Microsoft posted strong results for the third quarter of its 2010 fiscal year, largely thanks to sales of Windows 7. But the company continues to suffer heavy losses in its Online Services Division as it tries to match rival Google in the online search and advertising market.
During Microsoft's fiscal third quarter, which ended March 31, the Online Services Division, or OSD, reported a 12 percent increase in revenue, which rose to $566 million on the back of higher advertising revenue. That wasn't enough to offset a surge in operating expenses during the period. The division's quarterly loss grew by 73 percent to $713 million, compared to a loss of $411 million during the same period last year.
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OSD includes Microsoft's online advertising business, the Bing search engine, and its various MSN websites.
In a discussion of OSD's results, Microsoft blamed the increase in operating expenses on several factors. It said sales and general administration expenses increased by $145 million, largely due to "transition expenses" from the search deal struck with Yahoo, which handles some advertising sales for Microsoft while Microsoft provides for Yahoo's Web sites.
Another source of Microsoft's higher costs was research and development, which increased 33 percent during the fiscal third quarter to $77 million due to higher headcount and payments to Yahoo for expenses incurred before it moved to Microsoft's search platform. Sales and marketing expenses were also higher, up 30 percent to $69 million due to increased promotional activities.
Despite the surge in quarterly expenses and rising losses, Microsoft noted two areas where OSD made progress: online ad revenue rose 19 percent during the quarter and Bing's share of U.S. search queries rose to 11.7 percent during March, according to Comscore.
Yet, for all that Bing accomplished during the quarter, Microsoft's search engine has yet to slow Google's growth, let alone put a dent in its market share.
Following Bing's launch in May 2009, Microsoft's share of the U.S. search market rose from 8 percent to 11.7 percent, according to Comscore. But Google's market share remained relatively constant during the period, rising from 65 percent in May 2009 to 65.1 percent in March 2010.
Rather than drawing traffic away from Google, Bing's gains in the search market appear to largely come at the expense of Yahoo, which saw its share of the U.S. search market drop from 20.1 percent to 16.9 percent between May 2009 and March 2010.
Google also remains highly profitable, although an apples-to-apples comparison between its overall financial results and those of Microsoft's OSD are difficult to make based on the information available. For example, Microsoft doesn't count revenue and expenses for Windows Live -- which includes Hotmail and Messenger -- as part of OSD's financial results, instead accounting for them under a different business segment, the Windows and Windows Live Division.
Nevertheless, Google's profitability marks a sharp contrast with OSD's ongoing losses. The company's revenue rose 23 percent during the first quarter of 2010 to $6.77 billion, while its operating profit -- the company's revenue minus operating expenses, which excludes interest and taxes -- rose 32 percent to $2.49 billion.
Whether OSD will turn a profit remains to be seen. Microsoft believes Bing is on the right track. Speaking at a Morgan Stanley conference last month, Microsoft CFO Peter Klein said the Yahoo deal gives Microsoft's search business the economies of scale it needs to be profitable over the long term.
"We love the direction we're heading there," Klein said at that time.