Office sales plummet, netbooks hurt Microsoft profits

Strong sales of netbook computers, combined with plummeting sales of Microsoft Office to consumers, have hurt Microsoft's otherwise strong first quarter 2010 results.

At least one analyst expects the trend to continue, even with the release of a netbook friendly Windows 7 and a free web version of Office for consumers.

Netbooks made up about 12% of total Windows shipments in the first quarter, Microsoft general manager for investor relations, Bill Koefoed, said in a conference call after the earnings release. And netbook shipments are likely to keep growing faster than the rest of the market, acknowledged Chief Financial Officer Chris Liddell.

Due to Vista's bloated operating system, which takes more hard drive space and processing power, those netbooks almost all run Windows XP. Microsoft reportedly earns about $15 for every copy of Windows XP sold to a PC maker, or original equipment manufacturer (OEM), compared with $50 to $60 for every copy of Vista, and now, Windows 7, sold to PC makers.

As a result, OEM revenue was down 6% year-over-year, despite Microsoft's selling an unspecified "record number of Windows licenses" this quarter due to the release of Windows 7 to OEMs. Total Windows revenue of $4.09 billion was down 4% from a year ago.

Microsoft is trying to entice netbook makers to switch to the relatively streamlined Windows 7, especially the low end Windows 7 Starter.

Microsoft did not say how many netbooks this quarter shipped with Windows 7 instead of XP.

According to Rob Helm, an analyst with the independent Directions on Microsoft, Windows 7 Starter costs OEMs about twice as much as XP. For most netbooks, that will be too high, he said. As a result, he doesn't expect most OEMs to switch off XP until it is phased out next autumn.

Meanwhile, Microsoft Business Division revenue fell 11% year on year to $4.4 billion, dragged down by a 34% year over year decline in consumer sales. That mirrors a 30% annual drop in the prior quarter. Sales to consumers make up about a quarter of MBD's total revenue. They come mostly from retail sales of Microsoft Office.

Microsoft has juiced Office sales in the last several years through heavy promotions for students, military personnel, retirees and other groups.

That has come back to bite Microsoft, Helm said, by "hurting their [year over year revenue] comparables." Strong sales of netbooks, which are often too lightweight to run the full Office suite, has hurt, too, he said.

Consumer revenue may continue to fall, as Microsoft gets ready to debut the free Office Web for both consumers and enterprises.

Aimed to counter the free Google Docs, Office Web won't have all of the features of Office 2010. Microsoft plans to run ads inside Office Web to entice users to upgrade to Office 2010, Helm said. While that may entice large businesses, he doesn't see that tactic attracting many consumers.

"A lot of the new capabilities in Office 2010 depend on businesses running SharePoint Server," he said. "For consumers and small businesses, Office 2010 becomes a lot harder sell because it looks an awful lot like Office 2007."

Microsoft didn't talk about how it plans to win back consumers to Office during its conference call. Liddell said he doesn't expect MBD's overall sales to pick up in the second quarter, although they may pick up in calendar year 2010 as businesses begin to upgrade to Office 2010.