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Microsoft Selling Lots of Xbox Consoles, Surface Tablets — at a Loss

24 Jan, 2014 By: Erik Gruenwedel

CFO Amy Hood lauds retail partnership with Best Buy while remaining vague on its impact on winter holiday sales

Microsoft may be attempting to emulate Apple by transitioning from software behemoth to hardware and services facilitator, but the switch is not without cost to the bottom line.

Redmond, Wash.-based Microsoft Jan. 23 said it sold 7.3 million combined Xbox units in the second-quarter (ended Dec. 31), which included 3.9 million Xbox One consoles and 3.5 million Xbox 360 units. The Xbox One was the top-selling video game system in December, according to The NPD Group.

The Xbox One was launched Nov. 21 with a Blu-ray Disc drive for $499 SRP.

Yet, despite upping Xbox platform revenue by $1.2 billion compared with the previous-year period, related cost of Xbox goods sold increased by $1.6 billion.

“New consoles like the Xbox One, tend to be gross margin negative on the front," CFO Amy Hood said in the analysts’ call. "This is a heavy quarter for that over time. First, second, third-party games and other services, the margin profile with any console changes. But it’s never going to be an 83% gross margin. It’s just a different business, even for the market leader, and even successfully generating cash and returns."

Hood said Microsoft remains focused on the March launch of Xbox-exclusive video game Titanfall, from the original creators of the "Call of Duty" franchise, will help expand the Xbox market and up margins going forward.

“I would continue to think about our investment in being the leading next-generation console as certainly extending,” she said.

Meanwhile, Surface tablet revenue more than doubled sequentially, from $400 million in the first quarter to $893 million in the second quarter. Yet, the tablet remains unprofitable to Microsoft’s bottom line.

“When we launched Surface just a year ago, our goal was really to create a product that showcased what can happen when you innovate in hardware, in the service, and in the software. And as you know, we’ve learned a lot over the course of this journey. And we have to make more meaningful progress,” Hood said.

The CFO said launch of the second version of Surface would try to stay focused on “both price points and gross margin,” which she said was not so much the case with the first version of the tablet.

“I’m looking forward to making leaps as we go forward in our product roadmap. But I do think it’s more to think about it as a goal we absolutely have, as we continue to innovate the line,” Hood said.

When asked about the impact of the retail partnership with Best Buy, whereby some of the retailer’s floor space is allocated to Windows-themed boutiques, Hood was vague while remaining upbeat going forward.

“I do feel good about the investments we’ve made there … and continue to keep a focus on cost and expense as we do that. So do I think it had an impact? I do. But I really think the broader impact was investments and commitments we had with our partners to also improve the retail buying experience,” she said.

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