Surface Watch

Surface damage mounts at Microsoft as red ink reaches $1.7B

The tablet business has lost money each quarter, and each fiscal year

Surface Watch

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Most of the FY2013 loss was attributed to the massive $900 million write-off Microsoft announced in July 2013. That write-off, the first of two the Redmond, Wash. technology company has been forced to take on the Surface, accounted for a glut of Surface RT tablets Microsoft couldn't sell.

So, since the Surface's sales debut, Microsoft has lost $1.73 billion ($676 million plus $1.049 billion) on the new hardware.

While that loss may not pose an existential threat to Microsoft's finances -- it represented just 3% of the company's FY2014 gross margin, and less than 9% of the year's gross margin for the Devices and Consumer division, of which Surface is only one part -- it's certainly real money.

If Microsoft had managed to just break even on the Surface in FY2014, for instance, it would have boosted its year-over-year gross margin growth, a key financial metric the company cites in its 10-K, by more than a percentage point, from 4% to 5.2%.

In an analysis published last week, Dawson put the Surface debit into context. "Continued losses will make it harder and harder for Microsoft to keep the Surface project going, so a good performance in the next quarter or two will be critical to justifying its continued existence," he wrote.

In the interview today, Dawson elaborated. "You can accept some losses for a while, but how sustainable is that in the long term?" he asked. "Can you run [into the red] indefinitely?"

Dawson didn't think so, especially now with Satya Nadella as CEO.

"My sense is that Nadella is less willing to accept losses than was [Steve] Ballmer," Dawson said, referring to the former CEO. "Ballmer was willing to make decisions that involved heavy losses," Dawson added, citing both the Surface and the Nokia purchase.

One hint of Nadella's unwillingness to pour resources into a money-losing business came from his comments on the July 22 earnings call with Wall Street. "At times, we will develop new categories like we did with Surface and we will responsibly make the market for Windows phone," Nadella said then. "However, we are not in the hardware for hardware sake, and the first-party device portfolio will be aligned to our strategic direction as the productivity and platform company."

Dawson picked up on Nadella's "make the market" comment. "Is it still worth 'making the market' if you're not making sales?" Dawson asked. "They're losing hundreds of millions and without a large volume of sales, they're not making the market or rapidly increasing the market for Windows 8 tablets."

The rest of the year will tell the tale. Microsoft has portrayed early Surface Pro 3 sales as promising. "While it's still early, sales are outpacing earlier versions of Surface Pro," chief financial officer Amy Hood said two weeks ago.

"But if the Surface is one, not growing sales; two, losing money; and three, not creating a market, what's the point ultimately?" Dawson wondered.

Exactly.

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.

Copyright © 2014 IDG Communications, Inc.

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