About That Microsoft Quarterly Report

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“[W]hat we’re doing across the company between devices and the cloud and services is the front and center priority for us, and we are well on our way with what that, given what we have done with Windows 8 and what we are doing with Windows Phone and Windows Azure. I think that represents the core of the reinvention and the re-imagination of the Windows franchise.” — Satya Nadella, then head of Microsoft’s Server and Tools division, in a 2012 interview.

Microsoft’s first quarter of its fiscal 2015 was big. The fiscal quarter, corresponding to the calendar third of 2014, brought stronger than expected revenue and profit. The company’s cloud business continued to grow, Windows Phone put points on the board, Surface took off and Office 365 picked up a grip of new paying users.

Put more simply, devices and services had a big quarter, while productivity kept its transition on course. On the platform side, Microsoft’s recent Windows 10 partial unveil set the pace, even though that release didn’t factor into the earnings report.

The four horsemen of the new Microsoft — devices, services, platforms, and productivity — are therefore in what appears to be high repair. The market has to handicap whether the quarter’s growth is sustainable.

The quarterly results show the bearing-out of a number of bets that Microsoft made over the last few years. It’s worth taking a moment to take a look at how the company got to where it is today, so that we can correctly apportion responsibility. It’s too easy to presume that any success or failure under a CEO is completely of their own provenance. Let’s begin.

Ballmer’s Final Choices

When Microsoft’s former CEO Steve Ballmer announced that he would step down within a 12-month period, it capped a tenure that was as controversial as it was long. However, if you moved past the Vista days, discount the company’s massive miss on phones, and a dozen other mistakes, Ballmer’s exit came after a number of damn important decisions were made and set into play.

Toward the end of Ballmer’s tenure as CEO, Surface, which is just now hitting its stride with the Surface Pro 3, was born; Windows 8, which is just now hitting its stride with Windows 10, came to life; and Windows Phone, which is just now hitting its stride with the Nokia purchase and growing device volume, launched.

Strap on big investments into Azure, the launch of Office 365, a massive corporate restructuring, the green-lit construction of Office apps for rival platforms, and a picture of change emerges.

Of course, Windows 8’s nasty launch harmed the Windows brand, something that will take time to rectify. Windows Phone has cost Microsoft billions, and failed to deliver a truly diverse, strong OEM partner network. And Surface torched billions itself, publicly, and threw Microsoft’s potential as a hardware company into broad doubt. Those damages have not been erased. Instead, they are perhaps now being chipped away at.

I also think that it’s correct to say that despite some aggressive action, Ballmer didn’t see his creations through. The Nadella decision to get Office for iPad out the door and into the market is the simplest detailing of that fact.

Not to be too nice to myself, but here’s a quote from a post that I wrote around the time of Ballmer’s departure announcement:

If Ballmer had exited, say, during the Windows 7 period, I think that his time at Microsoft would have deserved a different badge. However, missteps included, the recent few years have been a fundamental shift for Microsoft, leading it to functional preparation for the future, which is to his credit. If the company had failed, we would have blamed the leader. So as the company finds new success, we should laud the boss. Let’s be consistent, at least.

Presuming that Ballmer’s successor is competent, he or she will be inheriting a firm in transition, but one with a future that is quite interesting. And it hasn’t been too long that we’ve been able to say that about Microsoft.

That mostly holds up.

Devices

The most recent quarter was Microsoft’s strongest hardware quarter to date. The company set an all-time record for Lumia sales, getting 9.3 million out the door. That’s only up 500,000 from the year prior, but it shows passable sequential quarter growth. Heading into the holiday period, Microsoft could break the 10 million mark for the first time.

Windows Phone is still far, far, far too small. But it’s growing, and that might be enough to keep Microsoft hanging onto the edges of the mobile market for now. To become a real player, the company will need to multiply its device volume many-fold.

On the Surface side of things, the last quarter was a surprise. I didn’t think that the product line would break the $700 million revenue mark. It did $908 million instead. Now, some of that revenue comes from orders booked the preceding quarter that were not delivered until the fiscal first, but even with that the number was a surprise.

Device volume for Surface compared to the even-shrunken PC market puts Surface on the microscopic end. As a project, compared to the PC market, Surface is a hobby. It is now a far less unsuccessful hobby, but a single quarter’s good results do not a trend make.

Also keep in mind that tablets based on Windows itself remain bit players in the tablet space that Android and iOS essentially own. Surface hasn’t changed that, despite improving unit volume.

Like with Phone, Surface is doing better, but has nearly all its growth still ahead of it.

As Phone and Surface did better, Xbox had a more middling quarter, moving more than 2 million consoles. Microsoft didn’t break out the Xbox One sales figures, which tells you all that you need to know. But the Xbox line has been around for more than a decade, and so its current performance isn’t as tied to Ballmer’s exit or anything that Nadella might be up to. We’ll come back to it when we dig into Windows.

Services

Microsoft announced in the final quarter of its fiscal 2014 that its “commercial cloud” revenue was on a “$4.4 billion annual run rate.” Did we get a new number this time around? Nope. Microsoft is being quiet, because, I can only imagine, someone in its PR or IR hallways decided that when you are doing decently in a market category, not talking about it is the way to go.

In its fiscal first quarter, the most recent, Microsoft indicated that its cloud revenue was up 128 percent compared to the year-ago period.

Azure, born under Nadella’s watch while he was under Ballmer, is doing pretty well. The company recently held a cloud-focused event that continued its push into the space. Microsoft noted during that event that only itself, Amazon and Google have put the billions into straight metal required to be a truly competitive cloud player.

Back when Nadella ran Azure, he had this to say on the product:

“Fundamentally, we’ve been at this platform business forever. This is part of our core DNA, that whenever we think about how do we build out anything that we do, we think about the developer component as a very, very significant, first-class piece.”

Microsoft’s cloud growth has been a multi-year story, and its most recent quarter is more continuation than revolution. But it’s worth noting that Azure started with Nadella under Ballmer and is growing what appears to be faster in dollar terms under Nadella’s CEO tenure.

Azure is not the market leader in terms of mind share here in Silicon Valley. And market share will become increasingly dear in the space. Amazon is working to expand its global footprint. Google is a foe on price. There is enough growth in the cloud to allow each revenue growth, I’d guess, but that doesn’t implicitly matter in real market share terms. That’s where the real war will continue with the platform companies.

Speaking of platforms:

Platforms

Moving from the most recent earnings report for a moment, Windows 10 approaches. The recent developer preview saw more than 1 million downloads in 2 weeks. The number was a bit softer than I expected, but perhaps more importantly is the simple little fact that Windows 10, even in its yet-nascent-very-oh-god-not-nearly-done format, is picking up some decent reviews.

Paul Thurrot, a human that I quite like, said something today that is worth quoting:

To date, most of the conversation around Windows 10 has focused on surface-level niceties like the new Start menu and the ability to run Universal mobile apps on the desktop side-by-side with other applications. These are important changes, to be sure. But other advances in Windows 10 rival and even surpass anything that Microsoft has ever attempted in the past. And with this in mind, it is very clear that Windows 10 isn’t just another major new Windows release. It is inarguably the most audacious release in the history of the platform.

I don’t state that lightly.

I agree. Here’s me from a few weeks ago (And I am not subtweeting Paul here. His post was great, and worth reading.):

Microsoft’s Windows 10 must patch the consumer-facing flaws present in Windows 8.x, and also bring enterprise customers into the modern era of computing. Couple that to the larger Windows trend of platform unification that Windows 10 will be the apparent culmination of, and you have what must be one of the most audacious software projects ever attempted.

That’s not to say that Microsoft will pull it off, but I like their guts.

The quarter saw the first release of something approaching Windows 10, an operating system that borrows on Windows 7 and 8 and 8.1, which all came under Ballmer.

So what began under Ballmer continues under Nadella, reaching a point of chrysalis this quarter, as the culmination of the company’s Windows 8.x strategy, and its work to unite its platforms under a single Windows tag.

Microsoft could still fuck it up. Never underestimate the ability of a big company to face plant when it comes to change. Especially when, as Paul and I noted, the project under work is massively complex.

Productivity

Finally, productivity: Akin to services, the current quarter wasn’t as seminal for Microsoft’s productivity efforts as earlier periods this year. But the numbers were still good:

Office 365 Home and Personal subscribers totaled more than 7 million, representing more than 25% sequential growth over the previous quarter.

Office 365 is just past its third birthday, putting it towards the end of Ballmer. It’s only accelerated under Nadella, who was more than content to launch the iPad build of the productivity suite, and zip ahead with the Android build, even as the ever-missing, touch-based build of Office for Windows muddles along. Ballmer started it, Nadella capped it, and the revenue is rolling in.

Ballmer’s Beta, Nadella’s Launch, And What’s Next

I am not trying to shade what Nadella has accomplished thus far as the CEO of Microsoft, any more than I am trying to draw up a hagiography for Ballmer. There’s little need to praise the rich, but it is worth noting that much of what is going well at Microsoft is a combination of both their work.

If Microsoft can keep its hardware business growing, and continue executing on its transition to SaaS in its various forms, the company could pupate in motion. That would be a feat. However, it’s far too early to call victors. Quite literally the smartest technology companies are working to make sure Microsoft fails. That’s not minor friction.