The Microsoft model seems to be working

Recent results from major vendors have given an insight into the challenges for vendors that deliver both hardware and software with Billy MacInnes noting Microsoft seems ahead of rivals

Recent results from Microsoft, IBM and Apple offer contrasting perspectives on the state of play in the technology industry today. IBM’s well-signalled transition away from hardware towards cloud and AI appears to have slowed and some are starting to wonder when, or if, it will ever arrive at its destination against a backdrop of 21 consecutive quarters of declining revenue. It’s true that the company’s earnings were above estimates but they were boosted substantially by IBM’s very low tax rate.

Meanwhile, software giant Microsoft’s cloud strategy seems to be progressing very nicely indeed with Office cloud revenues surpassing traditional licences for the first time in its most recent quarter and Azure growing by 97%. Overall, profits were up 109%. Like IBM, Microsoft also gained from a tax benefit ($1.8bn) after recognising losses accrued at its defunct smartphone hardware business.

CEO Satya Nadella was understandably upbeat. Innovation across our cloud platforms drove strong results this quarter,” he said.

The two main talking points from Apple’s most recent results were a decent performance for iPads with unit sales up 15% (although revenues rose by only 2%) and the growth in its services segment (up 22% to $7.266bn). Services is now the second largest product category at Apple, accounting for 16% of total revenues.

That still leaves the iPhone with the lion’s share of Apple’s business, accounting for 55% of all revenue. If you add iMac and iPad sales on top, that makes up 78% of Apple’s total revenue. For the most part, that’s purely hardware. It’s true the iPhone, iMac and iPad have distinct operating systems but those are all bundled for free with the hardware. Most Apple-branded software, such as Garageband, Photos, Pages, Numbers, Keynote, iTunes, is also free for Mac and iOS users.

Which suggests that close to 80% of Apple’s revenue comes from hardware (84% if you add the ‘other products’ segment which includes Apple Watch, Apple TV and Beats products).

In the current environment, where so much attention is focused on the cloud, software and services as the main pathways to future success, this seems a slightly strange state of affairs. True, Apple’s services unit is growing rapidly but it’s still less than a fifth of the overall business. It may well continue to grow strongly into the future but hardware is still the bedrock of Apple’s operation.

That’s not to say the software isn’t important. It plays a critical role for all Apple’s products in terms of differentiating them from the herd of their competitors. In the computer space, the vast majority of rival products run Windows. In the tablet and smartphone sector, it’s Android. It’s unlikely that Apple’s hardware products would perform as well if they were dependent on the software of strangers. Certainly, Apple is never going to put itself in a position to find out.

However Apple chooses to charge for its hardware and software, the fact they are intrinsically linked creates a value for both that is bigger than it would be for either separately. And while Apple might be happy enough to give its software away for free to users of its hardware platforms, it is far more reticent about handing any of it over to users on rival platforms except where, in the case of an app like iTunes, it suits Apple.

Samsung, on the other hand, has one of the leading hardware platforms for smartphones and tablets but is dependent on Google for the software that powers nearly all of them. True, it has developed its own OS, known as Tizen, which is already used in smart TVs, Gear smartwatches and selected smartphones in a limited number of markets. But there are concerns over the quality of the software with one security researcher claiming in April: “It may be the worst code ever” . Until those are assuaged, it seems unlikely that Tizen will be a viable alternative to Android for Samsung and users of its smartphones.

On the other side of the fence, Microsoft’s recent forays into hardware with the Surface and Surface Pro show it has grown tired of depending on the hardware of strangers to launch its software on new form factors and is keen to set design standards for the hardware vendors to follow. While that has been reasonably successful, it follows the adoption of similar strategies in the smartphone and MP3 player markets that ended up as ignoble failures. As a result, Microsoft has been forced to deliver its applications to smartphone platforms controlled by Apple and Google.

Does it matter? Well, it puts Microsoft between two contrasting approaches. While Google hasn’t publicly stated how much revenue it generates from Android, a lawyer for Oracle claimed in January 2016 that the search engine giant had made $31bn in revenues since 2008 from the OS and $22bn in profit . So, on one level, it matters a lot given that the Google model is pretty similar to Microsoft’s model for Windows in the PC era.

However, if you compare that to iOS which isn’t licensed to other vendors and doesn’t cost users anything, it suggests there is money to be made even if you don’t charge for the OS. It helps that Apple owns the hardware platform as well and gets a cut for applications delivered to the OS. Microsoft can make money from both platforms, of course, but it is dependent on both to do so. The positive for Microsoft is that the cloud serves as a perfect delivery mechanism for its applications in this new world order and they can be provided to users of both of the biggest mobile platforms without being tied to one or the other (or even to a Microsoft OS platform).

In any case, the demand for Microsoft applications for many of those mobile devices is directly tied to their need to interact with desktop PCs and laptops running Windows. Microsoft’s entrenched position in the PC environment is the springboard for establishing its applications in the iOS and Android space. Doing so also serves to bolster Microsoft’s cloud ambitions in a world where users will employ multiple devices to access applications and expect them to operate across different platforms via the cloud.

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