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Microsoft Not Driving PC Upgrades, Analyst Suggests

Microsoft's disappointing second-quarter earnings showed just how dependent the software giant is on new PC sales.

• By Kurt Mackie
• 01/22/2009

Microsoft missed its quarterly projection for only the second time in its history. The first time was back in 2000, Rosoff said. The company's bad financial news was made worse as Microsoft announced an immediate cut of 1,400 employees.

The main lesson Microsoft may draw from the results is to deemphasize its client operating system as the company's traditional cash cow, Rosoff suggested. Microsoft's second-quarter client revenue was $4 billion, representing an eight percent decrease compared with the previous year's 2Q result.

"They're [Microsoft] looking at the operating system as a necessary component, but it won't drive a surge of PC upgrades," Rosoff said. Microsoft had been expecting a 10 percent PC sales figure, but sales were flat, he added.

The days of PC sales being pushed by the operating system, as with Microsoft Windows95, "are long gone," Rosoff said. Rather, PC sales seem to be moving in lock-step with the economy, and consumers will tend to buy them when times are good, he explained.

Sure enough, in late 2008, amidst an obvious recession, consumers turned up their noses on buying new PCs. A report issued this month by analyst firm Gartner found that new PC sales in the fourth-quarter of 2008 hit a low not seen since 2002.

The outlook wasn't as bleak with the sales of netbook computers, according to Gartner. Netbooks are low-cost, low-tech mini-laptops running either free Linux operating systems or Microsoft's older Windows XP operating system. However, sales of netbooks are "cannibalizing" Microsoft's current Windows Vista operating system sales.

"Microsoft can't charge $80 or $100 when there's Linux for free on netbooks," Rosoff said. On regular PC sales, Microsoft's profit margins are typically about 70 percent to 80 percent, he explained.

Microsoft did not follow its usual practice of providing guidance on the overall PC market in its second-quarter report -- a point noted by Chris Liddell, Microsoft's chief financial officer, during Thursday's earnings conference call.

Microsoft expects to face a bumpy road ahead, according to Liddell.

"We are planning for economic uncertainty to continue through the remainder of the fiscal year, almost certainly leading to lower revenue and earnings for the second half relative to the previous year," Liddell said in a released statement.

Microsoft plans to cut a total of 5,000 Microsoft personnel over 18 months, which includes the 1,400 people cut on Thursday. That layoff figure excludes outside contractors, who may be cut on top of that number, according to Liddell. Outside contractor support could be reduced by "up to 15 percent," he said.

Rosoff noted that Microsoft has missed some important business trends over the years that have been exploited by others. For instance, Google seized the initiative on the Internet search advertising business way back in 2002. Microsoft has been trying to catch up ever since. Ballmer indicated during the 2Q earnings conference call that Microsoft is still interested in doing a search deal with Yahoo.

Another missed opportunity was the popularity of music MP3s, seized by Apple with its iPod device. Rosoff added that Microsoft is still about "a year behind with Windows Mobile."

Microsoft has other, more promising opportunities to pursue, such as unified communications, management software and desktop management tools, Rosoff said. Indeed, Microsoft's big bright spot in its 2Q earning release was revenues of $3.7 billion for its server and tools business, representing a 15 percent increase over the previous year's 2Q result.