Microsoft Corporation (NASDAQ:MSFT) is losing a fair amount of money on Surface tablets. Microsoft is spending more on marketing, distribution and manufacturing, which is adversely impacting the profitability, says a report from Stifel by analysts Brad R. Reback and Arvind Rajamohan.

Microsoft

Surface, initial response not good

Surface is facing similar responses as was shown to Xbox when Microsoft Corporation (NASDAQ:MSFT) launched it first. It is sacrificing its profitability on account of increased marketing, distribution, and manufacturing costs. Apart from increased cost aggressive starting price of $499.99 during launch, limited distribution have been the drawbacks, which cost the company around $1 billion, in 2013, compared to$853 million in Surface sales.

Microsoft COGS increasing due to Surface and Windows 8

Microsoft Corporation (NASDAQ:MSFT) reported that cost of goods sold (COGS) for fiscal year 2013 surged by $2.7 billion or 16 percent due to increased cost related to Surface and Windows 8 along with other factors.

Analysts note that these rises in costs were counterbalanced by $431 million in lower traffic acquisition costs and lower costs related to Xbox 360 sales. Increase in COGS, according to the report, was also due to $900 million Surface RT inventory adjustment in the fourth quarter and higher product cost linked with Surface and Windows 8.

Office and S&T performing well

Office is the top contributor in revenue for Microsoft Corporation (NASDAQ:MSFT) as 90 percent of MBD revenue is derived from Office and around 85 percent of its MBD revenue is contributed from enterprises. Report noted that there was 11 percent surge in the Office revenue from subscriptions and volume licensing agreements with software assurance with increase in its dynamic business at 12 percent in the financial year 2013.

Analysts are looking forward to a single digit growth in MBD in fiscal 2014, and research model is showing mid to high single digit decline in MSFT’s consumer business within its MBD segment.

Microsoft Corporation (NASDAQ:MSFT) product sales and Enterprise Service saw growth in 2013 at $1.3 billion and $434 million respectively, which was primarily driven by increased adoption of SQL Server, System Center, and Windows Server. Further, analysts expect demand for Microsoft S&T to remain healthy and increase by 8 percent in the financial year 2014. Management will grow its business, which will further increase margins in the near term.

Other takeaways from 10K

Microsoft Corporation (NASDAQ:MSFT) has around 99,000 full time employees out of which 58,000 are in the United States, and 41,000 are based internationally. In Financial year 2013, Windows Phone revenue hiked $1.2 billion following patent licensing revenue and sales of Windows Phone licenses.

Revenue from Xbox segment came down 12 percent or $950 million in 2013 due to delay in the release of Xbox One. The company shipped 9.8 million Xbox 360 consoles during the year, which is down from 13 million in FY12

Stifel has a ‘Buy’ rating on the Microsoft Corporation (NASDAQ:MSFT) with a price target of $36.