Disappearing Act: Xbox Sales Plummet While Microsoft's Other Devices Continue To Struggle

Microsoft’s mixed results have largely pleased Wall Street. But the good news on cloud services and stabilization in the PC market can’t mask an ugly truth for the software giant: All of its hardware divisions are performing somewhere between terrible and absolutely dreadful. The worst among them, though, was the Xbox division where the rapid deterioration of Microsoft’s console business may lead to another round of calls to spin the division off.

Things aren’t a lot better for Surface, which is at best treading water, or the Lumia smartphone group, which performed the best of the three albeit not by much. Here’s a look at how Xbox, Surface and Lumia are faring:

Xbox: One console, many problems

As Erik Kain reported here last week, the U.S. retail numbers for Xbox One don’t look that awful. The PS4 beat it handily at retail in June, by 36%, but with nearly 197,000 units sold, Xbox One seems to have benefited from its recent price cut.

That said, Microsoft can’t hide the fact that sales have been so tepid in 2014, it’s been working through channel inventory and manufacturing barely any new consoles. Consider these stats: In the prior quarter, Microsoft reported 2 million console sales of which 1.2 million were the Xbox One. That means the company was moving about 800,000 Xbox 360s just three months ago.

If we assume that the 360 is selling similarly at this point, then this quarter’s 1.1 million consoles likely consisted of just 300,000 Xbox Ones. To get a sense of how terrible that is, it’s as bad as Nintendo’s Wii U results for the quarter that ended in May.

Now, before anyone asks: How can Microsoft sell nearly 200,000 Xbox Ones in the U.S. in June alone if it shipped 300,000 worldwide for the entire quarter? The answer is that the channel has been sitting on too many consoles for and it’s now working through that backlog.

Going forward, that almost certainly means more Xbox sales, but unless Microsoft cuts into Sony’s substantial lead sometime soon, it risks becoming the also-ran of this generation. And it doesn’t help that despite saying nice things about Xbox, new CEO Satya Nadella doesn’t seem especially committed to it.

In his now infamous 3,100 word memo on the company’s future, Nadella spent one paragraph on Xbox. He talked about its importance, but it’s hard to see how it’s very strategic for a company that Nadella described as ”the productivity and platform company for the mobile-first and cloud-first world.”

Surface: Still drowning?

Speaking of mobility, Microsoft continues to talk about is Surface tablet/laptop hybrids as if they’re critical to the company, but the numbers continue to tell another story. Microsoft managed $409 million in Surface revenue, which represents well under 1 million Surfaces sold in the most recent quarter.

Worse still, that total is actually down from the prior quarter, when Microsoft managed $500 million in Surface sales. This quarter’s Surface revenue, in fact, matches the company’s first quarter total and reverses what now seems to be ephemeral success when sales doubled in the holiday period. Aside from seasonality, that uptick was driven was closeouts on the original models and shows no signs of repeating.

The only bright spots for Microsoft are that the Surface Pro 3 just started shipping near the end of the quarter and the PC market has shown some signs of stabilizing in 2014, down just slightly this year versus the near double digit drop seen in 2013.

But with unit sales running at somewhere between 500,000 and 1 million units every 3 months, Microsoft is accounting for less than 1% of the combined PC/tablet markets. How this is strategic to the company remains a mystery.

Lumia: Light at the end of the tunnel?

A similar question can be asked about the Lumia smartphones Microsoft acquired from Nokia. Unlike Xbox and Surface, at least Lumia appears to have shown some signs of growth. Microsoft reported 5.8 million smartphone sales for the quarter, but it only closed the acquisition on April 25. Extrapolating those figures for a full quarter would lead to a total of 8.1 million Lumias — about 10% more than Nokia itself sold in the equivalent period a year ago.

With the caveat that those extrapolations are subject to a substantial margin of error, some things do remain clear: Microsoft isn’t making money selling smartphones and is extraordinarily unlikely to do so anytime soon. The company reported earning $58 million in gross margin on $1.99 billion in phone revenues, but it’s likely that was all generated from the 30 million featurephones Microsoft sold, not the Lumias.

Those “dumb phones” are still popular in many emerging markets, but Nokia has been losing share rapidly and Microsoft is not especially interested in the business. On the smartphone side, the average selling price of the Lumia remains mired at just a bit over $150 — more than $400 below Apple’s iPhone ASP.

How Microsoft acquiring a small market share of almost entirely low-end customers advanced any strategic objectives at all is completely unclear. And while the unit growth is roughly proportional to what Apple achieved, the iPhone maker gained almost entirely a set of new high-end customers while Microsoft gained nearly none.

Devices and Services

The above-mentioned memo marked the end of Steve Ballmer’s “devices and services” era for Microsoft. If Nadella really wants the company to get focused on something, his path seems clearer than ever: Drop devices entirely. Each group would find its own destiny in this framework.

Xbox is a valuable franchise and could be spun off or sold without much trouble. Surface is essentially just another PC. Based on how few are sold, it would scarcely be missed. Lumia though is Windows Phone. While it could be spun out and might even find a home at an Android maker looking for some differentiation, it likely dies without Microsoft’s hefty subsidization. If not for Redmond’s largesse, Windows Phone never would’ve become Nokia’s OS of choice in the first place.

Sometimes, though, the hard choices are saying no. At Stratechy, Ben Thompson wants to split up Microsoft. His plan is intriguing, but because it involves spinning off Windows, it has about as much chance of happening as Nadella does of growing hair longer than Steven Tyler’s. But slicing off a bunch of hardware that altogether contributed just 15% of revenues and none of Microsoft’s profit isn’t completely far-fetched.

Nadella only has so much bandwidth to point Microsoft in the right direction. It’s hard to imagine a clearer path than this one.