Business Mix - Microsoft

In order to classify the larger software companies into the industry categories, it will help to quantify the mix of businesses that each participates in. Whereas the smaller companies will more likely be considered "pure plays" (falling into just one category), many of the larger ones will fall into more than one category.

As a rather obvious example, Microsoft has products and services that could be classified as Enterprise Applications (e.g., Microsoft Dynamics), as Infrastructure Software (e.g., Windows Server, SQL Server), and as Games (Xbox 360 and PC software). Microsoft also introduces another major software category, Desktop Applications, in which they are effectively the sole participant with their Office suite. And Microsoft has several non-software businesses (e.g., Xbox consoles, advertising, MSN) -- although it is far from clear that these non-software businesses make any positive contribution to Microsoft's market cap!

Pages 23-28 of Microsoft's FY 2007 10-K provide much of the data needed to infer Microsoft's revenues and earnings at a fairly detailed level. I won't show all the analysis here, but I should note that I did make four assumptions: (1) that Xbox consoles wholesaled at $350 each during FY07; (2) that the Server and Tools business split 45%-45%-10% SQL Server-Windows Server-Other; (3) that Microsoft Office comprised 92% of the Business Division's revenues; (4) that each division's operating margin could be applied uniformly to all the businesses within that division.




It's interesting to note that Microsoft's "core businesses" -- Windows and Office -- are two businesses in which it makes virtually all its profit, and (unsurprisingly) the two businesses in which it has nearly dominant market share. Both of these businesses face limited growth and potential eroding share, which is no doubt part of the reason that Microsoft has attempted to diversify beyond this core.

But other than the relational database business, where Microsoft appears to earn a decent profit and where it has a respectable market share, none of the other businesses appear to be making any significant contribution to Microsoft's profitability. Microsoft has a disadvantaged position against Google in the advertising business, and falls well behind Oracle and SAP in the enterprise applications arena.

Already this picture raises some questions about Microsoft's business portfolio. Is Microsoft taking the best steps possible to defend its core business and maximize its profit potential? Does Microsoft ever have a chance of achieving significant profitability in its non-core businesses, and what have to be true in order to believe that they could? Are there more sensible business adjacencies that Microsoft should pursue instead of these businesses?