Losses mount for Microsoft's Surface tablet line

Microsoft posts $45 million loss for Surface in Q1, 15% more than the quarter before

Economies of scale continued to elude Microsoft's Surface line as the tablet lost more money in the March quarter than in the preceding three-month period, regulatory filings showed.

In a 10-Q filed Thursday with the U.S. Securities and Exchange Commission (SEC), Microsoft reported $494 million in revenue from the Surface, the tablet line-up that debuted in 2012 and was refreshed last year. Revenue was down 45% from the December quarter but up more than 50% from the same quarter in 2013.

Microsoft pegged cost of revenue for the Surface at $539 million in the quarter that ended March 31.

The difference between what it brought in and what it laid out, and thus the amount Microsoft went into the hole on the Surface, was a tidy $45 million in the March quarter, $6 million more and 15% larger than in the period that ended Dec. 31.

Over the past nine months, Surface generated about $1.8 billion in revenue, while the cost of revenue ran $2.1 billion, a loss of approximately $300 million. The largest portion -- $216 million -- was in the September 2013 quarter.

As it did in January, Microsoft credited the larger loss to "a higher number of units sold," illustrating that the company continues to lose more money the more Surfaces it sells.

Overall, Microsoft's Devices and Consumer Hardware group -- the division responsible for not only the Surface but also the Xbox video game console line -- again posted a year-over-year decline in gross margin. According to the SEC filing, the March quarter's gross margin was down 34% compared to the same period in 2013.

But that was an improvement of sorts: In the December 2013 quarter, D&C Hardware's gross margin declined 49% year-over-year.

Those declines highlighted how much tougher it has been for Microsoft to make money on hardware compared to software, it's traditional strength. Historically, software produces much higher margins than does hardware. Microsoft has never revealed unit sales figures for the Surface, only revenue and gross margins. That makes it impossible to calculate an ASP (average selling price) for the line, or the average loss Microsoft must now take for every Surface it makes and sells. It's not surprising that the Surface costs more to sell than the tablet brings in. Unless a company sells a large number of something, letting it share fixed costs across a larger sales total, it may struggle to turn a profit. Another factor is that Microsoft had no experience creating and selling a complex device, like a tablet, before mid-2012 when it unveiled the Surface.

If the expected Surface Mini -- an 8-in. tablet many believe is just around the corner -- sells well, Microsoft might have a shot at profitability: Four weeks ago, Microsoft announced it would give away Windows to smartphone makers and OEMs building tablets with screens smaller than 8 inches. Not only will the change benefit OEMs that market Windows tablets and smartphones, but it will also let Microsoft strike the licensing cost from its own balance sheet. (Microsoft had promised OEMs that it would "charge itself" the cost of a Windows license so as to not give the Surface a pricing advantage.)

Microsoft Surface loss
Microsoft recorded a larger loss on the Surface tablet line in the March quarter than the previous period. (Data: Microsoft, SEC filing.)

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, on Google+ or subscribe to Gregg's RSS feed . His email address is gkeizer@computerworld.com.

See more by Gregg Keizer on Computerworld.com.

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