Tuesday, November 29, 2011

Comparing Platform Revenue at Apple and Microsoft

Mactrast's graphs illustrate the revenue by business segment for both Apple and Microsoft. Apple's business shows distinct seasonality in the iPod business during the holiday quarter over the period depicted, but little other seasonality. Both Apple and Microsoft show some product-launch effects, though Apple has more product launches: Microsoft doesn't release Windows 7 very often. The graphs are educational.

However, the conclusion Mactrast draws from the graphs – that Apple's Mac business (a largely-consumer-facing hardware business) is larger than Microsoft's Windows business (a generally OEM-facing software licensing program) – seems at first blush to be an irrelevant, apples-to-oranges comparison. Is it?

Microsoft's Windows business is a software business with software margins and software capital requirements. This has historically been great for Microsoft: it forces third parties to handle potentially troubling hardware manufacturing and fulfillment issues, while reaping profit on every unit regardless who sells the units. The result has been a market in which PCs are scarcely-differentiated commodities; Microsoft cares not who wins, so long as the unit volume in the entire marketplace carries enough licenses to support MSFT's bottom line numbers. MSFT's only pricing concern is that consumers pay enough for the machines that OEMs can afford to pay MSFT's demanded licensing fees. Toward that end, MSFT has segmented its OS lineup into a dazzling array of versions with different features enabled or disabled, ranging from "home" editions to enterprise-directed and high-end gaming versions, each at a different price to accommodate the margins on the hardware sold to various buyers.

Part of Microsoft's product segmentation in its Windows business has been its OS segmentation between its client-licensed operating system and its server-licensed operating system. Considering that Microsoft's Windows revenue includes high-dollar multi-user licenses for MS-Windows installations supporting enterprise Outlook, multi-CPU web servers, web servers backed by database applications – all revenue that Microsoft gathers under its "Server and Tools Business" segment – the direct comparison of Macs to the "Windows and Windows Live Division" is deceptive. Moreover, Microsoft's platform business – the OS licensing scheme – is so interrelated to Microsoft's software tools business (how else will people compile applications designed to exploit the APIs with which MSFT distinguishes its OS products from DOS, Unix, Plan 9, MacOS 9, MacOS X, etc.?) that the whole of Microsoft's "Server and Tools Business" has to be thought of as part of Microsoft's Windows business. Without servers that require MSFT's client software (Outlook, anyone?), Microsoft would not enjoy the enterprise lock-in it has acquired and maintains. The only reason Apple gives away developer tools for free is that when Apple announced the death of MacOS 9, it had to make migration to MacOS X tolerable to developers or the whole thing would fizzle: no apps on a computer, no point in buying the computer. Tools are an essential part of the platform ecosystem, and Apple's are free because Apple's revenue is based (historically) on hardware sales rather than (chiefly) on software licensing.

Then, one has to ask one's self whether it is seriously reasonable to separate Office from MSFT's Windows platform business, since Office is sold for no other platform and in effect is an upsell of the Windows platform itself? (E.g., to get uncrippled mail and calendars, one buys Outlook with the rest of Office, which one needs to exchange documents with everyone else on MSFT's Windows platform; Apple includes its calendar and mail client with every OS installation so the platform appears to have value – that is, utility – right out of the box, to differentiate it from cut-down no-frills PC offerings. Had Apple the market power of Microsoft, Apple would likely charge for these things as it does for iWork.)

Apple's Mac business generates a lot of revenue that doesn't flow straight to the bottom line because it flows to the likes of Intel, nVidia, Samsung, and a host of lesser-known suppliers whose wares are less known to the public than CPUs, GPUs, and LCDs. To match Microsoft's profit in its Windows business, Apple would need a lot more revenue. True, Apple is selling more and more Macs. And Apple did eclipse Microsoft in quarterly profit, but after rather than before passing it in revenue. Apple hasn't acquired such market power that it can charge developers for compilers and other MacOS X tools, though it does charge for higher levels of Apple Developer Connection that include additional software, support incidents, hardware discounts, etc.

I have high hopes for Apple's Mac business. Apple's Mac business is probably already larger than Microsoft's consumer-driven OS licensing business. However, Microsoft's enormous platform ecosystem dwarfs Apple's Mac business, despite Apple's Mac business including hardware sales.

This is not in itself a bad thing for Apple: it means that the opportunity to take share is dramatically larger than the revenue Microsoft currently milks from its huge platform base. With Tim Cook at the helm, Apple may even be capable of developing enterprise-friendly infrastructure products to enable direct competition with some of Microsoft's most profitable customers. Under Jobs, such thinking was mere fantasy.

On the other hand, adding iOS platform revenues (e.g., iPhone, iPod Touch, mobile apps) to MacOS X platform revenues makes a certain sense, because they share the same Mach-derived multithreaded kernel optimized for multi-CPU environments and use the same set of developer tools and the same APIs for programming applications. Both iOS and MacOS X have the same advantages in languages and localization and single-image installation, and derive from a common infrastructure investment in exactly the same way as MSFT's client and server operating systems. Adding iOS to MacOS X to guage the size of Apple's platform moves things a bit, because Apple crushes Microsoft in mobile. Asymco's graphs start to paint the picture, but make the same assumption as Mactrast that Apple's Windows business is captured entirely in the "Windows and Windows Live Division", when high-margin server OS licensing is captured among the Server and Tools Division's numbers.

Excluding servers from MSFT's platform business is as arbitrary as excluding mobile devices from Apple's, and either exclusion would omit the crown jewel from each business. They must be considered together. Whether Apple eats MSFT's lunch or co-exists peacefully will ultimately depend on Apple's inclination to deliver a server back-end that offers to enterprise things like Microsoft's back-end offerings to support Outlook. Well, maybe "peacefuly" is stretching it a bit: Microsoft keeps trying to do mobile phones and notebooks, which are Apple's bread and butter. Expect the competition to continue, and delightful declarations by Steve Ballmer to continue unabated.

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