that we are witnessing a new paradigm shift in computing. While the majority of debate has concerned itself with apps, content-publisher business models and the possible advent of the “post-PC era”, it is also worth stepping back and looking at the network-side implications of these new devices.

Some observers are expecting the advent of mobile-connected tablets to continue the assault on 3G and 4G network capacity, taking over where smartphones and laptops left off. Observing that tablets’ large screens are ideal for heavy-duty web and video consumption, there are certainly some doom-sayers predicting the imminent collapse of networks already suffering from congestion. For example, in July 2010, OpenWave’s CEO claimed that “There is no doubt that the iPad will be part of the data overload story when the wireless industry looks back in a few years time” . Even the FCC has used the potential tablet data threat in its efforts to gain additional spectrum rights for mobile broadband , saying “With the iPad pointing to even greater demand for mobile broadband on the horizon, we must ensure that network congestion doesn’t choke off a service that consumers clearly find so appealing or frustrate mobile broadband’s ability to keep us competitive in the global broadband economy.”

Other observers are more cautious. There are still some dissenters regarding the overall tablet story – will they really oust the netbook and laptop as the main mobile computing platforms? And even if they are game-changers, will they predominantly be used while connected to cellular networks, rather than WiFi?

While Telco 2.0 feels that tablets are indeed important in the medium term, we are concerned that 2011 may see the hype bubble pricked a bit, as the world’s gadget-enthusiast segment gets saturated before the mass-market really grasps what to do with a touchscreen device that isn’t pocketable. The rhetoric about the imminent death of the PC seems to fit poorly with data points such as Apple’s own rising laptop sales, paralleling the iPad’s growth.

The bitter pill of mobile data traffic

Telco 2.0 has talked about the mobile broadband “capacity crunch” and the challenging economics of 3G/4G networks on numerous occasions over the past few years. We have considered the role of offload, traffic management, two-sided approaches to “slicing and dicing” network capacity in both fixed and mobile domains, and the need for sensible pricing plans for mobile data. We have watched the explosion of smartphones and the typical data volumes grow to 100’s of megabytes per month per user – even 1GB+ for certain devices such as high-end Android phones.

In 2010, we identified a variety of new mobile broadband business models involving new device categories, evolution of the wholesaling/MVNO concept, and “priority connectivity” for certain applications, plus new non-subscription revenues from sponsored or third-party paid wireless data sessions in Mobile, Fixed and Wholesale Broadband Business Models. While all these are attractive, we also identified likely pricing pressure on mobile data plans – despite some offerings such as 3G dongle modem tariffs already being positioned often at too-low rates.

The net conclusion is that mobile capacity will need massive enhancement anyway – likely through a combination of both a move to more-efficient networks (HSPA+ and LTE, especially), and ways of moving to smaller cells and offload (WiFi and femtocells) – adding capacity by “densifying” the networks. All this is pretty much “baked in”, irrespective of the growth of additional new device categories.

Figure 1: Mobile networks need much more capacity, despite new revenue models

Source: Telco 2.0 EMEA Brainstorm, April 2010

The last two years have seen increasing concern – and in some cases panic – among mobile operators about the effects of exploding data traffic on their networks. The emergence of tablets is adding to the sense of worry. Although some of the existing problems can be attributed to the extra signalling load, in other cases congestion is indeed being driven by sheer volumes of traffic, especially in “busy hours” or “busy cells”. For example, 4-10pm in regions with a lot of mobile laptop dongles tends to be a peak period. A growing shift to video traffic, driven by web TV streaming sites, social networks and adult content, has arisen as a particular point of concern. Various analyses have put video at 50-70% of total mobile data traffic already, consumed both on smartphones but also especially laptops with larger screens and batteries. Again, tablets are looked at as potential accelerators of this trend – with the vision of iPads being used to watch live TV via cellular networks while users are “out and about” a stereotypical fear.

Some operators have already tried to head off the problem with phones, with for example T-Mobile UK suggesting to its smartphone users that “If you want to download, stream and watch video clips, save that stuff for your home broadband.” as part of its fair-use policy. However, many recognise that much of the problem has been brought by operators on themselves – especially through the mis-selling and mis-pricing of laptop data plans as being direct substitutes for home DSL and cable broadband, which clearly cannot have the same restrictions on video.

Tablets are potentially something of a quandary for operators – as a new category, there is no pre-existing expectation about exactly how data plans should be priced and managed – and few clear points on how much traffic they might be expected to generate. But conversely, if tablets are to be truly mobilised products rather than just WiFi-centric nomadic ones, they need to be usable without arbitrary restrictions or off-putting contract pricing.

(A quick note on signalling traffic: at the moment, it seems unlikely that tablets are going to major generators of load in this regard. Unlike smartphones, they are not “always-on”, running background tasks over the cellular network, or creating massive problems at the radio level through “fast dormancy” for power control. Irrespective of the precise applications used, they are likely to be similar to laptops/dongles, being online for lengthier sessions rather than ultra-frequent “pings” of servers.)

To work out whether or not tablets are a genuine source of concern for operators, Telco 2.0 has developed a simple analytical framework, bringing together sales volumes, operators’ role, traffic demands, data plans and the means for mitigation of network congestion. The following sections discuss each of these in turn.

Figure 2: Assessing tablets’ impact on mobile data networks

Source: Telco 2.0

Tablet demand

Telco 2.0 does not itself forecast shipments of specific computing product categories. However, we are in agreement that the overall tablet sector will grow strongly through 2011 and beyond, although we are slightly more bearish than some observers who proclaim “the death of the PC”, asserting that tablets will inevitably become the main portable computing format. Our view is that tablets will (largely) complement smartphones and notebooks, rather than massively substituting for either – although the smaller netbook PC format is more threatened. Research firm Disruptive Analysis has noted that typical tablet battery capacity – a proxy for processing or display, capability and therefore ability to “do stuff” – is mid-way between the two other device categories, reflecting a distinct role and market-space for tablets.

Figure 3: Device battery power diversity suggests different use cases for tablets, smartphones & laptops rather than outright substitution

Source: Telco 2.0, Disruptive Analysis

Depending on the exact definition of “tablet” (itself an imprecise term), around 17-20m devices shipped in 2010, of which about 15-16m were Apple iPads. Android-powered devices started making significant in-roads in Q4, gaining perhaps a 20% market share.

In January 2011, research firm IDC reported shipments of 17m tablets in 2010, forecasting 45m and 71m unit sales in 2011 and 2012 respectively.
Investment bank Goldman Sachs expects shipments of tablets such as the Apple iPad to more than double over the next year, going from 16m in 2010 to 35m in 2011. It expects 40% of that 35m to cannibalise PC shipments, with 20% cannibalising notebook sales and 80% cannibalising netbooks.
Research firm Ovum has forecast 150m tablet shipments in 2015
A more bullish prediction from iSuppli puts 2015 sales of tablets at 242m, although 39m of these will be full PCs in capability terms, masquerading in a tablet-style form-factor.
Apple is believed to have sold around one million iPad2’s on its opening weekend.

To read the rest of the article, including:

Telco 2.0’s Tablet Market Outlook for 2011 and 2015
Network Capacity Impact of Tablets
Forecast Global Traffic from tablets
Tablet Data Plan Pricing
Conclusion

…and the figures…

Figure 1: Mobile networks need much more capacity, despite new revenue models
Figure 2: Assessing tablets’ impact on mobile data networks
Figure 3: Device battery power diversity suggests different use cases for tablets, smartphones & laptops rather than outright substitution
Figure 4: High growth for tablets to 2015, but not all will be cellular-connected
Figure 5: Forecast global mobile data traffic from tablets, 2010-2015
Figure 6: Forecast mobile data traffic by device type, 2010-15 (Cisco VNI)
Figure 7: Selected mobile operator-supplied tablet 24-month contracts

…Members of the Telco 2.0^TM Executive Briefing Subscription Service can access and download a PDF of the full report here.
Non-Members, please see here for how to subscribe. Alternatively, please email
contact@telco2.net or call +44 (0) 207 247 5003 for further details.
‘Growing the Mobile Internet’ and ‘Lessons from Apple: Fostering vibrant content ecosystems’ are also featured at our AMERICAS and EMEA Executive Brainstorms and Best Practice Live! virtual events.

Tag: Tablets