Scratching the Surface

6 Jul


Last week Microsoft summoned journalists to Hollywood for a major product announcement. What they unveiled was Surface, a new tablet computer that will run Windows 8.

Microsoft is going to control both the hardware and software platforms for this device. It will be manufactured and marketed as a Microsoft product and compete directly for sales with companies that are otherwise partners in the PC business.

Although Microsoft is no stranger to this approach in the games market – its Xbox console is among the market leaders – this is a major change of strategy in the mainstream PC market, where previously the company has licensed its software to a range of 3rd party vendors and left them free to design, build and sell the hardware it runs on. 

This strategy led to mega-profits, as the marginal cost of each new copy of Windows and Office sold was close to zero. Microsoft dominated the technology sector and was for a time the world’s most valuable company. So why change a winning formula? And why risk antagonising a whole raft of your most valuable partners?

A hint lies in the identity of the company that is now wears Microsoft’s old crown and is rated the world’s most valuable business: Apple.

Apple now exceeds Microsoft (and incidentally Google) in operating margin percentage, despite the vast majority of their revenues coming from hardware sales. Apple’s thing has always been controlling the whole customer experience through tightly integrated hardware and software. Its model is cheap (or free) software running on moderately priced hardware; Microsoft’s has always been expensive software running on cheap hardware.

Mobile industry analyst Horace Dediu estimates that Microsoft makes a net operating profit of $78 per PC sold, assuming that PC has both Windows and Office installed (and most do). Apple, by contrast, makes $195 of operating profit per iPad sold.

Sure, Microsoft has bigger volumes – there were 336 million Windows PCs sold last year – but that will change. The iPad has created a new market that is growing rapidly, which is disrupting the PC market and in which there is almost no competition. It is a market in which Microsoft’s traditional model is doomed to failure. It simply cannot maintain its current per-device profits selling Windows and Office to 3rd party vendors when Android is free and Office-like software is available at a fraction of the cost.

Surface offers the Redmond giant a way out. If it can sell the devices at the same prices Apple sells its iPads for it can maintain its profits (at least on a per device basis).

The problem will be making and selling enough of them. And as we still don’t know – more than a week after the launch event – when Surface tablets will be available or how much they will cost, it is hard to know if they will succeed. While the PC market is not going to die anytime soon Microsoft needs a new strategy – for now, Surface looks like its big bet.


One Response to “Scratching the Surface”

  1. Tablet PC July 18, 2012 at 11:20 #

    Yes it is true. Tablet still has a long way to run in this world. As long as there are consumers that patronizing this gadget will never die. Also, I want to commend the good work of MIcrosoft and other tech companies in innovating this gadget into better one.

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