Microsoft's last quarterly numbers were pretty sad. Although group profit was up, it was up less than analysts hoped, and some divisions are seeing substantial reductions in performance. As expected, the PC decline is hurting desktop Windows licensing, and the mobile division is basically a money pit.
Chief among the mobile woes was the announcement that Microsoft was taking a $900 million writedown on unsold Surface tablet inventory. As we've discussed previously, the Surface Pro is struggling gamely, but the Surface RT is basically dead. Worse than dead, if the company is encumbered by as many as six million corpses sitting in warehouses, according to some estimates. Probably high-side estimates, to be fair, but it still adds up to that $900 million albatross.
The entertainment side of the business reduced its losses, but the company's ongoing war with Sony is approaching a ferocious new fight, as the PlayStation 4 prepares to duke it out with the Xbox One, a fight it could well lose unless Redmond pulls off a strategic coup at the last minute.
The company is going to have to think out of the box to turn its fortunes around. The extensive corporate reorganisation announced before the earnings shows the company is aware of how serious its predicament is.
There are a few glimmers of hope, even for the product lines most in the doldrums. HP showed, with its TouchPad in 2011, how fire-sale prices can reignite interest in a reviled product line. Although Microsoft has heavily discounted the RT already, it may have to go to similar lengths to clear out its ARM tablet stock.
Or it could bundle it, using rebates to create some value for the balance sheet - giving Surface RT tablets away with Xboxes, for example. I like this option, because it also addresses a major pain for Microsoft: the looming battle with Sony.
The Xbox One is Microsoft's upcoming third-generation console, and the Xbox history gives some useful insights into Microsoft's strategic mind-set. The Xbox came into the market in 2001, taking on the entrenched might of Sony's PlayStation 2, because Microsoft realised the growing importance of the entertainment sector and console gaming was a good way to break into the niche.
Predictably, the first-generation Xbox struggled, but Microsoft stayed the course and made huge progress with its second-generation device, the Xbox 360. Launched against the PlayStation 3, the 360 turned Microsoft's fortunes around even though Redmond bet on the wrong horse in the Blu-ray/HD DVD race. With motion gaming sparked by Nintendo's Wii, Microsoft's Kinect has dominated Sony's efforts, and the Xbox had a solid position going into the next round. At which point Microsoft blew it completely. A series of unpopular announcements (expensive, always online, no resale of second-hand games, etc) allowed Sony to outflank its rival with a series of pronouncements positioning the PS4 as a far more appealing device. Microsoft, reeling, made some concessions to its product strategy, but has clearly lost ground.
We have to remember that console gaming is not about gaming at all. It's about presence in the living room.
We have to remember that console gaming is not about gaming at all. It's about presence in the living room - entertainment, music, movies, communication... and gaming. Google's gigabit fibre projects are aimed at the same space, for example. Microsoft and Sony know how important this sector is, and how crucial it is to dominate it.
Similarly, the tablet market is also critical for Microsoft. Plummeting PC sales and booming tablet adoption underscores the company's desperately late re-entrance into the market, but there is zero chance that Microsoft will walk away at the first setback. It has to improve its mobile position, and will endure years of red ink on the balance sheet if it has to.
So, pending a strategic miracle, can Microsoft's reorganised execs make lemonade from its Xbox One and Surface RT lemons? I think they could. It would be a piece of cake to write a Surface app suite designed to offer gaming APIs for developers, media extension, remote control, communication and more. Offer Surface RT tablets as rebate options for the high-priced Xbox packs, and Microsoft could justify the price, clear tablet inventory, score points on the bottom line AND nail a feature win against Sony, building on its existing Kinect advantage.
This is actually nothing new - Sony's PlayStation Portable could function as a rear-view mirror for driving games on the PlayStation 3 in 2010, though the feature failed to gain much traction and remained a niche gimmick. And Nintendo's Wii U includes the Gamepad controller, featuring a touch-enabled LED screen used as an additional controller, TV remote, and game platform in its own right.
In fact, Microsoft is the only major console manufacturer without an external screen capability of some sort, so the opportunity exists for Redmond to not only catch up, but leapfrog the rest. The Surface RT might be a crippled tablet, but it is more than capable of functioning as a media extender.
Microsoft's Xbox experience shows the company's dedication to staying on course in a crucial sector until it gets it right.
There are other options. An HP-style fire-sale is one possibility. It could partner with a content provider like Khan Academy and sprinkle Surface RT tablets liberally throughout the education sector. It could even pull off a software miracle like BlackBerry did with its remarkable OS upgrade on the PlayBook. Windows 8.1 is imminent, after all.
Or maybe it won't. Whatever happens, Microsoft's Xbox experience shows the company's dedication to staying on course in a crucial sector until it gets it right, so don't write Microsoft out of the tablet space yet. The Xbox will probably hold its own even if Microsoft doesn't tackle the shortcomings, but the mobile space is something else entirely.
And all this is before we touch on smartphones, where Microsoft and BlackBerry continue to struggle against the combined might of Apple and Samsung. Gartner has posited an optimistic 12% market share target for Redmond, which would see it in a much happier position than it is today. Like tablets, this is a space where Microsoft cannot and will not stop trying, no matter the cost. The company has left its strategic realignment terribly late, but it has ample cash reserves, annuity income and strong enterprise product lines to keep it going until it cracks the mobile nut.
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