A simpler business environment means lower margins. If you profit from complexity you have a problem
“The cardinal sin of the computing industry is the creation of complexity,” is quote attributed to Oracle founder Larry Ellison and often repeated at the company’s Open World forum which I’m attending at the moment in San Francisco.
For the computer industry that complexity has been a very profitable profitable business with everything from the local computer shop through to the big technology vendors and integrators.
One of the biggest beneficiaries of that complexity were the salespeople, big complex enterprise deals meant big commissions.
With the shift to cloud services and apps, those fat margins and commissions have evaporated, leaving the lucrative old models of business stranded. IBM are probably the greatest victim of this while Microsoft are, once again, showing the company’s ability to evolve in the face of a fundamental market change.
For the salespeople the days of fat commissions are over, with thinner margins it’s not possible to pay big lump sums for winning contracts.
The simplification of the computer industry is changing the fortunes of many IT businesses, but that change isn’t limited to the tech sector or their salespeople as those fundamental changes are rippling into other sectors.
A constant claim by Internet of Things evangelists is that the IoT will squeeze inefficiencies out of businesses and this is exactly what we’re seeing with cloud and mobile based services like Uber and AirBnB.
If you’re in a business that profits from market inefficiencies then it might be time to figure out how to survive in a low margin environment. The challenge facing companies like Oracle is one whole industries are now having to face.
Microsoft is making the shift to the cloud and devices, but those markets are turning out not to be profitable.
This morning Microsoft announced its quarterly results and, once again, they confirmed the company’s move into the cloud, a transition that means the company has to deal with reduced margins in once immensely profitable markets.
While Microsoft’s earnings beat analyst estimates, the stock still dropped on out of hours trading on the US markets. The reason being margins showed a slight decline and the impending release of Windows 10, which will be free for customers upgrading, portends a further fall in income.
The fading of Windows is best shown in the results for the company’s Devices and Consumer licensing division which covers licensing of the operating system and is the second biggest contributor to Microsoft’s revenues and profits. The segment’s takings are slowly declining although surprisingly the division’s margins are standing up.
Microsoft division performance 2014-15
Windows’ decline shows the post XP recovery Microsoft was hoping for the division has failed to materialise beyond a bump last quarter, as the company explained in its media release;
Windows OEM Pro revenue declined 13%; revenue was impacted by the business PC market and Pro mix returning to pre-Windows XP end of support levels and by new lower-priced licenses for devices sold to academic customers
With company making various versions of Windows 8 and 10 free, it’s hard to see the division doing anything but accelerating its decline as fewer people actually pay for the operating system.
Fading margins
Also illustrating Windows’ falling fortunes is how the Computer and Gaming Hardware division’s revenue threatens to overtake the Devices and Consumer Licensing group’s contribution. The problem for Microsoft with this that the manufacture of Xboxes and Surface tablets only boasts a profit margin of 12% against consumer licensing’s 93%.
Last week at its preview of Windows 10 Microsoft showcased its HoloLens virtual reality technology, while impressive it’s unlikely to boast margins any better than Xbox consoles or Surface tablets. At best it will be a trivial contribution to the company’s bottom line.
Microsoft Margins by operating segment
Percentage margins
Q1-14
Q2-14
Q3-14
Q4-14
Q1-15
Q2-15
Devices and Consumer Licensing
87%
90%
87%
92%
93%
93%
Computing and Gaming Hardware
15%
9%
14%
1%
20%
12%
Phone Hardware
n/a
n/a
n/a
3%
18%
14%
Devices and Consumer Other
21%
21%
21%
17%
17%
23%
Commercial Licensing
92%
92%
91%
92%
92%
93%
Commercial Other
17%
23%
25%
31%
33%
35%
Dwarfing both divisions in both revenue and profit is the Commercial Licensing segment which also boasts fat margins of 93% and accounts for nearly half the money coming into the organisation. Commercial Licensing remains static and provides the bedrock for the company’s cashflow.
The big growth area remains the cloud with the Other Commercial division, which includes most of the online and professional services growing steadily. While showing growth, this part of the business boasts a relatively low margin of 33% so any market moves from Enterprise licensing to the cloud will have a sharp effect on the company’s bottom line.
Mobile black holes
Of all Microsoft’s divisions, the problem remains the Phone Hardware segment with low margins, declining sales and a shrinking market share. Reports released overnight indicate that over a third of Lumia devices sold are not being activated which may indicate distribution channels are having to deal with unsold stock.
Compounding Microsoft’s poor position in the phone marketplace is the resurgence of Apple’s iPhone, particularly in the Chinese market where Microsoft is failing dismally. Global market share figures are indicating Apple may soon overtake Samsung as the world’s largest smartphone vendor while Android systems are coming to dominate the global marketplace.
Tomorrow Apple will announce their results and we’ll see how the two companies are travelling, the contrasts will almost certainly be striking. For Microsoft, even if they do manage a shift to mobility and the cloud, they are unlikely to repeat Apple’s success in reinventing themselves.
“The advantages of Digital Maturity”‘ a paper recently released by researchers at the MIT Sloan school of management looked at how different businesses adopted technology and the effect this had on the companies’ profits.
The authors of the paper, George Westerman, Didier Bonnet and Andrew McAfee, defined ‘digital maturity as a combination of a company’s level of technology investment and the management skills to implement that technology. From this they classify businesses into four categories – the beginners, conservatives, fashionistas and digirati.
Wallowing in the bottom right are the beginners, who have little idea of how to use technology and as a consequence don’t apply tech to their business. While they’ll use computers and will almost certainly use tools like ERPs and accounting software, they won’t implement them beyond their immediate needs.
This could describe thousands of big and small businesses who have learned just enough to do what they need but don’t really understand, or care, about what their IT systems can do for the way they work.
Above the beginners sit the fashionistas, the businesses who like shiny tech things but don’t really have a strategic understanding of technology or how to apply it effectively. As a consequence the digital tools are underused and fashionistas don’t use them much more effectively than the beginners.
More effective users of technology are the conservatives and digerati, the latter are like the fashionistas except their managements understand how to integrate technology into their business.
The conservatives are probably the most typical business, slow to adopt new technology but when they do, the management ensures it is used effectively.
Of the four groups, MIT’s researchers found that the digerati and conservative categories earned between 9 and 26% more profit than their peers.
The use of technology makes a difference as well with the fashionistas getting a 16% better return on assets than the conservatives which is something worth noting about the adoption of tech in a business.
What the researchers concluded was that businesses who aren’t adopting technology are falling further behind in skills as well as profit noting that attaining ‘digital maturity’ takes several years.
It’s worthwhile reflecting on how digitally mature your business is and reviewing exactly how you’re using technology in your organisation. With the tools available for today’s business, there’s no reason to be playing with the beginners.
