Apple Will Become Bigger than Microsoft in 2010

Numbers updated to reflect revenue from Holiday Quarter 2009 earnings reports.

Windows Mobile in Decline

The writing is on the wall. The world is going more and more mobile, and Microsoft is anchored to the desktop. It had the chance to take over cellphones, to make Windows Mobile the world non-Nokia standard, but it fumbled the opportunity somewhere in the labyrinths of Redmond. Now it has been passed by RIM (BlackBerry) and Apple - and in 2010 it will probably be passed by Android.

In Microsoft's last financial year, Windows Mobile sold 18 million licenses. This year, in an expanding smartphone market, with only Windows Mobile 6.5 to offer, no hot cellphones, and manufacturers like HTC, Motorola, Palm, and even LG moving to Android, maybe Microsoft will sell 10 million licenses. RIM sold that many BlackBerries last quarter (end November 28). Apple probably sold that many iPhones and iPod touches in the September quarter and undoubtedly sold that many iPhones alone in the December quarter.

As Android is a cheaper (and currently better alternative), Windows Mobile is largely blocked in the consumer market. In the business market, it is a question of how long Microsoft-oriented IT departments will choose to keep Windows Mobile alive against user pressure for the iPhone and BlackBerries. (See The Microsoft Model Isn't Working for Smartphones.)

Microsoft Revenue in Decline

Even if the $1.5bn deferred revenue for Windows was added back into last quarter's revenue figures, Microsoft revenue year over year (YOY) fell for the third consecutive quarter. Head count is down too, to keep profits up.

Microsoft is now a company tied to the world economy, unlike in the last recession. Nearly all of its profits come from three product lines: Windows, Office, and Server.

Microsoft's only new growth product of any size is the Xbox 360, and that is climbing out of the $6.4bn hole it blew in the accounts and now has to compete with a resurgent Sony PS3 for second place in the console market.

Out of last quarter's Microsoft analyst conference call - just before CFO Chris Liddell jumped ship to General Motors - the overall message was: Until businesses start spending more on IT, Microsoft won't show significant growth and will continue cutting costs.

Windows Revenue in Decline

Even if the reported upturn in PC sales is enough to stop Microsoft's revenue from dropping further, so many new sales are netbooks or low-cost PCs that sales to OEMs will be cheaper versions of Windows 7. These will generate a few more dollars than the previous stopgap of Windows XP, but basically Microsoft has lost control of pricing in the PC market.

The onward march of Moore's Law has reduced the price of PC hardware to less than that of a good smartphone. Today the largest components cost is Windows, and that will come under pressure in the consumer market from Android, Chrome, and Linux.

Microsoft has nowhere to retreat, apart from lowering prices, if it doesn't want to slowly lose market share, as it has with Internet Explorer. Windows simply isn't perceived as offering value for money in more expensive PCs, which is why, according to NPD, in recent months Apple has taken between one-third and nearly half of all the consumer dollars and over 90% of $1,000-plus PCs in US retail.

Microsoft's overly complicated licensing will also help to drive small and medium business customers away. So far the evidence is anecdotal (see Windows 7 Licensing or How Microsoft Lost Our Business), but a system that makes it worthwhile to offer Boot Camp courses is in a state of siege.

Windows will neither attract new users nor hang on to users who don't have to stay. This is opening yet another front for Apple simplicity.

Apple Ascendant

How much more revenue does Apple need to catch up with Microsoft?

* GAAP revenue. All other revenue figures are non-GAAP, as these differ significantly from GAAP (for Microsoft, deferred Windows 7 revenue is included; for Apple, revenue from iPhone and Apple TV sales is shown in the quarter when the units were sold). Apple is committed to move from subscription accounting before the end of the financial year in September. Until it moves, the non-GAAP figures reflect what revenue and profits will be.
** September 2008 was the first quarter for which Apple detailed the non-GAAP figures.

Where will Apple gain the revenue? When will Apple pass Microsoft?

The difference is nearly $4.4bn between Apple's excellent September quarter and Microsoft's revenue for last December. When the $1.7bn for Windows 7 deferred revenue is added into the GAAP figures, Apple won't be seen as passing Microsoft this quarter. However, if Apple reaches $15.5bn, it will be ready to do so from the March quarter onwards.

iPhone Growth

iPhones are going from strength to strength. 3.0 to 3.5 million more in the December quarter than September, or at least +$1.8bn looks reasonable.

In France, iPhone already has at least 40% of the smartphone market and has sold 1.8 to 2.0 million already, according to Le Figaro. Over the Christmas period, according to a Les Echos interview with the CEO (Google translation), 77% of Orange contracts sold were iPhone based. According to a Europe 1 radio interview with Stephane Richard, this was a little over 200,000. Already the largest French carrier is concerned that a monopoly is developing and that the other manufacturers have yet to develop a competitor.

In the UK, a third carrier, Vodaphone, was added this month and promptly sold 50,000 iPhones the first day, so the competition between carriers is likely to ramp up there too. Going forward, the exclusive contracts in Germany and Spain should end over the next 12 to 18 months, again driving down contract prices and adding to iPhone sales.

In Asia, according to iPhonAsia.com, KT has sold over 150,000 in Korea since the November launch; China Unicom, after a poor start, sold 200,000 in under 20 days; and there are about 2 million gray market imports through Hong Kong; in Japan, Softbank has sold around 3 million.

With these expanding sales, Apple can continue to sell over 10 million iPhones a quarter. That alone will drive it past Microsoft in the March quarter in non-GAAP revenue.

Macintosh Growth

Macs have also been strong, outgrowing the PC market in 19 of the last 20 quarters. That will continue, with Apple taking a larger bite of the consumer market from those who look on a computer as a tool and want one that just works. Others who love their iPhones and iPods will also try them out in the Apple Retail Temples, where the number sold goes up most quarters while the new-to-Mac share stays around 50%.

If Apple hadn't needed to halt deliveries of the 27" iMac for two weeks, Mac sales surely would have been up over September. Instead, they will probably be flat. That is around 3 million for the December quarter. That two weeks of sales lost in the December quarter will end up adding to the March figures if the widely reported screen issues are fixed.

iPod touch Growth

iPod unit sales may be down from last year, but many more of them will be Touches, which is how iPod touch app downloads overtook those for the iPhone at Christmas. This means the average selling price for iPods will be up. December quarter unit sales are around twice those of September, so revenue should be up by $1.5bn or more. In the March quarter, as usual, the unit numbers will drop back, but expect the iPod touch to show at least 100% YOY growth yet again as it takes over from the other iPods. This steady migration to the iPod touch will keep the YOY revenue flat to up.

iTunes Store Growth

The iTunes/App Store last year had a $200 million jump mainly from more music downloads, with a further 50 million in March as iTunes gift cards were cashed in. With a billion app downloads over 98 days, if only 25% of those were paid for at $2.50 each, that's over $600 million from apps alone. If music downloads stayed at the same level, the iTunes Store may see its first $1.5bn quarter. In any case, there should be a gain of at least $300 million in December, with $50 to 100 million more in March.

Any changes in peripherals and other hardware, software, service, and other sales are usually minor. Together they should bring in around $1 billion.

Passing Microsoft Within 6 Months

Apple believes in maximizing publicity. This means that the accounting change will take place as soon as it is clear that its revenue has passed Microsoft's. This is likely to be in the March quarter, but Apple may wait until the June quarter just to be sure.

In a couple of years, when it has a track record of being bigger, Apple will be invited to join the Dow Jones.

Microsoft has always been about the numbers. How will it cope with being behind Apple (and probably Google)?

Many people seemed to choose Microsoft solutions because nearly everyone else chose them. It was a safe bet, because sooner or later Microsoft would get the solution right - the same reason that IT professionals used to choose IBM. Judging from the CES keynote, it looks like the best path for Microsoft to follow will be IBM's. That way Microsoft can still be a large company, but one oriented even more towards business.