After a disastrous launch and a big writedown, analysts were ready to write off Microsoft’s Surface division five years ago. But instead of disappearing, the Surface division has been a surprising success.
Microsoft just closed the books on its 2018 fiscal year. As usual, it didn’t break out unit sales or revenue for the Surface division, but after going through the last four quarterly reports I was able to calculate that the division brought in total revenue of about $5 billion.
No one in their right mind would have placed a bet on that number five years ago. At the end of FY2013, Microsoft had to take a one-time writedown of $900 million to account for the spectacular failure of its Surface RT.
Many companies would have given up at that point, but not one run by Steve Ballmer, who famously described Microsoft’s approach as “long-term, tenacious, and partner-centric.”
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As he once told an arena full of partners, “We don’t go home. We just keep coming and coming and coming. Tenacious, tenacious, tenacious.” (As Ashlee Vance noted when transcribing those remarks for the New York Times, “The man likes to talk in threes.”)
In fact, while PC shipments overall have been flat or down for the past four years, the Surface business has been growing at a compound annual rate of better than 22 percent a year.
Data from Microsoft SEC filings
To put that in perspective: In less than six years, the Surface business has grown to roughly 20 percent of the size of Apple’s entire Mac business. Apple brought in just over $25 billion in revenue in the fiscal year that ended September 30, 2017. Its compound annual growth rate since 2014 is 2.4 percent.
And that trend is holding steady in 2018. For the two most recent quarters that Apple reported, its Mac revenues were down 5 percent and flat, respectively.
By contrast, Microsoft’s Surface business was up 25 percent and 32 percent in its most recent two quarters. (In fairness, Microsoft’s SEC filings note that the previous year comparables were “impacted by product end-of-life-cycle dynamics.”)
So what accounts for this steady success in a market where other OEMs are struggling? In a word, good products.
After the Surface RT disaster, Microsoft didn’t have much luck with its first two Surface Pro models, which were bulky, quirky, and unlike anything the market had ever seen. (Being a showcase for the unloved Windows 8 didn’t exactly help, either.)
And then came Surface Pro 3, which went on sale a few days before the start of Microsoft’s fiscal 2015. At the end of that fiscal year, the company noted in its official SEC filing that “Surface revenue increased 65 percent to $3.6 billion, primarily due to Surface Pro 3 units sold.”
(I noted with interest that that FY2015 annual report was the one and only time Microsoft has disclosed its annual Surface revenue instead of hiding it in a series of arithmetic problems over the course of four quarterly reports.)
This hybrid device isn’t for everyone, but the small changes add up to a significantly better user experience.
The success of the Surface Pro 3 was attributable to solid engineering, as reviewers who had scoffed at earlier models gave the sleek, well-balanced newcomer generally excellent reviews. (For a sampling, see “The ultimate Surface Pro 3 reviews roundup.”)
The Devices group, of which Surface is one part, had a terrible FY2016 as Microsoft began its painful exit from the smartphone business. Surface was the lone bright spot, with revenue increasing $486 million or 13 percent. The company highlighted the October 2015 release of Surface Pro 4 and Surface Book as the major driver of that growth.
In FY2017, the Surface business saw revenue decline about 2 percent from the prior year, a reflection of product launches that were solid but not spectacular: Surface Studio (a high-priced product aimed at a narrow market segment), a refreshed Surface Pro, and the Surface Laptop, which was saddled with the weird Windows 10 S.
For the most recent year, revenues are up, by my calculations, about 17 percent, thanks to the well-reviewed Surface Book 2 and a well-stocked commercial channel that has apparently been successful at getting corporate buyers to purchase Surface-branded products in volume.
For 2019, Microsoft is trying to extend its winning streak for another year with a daring move.
The recent announcement of the Surface Go product line is a major shift from the playbook that’s worked so well for the past few years. Instead of targeting premium products at premium prices for well-heeled professionals, the Surface Go is aiming for a $399 price point.
That’s squarely in the segment where the original Surface RT failed so miserably.
At that price, I would normally be inclined to dismiss the Surface Go out of hand. But given the quality of products that Microsoft has been shipping under the Surface brand lately, I’m intrigued.
Can Panos Panay and his team work the same magic with this market segment that the Surface Pro and Surface Book did for the high end? Ask me again after the fiscal year ends on June 30, 2019.