While 2011 was not a breakthrough year for Microsoft products, the company held steady amid criticism regarding its absence from the tablet market, its late arrival to the cloud, and low sales for Windows Phones.
However, financially the bottom line was not a problem in Redmond. For fiscal 2011, Microsoft notched a record-breaking $69.9 billion in revenue, up 12 percent from fiscal 2010. And it did this despite sluggish sales of Windows and PCs.
Despite the modest increases in sales, Windows is still a massive revenue generator for the cash-rich Microsoft. Add to that strong sales of Xbox and Xbox Kinect and the tight grip Microsoft has on the enterprise with Office, SharePoint, Exchange, Lync and Windows Server licenses, and the company will continue to thrive financially in 2012, according to industry analysts.
"There are challenges in areas like online services and mobile, but Microsoft's lucrative Server and Tools and Business Divisions are healthy and will stay that way," says Roger Kay, an analyst and president of research firm Endpoint Technologies.
However, with more employees bringing their own non-Windows devices to work and more back-end technology moving to the cloud, Microsoft can't rely on desktop software licenses forever.
To that end, Microsoft is making progress with cloud services like Office 365, Dynamic CRM Online and Windows Azure. It is also making Office apps like OneNote and Lync available on iPads and iPhones. The success of these cloud services should keep the company balanced in the challenging years ahead, say analysts.
Still, It's All About Windows 8
Microsoft's biggest challenge in 2012, according to industry watchers will be the roll out of Windows 8 — specifically getting Windows 8 running on fast and light tablet PCs.
"It is critical that Microsoft begin making inroads against the iPad," says Wes Miller, a VP at independent research firm Directions on Microsoft.
The success of Windows 8 is so important, says Miller, because it affects all parts of the Microsoft machine.
For instance, despite the huge success of Office 2010 — and the moderate success of cloud counterpart Office 365 — Office is still tied to Windows, and it faces the challenge of staying relevant in an iPad world.
"In some ways, unless an iPad version appears, the next version of Office is largely dependent on the market success of Windows 8," says Miller.
The Pressure Is on Windows 8 from Two Fronts
Windows 8 will be entering a hostile environment when it becomes generally available in the second half of 2012.
The hardware options and the culture surrounding them have changed since Windows 7 launched in October 2009. The Apple iPad was introduced to the mainstream in April 2010 and the market opened its arms, thus creating a legitimate tablet market and taking a bite out of the traditional PC market.
In that sense, Windows 8 will have to live two lives. Microsoft is expected to launch a Windows 8 version suited for ARM-based tablets. That version will be different from the desktop product, which will run on x86 microprocessors from Intel and AMD. This will create challenges such as forcing developers to create Windows applications for both tablets and desktops that will not necessarily be cross-compatible.
At its BUILD conference in September, Microsoft stated, though not very clearly, that Windows 8 ARM tablets will not run any x86 applications built for previous versions of Windows. However, Metro apps - touch-based apps designed for Windows 8 tablets -- will run on Windows 8 PCs.
In addition to such app compatibility confusion, Miller says, Windows 8 will simply be a hard sell on PCs because it doesn't deliver much more value than Windows 7.
"On the desktop, the multi-touch capabilities of Windows 8 will not be of much use," says Miller. "It is really an improved version of Windows 7 on the desktop."
But as an ARM-based tablet OS, Windows 8 has more potential and that's where the real pressure will be, says Miller.
"In order to convince consumers to buy a Windows 8 touch device instead of an iPad, Microsoft's partners must first have compelling devices at Windows 8 launch that are thin, light and fast, with very long battery life," he says. "That is a big challenge given what we've seen manufacturers offering up with Android-based ARM tablets over the last year and a half [all have been unsuccessful in curtailing iPad's dominance]."
Beyond the devices themselves, Microsoft must also build a strong ecosystem of apps to win over tablet consumers.
"It's the apps and the device together that make a device move in the market," says Miller. "If one or both are weak, it won't succeed."
Is Windows 8 Too Late?
With the operating systems release not coming until October, Windows 8 tablets may not even have a chance to succeed in 2012.
During the last quarter of next year, Windows 8 tablets will be a mild success at best, predicts Tim Bajarin, president of tech consulting firm Creative Strategies. But by that time, Apple will have released the iPad 3 and a variety of Android-based tablets (such as the Amazon Kindle Fire) will have evolved, too.
"If Windows 8 on tablets get any market traction, it will be in business," says Bajarin. "I don't see it having any real opportunity with consumers as its pricing is likely to be at the high end of the consumer tablet market."
For both PCs and tablets, Windows 8 is in a tough spot, says Endpoint Technologies' Kay. On the PC side, Windows 8 will be confronted with the "Why should I upgrade?" question from consumers and, more so, businesses.
"It will be prettier and have cool multi-touch functionality, but that's not a reason to upgrade from Windows 7," says Kay. "There was pent-up demand for Windows 7 after Vista, and Windows 7 delivered what people needed. Windows 8 doesn't have that pent-up demand."
Microsoft has been good with providing backward compatibility, but if a business needs to develop new apps for Windows 8, if there's incompatibility between Windows 8 PCs and tablets, or if they need to add more IT support, there isn't a big upside to upgrading, says Kay.
Microsoft can afford to have Windows 8 struggle on PCs, he adds, but tablet success is essential because tablets are a factor in the high stakes mobility game that Microsoft is losing to Apple iOS and Android.
"Microsoft is in trouble in mobile and that won't change in 2012," says Kay. "The highest risk is Windows Phone. If Microsoft doesn't break through there it will be out of the smartphone game. With Windows 8 the risk is more moderate because it will run on more form factors."
But Windows 8 tablets may ultimately pay a price for trailing behind Apple and Google in the tablet race.
"Microsoft better hope that there will even be room for a number 3 when Windows 8 launches," says Kay.