Microsoft loses money on each Surface sold

Goes in the hole to the tune of $39M on the devices during 2013's fourth quarter

Microsoft lost $39 million last quarter selling its Surface tablets, the company acknowledged in filings today with the U.S. Securities and Exchange Commission (SEC).

While Microsoft reported increased Surface revenue for the October-December 2013 quarter of $893 million -- more than double the $400 million in the quarter ending Sept. 30, 2013 -- it pegged the cost of that revenue at $932 million.

The difference between what it brought in and what it laid out -- cost of revenue would include not only the money necessary to assemble the tablets, but also distribution and marketing expenses -- and thus the amount Microsoft went into the hole, was a brisk $39 million.

Microsoft launched its second-generation Surface devices, the low-end Surface 2, which runs the scaled-down Windows RT, and the pricier Surface Pro 2, a notebook replacement powered by Windows 8.1, in late September.

The company also kept the first-generation Surface RT in its line-up, although at a reduced price of $299, in an effort to unload the 2012 tablet that was so over-ordered that Microsoft was forced to write off $900 million last year.

In the third quarter of 2013, Microsoft did not spell out the revenue versus cost of revenue comparison in such stark terms, but revisiting the SEC filing from late October makes it clear the company also spent more than it made then.

Microsoft said Surface revenue of $400 million for the third quarter had been more than offset by a "$645 million higher Surface cost of revenue," and explained the disparity by pointing out that "Surface product costs increased with higher volumes sold [and] other costs grew as we read[ied] inventory lines for the Surface 2 launch and the holiday sales cycle."

Those higher costs have eaten into Microsoft's once-famous margins, a move analysts expected as the company shifted to a device strategy by selling its own hardware. "The more you are into hardware, the lower the margin," said IDC analyst Rajani Singh last year. "The bottom line will go down as their product mix changes."

Overall, Microsoft's new Devices and Consumer Hardware group posted dramatically lower margins -- down 49% in the fourth quarter compared to the previous period -- according to Microsoft's filing.

The most telling line in today's Form 10-Q, however, hints that Microsoft is, in fact, losing money on every Surface sold.

"Surface cost of revenue increased with higher volumes sold, including sales of Surface 2 and Surface Pro 2," the company stated.

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, on Google+ or subscribe to Gregg's RSS feed. His email address is gkeizer@computerworld.com.

See more by Gregg Keizer on Computerworld.com.

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