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29 October 2015

Microsoft’s smartphone sales collapse and even Surface feels the pinch

‘Mobile first, cloud first’ is Microsoft’s new mantra, but its fiscal first quarter financial results showed growth in only one of them. Indeed, the mobile hardware business saw its revenues fall by a huge 54% year-on-year, to $1.1bn at constant currency, a sad comedown from the glory days of Nokia, and with gross operating profit of just $100m.

The collapse of the smartphone business which Microsoft acquired from Nokia is both a result of the firm’s misguided lurch into device hardware, and a justification for CEO Satya Nadella’s decision to limit the damage by drastically cutting back on handset activities. It is very clear that his ‘mobile first’ slogan does not mean selling millions of Windows smartphones, as his predecessor Steve Ballmer seemed to dream of doing, but delivering cloud applications and services to all kinds of mobile users, to boost the success of core platforms like Azure and Office 360.

In fact, Nadella should have been braver and axed cellphones altogether, rather than retaining them for three target markets (enterprise, premium and entry level), and launching new Lumia models, as Microsoft did earlier this month. Even with those three new offerings, according to CFO Amy Hood, the firm expects phone sales to remain down year-on-year.

The sorry state of the phone business is clearer since the company changed its financial reporting structure, so that the products are no longer lumped in with a broader ‘devices and consumer licensing’ segment.

By contrast, the newly minted ‘Intelligent Cloud’ segment was the only one to report a growth in Q116 revenue. Compute usage on the Azure platform has doubled year-on-year, and its revenue grew by 135% on a constant currency basis, while the cloud focus paid off in other areas too – Microsoft now has 60m monthly active users for Office 365 Commercial, for instance, as well as 18m consumer subscribers for the cloud-based offering.

While Lumia revenues may never recover, Microsoft feels the need to have some devices on which Windows 10 Mobile is guaranteed to run, in order to deliver its strategic promise of an operating system that spans all types of devices with a common apps base. If it can achieve sufficient interest in its own smartphones to encourage other OEMs to support Windows 10 on mobile devices, its inhouse activities should just fade quietly away.

Microsoft aims to have Windows 10 installed on 1bn devices by mid-2018, and Nadella said on the earnings call that there are already 110m active Windows 10 mobile devices since the platform launched in July.

Even Microsoft’s surprise success on the hardware side, the Surface tablet line, was under pressure in the quarter, reflecting the depression in this whole sector (which has also affected Apple’s iPad). Surface saw its revenues fall to their lowest point in five quarters, at $672m. Microsoft executives blamed this on increased sales of its lower margin Surface 3 model as well as a tendency for buyers to wait for an anticipated refresh of the family, with the Surface Pro 4 and Surface Book due to start selling soon.

For the company as a whole, net profit was up 2% year-on-year to $5.4bn, excluding one-off such as severance and acquisition costs. Total revenue was down 7%, though both figures outdid Wall Street expectations. This week, Microsoft cut 1,000 jobs, according to the New York Times.