There was very good news for Microsoft in its earnings report yesterday, with sales of its Surface tablets more than doubling from the previous quarter. Microsoft did it by losing money on every Surface it sold. Could that actually be a good thing?
Overall, the quarter was a very good one for Microsoft, with record revenue of $24.51 billion, outstripping analysts' estimates of just under $24 billion. The best news seemed to be from the company's Devices & Consumer Hardware unit, in which revenue grew 68% to $4.72 billion from $2.8 billion the previous quarter. The Xbox and Xbox One were big sellers -- 7.4 million consoles sold into the channel. Overall, it seemed a validation of Steve Ballmer's reorganization of the company and his focus on Microsoft-built hardware.
The most striking news concerned sales of the struggling Surface line of tablets. In 2013, the Surface RT sold so poorly that Microsoft was forced to take a $900 million writedown on unsold inventory. So when Microsoft reported its results this quarter, the Surface seemed to be a winner. Surface revenue more than doubled, with $893 million in sales compared to $400 million in sales the previous quarter.
Things, though, are not what they might seem. Computerworld's Gregg Keizer did some digging and found out that Microsoft spent $932 million on the Surface line in the quarter, which means the company lost $39 million on it. He uncovered the Microsoft spending in Microsoft's SEC filing from late October.
The increased Surface sales should not be that much of a surprise, because it's in line with previous indications. Holiday sales of the Surface were quite solid, with a number of outlets selling them out. In the post-Christmas period, the Surface line had 2.3% of all Internet tablet traffic, beating out the entire Google Nexus line of tablets, according to the online ad network Chikita.
In addition, Microsoft seems to have finally hit a sweet spot with the Surface design and marketing, selling it as a productivity-enhancing tablet rather than just one for entertainment.
So how much of a problem is it that Microsoft essentially subsidized the Surface's success? Not much. That $39 million loss is just a rounding error on Microsoft's bottom line. Microsoft desperately needs to succeed in mobile, and if it takes a number of quarters of subsidizing the Surface, so be it. At whatever point it builds more market share, it will figure out ways to turn a profit and increase margins. For now, though, losing money on each Surface it sells, as long as it sells lots of them, is a smart move.