Microsoft reshuffles into 3 businesses for financial reporting

Will make it easier to mask hardware's hard road to profit, says analyst

satya nadella

Microsoft today changed how it will report its financial performance, reducing the number of operating divisions to three, in an effort to align with CEO Satya Nadella's emphasis on the cloud and productivity platforms, and opportunities to reap revenue from customers after they've moved to Windows 10.

The three operating segments -- Intelligent Cloud, Productivity and Business Processes and More Personal Computing -- replace six earlier divisions, which were roughly organized on a consumer versus commercial basis.

Microsoft's previous financial reporting had been in place for just two years. Then-CEO Steve Ballmer reconfigured both the company and its financial reporting.

microsofts new reporting segments1 Microsoft

Microsoft broke apart its six reporting divisions -- which had been organized in a consumer-versus-commercial fashion -- then mixed and mashed the components into three new businesses.

The changes will begin immediately, said Chris Suh, the general manager of investor relations, in a conference call with Wall Street analysts. The next earnings statement, slated for an Oct. 22 release, will rely on the new structure, although analysts will also get the results in the older format for comparison.

Intelligent Cloud will be composed of the Windows server licensing business, enterprise services and Microsoft's Azure cloud platform. Productivity and Business Processes, meanwhile, will be primarily the Office franchise -- both consumer and commercial, both perpetual licensing as well as Office 365 -- along with the Dynamics CRM (customer relationship management) portfolio. More Personal Computing will include Windows, Bing search revenue, and all of Microsoft's own hardware, from Surface and smartphones to Xbox.

While the mix-and-mash of the old into the new may be confusing to anyone not delving into Microsoft's numbers on a regular basis, Suh and Frank Brod -- the company's chief accounting officer, who was also on today's call -- touted it as both more in line with Nadella's pivot toward mobile, cloud and platforms, and as more transparent.

It will also more clearly show the company's ambitions, said Brod, who cited More Personal Computing's bundling of both upfront Windows licensing fees and after-sale monetization opportunities, like ads served by Bing.

Microsoft has been adamant that it will be able to shift emphasis from making money selling software -- Windows in particular -- to selling services to those running the OS. That thinking, for example, drove the decision to give away free upgrades to Windows 10.

Some information that analysts used to build their forecasting models -- and which reporters, including those at Computerworld, have relied on to highlight the company's successes and failures -- will disappear under the new format.

Microsoft will no longer regularly provide unit sales of its Xbox video game console or its Lumia smartphone, for instance. Teasing out such basics as Windows' performance will be much more difficult, and by combining multiple groups -- some which traditionally boast high gross margins, others that may bring in revenue but are either not profitable or barely so -- Microsoft will make it tougher for outsiders to parse the difference.

"It looks like we'll get less granular visibility into the performance of individual parts of the business, especially in hardware," said Jan Dawson, chief analyst at Jackdaw Research, in an email. "Bundling Windows with phone, Xbox, and Surface will mask the underperformance of the hardware divisions, although it'll also take some of the shine off Windows."

Microsoft will also ditch reporting of gross margin, a measurement of revenue minus the cost of goods (COG), and instead focus on highlighting operating income, the amount of profit after deducting operating expenses, which include not only COG but also sales costs, wages and depreciation.

That change will make it harder to pry hard data from some segments. Under the earlier reporting format, for instance, the Computing and Gaming Hardware group -- Xbox and Surface, primarily -- recorded revenue of $1.9 billion in the June quarter for a gross margin of 22%, signaling the difficulty of producing profit on devices. By tossing that into the same bin as the high-margin Windows business, it will be impossible to get a sense of whether, say, the Surface line is making or losing money.

But Microsoft will not be able to disguise its bigger problems with the new format, Dawson said. "The only part of the business that's seeing increasing margins is Intelligent Cloud, which is on track to become the most profitable segment sometime in the next year or two. [Meanwhile,] margins in Productivity and More Personal Computing shrink steadily," Dawson said after reviewing the new reporting.

Overall, Dawson wasn't much impressed with the changes. "The new segments feel like something of an over-simplification of the real structure of the business, with Office lumped in with Dynamics, search and Windows lumped in with hardware, and enterprise services lumped in with server products," he said.

Microsoft will hold its next call with Wall Street on Oct. 22 starting at 2:30 p.m. PT, when it will use the changed reporting to present its earnings.

Copyright © 2015 IDG Communications, Inc.

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