Through a glass darkly: Microsoft’s new financial reporting format
By Juan Carlos Perez
CIOs will have a harder time evaluating how well key Microsoft products are selling now that the company has restructured the way it breaks down its revenue streams, according to analysts.
The new reporting format, detailed last week, will make its debut next month when Microsoft issues its financial report for its first fiscal quarter, which ends today.
The company said that it will be easier for outsiders, in particular investors and Wall Street analysts, to grasp Microsoft’s financial performance, especially after its corporate reorganization and new focus on hardware devices and cloud services.
But some see the changes as negative for enterprise IT decision makers, saying CIOs and IT managers will likely struggle making sense of the numbers.
“I think this makes it harder for IT pros to determine what’s going on,” said Michael Cherry, an analyst with Directions on Microsoft.
Being able to determine how well—or not—a product is selling is an important element CIOs use to decide whether to commit to it, and so they look at quarterly financial reports for that insight, he said.
“They want to make sure that a particular technology, platform or product will be around for a while,” Cherry said.
The new reporting structure breaks Microsoft’s business into two big revenue buckets—Devices & Consumer and Commercial—which is a misstep right out of the gate, according to IDC analyst Al Gillen.
It may make the distinction between consumer and enterprise sales clearer, but the new format adds little transparency otherwise, he said via email.
“Lumping all software products into two broad categories makes it difficult, if not impossible, to see how any individual software product is doing,” Gillen said.
The analysts also question the way in which the two buckets were subdivided into five subcategories, saying strange bedfellows are grouped together. For example, the Hardware subcategory of Devices & Consumer groups the Xbox 360 console and accessories with the Surface tablets, PC accessories and video games.
A burning question right now is whether Microsoft’s foray into making its own tablets is a viable long-term plan or whether the effort will be scrapped, since the first generation of Surfaces didn’t sell well.
“If the Surface goes in there with Xboxes and mice and keyboards, will you be able to tell the [financial] health of Surface?” Cherry said.
The answer for the Surface and other individual products will vary from quarter to quarter and depend on how specific and granular Microsoft gets in its reports beyond the two main buckets and five subcategories, he added.
The analysts also don’t like that the revenue streams of key products like Windows and Office have been bifurcated and mixed in with each other and other products. “There may be some math people will have to do to get the picture,” Cherry said.
For instance, whereas before Microsoft had a Windows Division for the OS and a Business Division where Office sales were recorded, now in both cases the numbers will be more scattered.
Sales of Windows to hardware makers (OEMs) and to individual consumers will be reported in Devices & Consumer’s Licensing subcategory, lumped in with sales of Office to consumers, Windows Phone and patent licensing revenue.
Meanwhile, Windows Server, Windows Embedded and Windows enterprise volume licensing will be reported in Commercial’s Licensing subcategory. That tent is also occupied by non-Windows products like Office for businesses and enterprise servers and application development tools like SQL Server, Exchange, SharePoint, System Center and Visual Studio. Other dubious choices to put into this subcategory: Skype and the Dynamics enterprise apps.
Office 365 break out
As if this wasn’t fragmented enough for those tracking Office, the Office 365 suites will be reported in two other subcategories.
The Office 365 cloud email and collaboration server suite—which includes online versions of SharePoint, Lync, Exchange and Office—will be reported in Commercial’s “Other.” It’ll share the roof with a very diverse collection of products, including support and consulting services, Dynamics CRM Online, Windows Azure and a set of yet-undetermined commercial products and online services that don’t fit in anywhere else.
And Office 365 Home Premium, the subscription-based edition of the desktop suite including apps like Word, Excel, PowerPoint and OneNote, goes into Devices & Consumer’s Other subcategory. Its housemates will be another motley bunch, including Xbox Live transactions, the Windows Store and Windows Phone Marketplace, online advertising from sites like Bing.com, Microsoft-developed Xbox games and Microsoft retail store sales. Microsoft will also include in this subcategory “certain other consumer products and services” not yet disclosed that don’t fit in elsewhere.
Industry analyst Michael Osterman from Osterman Research said that while the segments align with the markets in which Microsoft operates, he foresees trouble tracking the performance, in particular, of Windows Phone, Exchange, SharePoint and Lync.
For his part, Cherry also worries specifically about clarity into Office 365, which is important in its various editions and bundles because it represents a new attempt by Microsoft to evolve from traditional software licensing into the cloud subscription model. He also predicts difficulty evaluating Bing’s search advertising sales performance.
Additional complications in the reporting format may arrive when Microsoft closes its acquisition of the Nokia smartphone business.
Microsoft finds changes useful
For their part, Microsoft officials have been enthusiastic about the changes. Last week, Chief Accounting Officer Frank Brod said the new reporting format will let Microsoft provide better insight into its business model transition and economics and show progress in its devices and services strategy, as well as deliver increased accountability on gross margins.
“The new financial reporting structure will provide our company with more transparency, great accountability and better execution, not only for today but also for the long term,” Brod said during a webcast to discuss the changes.
The new format was also designed to better reflect Microsoft’s reorganization. Announced in July by CEO Steve Ballmer, the restructuring’s goal is to make Microsoft function in a more unified, cohesive manner. Ballmer said it will make it more agile in responding to market opportunities as it evolves from a packaged software focus into a provider of hardware devices and cloud services.
As part of the restructuring, Microsoft dissolved its five business units—the Business Division, which housed Office; Server & Tools, which included SQL Server and System Center; the Windows Division; Online Services, which included Bing; and Entertainment and Devices, whose main product was the Xbox console.
It replaced them with four engineering groups organized by function, around operating systems, applications, cloud computing and devices, and by centralized groups for marketing, business development, strategy and research, finance, human resources, legal and operations.