Are Microsoft Corporation's Surface Sales About to Fall Off a Cliff?

Microsoft's Surface 2 Pro tablet. Source: Microsoft.

Almost two months ago, shares of Microsoft Corporation (NASDAQ: MSFT  )  surged after the tech titan reported better-than-expected fiscal second-quarter results.

CFO Amy Hood elaborated on its performance, saying "We delivered record revenue as demand for our business offerings remains high and we made strong progress in our Devices and Consumer segment." 

Now-retired CEO Steve Ballmer echoed that sentiment, also pointing to a "great holiday quarter" for its consumer segment.

Sure enough, even as Windows OEM revenue declined 3% on soft consumer PC sales, revenue from Microsoft's devices and consumer segment jumped 13% to $11.91 billion. To explain that strength, the company can thank 7.4 million Xbox consoles sold during the quarter, 34% growth in advertising revenue from Bing, and -- perhaps most surprising -- Surface tablet revenue, which more than doubled over the previous quarter, from $400 million to $893 million. 

Surface sales aren't what they seem
That last statistic seems especially impressive, right? What more could Microsoft investors ask than having sales of their promising tablets more than double over the course of just three months?

Well, I suppose they could ask Microsoft to actually make money on those sales.

Don't get me wrong; that was a big bump by any measure and definitely a step in the right direction. But Microsoft's respective Form 10-Q also lists Surface cost of revenue last quarter as $932 million, which means it lost around $39 million from the tablets despite their growth.

Then again, much of that had to do with the fact that -- thanks to a temporarily low $199 price tag -- Microsoft's first-gen 32GB Surface RT ended up being Best Buy's top-selling item on Black Friday. But is moving bunches of merchandise at rock-bottom prices all that encouraging?

Remember, Apple  (NASDAQ: AAPL  )  sold more than 26 million iPads last quarter for $11.468 billion. And while that was only a 7% year-over-year increase in iPad revenue for Apple over the same period last year, it also marked an 85% sequential gain from the previous quarter.

What's more, Samsung  (NASDAQOTH: SSNLF  )  simultaneously reported a two-fold year-over-year surge in tablet sales, thanks to the end-of-Q3 launch of its Galaxy Tab 3 and Galaxy Note devices.

Suddenly, Microsoft's own Surface holiday bump doesn't look all that great.

What now?
This also raises the question: With the holiday quarter complete, will consumers still want to buy Microsoft's Surface tablets without the steep discounts?

Maybe, but I wouldn't hold my breath.

To its credit, at least some of Microsoft's tablet strength last quarter can be chalked up to the Oct. 22, 2013, launch of its Surface 2 and Surface 2 Pro devices. And though we've seen sporadic reports of Surface 2 supply shortages over the last two months, it's still unclear whether that's a result of actual consumer interest or Microsoft just carefully managing inventory.

I wouldn't blame it if the latter turned out to be the case. Last summer, Microsoft had to take a $900 million inventory writedown thanks to -- you guessed it -- those Surface RT tablets, which finally sold well in its most recent quarter. 

Unfortunately, Microsoft hasn't provided any clarity by breaking down its Surface sales numbers, so we can't tell just how many of higher-margin Surface 2 tablets it's actually selling.

In the end, though, combine that with the fact Microsoft only now appears ready to launch Office for Apple's iPads later this month, and I can't help but wonder whether we're seeing the latest signs of desperation as Microsoft's own tablets continue failing to grab any meaningful market share.

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Read/Post Comments (8) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 22, 2014, at 12:43 PM, anthonyx26 wrote:

    I work for a large IT shop and I talk with a lot of businesses. The Surface (RT/2 and 2/Pro) are great devices, and businesses recognize that but they also see no compelling reason to replace their existing iPads with them. But add in Office/Modern and it will be a device to be reckoned with. My guess is that Office for iPad will not be as fully fleshed out as Office for Windows Modern. Time will tell once its released.

  • Report this Comment On March 22, 2014, at 12:47 PM, Mathman6577 wrote:

    Good article and good points. Microsoft (and Google and Amazon) have not cracked the hardware code yet like Apple and Samsung have. They need to stick to their strengths in software.

  • Report this Comment On March 22, 2014, at 2:00 PM, crca99 wrote:

    I spend so much time on Office products you'd think I'd want a Surface, but they are so ugly. Fix the looks and allow classic start button and sales might ramp up.

  • Report this Comment On March 22, 2014, at 5:08 PM, jameskil wrote:

    First off, iOS is a phone operating system, including all its simplicities and limitations. So, even if Microsoft releases an Office for iOS, its not going to be full feature. This is why the MAC has a different OS then all the other Apple devices. Duh! Second, losses for the Surface. How many iPad were sold before Apple made a profit? There are costs to going into the hardware market including what you experience and learn. Microsoft learns, hence the Surface 2. Third, IT groups hate the iPad. The is no management capability, and sooner than later, they will hit the wall with regards to ability of the device vs. business requirements ... this is where a Phone OS will expose its limitations. Apple is quite happy cranking out iPad sold to consumers. They have avoided making it an enterprise level device not only because of its limitations beyond that of a consumer device, but also because of the long tail support responsibilities of enterprise support, both in infrastructure and application development support, which they have never owned up to, but demonstrate in their history. Users and "industry analysts" are pushing tablets like iPad to be the wholesale replacement for PCs, because they are never assigned the responsibility of support and enhancement, nor selecting a device "ecosystem" to base corporate services and applications. Sure, it can handle a class of needs that don't say "mission critical", but even today, its a companion device. At least the Surface 2 and beyond can play both roles ... a consumer device with an OS robust enough to expand capabilities, as well as an enterprise device that can be a plug in to your corporate infrastructure, will all the pieces in place for ongoing support and management. Raw sales numbers looking on the tablet market are not the telling figure because these devices that dominate run pretty simple apps, and support simple tasks like browsing and email, and work well as a standalone device or in a group of small population. But beyond that, that can't support more robust usage, and a large device population that's absent support and management capability. Also, they have yet to be the target of choice for the hacker world, so have not yet exposed those vulnerabilities. The last thing to point out is, the Fool who wrote this, has no experience in the business world, other than being a sales rep to government agencies, so views of technologies and markets, as well as capabilities vs. usage of tablets are based on zero experiences in the working IT world ... so adjust accordingly (always a big factor on most commentary coming from the Motley Fool and its peers). As for the Surface being "ugly", what is so ugly about the same shape as an iPad? Dunno on that one ...

  • Report this Comment On March 22, 2014, at 7:22 PM, TMFSymington wrote:

    ^^ "...the Fool who wrote this, has no experience in the business world, other than being a sales rep to government agencies, so views of technologies and markets, as well as capabilities vs. usage of tablets are based on zero experiences in the working IT world..."

    For the record, I paid my bills in college -- where I earned my bachelor's degree in Computer Science -- as a web programmer, network technician, and driving around our local Best Buy's Geek Squad bug. And in the previous (Sales Engineer) job you referenced, I had the privilege of working double-duty managing most our local office's IT and network infrastructure, and was required to travel to satellite offices to assist in network migrations/upgrades and the collection of hardware/software requirements. So there's that.

    But that's also beside the point. Even ignoring the fact Apple/Samsung are working hard to make inroads in the enterprise space, I'm not saying the Surface is a useless device. In fact, I think Microsoft made significant improvements with the Surface 2 -- esp in the hardware dept.

    Bottom line: It's still not selling well, and Microsoft's Surface sales numbers listed on the press release last quarter were misleading. In the end, Microsoft has too much cash and ambition to dismiss its tablet ambitions completely, but I think the Surface is too little, too late.


    Steve (TMFSymington)

  • Report this Comment On March 22, 2014, at 7:34 PM, sesvs43 wrote:

    My wife is a traveling consultant. Just got her a surface 2. She now leaves her old windows laptop at home, and gave her ipad to our kids. Replaced both with a surface 2. Sure, its not a full replacement for her windows laptop, but it does everything she needs when on the road. I haven't yet jumped to the surface pro because of cost. Will reconsider when price comes down. Too bad most folks writing articles on the surface 2 family of devices, aren't qualified to access the device's capabilities nor do they have any practical experience getting real work done (beyond emailing, surfing the web, and being entertained), in the real world.

  • Report this Comment On March 25, 2014, at 4:41 PM, spike1967 wrote:

    I can't help but wonder how the Surface sales would have been if it wasn't for the hatchet job from the press and bloggers alike!?

    I also find it very strange that whilst the so called "professional" opinion makers, mark the Surface line so poorly yet the users rate it so very highly? Why is that?

    and have you noticed how the same old gripes are trotted out with each "review"

    not enough apps (100k is not enough)

    doesn't run legacy software (oh please)

    $900m right down

    Have to pay $x for the keyboard (Bo hoo, like Apple ever gave such an accessory away for free)

    blah blah blah

    the bottom line is all arm based operating systems have limitations, RT 8.1 is a fresh take (lets face it iOS and Android are getting long in the tooth and a little stale) the market NEEDS diversity and competition. This in turn pushes Apple, Microsoft et al to innovate.

    I have both the old RT and the Surface pro 2 and am more than happy with both so much so I no longer use my iPad and in the office Surface kicks butt!

    just sayin!

  • Report this Comment On March 27, 2014, at 11:50 PM, iphonerulez wrote:

    With MS Office now on the iPad, there doesn't seem to be much of a need of the Surface 2. Looks like Microsoft might be heading for another write-down in inventory. Microsoft will probably make a lot more money by just killing the Surface 2 and supplying all the tens of millions of iPads with MS Office.

    Hey, we all felt it in our hearts the Surface RT and Surface 2 were doomed from the start. Microsoft seems to be getting desperate to pick up a few crumbs wherever they can. I have to admit, I never thought I'd see Microsoft on bended knee, begging Apple to throw them tablescraps, especially after MS dumped all over the iPad. I guess you can never tell who your savior is going to be.

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