News Analysis: As Growth at Microsoft’s Mobile & Embedded Devices Business Slows, So Grows the Industry?

Is Microsoft a bellwether for the device-software industry? If so, the industry might want to brace itself for a slowdown, albeit one that could ultimately result in long-term profits.

Microsoft recently reported that its Mobile & Embedded Devices (MED) business brought in revenue of $337 million for fiscal 2005 (ended June 30), a 36 percent increase over revenue for fiscal '04. While that growth rate may sound promising, it actually marked a slowdown from last year, when revenue grew by 58 percent over the previous year, to reach $247 million.

Microsoft projects MED's revenue growth will slow even further, though the forecast is clouded somewhat. Currently, Microsoft sources project MED revenue for fiscal '06 of at least $310 million, a $27 million decline from fiscal '05. That shift is due, in part, to Microsoft's shifting of its MapPoint business, currently part of MED, to the MSN division, taking approximately $100 million in revenue along with it. But even if Microsoft were to leave MapPoint in MED, that would bring '06 revenue to $410 million, meaning year-to-year growth would be only 20 percent, or less than half what it had been two years earlier.

MED is operating at a loss, according to Microsoft, although one that is gradually being reduced. The company says MED had an operating loss of $219 million in fiscal 2004. By the following year, MED's operating loss had been reduced to $46 million. Looking ahead, Microsoft projects that MED will achieve sustained profitability sometime in fiscal 2006.

MED, one of Microsoft's seven profit-and-loss centers, is responsible for Windows Mobile for Smartphone, Windows Mobile for Pocket PC and Windows CE for Automotive. Its OS products power devices ranging from small, handheld, mobile devices to large industrial automation machines. For example, MED is No. 1 in the standalone PDA market and No. 2 in the connected-device market with more than 5 million devices shipped in the last year alone, the company says. Windows Automotive technology is available from 18 automakers, including BMW, Honda and Volvo. And in the real-time operating system (RTOS) market, Microsoft's market share is greater than 25 percent, according to Gartner. “We're very bullish about not just our opportunities in Windows Mobile—which are clearly strong—but our opportunities in some of these other areas,” said Pieter Knook, senior VP of MED, in a July presentation to financial analysts.

Niche Slowdown?

MED appears to be following a typical small-company pattern of unsustainably fast growth followed by an inevitable slowdown, says Daya Nadamuni, a Gartner research VP who watches the embedded-software development tools and RTOS markets. “With its mobile and wireless products, Microsoft has focused a lot of its efforts on very specific vertical markets within the consumer electronics vertical space,” she says. “So it could be that they have penetrated those market niches to a very high degree, causing growth to slow down.”

But Chris Lanfear, embedded software group manager with Venture Development Corp. in Natick, Mass., says MED's numbers are simply coming down to earth. Expectations of year-over-year growth of 40 percent to 50 percent are unrealistic, he says, adding: “The market’s maturing, and Microsoft’s maturing along with it.”

Longer-term, Lanfear thinks, Microsoft is poised to take advantage of greater opportunities in the embedded and device-software space. “I think they're in a pretty good spot,” he says. “MED does not necessarily need to be a huge profit maker for the company, at least not in the short term. This is a long-term grand strategy of owning both the back end and the front end of information technology.”

Yet profits could remain elusively in the future, warns Richard Williams, an analyst with Garban Institutional Equities in Jersey City, N.J. He figures embedded software providers still have a long way to go before they realize substantial profits. “Embedded is one of the highest potential markets that you can find in software to date—it’s just that it’s been that way for six or seven years now, and the growth that we’ve seen has been pretty mediocre over that period,” he says.

What Next?

Looking ahead, Microsoft says it intends to focus on several areas, including IP set-top boxes and VoIP-enabled devices. The company also says it is pleased with its Windows Embedded Point of Service offering. Based on the product's early successes, Microsoft plans to focus on other key vertical segments in the coming year.

Yet Gartner's Nadamuni believes that if Microsoft wants to maintain or improve MED's growth rates, the company will need to offer software in other embedded market segments. “Microsoft has picked the devices they are going after very carefully, but it’s a reasonably restricted set of devices,” she says. She adds that the company faces stiff competition from open-source vendors like Linux providers.

As a result, Nadamuni adds, Microsoft must go after new markets and upgrade its products. But even this strategy could be hazardous, she warns: “The danger is overextending itself, because each of these different markets has a slightly different set of needs.”

In other words, while MED has done well in the PDA market, whether it can do equally well in, say, the automotive device-software market, remains an open question. It's also one that the rest of the industry will be watching closely.

MICROSOFT MOBILE & EMBEDDED DEVICES AT A GLANCE

Revenue and Net Income/Loss:

• Fiscal 2006 (forecast): at least $310 million (reflects transfer of MapPoint to MSN, worth approximately $100 million); profitability projected for sometime during the year.
• Fiscal 2005: Operating loss of $46 million on revenue of $337 million.
• Fiscal 2004: Operating loss of $219 million on revenue of $247 million.
• Fiscal 2003: Revenue of $156 million (loss figure unavailable).

Product Lines:

• Windows Mobile software for Pocket PCs, Smartphones and portable media centers.
• Windows Embedded (WinCE), including point-of-service systems.

Executive Leadership:

• Pieter Knook, senior VP. Appointed October 2003; has held various Microsoft positions since joining the company in 1990.
• Ya-Qin Zhang, corporate VP. Appointed March 2004; former managing director and chief scientist of Microsoft Research Asia.
• Suzan DelBene, corporate VP of marketing. Appointed March 2004; former CEO and president of Nimble Technology.

Partner Ecosystem: More than 2,500 organizations worldwide, including:

• In-car device makers, including Kenwood, Matsushita, Pioneer.
• Phone makers, including Intermec, LG Electronics, NEC Infrontia.
• Windows CE device makers, including Thomson, Samsung, Wyse.
• Windows Embedded deployments, including Bell Canada, Korea Telecom, Telecom Italia.

DATA: Microsoft

NICOLE LEWIS is a freelance writer and regular contributor to DSO.com.