As in so many large companies, Microsoft’s parts are worth more than the whole.
Taking a look at how Microsoft is doing by business segement is quite revealing. One of the characteristics of insanely successful companies is that they have so much excess cash that pressures to invest it in allied (sometimes not so allied) businesses takes hold with a vengeance. It’s also predictable that management feels lightning will strike again and these forays will garner returns comparable to the core business – kind of like a god complex.
Most of the times it does not work out that way.
Microsoft is a good example. The following segment data shows profitability by market segment:
Microsoft Segment Data – 2008
| Segment | Revenue | Income | Profit Ratio | Comment |
| Client | 16,865 | 13,105 | 77.7% | The Golden Egg |
| Server and Tools | 13,102 | 4,539 | 34.6% | Third Best |
| Online Services Business | 3,214 | (1,222) | NA | A dog |
| Microsoft Business Division | 18,929 | 12,369 | 65.3% | Another Golden Egg |
| Entertainment and Devices Division | 8,206 | 497 | 6.1% | Not worth it |
| Unallocated | 104 | (7,017) | NA | Eliminations |
| Consolidated | 60,420 | 22,271 | 36.9% | TOTAL |
Segment Definitions
- Client offerings consist of premium and standard edition Windows operating systems.
- Server and Tools concentrates on licensing products, applications, tools, content, and services that make information technology professionals and developers more productive and efficient. Server and Tools offerings consist of server software licenses and client access licenses (“CAL”) for Windows Server, Microsoft SQL Server, and other server products.
- Online Services Business (“OSB”) consists of an on-line advertising platform with offerings for both publishers and advertisers, personal communications services such as email and instant messaging, online information offerings such as Live Search, and the MSN portals and channels around the world.
- Microsoft Business Division (“MBD”) offerings consist of the Microsoft Office system and Microsoft Dynamics business solutions.
- Entertainment and Devices Division (EDD) offerings include the Xbox 360 platform (which includes the Microsoft Xbox video game console system, Xbox 360 video games, Xbox Live, and Xbox 360 accessories), the Zune digital music and entertainment platform, PC software games, online games and services, Mediaroom (our Internet protocol television software), the Surface computing platform, mobile and embedded device platforms, and other devices.
Source: Microsoft Annual Report
Excuse me, but businesses with profit margins of 60 – 70% are first, hard to come by and second, carry market valuations that reflect superior growth and profitability. In Microsoft’s case, two segments really drag down valuation to Microsoft’s shareholders detriment. Looking at this company dispassionately, one concludes fairly quickly that its core competency is software, and anything else is a diversion. For giggles, let’s scrub the segments like so:
| Segment | Revenue | Income | Profit Ratio | Comment |
| Client | 16,865 | 13,105 | 77.7% | The Golden Egg |
| Server and Tools | 13,102 | 4,539 | 34.6% | Third Best |
| Microsoft Business Division | 18,929 | 12,369 | 65.3% | Another Golden Egg |
| Unallocated | 104 | (7,017) | NA | Eliminations |
| Consolidated | 49,000 | 22,996 | 46.9% | TOTAL |
Adding another 10 points in profitability is not too bad! I kept Unallocated the same but this would be less than I’m showing here. What is also not shown are the benefits from keeping the troops focussed on what they do best. All this suggests that Microsoft could hit something on the order of 50 – 60% profit ratio.
I’d be the first to say that Microsoft can’t sit on its annuity businesses – it has to grow if it wants to maximize shareholder value. But growing in areas where its core competencies are better leveraged are more promising longer term than fooling around with hardware products like the Zune and Xbox; as good as some might think they are, it’s not as profitable as software. The key test for any business segment is how it would look as a stand-alone business; by any measure, two of Microsoft’s them would last about 10 seconds.
It won’t happen with the current management team, but an interesting “what-if”.
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