Why Expenses Have Been Rising

Most of the growth in Microsoft’s operating expenses has come from one-time events, particularly legal settlements. This chart shows Microsoft’s cost of revenues (i.e., cost of goods sold), research and development (R&D) expenses, sales and marketing (S&M) expenses, general and administrative (G&A) expenses, and total expenses, both in absolute dollar terms and as a percentage of total revenue, for the last 12 quarters.

When measured as a percentage of total revenue, cost of revenue, R&D, and S&M have remained more or less constant since the beginning of FY’02, although cost of revenues jumps slightly every year in the Dec. quarter (Q2) because of higher Xbox sales during the holiday season (Microsoft loses money on each console sold), and some quarters show abnormally high S&M expenses due to the launch of major marketing campaigns.

One-time events are usually responsible for quarters in which total expenses are unusually high. Q2’04 saw a notable increase in R&D, S&M, and G&A expenses because Microsoft implemented a program to let employees buy back “underwater” stock options. This cost was allocated based on the job function of each affected employee. Other quarters saw abnormally high G&A expenses due to legal settlements: in Q3’04, G&A included the US$1.92 billion settlement with Sun Microsystems and US$605 million set aside for the European Commission fine; in Q4’03, G&A included the US$750 million settlement with AOL Time Warner; and in Q2’02, G&A included US$660 million set aside for the resolution of consumer class-action antitrust lawsuits.