Microsoft (NASDAQ:MSFT) generates most of its revenue from software and services, but it also owns a growing hardware division, which produces its Surface devices and Xbox consoles. In 2018, it launched four new Surface devices -- Surface Go, Surface Studio 2, Surface Pro 6, and Surface Laptop 2. It also ramped up sales of the Xbox One X, which was launched in late 2017.
Last quarter, Microsoft's devices revenue -- which comes from its Surface devices, PC accessories, and other devices -- grew 9% annually to $1.26 billion, or 4% of its top line. Within that total, its Surface revenue rose 14%. Revenue from its gaming unit -- which sells its Xbox consoles, games, and services -- went up 44% annually to $2.74 billion, or 9% of its top line. That growth was mainly fueled by a 36% jump in its software and services revenue.
Those figures indicate that Microsoft will keep evolving into a hardware company to lock more users into its software ecosystem. Microsoft hasn't presented a clear road map for its hardware business yet, but here are five devices the company could reveal this year.
1. Surface Book 3
Microsoft launched Surface Book 2 back in October 2017, so the popular 2-in-1 device could see an upgrade this year with Intel's ninth-generation CPUs, NVIDIA's new Turing GPUs, and a 4K display.
TechRadar believes that Microsoft will launch Surface Book 3 between September and November to capitalize on the back-to-school and holiday shopping seasons. That could give it an edge over Apple's (NASDAQ:AAPL) iPad Pros and the new 10" iPad and iPad Mini, both of which could arrive in the second half of 2019.
2. Surface Pro 7
Microsoft upgraded Surface Pro (2017) to Surface Pro 6 last October, so we could see Surface Pro 7 arrive in the final quarter of 2019. Surface Pro 6 added an eighth-generation Intel CPU and new color options, and Surface Pro 7 might include a ninth-generation CPU, smaller bezels, and USB-C ports -- which were curiously absent from Surface Pro 6 and Surface Laptop 2.
3. Surface Phone
Last summer, a leaked document indicated that Microsoft was developing a new portable device code-named "Andromeda." In the document, Microsoft called Andromeda "a new pocketable Surface device form factor that brings together innovative new hardware and software experiences to create a truly personal and versatile computing experience."
Based on the illustrations in Microsoft's patents, Andromeda could be a dual-screen foldable smartphone in which one screen can be used as a primary keyboard. But if Microsoft really launches Andromeda as a Windows-powered phone, it faces a tough uphill battle against the iOS/Android duopoly in the smartphone market.
Moreover, Android OEMs are already launching dual-screen devices -- including ZTE's Axon M, Royole's foldable FlexPai, and a foldable Samsung phone, which could launch this year.
4. Second-generation HoloLens
Microsoft launched the first-generation HoloLens back in 2016, but only early adopters and enthusiasts who paid $3,000 for the developer edition have spent significant time with the mixed reality headset.
Instead of rushing forward toward a mainstream launch, Microsoft plans to introduce a second-generation developer edition of the HoloLens in the second half of 2019. The device is expected to be smaller and thinner, use improved light sensors and a localized AI co-processor, and have a wider field of view and longer battery life. The device could help Microsoft leapfrog over recent AR headsets like the Magic Leap One and stay ahead of Apple -- which has also been dabbling in AR software and hardware.
5. Next-gen Xbox consoles
Microsoft probably won't launch a new Xbox One console in 2019, but it could offer us early glimpses of the two next-gen Xbox consoles, which are code-named Anaconda and Scarlett Cloud.
Anaconda will reportedly succeed the Xbox One X with big hardware upgrades, while Scarlett Cloud will be a cheaper console optimized for cloud-based games. A cloud-based gaming console would complement Microsoft's cloud gaming efforts and boost the Xbox division's higher-margin service revenue.
The bottom line
Microsoft's evolution from a software company into a hardware one naturally expands its ecosystem and diversifies its business away from Windows and Office licenses. Tethering more companies and consumers to that ecosystem also strengthens its commercial cloud business, which rose 47% annually to $8.5 billion last quarter.
It also widens Microsoft's moat against Apple and Alphabet's Google, which conquered the smartphone market and forced it to rely more heavily on 2-in-1 PCs and gaming consoles to stay relevant. Therefore, investors should keep track of Microsoft's hardware launches and the growth of its devices and gaming units in 2019.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, and Nvidia. The Motley Fool owns shares of Microsoft and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.