subscription

During the first quarter of fiscal year 2014, we changed our organizational structure as part of our transformation to a devices and services company. As a result of these changes, information that our chief operating decision maker regularly reviews for purposes of allocating resources and assessing performance changed. Therefore, beginning in fiscal year 2014, we are reporting our financial performance based on our new segments; Devices and Consumer (“D&C”) Licensing, D&C Hardware, D&C Other, Commercial Licensing, and Commercial Other.

The previous reporting segments were:

• Windows & Windows Live
• Server and Tools
• Online Services
• Microsoft Business
• Entertainment and Devices
• Unallocated and other

The new are:

• D&C Licensing: Windows OEM licensing, Consumer Windows, Consumer Office, Windows Phone (including related patent licensing)
• D&C Hardware:  Xbox 360, second-party and third-party video games, and Xbox LIVE subscriptions; Surface; PC accessories
• D&C Other: Resale, including Windows Store, Xbox LIVE transactions, Windows Phone Marketplace; search advertising; display advertising; Subscriptions including Office 365 Home Premium; Studios including first-party video games; retail stores.
• Commercial Licensing: Windows Server, Microsoft SQL Server, Visual Studio, System Center; Windows Embedded; volume licensing of Windows; Microsoft Office for business (Office, Exchange, SharePoint, and Lync); Client Access Licenses;  Dynamics, Skype.
• Commercial Other: Enterprise Services, including Premier product support services and Microsoft Consulting Services; Cloud Services, comprising O365, other Microsoft Office online offerings, Dynamics CRM Online, and Windows Azure.

From Microsoft's FY14 Q1 10Q via Microsoft Investor Relations - Press Releases

The mapping between the old and new is not straight forward. There is overlap between D&C Licensing and the old Windows and perhaps between Entertainment and Devices and D&C Hardware but there are many gaps. There is also some overlap between the old "Business"/"Server" segments and the new "Commercial" but, again, they cannot be matched.

I show the difference between the two structures in the way revenues are allocated below, using color to try to show similarities.

Given the re-stated quarters it's possible to compare one year's historic performance at a segment level. For example, the company states that "Devices and Consumer revenue grew 4% to $7.46 billion" while "Commercial revenue grew 10% to $11.20 billion".

Since we don't have data older than one year, our ability to assess the company over longer time periods will be drastically reduced and a new picture will take a long time to emerge.

There is however one aspect of the new structure that needs to be appreciated right away: the allocation of costs has changed fundamentally. The company explains:

Cost of revenue is directly charged to the D&C Hardware segment. For the remaining segments, cost of revenue is directly charged in most cases and allocated in certain cases, generally using a relative revenue methodology.

We do not allocate operating expenses to our segments. Rather, we allocate them to our two segment groups, Devices and Consumer and Commercial. Due to the integrated structure of our business, allocations of expenses are made in certain cases to incent[sic] cross-collaboration among our segment groups so that a segment group is not solely burdened by the cost of a mutually beneficial activity as we seek to deliver seamless experiences across devices, whether on premise or in the cloud.

[my emphasis]

In that brief paragraph Microsoft has formally and in a financially binding way declared itself to being a functional organization. ((Welcome to the club.))

The mechanism seems banal: operating costs are no longer assigned to product divisions but to two large buckets. In practice this means that profitability (P/L) cannot be assessed or assigned to individual managers. The lack of P/L responsibility means that incentives from top to bottom have to be re-engineered. If this goes wrong, the Assets ((read: people)) of the company could evaporate.

If the assets go, then processes and priorities are for naught.

In other words, what the company is undertaking is a priority shift (to a  functional structure to create integrated experiences) which requires a process change (whereby employees work according to new incentives) while preserving the fragile assets the company depends on (a motivated and skilled base of employees.)

This makeover is as ambitious as a re-org gets and the context, scope and target are as difficult as they can be. This is, after all, the largest software company operating the the most dynamic industry whose multi-sided markets are notoriously volatile due to disruptive forces.

The challenge also suggests why Ballmer left and who should replace him. A priority transplant operation requires a different set of skills than those held by the manager who created the processes for the previous set of priorities. That's the manager's dilemma: even if you foresee the changes needed and push for them to be enacted, your reward might be to be replaced by someone who can make the changes happen.

Those who envision and persuade for change are rarely allowed to enact it.

This interview was conducted with Bruno Ferrari Editor of Exame magazine in Brazil.

First, do you have forecasts for tablet market share including Microsoft for next years? (Apple, Android, Amazon etc)?

I have some guesses but I don't think it's something that is defensible. Too many things can change. Fundamentally I believe Microsoft sees the tablet as a PC and intends to migrate a substantial portion of would-be PC customers to tablet forms. If they are successful then they preserve the existing PC user base and allow it to grow a bit.

In contrast Apple sees the iPad as a new type of device that is used for things not directly related to PC style computing. In that sense the iPad competes with PC non-consumption. It means people may own both a PC and an iPad and some will own only an iPad. The iPad will expand the market while taking share from the PC. Windows tablets will try to hold the Windows share steady.

 How do you analyze Microsoft’s strategy with Microsoft Surface? Don’t you think they’re admitting themselves that Apple was right since the beginning?

We don't know the strategy yet. Without pricing and an idea of how the other OEMs will respond, I have more questions than answers. The fact that they are doing their own PC hardware does indicate that they see the industry architecture changing and that a large number of vendors offering hardware "choice" is not really the basis of competition in PCs. In other words, buyers are not willing to pay a premium for Windows because the hardware it's available on is offered in a wide range of options.

Do you think MS growth at tablet market will surpass the lost at PC (desktop and notebook) market in the next years?

This is a crucial question. It's possible that Windows 8 on tablets will create new markets, like the iPad has done and it could take the leading role in expanding computing in a post-PC era. However, to do this, Windows 8 and its successors need to be optimized to solve the new jobs people may have for mobile devices. They have to do this even though they need to sustain the old use cases and business models. To succeed Microsoft needs to "fork" the business model and create new ways of profiting from hardware and software. The rumors that Windows 8 RT devices will be sold at a loss is perhaps a hint that this is the plan.

Did you see the rumor of a 199 dollars Surface? If it’s true, do you think is a good strategy?

It all depends on what will be the alternate source of revenue. I assume there will be some sort of subscription service, taking a page from the telecom industry. Perhaps a mixture of Windows Live services (media, documents in the cloud and software updates). We have to see whether subscription computing makes sense for consumers.

How do you see the problem that MS is creating with its OEM by turning itself on a tablet maker?

There is a problem, of course. However here again the question is whether they are moving to an "ecosystem subscription" model and whether they want to offer revenue share to OEMs. If they offer something then Microsoft plays the role of the operator and device makers are paid some up-front subsidy in exchange for keeping their systems locked into the network.

 One more questions: did you already estimate the shipments of Samsung Galaxy Tab since its launch?

Sorry, I don't have the Galaxy Tab estimate. However, here is what I found:

A week after its release, Samsung announced that they had sold 600,000 units. On the 4 December, it was reported that the 1 million mark was reached, two months after launch. However, an executive at Lenovo claimed that Samsung had only sold 20,000 out of the 1 million Galaxy Tabs that were shipped. In January 2011 Samsung announced they had shipped 2 million units to stores. In August 2012, actual sales figures were released in the patent infringement court case against Apple showing that a total of 725,000 Galaxy Tabs were sold through Q2 of 2012.

Source: Wikipedia.

Note that the figure of 725k is US only.

In my last podcast (Impatient for Growth) I mentioned my frustration at Apple's slow entry into emerging markets outside of China. I cited Tim Cook's comments that he did not see an opportunity there in the short term. He mentioned the multi-level distribution challenge which I took to mean the difficulty in setting up Apple stores (in itself due to restrictions on foreign owned retail chains) and the absence of device/service bundling.

This requires more analysis and the best place to start is to look at the data available.

The market potential is enormous. Globally, there are 6 billion mobile cellular subscriptions (end of 2011, ITU) and 86% penetration, but only 1 billion have mobile broadband subscriptions (which make ownership of a smartphone worthwhile).  In India there are 893 million subs (vs 986 million in China).

In 2011 142 million mobile cellular subscriptions were added in India, more than in the Arab States, CIS and Europe put together.

So the potential and growth are spectacular. But that is just 2G. Mobile broadband (i.e. 3G) is rare. Globally, developing countries have only 8% mobile broadband penetration vs. 51% in the developed world. Mobile broadband is a proxy for mass adoption of the iPhone (though perhaps not for Android inasmuch as it's employed as a feature phone).

The situation for 3G in India is even worse than the overall developing world. 3G licenses were only first awarded at the end of 2010 and the process was fraught with allegations of corruption. In the year and a half since, there came to be an estimated 10 million HSPA connections in the country.

The potential therefore is huge but the timing is difficult. Analysts are projecting 100 million mobile broadband connections by 2014 and over 350 million by 2016. Apple can affect this rate of growth as it's not only enabled by the network roll-out but can affect the take-up rate by consumers.

It's a chicken-and-egg problem. No network means no devices but no devices may mean the network cannot be paid for. In the initial phases, the economics of mobile broadband are still dominated by the incentives for operators to pay for the infrastructure rather than for consumers to pay for the service. The iPhone will have a role to play and the question is whether 2014 or 2016 are the dates when Apple will be able to claim that they've cracked the India code.

We've been very, very focused on China. China, we've had incredible success with iPhone. Over the past few years, we've gone from a few hundred million dollars of revenue in greater China, to last year $13 billion. So we really've been focused on trying to understand the market there and then taking those learnings to other markets. As it turns out--and not very many people agree with me on this, probably--but what I see is that there's a lot of commonality in what people around the world want.

Transcript: Apple CEO Tim Cook at Goldman Sachs - Apple 2.0 - Fortune Tech

People do want the same things globally, but due to various constraints they typically don't get the same things at the same time.

One of the most important constraints on the purchase of iPhones is the state of 3G (or, more broadly, mobile broadband) networks. An iPhone is a mobile computer whose primary value is derived from high bandwidth data communication. Because this bandwidth is not universally available, the iPhone faces a restricted addressable market.

The good news is that 3G networks are being adopted very quickly. The International Telecommunications Union reports that 20% of mobile users have "active subscriptions to mobile broadband" (1.2 billion out of 6 billion). That's encouraging but the subscription rate varies widely by country. Ideally we should look at the data on a country-by-country basis.

To start, I took a look at two countries which may form an interesting sample: the US and China. The following chart shows the subscriber structure in the two countries grouped by 2G/3G subscription and by operator.

The two left-most columns represent nominally addressable iPhone markets. The two right-most columns represent currently unaddressable markets. Note that

although China is a far bigger market, the lower 3G penetration means that the theoretically "addressable" market for the iPhone is smaller in China than in the US (136 million vs. 183 million respectively).

However, there are further restrictions. Apple does not have distribution agreements with many (most?) of the world's operators. In these particular countries, China Mobile, T-Mobile and "Other" US operators do not distribute the iPhone. We should subtract those operator customer bases out of the addressable market. But those conditions are variable: operators may sign up for future versions of the phone and 3G subscription rates are increasing. That means we can segment the market as follows:

1. Currently addressable operators and 3G subscribers
2. Potentially near term addressable users if all operators agree to distribute the iPhone in these countries
3. Potentially longer term addressable users if all users switch to 3G and all operators distribute the iPhone.

This segmentation leads to the following diagram.

I also added the current users given comScore data for the US (29 million) and an estimate of 8 million Chinese users. Here are some observations:

1. 10% of China's currently addressable market is penetrated while the US penetration is 18%.
2. If all operators would agree to distribute the iPhone (i.e. including "Near Term" in the addressable total), the Chinese penetration would be 6% and the US 16%.
3. If we include all users as addressable, China is about 0.8% and the US is at 8.5%.
4. The penetration of the iPhone in the US and China combined therefore stands at about 3% today.

The question that comes next is what is a reasonable limit to total penetration? What can we reasonably expect or what could Apple reasonably target?

I've been using a global share of 20% as a reasonable target to test growth assumptions. Assuming no significant growth in user bases, 20% share in the long term (>5 years) yields a total of about 258 million users. That's equivalent to a 7x increase. Put another way, a 5x increase yields a market share of 14%.

Note that these are "penetration" figures or share of available users. This is in contrast to share of units sold in a given quarter. Apple has maintained 20% share of smartphones fairly consistently. If share of units sold in any given time period remains at or above 20% and if smartphones and 3G networks become ubiquitous then reasonable men might consider these targets obtainable.

The latest data from Google shows that the Android activation rate is increasing at a relatively steady rate (i.e. acceleration is constant). The data provided so far is in the blue circles below. The green line is the interpolation and extrapolation of that data.

As the graph is projected forward we get an activation rate of one million per day by mid August of this year. If it continues then we could see 1.5 million per day by end of 2013.

The corresponding number of cumulative activations is shown on the following log chart (with blue circles showing the actual data and the green estimates.)

The forecast is therefore that Android activations will cross one billion by November 2013.

The following chart compares the growth ramps of the various mobile operating systems indexed from the same starting points (measured in quarters after launch).

If Android does keep accelerating at the same rate then it will reach a billion users in five years. Of course, this total will not be a unified ecosystem in that many versions of Android will be co-existing. There will also be additional variants of Android which will not include Google services (these are not included in the totals above) which will compete to some degree with this platform.

However, it's still an amazing story. The crucial question is whether the billion Android phones will have an effect on the opportunity for new entrants like Windows Phone and future BlackBerry variants as well as Bada and other Linux-based platforms.

The answer is that there will be well over 6 billion mobile "connections" by the end of 2013. ITU reports that "By the end of 2010, there will be an estimated 5.3 billion mobile cellular subscriptions worldwide, including 940 million subscriptions to 3G services." It follows then that if this forecast is correct then by the end of 2013, Android will have about 17% penetration of the connections market.

Tomi Ahonen has compiled a fascinating data set on 42 major countries' smartphone penetration rates. The compilation is based on Netsize Guide, Informa, Google and Ipsos data. It is a complex sample with multiple possible sources of error (read the post for the caveats.) However, this is a breakthrough. It's the first time I've seen this level of detail at a country level in the public domain.

I maintain visualizations of ITU data which shows overall mobile consumption and broadband consumption and penetration. In order to maintain a consistent basis of comparison, I prefer to use ITU's measure of consumption which is "subscriptions" rather than "population". The ITU derives this measure because mobile operators think of points of connection (subs) rather than people as the measure of consumption. This makes some sense because connections are what are monetized--not people.

So the first piece of analysis is to show this measure of penetration (smartphones as a percent of subscriptions) for the 42 sampled countries.

This view shows which countries "lead" adoption in terms of penetration. It shows that the US is quite high in the ranking and the most penetrated "large" country.

This is highlighted by the following chart which shows penetration of smartphones vs. total subscriptions with bubble size representing population size.

The US stands out from the inverse relationship between size of mobile population and smartphone penetration.

Part of this is due to the US having relatively low mobile penetration in general. It's below the median because multiple mobile phone use is uncommon.

But these bits of data are not the most interesting. In my opinion the following is:

This last chart shows the total size of non-smart subscriptions vs. the total size of smartphones in use for the 42 countries listed in the legend.

There are 3.7 billion non-smart connections and 0.6 billion smartphones in use. Although not all of these 3.7 billion connections need to be enabled with a smartphone, the fact remains that there are six times as many non-consuming network connections that can still be addressed.

How and when this ocean of non-consumption will be converted to computing devices are the most obvious questions the data raises. Of the selected countries only 13.5% of the connections are "smart".

ITU data shows that at the end of 2010 there were 5.4 billion global subs. This survey was conducted more recently so the total is likely much higher (perhaps around 6 billion). The survey thus covers about 72% of the world. That implies that at least 90% of the market remains unserved.

As previously described in an earlier piece on the transistor, there is a theory that underlies much of what this web diary is about. Telecommunications is undergoing wrenching change. And not for the first time. The history of the industry is filled with disruption and thus with drama that leads to fine storytelling.

One such great story is that of Western Union and the telegraph.

Western Union was formed as a company in 1851 and ten years later had completed the first transcontinental telegraph line. Following on that breakthrough, it introduced the first digital real-time data service, the stock ticker, in 1866. Business boomed and by 1870 it was the world's most powerful telecommunications company.

By any standards it was innovative: it offered remarkable and revolutionary telecom data services, a century before the Internet. But in the century that followed why didn't Western Union become the leader in voice communications, ceding that position to the Bell companies?

Alexader Graham Bell did not invent the voice telephone with the intention of toppling Western Union. In the language of today's technology entrepreneurship he hoped Western Union would be his "exit". He pitched the phone to them as an improvement to their core telegraphy business. Bell offered the patents for the telephone to Western Union for a mere $100,000, roughly $2 million in today's dollars. In other words, today the deal would be: two million dollars to own all voice IP.

Western Union passed

Now why would they do that? Imagine you are an analyst at Western Union advising management on technology acquisition and M&A. What process would you use to evaluate it? First, most obviously, you would try to get feedback from marketing and sales. They should go out and survey their customer base to find out who would be interested and how much they would be willing to pay.

The sales force would naturally seek out their best customers and ask them first. Those customers were the stock ticker users. They were extremely voracious users of the ticker tape system. It should be no surprise why we have "ticker tape parades"--there was enough of the stuff lying around offices in New York to shower down and flood Broadway end-to-end". Ticker tape was a boon to merchants and traders. Chicago would know what's happening in the New York stock exchange instantaneously. Price data was traveling at the speed of light.  The sender and receiver were in lock-step sync. To suggest to these customers a voice product would sound like a step backward. Why would they want to talk to the other party? The data was coming on tape and it was also recorded for posterity. Speaking with the other person meant confusion and delay and a mess of record keeping.

The word from the customers would be a resounding negative.

Second would be the business model.  How would you charge for voice? Data was subscription based, and the fees were huge. Voice would be metered and the price low. If targeting consumers, telegrams were priced by the word, but you couldn't price voice by the word. Marketing would stare back at you as if you had committed a judgement error.

Thirdly you would look at the cost side. Operations would give you more bad news. Voice technology was different enough that it needed new infrastructure. Switchboards, operators, handsets and new power and insulator requirements were all expensive and had no clear return. Voice was a loser all around.

So the decision was perfectly reasonable, smart even.

This is not to suggest that Western Union did not accept any new technology or invest in it. For decades after the phone, Western Union continued to invest in innovation: It introduced an electronic payment system (called money transfer) in 1871. In 1914 it offered the first charge card and in 1923 it introduced teletypewriters. Singing telegrams followed in 1933 and fax service in 1935. Intercity wireless microwave communications were introduced in 1943. Telex came in 1958 and the product of marketing genius, the 'Candygram' in the 1960s. By 1964 its network was all wireless using a transcontinental microwave system. Western Union became the first American telecommunications corporation to maintain its own fleet of geosynchronous communication satellites, starting in 1974. The fleet of satellites, called Westar, carried communications within the Western Union company for telegram and mailgram message data to Western Union bureaus nationwide.

And it wasn't lacking in talent either. Western Union had the best telecom managers in the business and was raking in profits to fund expansion. It attracted the best and brightest engineers for generations. Western Union probably passed on hundreds of other inventions and ideas, and rightly so.

So what happened to WU?

It's still around. However, due to declining profits and mounting debts, Western Union slowly began to divest itself of telecommunications-based assets starting in the early 1980s. Due to deregulation in the US, Western Union began sending money outside the country, re-inventing itself as "The fastest way to send money worldwide". In 1987, an individual investor acquired control of Western Union through an outside of chapter 11 process that was a complex leveraged recapitalization. After several other changes in ownerships and moves through bankruptcy, WU is now a public company with an enterprise value of about $12 billion based entirely on international money transfer business.

3G as a disruptive technology

Today we've come around full circle. Whereas voice was disruptive to a data network provider in the 20th century, data is disruptive to a voice network provider in the 21st. The mis-application of 3G network technology to sustain voice-oriented business models gives one a strong sense of déjà vu.

The telecom world moved swiftly to 1G and 2G cellular voice. Each new generation of mobile telecom was sustaining the core business model of subscriptions feeding centrally managed networks and symbiotic device vendors benefiting from handset and switching system upgrades. Standardization, international expansion, lower price points and network effects made this industry the most ubiquitous technology distributor the world had ever seen.

3G however was different. It was effectively mobile broadband data. It enabled data services to be de-coupled from the network operators. IP protocols did not require the servers to be located on operator premises or even to be managed or monitored by them. Devices could be general purpose computers not specific purpose communicators. Incumbents did not adapt to this well.  They continued to build business plans according to a central-switch blueprint.

So although incumbents did not reject the smartphone as a technology, they tried to make it sustaining when plainly it isn't. They essentially tried to cram it into their business models.

The struggle to keep the service structure of telecom centered around the network operator will continue, but short of pulling the plug on 3G and LTE, there is little that the incumbents can do to stop it.

So what's the lesson?

Some technologies are embraced and some are rejected. You can't fault every rejection and you can't praise every acceptance. The most likely reason for embracing something is that it helps grow your existing business. The most likely reason for rejection is that it may harm your business. Even acceptance sometimes leads to mis-application in sustaining the core rather than planning for its demise.

The decision on how to handle something new and potentially disruptive requires a different sense of what's right and wrong about it.

--

Photo: Former headquarters of WU, located at 60 Hudson, New York.

An Ericsson survey shows that the number of global subscriptions to mobile phone services has passed over 5 billion. The global population is estimated at 6.9 billion.

It’s hard to estimate what 100% penetration in this industry is but there is a strong possibility for another billion accounts to be added in the next year. This estimate includes all service accounts, not individuals. As users begin to carry multiple devices (i.e. phones and iPads), the number of subscriptions could easily exceed the global population. In some countries, penetration above 100 percent is already the norm.

http://news.yahoo.com/s/ap/20100709/ap_on_hi_te/us_tec_global_phone_use

On a planet with around 6.8 billion people, we're likely to see 5 billion cell phone subscriptions this year.

http://www.itu.int/net/pressoffice/press_releases/2010/06.aspx

ITU expects to see the number of mobile broadband subscriptions exceed one billion globally during 2010, having topped 600 million by the end of 2009. With current growth rates, web access by people on the move — via laptops and smart mobile devices – is likely to exceed web access from desktop computers within the next five years.

Mobile broadband is a good proxy for mobile computing so it’s very likely that these 1 billion subs will use advanced devices if not smartphones per se.

I can't believe this. http://musically.com/blog/2009/10/15/comes-with-music-107k-users-worldwide/

For kicks, I looked up what I wrote about Comes With Music (CWM) a year ago:

Trouble Comes With Music By Horace Dediu on October 3, 2008 12:18 PM The troubles that CWM will face: The model is complex and the value prop is convoluted with users discouraged from making informed purchase decisions. CWM is firmly embedded in a value network that is in the final stages of disruption. Profits have evaporated and participants are in a state of defensive rigidity that prevents investment in innovative business models. To some buyers (esp. parents who will pay), the concept may sound more like "music sold as hardware" than "hardware loaded with music". Music sold as hardware is what the CD is/was but this new hardware is bound to wither away and become disposable in a year, PC copies notwithstanding (as transfers between PCs are limited). Therefore, the limitations of perishable music persist and comparisons to durable media are unfavorable. Competitiveness with pirated music is often cited as the goal. The means to that goal is the advantage of having "unlimited" content available vs. "60,000 songs on your hard drive". The unstated assumption is that new music is always more desirable over a rich, but dated back catalog. Long tail theory says that's not true for an increasingly larger group of consumers. Finally, the bet is that users will upgrade devices as if they were a subscription. This becomes "music sold as hardware subscriptions". As "music as a subscription" has not taken off, it does not bode well. One reason is that subscribed music is hired for a different job than owned music--one of discovery and casual listening--a job we used to hire Radio for. A job that is now obsolete in the era of social networking.

Nokia's official comments one year hence:

the official blog on which Nokia is celebrating CWM’s first birthday acknowledges: “Sure, it didn’t start out that rosy, with lots of folk not really certain about what Comes With Music offered ... we never shied away from the important education process that is needed in order to fathom that you can download and forever-keep as many tracks as you like – but the past 365 days have seen a much greater understanding and appreciation for the service emerge.”

Subs numbers:

• UK – 32,728 (launch date: Oct 08)
• Singapore – 19,318 (Feb 09)
• Australia – 23,003 (Mar 09)
• Brazil – 10,809 (Apr 09)
• Sweden – 1,101 (Apr 09)
• Italy – 691 (Apr 09)
• Mexico – 16,344 (May 09)
• Germany – 2,673 (May 09)
• Switzerland – 560 (Jun 09)

For comparison: Spotify has 6 million users and iTunes has 120 million registrations.