Microsoft Corporation (NASDAQ:MSFT) is still trying its hand at hardware despite the massive losses its efforts have produced so far. The one bright spot in the firm’s hardware mire has been the Xbox One. The home console segment, despite massive losses to Sony in market share, is still a success.
Just because it’s a success in terms of sales doesn’t mean it’s one in terms of finances. Microsoft may not make a profit on gaming at all because of the amount of money the firm spends on research and development. One thing is clear, though the opposite is often repeated. Microsoft doesn’t make money on each console it sells.
Microsoft doesn’t make money on the Xbox One
This misconception is largely due to the way in which Microsoft reports its numbers for the Xbox One division each quarter. The firm’s gaming numbers are a complex mess. Gaming is divided between two segments and mixed in with everything from Bing to Skype to Surface.
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We’re going to break down the numbers from the firm’s most recent reports in order to show that it’s not likely Microsoft makes money on each console sold. The firm records console sales in a less complex way than it records software sales.
The “Computing Gaming and Hardware” segment includes sales of the Xbox One and the Surface. It showed revenue of $1.93B in the three months through June. Microsoft said that $880M of that came from Surface. That means that the Xbox One made $1.05B in sales in the quarter, which it recorded as its fourth quarter of 2015.
Gross margin for the entire segment came in at 22.5 percent. Gross margin is the difference between the direct cost of making something and the price it’s sold for.
Microsoft (NASDAQ:MSFT) wasn’t direct in its break down of the gross margin for the quarter, but the firm did tell us that for the full year 2015 gross profit for the Surface came in at $1.3B and gross profit for the full segment came in at $1.788B.
That means that for the full year 2015, as Microsoft recorded it from July 2014 through June 2015, the gross profit on the Xbox came in at $458M.
Microsoft also refuses to break down its consoles sales into Xbox One and Xbox 360 units. We know from its reports that it sold 12M consoles in total during the twelve months through June 2015.
That means that the gross profit, per console, comes in at $38. Because Microsoft won’t break down Xbox 360 sales against those of the Xbox One we’re forced to make some guesses at this point.
VGChartz isn’t the best source for hardware sales data, but we’re going to use it to model some of the numbers as we don’t have the data from Microsoft. The outlet estimates that about 8.5M units of the Xbox One were sold between July 2014 and June 2015, the period we’re looking at.
It says sales of the Xbox 360 in the same period came to around 2.6M. That means we’re about a million of of the total number of Xbox sales that Microsoft gave us. We’re going to use the sales ratio that VGChartz gives us. It shows that about 75.6 percent of Xbox Sales were of the Xbox One.
This leads us to assume sales of 9.19M Xbox Ones during the twelve months through June 2015. We’re going to be generous and say that the gross margin on the Xbox 360 is 20 percent higher than that of the Xbox One, in reality it’s likely much more.
Doing the math we can estimate that Microsoft has a gross profit of $36.50 on each Xbox One sold. Unfortunately for Microsoft the story doesn’t end there.
Gross margin isn’t a profit
Gross profit isn’t the kind of profit you get to put in the bank, it’s just the kind of profit you can put down on a piece of paper. If you own a shop and you buy in a product, lets say the PS4, at $200 and sell it for $400, your gross profit is $200. That’s 100 percent margin, and you’ve done well right up until the bills arrive.
Firms don’t just have to pay for goods. They have to pay for research and development, and rent, and the electricity bill and wages for Phil Spencer and marketing and many many other expenses.
Operating profit includes these sorts of costs while net profit includes those as well as taxes, depreciation and interest. If our numbers are right the gross profit on the Xbox One is $36.50X9.19M=$335M.
Microsoft folds its operating costs for the Xbox division into those of the rest of its business, making it impossible to work out how much it spends on engineering the Xbox One, on developing software updates, and on marketing and selling the console.
With marketing for big titles like Grand Theft Auto V and Destiny reaching over $100M, and dev costs going up and up, we can be pretty sure that Microsoft ate through $335M in costs in the twelve months through June.
We know that in 2014 through May Microsoft spent about $35M on TV ads in the US alone. The holiday period is much more costly for game ads. That means costs in the US, for TV alone, likely broke the $100M barrier. Globally the firm likely spent much more, leaving it with less than $200M for everything else.
Developing backwards compatibility isn’t cheap, and neither is putting together the hardware needed to run the servers that let the Xbox One go online.
Until the firm reveals something that suggests otherwise that’s the best supposition to move forward on. Despite an estimated $36.50 gross profit on each console it makes, each Xbox One likely loses money for Microsoft.
Why does Microsoft hide the Xbox One?
Microsoft (NASDAQ:MSFT) isn’t alone in hiding its numbers. There’s good reasons for a firm as big as Satya Nadella’s concern to want to hide the truth. It doesn’t want those competing with it to know its secrets, and it doesn’t want Wall Street catching hold of a narrative that it can’t control.
Sony also keeps a tight grip on the kind of info it releases in its annual reports and its numbers, though not mixed up with other business like those at Microsoft, are just as opaque as those from the Redmond, Washington, firm.
If the Xbox One is losing money Phil Spencer and Satya Nadella don’t want the rest of the market knowing that, and they certainly don’t want big investors finding out.
The important thing is not to ask whether Microsoft makes money on each Xbox One sold, even though the answer is likely no. The Xbox business as a whole is what really matters.
Rick Sherlund of Nomura reckons that the Xbox 360 business, Microsoft’s most successful gaming entry, actually lost the firm money in the course of its run as king of the console market.
Not everybody agrees with that view, but it’s clear that the way Microsoft hides its numbers makes it easy for narratives like that to build. The Xbox One is likely losing money for Microsoft, though the firm isn’t going to make that the headline of its next earnings report.