Will Microsoft's Satya Nadella dump Windows Phone and the Xbox?

If Microsoft CEO Satya Nadella is true to his logic, one day he'll dump both Windows Phone and the Xbox -- and of course, the Surface. But is he willing to follow that logic, or instead keep Microsoft's worst-performing divisions?

That Nadella should eventually rid Microsoft of the Xbox and Windows Phone is based on his recent statements, as well as on a superb analysis that Computerworld's Gregg Keizer did about how poorly Microsoft's hardware divisions perform financially compared to its software ones. Keizer's analysis reveals a company in which nearly all profits are concentrated in software, and in which hardware is a drain.

Let's start with Keizer's analysis. He notes that::

Two of the company's six business units -- Devices & Consumer (D&C) Licensing and Commercial Licensing -- generated 68% of the company's total revenue for the second quarter of 2014 and 93% of its gross margin.

Those two units sell software licenses. D&C sells Windows licenses to computer manufacturers, and Commercial sells Office, Windows Server, and other software licenses to enterprises. Their margins, he notes, were "stratospheric" in the last quarter, with D&C's at 92% and Commercial's at 94%.

As for the the divisions that sell the Xbox, Surface, and Windows Phone devices, they practically contribute nothing. Computing and Gaming (C&G) Hardware, which makes the Xbox and the Surface, had a gross margin of 1% for the quarter. Phone Hardware had a gross margin of 3%. And even those dismal numbers overstate how little those divisions add to Microsoft's bottom line. Keizer says that C&G Hardware contributed only 0.1% of the company's gross margin, and Phone contributed only 0.3%.

Under a strategy devised by former CEO Steve Ballmer, Microsoft was a devices and services company. Clearly, Microsoft couldn't get rid of hardware if half of its mission was to sell devices.

However, under Nadella that's changed. He now says Microsoft is a "productivity and platforms" company. No mention of any kind of hardware.

Keizer points out that in the company's earnings call on July 22, Nadella said:

"We are not in hardware for hardware's sake, and the first-party device portfolio will be aligned to our strategic direction as the productivity and platform company."

And back in May, Nadella said in an interview at Re/code's technology conference:

"We are a software company at the end of the day."

So if Nadella follow the direction he's set for Microsoft, he should dump the Xbox, Windows Phone hardware (he could still keep the Windows Phone operating system), and the Surface. The hardware doesn't align with the direction he's set for Microsoft as a productivity and platform company. And the hardware doesn't contribute to the company's bottom line, either. By keeping the hardware divisions, Microsoft's attention is taken away from its primary mission.

But Nadella shows no inclination of getting rid of the Xbox, at least. At the Re/code interview he said:

"I have no intent to do anything different on Xbox than we are doing today."

He may be more ambivalent about getting rid of manufacturing Windows Phones eventually. When asked in the Re/code interview whether he was in favor of the Nokia deal when he first heard of it, he sidestepped the question, saying "I'm not going to answer that." That certainly sounds like he wasn't a fan.

As for the Surface, Nadella has already killed the Surface Mini, so it doesn't seem as if he's wed to the Surface line.

What's the upshot of all this? The Xbox seems here to stay. And clearly, Microsoft is going to continue manufacturing Windows Phones for quite some time as well, given the massive investment it recently made in buying Nokia's phone division. As for the Surface, it appears to be on the shakiest ground.

Copyright © 2014 IDG Communications, Inc.

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