Is There A Cure For Microsoft’s Biggest Headache?

By on Aug 30, 2017 in Mobile Design | 0 comments

Microsoft (MSFT) is sitting on a $38.773 billion headache, which is the amount of money it made from its More Personal Computing segment during fiscal 2017. But it must also be said that the problem was created by design, because Microsoft grouped all of its products facing a difficult environment in one segment, thereby freeing up the other segments and making it easy for us compare and contrast the growing and slowing segments.

The biggest issue with the More Personal Computing segment is Windows revenue, which is still a sizable contribution to Microsoft’s pot. Microsoft made approximately $5.160 billion from Windows during the fourth quarter, a growth of 2% compared to last year. But that’s not the problem. In this article, we’ll look at one particular division within More Personal Computing to see if it has the growth potential to compensate for future declines in Windows revenue.

Windows accounted for 58% of More Personal Computing’s revenue during the quarter. With PC sales sliding lower with each passing year, the future is not so great for Windows revenue. But the real question we are trying to answer in this article is this: can the other parts of the More Personal Computing segment, which account for 42% of the segment’s revenue, provide cover for further Windows revenue decline in the future? Because if they can, then Microsoft’s overall growth rate can further accelerate, giving it even more upside for the long term.

Microsoft grouped Windows, Gaming, Surface and Search Advertising under the More Personal Computing segment. I already have discussed the Windows problem in detail in my previous article titled How Risky is Microsoft? so in this article we will keep our focus on Search Advertising revenues, which have steadily grown in the last three years.

Search Advertising

During the fourth quarter of 2017, Microsoft said that Search Revenues (excluding Traffic Acquisition Costs) increased by $124 million, an 8% increase. That means Search Advertising revenue during the quarter must be approximately $1.550 billion.

“Search advertising revenue increased $124 million or 8%. Search advertising revenue, excluding traffic acquisition costs, increased 10%, primarily driven by growth in Bing, due to higher revenue per search and search volume.” – Q4-17 Press Release

Source: Chart created by author using Search Advertising growth (GAAP) numbers provided by Microsoft in their Quarterly Earnings Slides.

Search Advertising’s quarterly revenue of more than $1.5 billion may not be much, but if Microsoft can keep its 10 percent growth rate, that would keep adding $150 million every quarter, providing some cover for Windows if its revenue further declines.

Unfortunately for Microsoft, revenue growth from Search Advertising has been coming down at a steady clip, and there are plenty of reasons why the growth could get slower and lower over the next several years.

The Current State of the Search Market

Alphabet’s Google (GOOG) (GOOGL) has completely dominated the search engine market. Though Windows remains the number one desktop operating system, Microsoft lost the desktop browser battle to Google Chrome, which contributed to Google sitting pretty with 81% of the desktop search engine market share, with Microsoft’s Bing holding a mere 7%.

On the mobile front, Microsoft is completely routed by Chrome’s 96% market share against Bing’s 0.67%.

The shift to mobile is very real and is an ongoing one. As more and more users in developing economies move toward mobile, usage will keep increasing over the next 10 years. It’s a double threat to Microsoft because the traffic shift toward mobile not only threatens to reduce Windows revenue, but also will impact the company’s Search Advertising revenue. With Android holding a major portion of the mobile OS market and continuing to expand its numbers, the opportunity for Bing will become smaller and smaller.

No doubt, Microsoft has done an admirable job of keeping Bing in the hunt instead of giving up. Microsoft kept Bing in the market by finding partners that it can work with. In 2009, Microsoft signed a 10-year deal with Yahoo to get Bing search engine to power the Yahoo website. In 2015, Microsoft struck a deal with AOL, which got AOL to manage advertisements on Microsoft products while getting Bing to power search results on AOL websites. It was indeed a massive deal because AOL is one of the top media properties in the world.

Based on multiple precedents, it’s highly probable that Microsoft will leverage its position and keep striking deals with other companies, which will keep the traffic flowing toward Bing. However, strong growth will remain a problem for Bing because Google controls the browser market with Chrome and the mobile OS market with Android, and growth for Bing and its revenues will remain directly dependent on the size and length of the deals that Microsoft strikes. That’s not the best place to be if you are looking for steady growth.

From that perspective, search revenue growth in the next three years looks a lot more difficult to achieve than it was in the last three years. And the growth in the last three years clearly coincided with Microsoft’s deal with AOL.

Windows quarterly revenues are 3.3 times the size of Search Advertising, and it will be very difficult for Search Advertising revenues to provide cover for Windows revenue decline if it happens over the next five to 10 years. Can any of the other sub-segments offset a possible Windows revenue decline? I’ll get back to you on that but, for now, it’s clear that Search Advertising revenue itself is highly dependent on the deals that Microsoft is able to make over the next few years. As such, it’s not the right “see” to the Windows “saw.”

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