Wednesday, 10 August 2016 03:49

Microsoft's Bing Bet Is Starting to Pay Off


Bing has long been the butt of jokes, as the Microsoft (NASDAQ: MSFT) search engine is often seen as a second-rate competitor to Google, an Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) subsidiary.

But in Microsoft's latest fiscal year, which ended on June 30, its search advertising business brought in roughly an estimated $5.5 billion in revenue. That's more than major digital advertising platforms such as Twitter or Tencent, although it still pales in comparison with the $52 billion Google brought in from its owned and operated websites last year.

More importantly, Microsoft managed to make Bing profitable in 2016. Bing's transformation from a money pit to a profitable business that's still growing at a formidable pace can help offset some of the revenue losses Microsoft is experiencing from the decline in PC sales.

Can the growth continue?

When Microsoft announced that Bing had turned profitable during its fiscal first quarter, it pointed to the adoption of Windows 10 as a big driver of Bing searches and revenue. Search advertising revenue growth accelerated this year after the release of the new OS. Revenue grew 54% last quarter, compared with 21% in the fourth quarter of fiscal 2015.

In the quarterly conference call, Microsoft said more than 40% of June's search revenue came from Windows 10 devices. But Windows 10's free upgrade window will close at the end of the month, which means the adoption rate is sure to slow down over the next year. As such, it's unlikely the boost Bing is experiencing from its prominent position in Windows 10 will last much longer. Microsoft says it currently has 350 million active devices running Windows 10, and it recently walked back its original goal of reaching 1 billion devices by 2018.

Microsoft has also benefited from strategic partnerships such as the one in place with Apple to make Bing the search engine behind the iPhone's digital assistant, Siri. Apple had a huge year of sales last year, but it's now starting to experience a decline in iPhone unit sales. Microsoft also struck a deal with to make Bing the default search engine on its Fire tablets and the search engine behind the popular Alexa smart speaker, which took off last year.

With several major growth drivers in fiscal 2016, Bing had a great year. 2017 will have challenges from the slowdown of Windows 10 and iPhone adoption, as well as the potential for another digital-advertising platform to acquire one of its partners.

Growing profitability

While Microsoft doesn't break out the profitability of Bing, there are reasons to be optimistic that Bing will continue to become more profitable even if growth slows this year.

One important factor is that Microsoft outsourced its display advertising business at the beginning of fiscal 2016. That has allowed the company to focus its sales team on its search advertisements, which generally carry higher prices and margins than display ads. That makes the sales team more cost-efficient for Microsoft to run while it collects high-margin revenue from outsourcing its display ads.

Microsoft is still growing its ad prices, as indicated by the language "higher revenue per search" in its earnings releases. With a continued focus on search ad sales, ad prices should continue to climb. By comparison, Google continues to see its average ad price decline as it gets more traffic from mobile and YouTube TrueView ads. Although that's more than offset by an increase in ad impressions.

While Bing will likely never overtake Google for search supremacy, it has successfully transformed the search engine and advertising business from a joke to a nice profit center for investors. Investors can expect those profits to continue to grow going forward, even if revenue growth faces some challenges.

Growth from Bing is helping to offset the decline in personal-computing revenue, and with signs that the PC market is stabilizing, it could result in incremental net income in the near future.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends GOOG, GOOGL, AMZN, APPL, and TWTR. The Motley Fool owns shares of MSFT and has the following options: long January 2018 $90 calls on AAPL and short January 2018 $95 calls on AAPL. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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