Microsoft Surface -- the combination tablet/PCs -- have finally turned a profit, according to some members of the trade press. Unfortunately, geeks sometimes don't understand accounting. In this case, the numbers suggest Microsoft's Surface business is improving but only Microsoft knows for sure if Surface is a profitable business. Here's why.
Let's start with the disclosed facts. During an earnings call last week, Microsoft said Surface sales were roughly $908 million during its most recent quarter. Moreover, costs to make the combination PC/tablet device were $839 million. That equates to a $69 million quarterly profit on Surface, right?
Actually, no. The two figures don't include additional costs such as marketing and distribution.
While it's impossible to say just how much Microsoft is paying to market and deliver Surface right now, keep in mind Microsoft's high-profile 5-year, $400 million agreement with the NFL. That deal covers both Xbox One and Surface.
So let's assume half of the spending ($200 million over 5 years) involves Surface. That's $40 million per year -- or $10 million per quarter -- just Surface ads just with NFL. Suddenly, Microsoft's $69 million quarterly Surface profit becomes $59 million. Poke around and see where else Microsoft is advertising Surface... and suddenly that quarterly tablet profit gradually moves toward break-even or perhaps even red ink.
Again, all the numbers in the paragraph above are hypothetically speaking. But they drive home the core point: Surface may not yet be profitable because of costs Microsoft has not disclosed (nor is Microsoft required to disclose the figures).
Surface IS Making Progress
Still, Microsoft deserves some applause for its Surface progress. Back in mid-2013, Microsoft took a $900 million write off for Surface Tablets -- mostly related to the slow-selling, lower-powered RT model.
At the time, some Wall Street pundits and many IT media members criticized Microsoft for competing with its hardware partners (Dell, HP, Lenovo, etc.). I concede, I was among those who knocked Microsoft -- especially since there seemed to be no real Surface sales strategy beyond Microsoft's own website and big box retailers.
Staying the Course
Gradually, the Surface story has improved. The latest Surface Pro 3 release has won generally favorable reviews. At the same time, the traditional tablet market has suffered a sales slowdown -- including Apple, where iPad sales declined about 600,000 units in Q4 2014 vs Q4 2013. The reasons:
- Tablets are now getting pinched between so-called phablets (large-screen phones that are nearly tablets) and traditional PCs.
- The tablet upgrade cycle among consumers seems to be far longer than the traditional PC upgrade cycle.
For instance, I'm an iPad 1 owner and I've never purchased newer iPads because the original offering is "good enough" for most of my needs. Plus, I now have the iPhone 6 Plus -- the larger-screen phone that really makes me wonder "do I need another tablet, ever?"
Meanwhile, Microsoft has positioned Surface as a Tablet that's also a full-blown PC. Sure, most of the major PC vendors have made similar marketing moves -- backed by Intel, which wants everyone to buy a "two in one" device (tablet/PC combo).
But heavy Surface marketing -- and the media's fascination with Microsoft's business strategy -- have bolstered Surface brand recognition.
If Microsoft delivers a solid Windows 10 release next year, Surface's prospects could grow even brighter.
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