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Who will be Microsoft's Tim Cook?

As previously noted, Apple has overtaken Microsoft (and Google) in operating margin percentage. This is an astonishing statistic as Apple is still largely perceived to be a “hardware company” while Microsoft is a “software company” and Google is a “services company.”

To suggest that “hardware” could be more operationally profitable than either software or services is akin to heresy in technology analysis. This reversal is newsworthy indeed. However, even the most casual observer would note that Apple does not derive its market power from hardware alone. It is, in fact, an integrated hardware, software and services company (with a few more roles besides.)

So the emergent successful business architecture in this technologically transitional period is of integration and completeness of solutions.

This shift explains at least at a conceptual level Microsoft’s tectonic Surface shift.

But what about another point of view? What does integration mean for Microsoft’s income, cost and profit structure? Is integration self-disruptive to Microsoft?

Here’s a reminder of Microsoft’s revenues and operating income by division:

The challenge of devices for Microsoft is that the licensing of software for devices is very difficult to sell.

In 2011 Microsoft received about $18.7 billion in Windows revenues and $23 billion in Office revenues. The chart shows that this is a fairly steady growth business. According to Gartner, in 2011 there were about 336 million Windows PCs sold and that this too is a fairly stable and mature business.

If we simply divide revenues by PCs sold we get about $55 Windows revenues per PC and $68 of Office revenues per PC sold [1]. The total income for Microsoft per PC sold is therefore about $123. If we divide operating income by PCs as well we get $35 per Windows license and $43 per Office license. That’s a total of $78 of operating profit per PC.

Now let’s think about a post-PC future exemplified by the iPad. Apple sells the iPad with a nearly 33% margin but at a higher average price than Microsoft’s software bundle. Apple gives away the software (and apps are very cheap) but it still gains $195 in operating profit per iPad sold.

Fine, you say, but Microsoft make up for it in volume. Well, that’s a problem. The tablet volumes are expanding very quickly and are on track to overtake traditional PCs while traditional PCs are likely to be disrupted and decline.

So Microsoft faces a dilemma. Their business model of expensive software on cheap hardware is not sustainable. The future is nearly free software integrated into moderately priced hardware.

For Microsoft to maintain their profitability, they have to find a way of obtaining $80 of profit per device. Under the current structure, device makers will not pay $55 per Windows license per device and users will not spend $68 per Office bundle per tablet. Price competition with Android tablets which have no software licensing costs and with iPad which has very cheap software means that a $300 tablet with a $68 software bill will not be competitive or profitable.

However, if Microsoft can sell a $400 (on average) device bundled with its software, and is able to get 20% margins then Microsoft is back to its $80 profit per device sold. This, I believe, is a large part of the practical motivation behind the Surface product.

The challenge for Microsoft therefore becomes to build hundreds of millions of these devices. Every year. Sounds like they need a Tim Cook to run it.

Notes:

  1. Microsoft accounts for revenues using deferrals due to Software Assurance pre-payment models for many corporate customers so this figure is not a precise value for each license sold.

 

  • nuttmedia

    Excellent breakdown of the marginal economics. Thank you for that. Their move in this direction is provocative on many levels. Tectonic is the right descriptive not just in terms of size, but also in analogizing the time it could take to turn over requisite infrastructures and shift fundamental business philosophies – particularly those with a long history of success. Suffice it to say, their hourglass does not have a great number of turns before it is too late.

  • Xavier Itzmann

    Guys, come on.

    The Surface as iPad competitor/Microsoft business model sustainability vehicle is vaporware. Sure, it may be a neat design, if you assume that it will run legacy Windows applications. But by the time you include a tactile keyboard, USB ports, powerful CPU, etc… is it going to be price competitive with $400 iPads?

    Isn’t it true that anyone who has come up with devices that match the iPad hardware feature by feature has had to come in at a higher price point than iPad, and therefore crashed immediately and abjectly in the marketplace?

    The Surface is supposed to have hardware that exceeds the iPad. It may be a very good computer, indeed, or maybe not. But it is not an iPad competitor, because:

    (a) It will cost significantly more than iPad so that it can deliver the 20% margins Horace posits; or

    (b) It will cost about the same as iPad, in which case Microsoft will not be able to use as its replacement business model because of lack of margins. It will prove unsustainable.

    Either way, this is vaporware. The Surface is not what people are projecting it is. We’ve seen people projecting their ideas into other blank slates before, and the results have not been pretty.

    • Just_Iain

      Xavier,
      Until Microsoft releases the prices, all the talk is in itself vapour and speculation. I’ll wait till it launches to see how well it does.

    • Walt French

      Guess that’s why they need a Tim Cook.

  • blakeives

    Horace,

    Stacked bar charts, which you appear quite enamored of, are notoriously difficult to decipher, and these two are nearly unintelligible. What’s with the weird Y axis on chart one? Take a look at Edwin Tufte’s books or maybe this little tutorial will be quicker and cheaper: http://dspace.udel.edu:8080/dspace/bitstream/handle/19716/2666/Visualization%20of%20Data.pdf?sequence=1.
    With the exception of this small presentation caveat, I greatly value your analysis and incites!!!!

    • capnbob67

      Your opinion of being unintelligible says far more about you than Horace. Stacked bars do contain a lot of data but typically replace several other charts or even more confusing line charts. Please offer an alternative that would be more intelligible to you.

    • capnbob67

      Your opinion of being unintelligible says far more about you than Horace. Stacked bars do contain a lot of data but typically replace several other charts or even more confusing line charts. Please offer an alternative that would be more intelligible to you.

  • http://www.facebook.com/people/Jeff-Silverman/1634666325 Jeff Silverman

    Horace, your work here i outstanding. The New York Times has a blog today using yesterday’s post. I have three simple points:

    a) Microsoft seems unwilling to disrupt itself; their Surface tablet is half pregnant
    b) They are turning their business model (and previous partners: (HP, Dell, Samsung etc in phones and PC’s) into disarray- so even though their Surface is not likely to yield the results it wants because it is half pregnant, they are going to suffer the pain of disrupting itself
    c) Going from being a software company to a hardware company is very difficult

    Seems to me that Apple may win more by Microsoft’s moves- then it was winning before hand.

    Finally- If I was a shareholder in MSFT, I would grade Mr. Balmer with a D; their event had more unanswered questions than answers; how can they hold an event without a price, delivery date and allowing the press to use the devices?

    • Walt French

      I’m sure none of the OEM partners are happy about this.

      But it might work as a wake-up call, reminding them that they have let others control their destiny by not innovating. Innovating has always been a necessary (if not sufficient) part of success in tech.

      Or, it might prompt some into an IBM-style abandonment of the PC business. That company seems to know how to prosper without selling low-margin commodity boxes.

      • JohnDoey

        No, it is Microsoft’s fault, not the fault of the PC hardware makers.

        The PC makers have no software and that is 99.9% of the computer and no innovation happens without it. By separating hardware and software, innovation was bound to suffer, and so you have PC BIOS and VGA ports (the graphics port from the CRT) in 2012.

        The PC makers also have no money — Microsoft takes almost all of the profit on a Windows PC sale and has not reinvested in hardware or managed their hardware platform responsibly. Instead, Microsoft loses that money on their websites. And the PC makers cannot even move to ARM to reduce their costs because Microsoft does not yet support it, even 5 years after OS X moved to ARM.

      • Walt French

        I haven’t yet fully digested Horace’s analysis of the value stack that Surface is meant to capture. But it seems odd that the hardware function makes no money, and yet is critical for Microsoft to capture. Meanwhile, Apple manages to earn kudos for its hardware, with a fair number of people running Windows on MacBookAirs.

        Bear in mind, please: I’m not talking about “fault.” The OEMs have been happy with their arrangements, at least enough that they themselves didn’t make major efforts in diversifying businesses or initiatives that might have higher margins. HP and Dell will continue to make most of their profits on services and support. Acer and Asus, with essentially NO lost business if the corporate buyer specifies Surface, might actually benefit if HP and Dell under-invest in hardware.

        Retreating from hardware into services and software has been a pattern in computers for decades: after Cray left the very highly regarded Control Data, for instance, it morphed into CDC, now Ceridian. If Dell & HP can be as profitable as IBM, or at least survive like Ceridian, they should be happy going down that well-worn path.

      • graphex

        If the OEMs are truly steamed, what can they do other than run away or fight. To run means they are only selling their businesses to those interested in buying and that’s either Microsoft or Asian manufacturers. But both of these have little incentive to pay any serious money. To fight means to continue selling Windows PCs, tablets and phones against your regular competition AND now against your OS software provider, who’s got a price advantage of getting the OS for ‘free’. An option in fighting is to do something different but it’s doubtful if Linux or Chromebooks would fare any better than they have so far. They could give Mr. Cook a call to ask about licensing his desktop OS, but I’m not sure he’d take the call. ;-)

    • kankerot

      PC margins are so thin they might as well let MS have it. HP was thinking about moving out from PC and IBM has done it succesfully.
      Squeezed by suppliers like MS and Intel and consumers on the other end margins are anaemic.
      Dell et al made a faustian pact with Microsoft. Its similar the pact hardware suppliers have made with Apple. Two major suppliers to Apple are scrambling for relevevance as it seems Apple is moving to a new supplier for their bonded screen tech.
      Any company that becomes overly reliant on another is just exposed to being disintermediated.

      • Kizedek

        “Dell et al made a faustian pact with Microsoft. Its similar the pact hardware suppliers have made with Apple. Two major suppliers to Apple are scrambling for relevevance as it seems Apple is moving to a new supplier for their bonded screen tech.”

        It is not at all similar; and I do think your points would be more powerful and interesting if you didn’t constantly try to to criticize Apple in every paragraph.

        The relationship is not the same for a start. In the first, a “partnership” towards an integrated product, MS in effect acts as the supplier. With its monopoly on OS, the type of abuse MS has leveraged over its hardware partners in the past would be akin to Samsung abusing Apple, not the other way around. Samsung would have to say to Apple: “if you use any other screens or components other than the ones we supply you — in ANY of your devices — then you will get NO screens from us”… and that would work IF Samsung supplied 95% of the screens in the world. Ergo, Apple could not put out a viable device without capitulating to Samsung. No screen, no device. No Windows, no PC. But it’s worse than that, because you expect Samsung to both supply screens to hardware companies like Apple, and to create its own hardware products using some of the same screens. While, for its part, Samsung knows it is not the sole supplier of screens on the planet and knows it has to compete with others for contracts; unlike MS which is the sole supplier of Windows and Office and uses that fact to keep other OS’ out of the desktop market entirely.

        No, Apple has a simple contractual relationship with its component suppliers (I like how you call them “hardware” suppliers, presumably in an effort to downplay Apple’s role in creating the devices).
        Apple: “can you make X million of these components to our specifications over the next Y months?”.
        Supplier: maybe.
        Apple: “Well, can you reserve X amount for us over the next Y months, with first option on further Z amount, if not your total output.”
        Supplier: “hmmm, it’s not our usual thing, we have to rejig our tools; and how do we know you are gonna go through with it and buy them from us, what if we get all set up, make the components, but we are then left with a bunch you don’t want; or what if this other hardware company offers us more per component?; whatchu gonna do to make it worth our while?”.
        Apple: “how does 5 Billion USD up front sound? And if you think it’s still difficult, we’ll invest in your assembly line.”

        So, Apple fulfills its contract and the supplier fullfils its part. Next year Apple wants some more parts, but meantime 10 other component companies see that Apple is selling a boatload of devices and paying 5 Billion up front for a steady supply of components, and they want in. So there is a bidding war. Normal. Faustian? How?

        “Faustian” and similar epithets are more accurately applied to the pacts between MS and Windows OEMs because the “appeal” and success of the product depends on both parties and both are present in the mind of the consumer as they purchase the product. MS gets paid for each PC sale in any case, no matter which PC OEM makes the most sales. BUT, the decline of the traditional PC and the Netbook has a lot to do with MS’ lack of foresight, innovation and execution with their Windows platforms, coupled with the fact that the OEMs are each completely reliant on MS. And when that SOLE supplier on the whole planet of a part you are dependent on starts competing with you, there are even more issues. So, there I do agree with your last sentence.

      • kankerot

        Sipping the Apple Kool Aid? Apple has a negative cash conversion cycle so it gets paid by its customers before it pays it suppliers. So you $5bn story plucked out of thin air is great piece of fiction. Because it’s not the way Apple operates – no matter how muuch you dream it does.
        http://financials.morningstar.com/ratios/r.html?t=AAPL
        What you can’t seem to accept probably as you are a fanboy is that neither Apple nor MS really do care much for their partners – they will leverage them for as much as they can. To think somehow Apple is benign is deluded.
        So using your logic then Apple is abusing its power as the most profitbale and largest app ecosystem to force in app purhases to be subject to 30% fees causing content providers to pass on these costs to consumers.

      • http://twitter.com/asymco Horace Dediu

        Apple (and Nokia before them) did pay significant amounts (in the $ billions) for securing component supplies. First it was with hard drives in the iPod era and then with Flash and now with screens. Apple also indirectly finances production through the purchase of capital equipment installed at supplier premises. Management has discussed this during conference calls.

      • kankerot

        They invested as the suppliers no way had the investment capable to do so as Apple asks for profit margins on each supplier – it keeps a tight control. It keeps them close and dependent until it decides to part company and then its too late.

      • Kizedek

        I didn’t say Apple was benign, I said it was merely part of a normal buyer-supplier relationship; nothing too machiavellian or faustian going on there.

        Re, apps: Not at all. My logic tells me that you are once again twisting the picture to make your point that Apple is particularly onerous.

        First, passing on costs occurs in every industry and multiple times for every product; it is not unique to the App Store. If you need to learn how to price your app effectively, I can point you to a few good articles and discussions on the subject. Just ask.

        Secondly, the issue has little to do with how large, popular or profitable Apple’s app ecosystem is — in this case those things are largely the results of happy customers. Rather, monopoly is about how much opportunity for competition there is. Apple’s App Store is not the only game in town. Furthermore, Apple is not stopping a developer from releasing his product on another platform (that would be akin to the abuse MS was guilty of).

        In fact, as you constantly remind us, many more people are far happier with their patronage of the Android ecosystem. Perhaps you are voicing a non-existent concern about alleged abuse on the part of Apple because you are simply being blinded by the large numbers of app downloads reported by Apple and Horace: really, only a few misguided fanboys like me are actually using the App Store — it’s just that we are downloading far more apps between us than the rest of the world put together.

        I find it amusing that in almost every other discussion you seem quick to defend the significance of Google and Android and discount the stature of Apple’s iOS platform by dismissing the importance of profitability and the depth of the ecosystem, etc. But, instead of trumpeting Apple’s paltry 10% share of smartphones or somesuch this time, here you are acting like Apple is in a position to warrant real charges of abuse. “power” “most” “largest” “force” subject” “causing” “costs”. As though hapless consumers everywhere are forced to let their children go hungry because Apple is “extracting” an extra 30 cents from those few crazy fanboys who actually buy into the ecosystem. So, which is it?

      • kankerot

        I am not twisting the picture. MS did abuse its position of power, now Apple is doing likewise with it’s policy on in app subscription purchases requiring 30% of the revenue cut.
        ” in this case those things are largely the results of happy customers”
        Yet Microsoft dominance of the PC marjetplace is always argued as being due to their onerous tactics. Have you done a survey or this just more opinion passing as fact?
        When have I constantly reminded of Android patronage? I am not a fan of any of these ecosystems from Androids that is based on Google need for data or MS / Apple need to lock you in.
        I have never dismissed the importance of profitbality. I have simply stated that Apple are making supernormal profits.
        I was talking about subscription revenue inside apps – not the price of apps.

      • deemery

        I worked a bit in a hobby shop, which I think is representative of retail. Something we sold for $10 cost us $6. That’s more than the Apple iTunes store where Apple gets $3 on a $10 item.

      • steven75

        Do you also have a problem with VISA and Mastercard?

      • DocNo42

        @kankerot:disqus “I am not twisting the picture. MS did abuse its position of power, now Apple is doing likewise with it’s policy on in app subscription purchases requiring 30% of the revenue cut. ”
        So in complaining about the 30% “revenue cut” your basically implying (or outright stating) that Apple brings no value to the table and thus the 30% is unreasonable? Because if there is value in being in the iOS ecosystem, then Apple *should* be able to get something for that, no?

      • kankerot

        So MS should start charging 30% cut on all apps on windows?

      • DocNo42

        @kankerot “I have simply stated that Apple are making supernormal profits. ” And? Are you further implying they don’t deserve to be doing so? If not, why even bring it up?

      • kankerot

        So you cannot bring up facts that are relevant. Who made you the forum mod?

  • kankerot

    http://www.gartner.com/it/page.jsp?id=1893523
    That says there have been 352m PC shipped and it does not include servers. So your numbers need to be checked.
    Note: Data includes desk-based PCs, mobile PCs, including mini-notebooks but not media tablets such as the iPad. Source: Gartner (January 2012)

    • http://www.asymco.com Horace Dediu

      That number includes Macs.

    • capnbob67

      Chowder… please return later.

  • Walt French

    “The challenge of devices for Microsoft is that the licensing of software for devices is very difficult to sell.”

    You’ve written this before, and your logic was unassailable then. You used words more like “Google disrupted Win Mobile by giving away the OS.” What was a very clever disruption in 2005 when Google plotted it, became a fait accompli by 2008, and available (thank you!) to analysts worldwide a year or so later, even if we’re a little slow on the uptake. Of course, in 2007 the iPhone also changed everything by raising the bar for mobile software.

    And only now, in 2012, after Dell & HP had to be bribed to offer attractive designs to users, Microsoft is attempting to address it? Well, actually not only now: the Kin was a Microsoft-branded (Sharp built) foray into this area, albeit a catastrophic failure because competitors shifted the landscape so sharply.

    The X86 Surface looks potentially attractive for mobile business users, but I can’t see Microsoft overcoming the consumer perceptions of MS products being complex and forbidding, while their consumer forays have been copies of others’ work, and often stabbed in the cradle by quick discontinuation. This looks like a watershed to me.

    • kankerot

      Copies of other works? What do you define as copies?

      • Walt French

        Zune.
        Yes, Great Artists Steal — but they make it their own. I’m not really religious about this, but when I look at WinPhone (I’m watching their WP8 presentation right now), I see them talking about tech features, not how they are asymmetrically competing with Android & Apple. Win8 to be great b/c it’s to use the desktop kernel. Ooooh!

      • kankerot

        So its not copying when its an improvement. How apt. Apple talk about technical features look at the retina MBP. As to the benefit very little because icons and apps need to be rescaled.
        As to your last line – well if you see no benefit to code re-use and hitting one code base then not sure whether that’s in jest.

      • kankerot

        So its not copying when its an improvement. How apt. Apple talk about technical features look at the retina MBP. As to the benefit very little because icons and apps need to be rescaled.
        As to your last line – well if you see no benefit to code re-use and hitting one code base then not sure whether that’s in jest.

      • Joe_Winfield_IL

        The Surface keyboard cover is both copying and innovating. The magnetic snap-on feature is blatantly stolen, but they added enough functionality with the touch keyboard that nobody will care where they came up with the attachment mechanism. This is an example of great artists stealing to make it their own.

        As to the rest of this debate, Microsoft is speaking to both developers and customers with the WP8 presentation, but they struggle to effectively communicate with customers. Two quick examples:

        -Apple announces 10 hour battery life on the new iPad, Microsoft announces a 42Wh battery in the Surface Pro

        -Apple includes a “retina” display so sharp your eyes can’t detect pixels, Microsoft includes “HD” and “Full HD” displays on its two Surface models, with no definitive explanation in terms of resolution or user experience.

        Of course you could go on and on with this type of comparison, but the point is that Apple is constantly telling users why the tech features matter to them. The developers fall in line because the users are there and the SDKs are clean and well documented. Microsoft gets a bit lost in engineer speak. The end result is that they are selling a list of features, rather than preaching advantages or benefits. Users don’t buy features.

      • TheEternalEmperor

        Both video and photos look good without rescaling and Apple has already enhanced there there stuff.

        This release caught few by surprise, and is FAR easier to redo assets than code.

        As for Apple talking about “technical” features. There is a world of difference talking about a “screen” and talking about a CPU architecture. Everyone understands a screen that looks better. Far fewer under CPU architectures.

      • JohnDoey

        Honestly, when you have to change the definition of basic words like “copy” to excuse Microsoft’s behavior, that means you have already lost.

        They copied the Mac and they said that it was OK because the Mac UI was a steering wheel, the only possible way to steer a computer. Then iPhone shipped and proved them totally wrong. Microsoft could have and should have built their own UI for Windows, to suit the needs of their users, and it probably would have looked more like iPad than Mac if they had done the work. They would have realized that their users benefit more from full-screen and from very minimalist graphical elements, since they are coming from a command line.

        And then they spent about 10 years trying to stick the Mac UI onto tiny phones with 2 inch screens before Apple shipped iPhone and made a mockery of that effort also. If not for their fascination with the Mac UI, Microsoft might have been the one to do iPhone. Had they actually thought about the union of phone and computer instead of just “how to we get Windows(R) onto this phone?”

        So not only is it not controversial to say that Microsoft is a copyist, they have already been seen to have screwed themselves over with their copying. Not just by wasting time with mouse pointers on phones, but also because when the Intel Mac came out, all of the most profitable Windows users bolted for real Macs. There was nothing to keep them on a copy of the Mac when the real thing was now available with the same CPU’s. Had Microsoft made something unique, it would be harder to steal those users away.

      • kankerot

        The first MAC wasn’t a copy of the GUI developed at Xerox Parc ie the Xerox Aalto?
        So you mean the Xerox UI when you mean the MAC.
        The point is that MS has copied, so has Apple but it seems you just cannot accept that corporations, peoples take designs and then try improve them.
        If everything Apple did was original then how is it they developed a phone as I am damn well sure there were phones before the Iphone.

      • Walt French

        A friendly pro tip: “MAC” is an acronym for Media Access Control address, a hardware address that uniquely identifies each node of a network.

        Most professionals work in programming environments where case matters. These mistakes are seldom without consequence, so giving something the wrong name usually signifies sloppiness or intent to give insult.

        You may actually intend to proffer insults, but they’re not part of useful discourse. So a “word to the wise”— don’t label yourself as somebody just looking to cause trouble because you don’t understand/care what you’re talking about.

        PS: “Iphone” is a bit more problematic, especially as the first word in a sentence. I don’t know what the AP Stylebook would say, and people look over that. But in a post that is fussy about identifying things, “MAC” sticks out like a sore thumb.

      • kankerot

        Walt. I know what a MAC address is. Way to go adressing my prose and not the point I made.
        “Most professionals work in programming environments where case matters.” Semantics.
        “You may actually intend to proffer insults, but they’re not part of useful discourse. “

      • deemery

        “semantics” – the branch of linguistics and logic concerned with meaning.

        I don’t understand why people use ‘semantics’ as a term to dismiss something they think is irrelevant.

        And here’s my analogy: The Xerox PARC work on GUIs is akin to Apple’s iPhone work on haptics. Both have proven to be foundational for a large number of devices. But Apple was smart enough to profit on its work…

      • Tatil_S

        No, it was not a copy. You can read many more differences in SJ biography for example, but even some of the basic stuff such as overlapping windows and typography was not in Xerox version. It was a great idea, but it had to refined before it became the hit that it was.

      • kankerot

        SJ biography is the difinitive guide on this – seriously? Like he is going to admint to copying.
        My point still stands – all companies copy but you simply cannot accept that Apple does it like any other company. I wonder why people deify Apple and defend a corporation that really wouldn’t care one jot about them -this also applies to Android, MS etc

      • Tatil_S

        First of all, if you actually read that biography, you’d know that Isaacson gives even less credit than Apple deserves for a good many techology innovations. He treats Bill Gates as a more reliable source than SJ, even though both have good reasons to bend the truth.

        Unless you have sources that say otherwise, I don’t see how you can simply ignore the claimed differences between the two operating systems. I don’t see anybody yelling, no, all of these things actually existed in Xerox Parc or that they thought about emphasizing typography, which gave rise to desktop publishing or whatever else you can think of as significant. Feel free to dig up Xerox operating system from other sources. You know what they say, put up or shut up.

    • http://www.facebook.com/people/Shameer-Mulji/1685212657 Shameer Mulji

      “The X86 Surface looks potentially attractive for mobile business users..”

      This is where I see the Surface having the greatest success – business users and enterprises which is MS’ stranglehold. If anything, I think the announcement of the x86 Surface puts a temporary (or permanent) halt on any increased uptake of the iPad in the enterprise. Enterprises, being conservative, will definitely want backwards compatibility with legacy apps, seamless integration with MS back-end servers, and Windows developers will want to continue using the tools they’re familiar with. Also, don’t forget Win8 tablets will come bundled with a full version of Office 13, which the iPad cannot run,

      Where the Surface will have a great challenge is with everyday consumers who want a device for personal / home use, content creators that are entrenched in the Apple / Mac ecosystem, and education.

      • DocNo42

        “I think the announcement of the x86 Surface puts a temporary (or permanent) halt on any increased uptake of the iPad in the enterprise.” Not in the enterprises I’m involved in. If anything, things like BYOD are going to accelerate the flight from Windows – traditional FUD (pre-announcing vapor) is not going to work in the current consumer driven market.

    • DocNo42

      “the Kin was a Microsoft-branded (Sharp built) foray into this area, albeit a catastrophic failure because competitors shifted the landscape so sharply.” I think the very public and disastrous loss of the Sidekick infrastructure right before the Kin did more to 86 it, along with the obvious shake in confidence Microsoft had in the system afterwards, than market forces. Blackberry coasted on messenger for the last couple of years and the Kin bested Blackberry messenger in every way for those (i.e. teenagers) that lived in that market. Like HP with WebOS, I think Microsoft prematurely killed the Kin – which was a shame. It could have grown into a lower priced alternative to a full blown smartphone by offering a substantial discount in what still gives me the most heartburn – data plan pricing. If I could have done email, light web surfing and at half the current $70 a month I pay now (which there were many plans for the Sidekick that offered that) with the advent of the iPad I could see me ditching the iPhone for a Kin, and using the iPad for the heavy lifting. Data plan costs and forced bundling with outrageous minute plans is the real elephant in the room with mobile devices, especially phones.

      • Walt French

        “If I could have done email, light web surfing and at half the current $70 a month I pay now …”

        Sure, a more modest-priced service would appeal to many people. I certainly never would’ve bought the Nokias that preceded the iPhone, because they were too little for too much, and I stayed with my T-Mo/RAZR combo for some time after, due to the lower costs and flexibility of using the RAZR as a “modem” for my laptop. (My wife getting a corporate discount and the untimely death of the RAZR moved me over.)

        But obviously, Microsoft did NOT see the Kin as being strategic for them, able to generate enough revenue to justify the costs, and possibly cannibalizing their other efforts.

        I’d say, “classic disruption theory example #173.”

  • poke

    I’m skeptical that the Surface signifies a change in direction for Microsoft. I think it’s more likely an indication that they see iPad-like tablets as being on par with mp3 players, set top boxes and game consoles. These are all areas Microsoft has been willing to build hardware because they don’t see them as a direct threat to their core business. Microsoft, I think, sees Surface as a halo product for Windows PCs.

    I think Microsoft’s Windows 8 strategy also reflects this. Metro is a nearly self-contained environment for applications aimed at what Microsoft sees as the “media tablet” market – i.e., limited functionality, low-power iPad-like devices. The core environment (where you run Office) is still the Windows desktop. The media has picked up on Metro as a preview of the future but I think it’s more like an extension, like Media Center, aimed at a niche class of devices (in Microsoft’s view). (Perhaps the only feature that points to Metro being taken seriously at Redmond is the fact that it’s also used as an app launcher for the desktop.)

    Both developments can be interpreted as an indication that Microsoft is underestimating the impact of the iPad rather than as a change in strategy. Which is more likely?

  • http://twitter.com/WalterMilliken Walter Milliken

    1) This looks a lot to me like a classical Microsoft defensive move: pre-announce a product to keep their core market (enterprise) from buying a competing product (iPad). This looks a bit less vaporous than the usual pre-announcement, but the lack of details suggests the announcement is primarily to ensure enterprises don’t leap into the Apple camp over the summer.

    2) How much traction they get will depend on their tradeoffs in the two models, specifically price/performance/battery life. We don’t have data on that, and won’t for quite a while, it looks like.

    So far, it doesn’t seem to me that either product will likely be that compelling for corporate IT, unless the Intel version is *much* cheaper than the iPad. (The ARM version doesn’t appear to integrate into corporate IT well enough to be viable, if what I’ve read is true.) But if it’s the same price as an Ultrabook (as MS implied), and the same (or less) functionality, it’s not clear what the benefit is except a bit more portability. While he same issue could be raised with the iPad and the Macbook Air, the iPad is *much* cheaper (as well as somewhat less powerful).

    Microsoft seems to be positioning the Intel Surface as a Windows laptop replacement, not a different product entirely (like the iPad). The ARM Surface is much closer to the iPad, but it appears as though it’s aimed at the consumer market (or maybe the BYOD consumer/enterprise market). It’s possible they’ll try to co-opt the BYOD movement in enterprise to push out the iPad in favor of the “Windows” RT model, but the poor enterprise support announced so far for the RT doesn’t make sense if that’s their strategy.

    You’d think that Microsoft would have learned by now they don’t have much brand value in the consumer space (except maybe for Xbox), so I’m puzzled what they think they’re doing with the RT model. Unless maybe it’s just a marketing ploy to have a “Windows” device at an attractive price point. But that trick didn’t work for netbooks very well, once there was a price competitor with better performance. And they were much more “real Windows” than the Surface RT will be.

    • http://www.facebook.com/profile.php?id=644846198 Ron Smith

      Enterprise has already been leaping into the iPad fold.

      • http://twitter.com/WalterMilliken Walter Milliken

        Certainly faster than usual for something that new, yes, but I don’t think it’s killing Windows box sales in the enterprise… yet. I think *that’s* what MS is afraid of.

      • JohnDoey

        No, you’re way behind. iPad is *the* story in business computing over the past 2 years. It’s cheaper than Wintel in every way. Very hard to ignore.

      • Walt French

        Yes, Microsoft *really* needs a decent post-PC form factor for the Enterprise. As Horace has noted, by the time you have the data about how much your business has been disrupted, it’s often too late to take countermeasures.

      • Tatil_S

        Unfortunately, our IT dept has also discovered ways of adding ineffective virus etc. protection systems that constantly run in the background, steal battery life, reduce responsiveness and mess up contacts lists. Give such IT departments two more years and iOS devices will be develop a reputation that they are as complicated, clunky and unreliable as cheap Windows machines.

    • Walt French

      Nice take.

      I’m NOT that plugged into IT, but certainly in some cases, the X86 Surface will be positioned as a platform for legacy apps, that has an incremental upgrade path to “full tablet.” If the keyboard is not awful, this might actually work fairly well.

      Or maybe not. This won’t do anything to break the perception that Windows needs a large amount of IT nursemaiding, infantilizing ordinary users. It won’t do anything for the BYO model. Running full Windows (not RT) will present a challenge to power management and battery life (compared to ARM tablets).

      But at least Microsoft can credibly claim not to be in third place when it comes to post-PC corporate tools. Whatever Google announces at I/O will be seen as a response to Surface, not the other way around.

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  • Mike Wren

    Business Insider says Microsoft is not trying to copy Apple but is just “trying to kick its partners in the butt to get them to make tablets” kind of like what Google has been doing with the Nexus. That is the reason the Surface will only be sold in Microsoft’s 20 stores and online.

    I think Microsoft will keep its options open and if they aren’t satisfied with Windows 8 tablets by partners then they will open up the Surface sales channel. But longer term the Apple way is the direction they have to go as Horace states. It’s a balancing act for now. They are going to take the muddle through approach and be half pregnant like the current EU and US politics. Microsoft’s internal political battles must be similarly intense between keeping the status quo versus doing self disruption as Apple does.

    ”Microsoft Isn’t Copying Apple With Its Tablet” — http://www.businessinsider.com/microsofts-surface-plan-2012-6

    • Joe_Winfield_IL

      If that’s the case, how do you think Microsoft should price the Surface tablets? Even if they are in limited supply, the pricing will be closely watched by both potential customers and OEM partners. The company will be sending a strong signal one way or another when they price these things.

    • Tatil_S

      It is quite likely that with so many internal divisions pulling from so many angles that MS cannot go “all in” for a completely new business model and instead it will settle on something like Zune, the hardware, that has very small volumes and financial backing to catch much market share, while being very ineffective at serving as a reference design. I hope not, but it would not surprise me if it happens.

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  • http://whereandynerds.net/ Andy Assareh

    I believe this realignment of the axis of competition is a significant strategic victory for Apple. Apple has a decade of experience now profitably delivering integrated platforms that customers love (edited to add i mean above and beyond the Mac, several decades including the Mac.) Microsoft has a decade of experience with Xbox, but not profitably. Apple has built up tremendous operational expertise, component buying power and overall lessons learned. Microsoft will be a bit out of their element in this new game.

    • kiran bhanushali

      art of war

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  • Chui Tey

    The biggest risk MS has is not in the toaster-type devices. The XBOXes and Surface RTs are locked down and are hard to break. I wonder though whether MS is capable of providing a decent experience on the x86 Surfaces. It has the potential to unravel very quickly as people try to install legacy apps, antivirus etc and then see their battery life plummet, performance slows and the usual bitrot in their OS.

  • Jim Zellmer

    Microsoft “burns the ships” and Apple’s iOS 6 “mostly” supports the 3 year old iPhone 3GS. It would be interesting to consider the strategy tax for both players.

    A bit of history on this role reversal can be found here:

    http://www.zmetro.com/?p=4628

  • James Saldana

    The WINTEL (DELL) commodity market model just died at the hands of Steve Jobs.

    The free and or cheap nature of software and media in Apple’s an Android’s eco-systems forced this change. But in the end it was Apple that turned destroyed the very market that almost brought it down 15 years ago.

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  • zato

    Xavier Itzmann wrote: “Either way, this is vaporware. The Surface is not what people are projecting it is.”

    Yes – Surface may be just a “kickstarter” project to jump-start the Win-8 tablet market. The fact that there was no pricing or availability is a sign that Microsoft’s partners were not informed, leaving Microsoft a way to back off, if the partner’s are VERY unhappy.
    Microsoft wins through intense price and feature competition between partners.

  • Frank

    Nokia is Microsoft Cook (if you consider Cook as the ability to streamline operations)… Even if in the past they missed the smartphone wagon, they know how to build devices. They are learning to work together for 18 months now and in a quarter or two Nokia will be very cheap (even more for MSFT deep pocket guys).

    Nokia ability to build devices is not as strong as apple’s one but as a first step, if we’re talking about 5% to 10% marketshare in that space, it would certainly work.

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  • http://twitter.com/LionelatDell Lionel Menchaca

    Answer to your headline? Steven Sinofsky.

  • uberlaff

    That would be Nokia… they manufactured 1 million devices a day in it’s prime and still made a profit.

    Nokia lost because Apple had better design and vision. If Microsoft purchased Nokia and took on the design and vision; Nokia would bring the “Tim Cook”.

    • Tatil_S

      It seems Gruber is thinking along your line.

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  • garenyondem

    You are driving it to Apple and MS monoploy from every angle. What if every company released its own OS. There would be no common base in any industry. Sombody has to sell technically supported operating system lisances to manufacturers…

    • Tatil_S

      I agree. Integrated model is great for many, but it would be nice to have one or more players with different playbooks.

    • http://www.asymco.com Horace Dediu

      Crazy no? What if every car company had to design and build its own engines?

    • http://www.asymco.com Horace Dediu

      Crazy no? What if every car company had to design and build its own engines?

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  • http://twitter.com/marinelay3r Rhamesis Muncada

    I’ve been trying to wrap my head around the Microsoft Surface announcement for the better part of the week. Much of it I think will work well and be competitive. The Metro interface is innovative. The hardware looks slick, especially the cover keyboard accessories.
    What I’m trying to understand is what Microsoft’s internal goals are. Sure, MS wants to get a piece of the fast-growing tablet market. Anyone can see that. It also wants to counter MacBook Air, whose best PC-based competition (ultrabooks) has had mixed reviews and so-so sales. It’s probably best to throw any 2012 sales targets out the window, since only the RT version will likely sell – and in October, giving it only a quarter to show for itself.
    It’s 2013 and 2014 that will be interesting. Yes, MS is going to eat into its own OEM partners’ market and they’re grumbling about it, no doubt. But how bad will it really be? Consider that the worldwide PC market for 2012 is estimated at 368 million units sold. How many of those will be Surface Pro devices? Remember that the Surface Pro will come with a single screen size, 10.6″. Until the MacBook Air and ultrabooks popularized the smaller laptop form factor, a 10.6″ screen was the domain of netbooks and tiny niche devices. The Surface Pro will pack a Full HD (1920 x 1080) display into those 10.6″ so there’s no doubt that it’ll look crisp. At the same time, it has to be looked at as a tweener or niche player, not necessarily a broad computing device. The market has become accustomed to 6-lb., 15″ screen size notebooks with generally crappy displays that cost well under $1000. Most of the market will look at the Surface Pro as a either a toy or as an aspirational item.
    A few days ago, as I went through my local mall, it all clicked. At Valley Fair Mall in Silicon Valley, a Microsoft Store was launched last year, almost directly across the way from a high-traffic Apple Store. I went to the Apple Store to check out the MacBook Pro with Retina Display, passing the Microsoft Store on the way. I looked in there and saw that, as usual, there were perhaps less than 20 customers in the store. Energy was low, especially compared to an Apple Store.
    What the Microsoft Store is missing is a halo (no pun intended) product. Until the Surface announcement, Microsoft hadn’t made its own computers. It makes great accessories such as keyboards and mice, but those are commodity items. The Xbox 360 isn’t a halo product because it’s seven years old and is due for a replacement. The Kin was a marketing abortion, the Zune a sales abomination. Microsoft needs Surface to be its halo product, its reason to lure people into stores. Apple Stores are packed because they have multiple halo products: MacBook Pro/Retina, MacBook Air, iPad, iPhone, even the iPod at one time.
    If you look at Microsoft’s progress in opening its Store locations, you’ll see that they’ll have at least 20 by the end of the year. The stores first launched in the southwest and California, and they’ve been moving east. Within months there will be four such stores in the Tri-State area, along with locations in upscale malls near DC, Atlanta, and Chicago.
    Combine the introduction of the Surface models and the opening of the stores, and it’s easy to see where this is all headed. Surface RT may struggle compared to the iPad due to its lack of legacy compatibility, but at least it’s an attempt to claim part of the space. Surface Pro is where the real action is. As the halo product, it’s trying to claim at first the all-important executive niche. Microsoft wants Surface Pro to be the C-level productivity device you see on planes and in seminars, not an iPad or MacBook Air. At this point it’s unclear how many Microsoft will manufacture initially. Do they project sales of 1 million in 2013? 5 million? 10 million? If they landed just 1% of the PC market with Surface Pro, that’s nearly 4 million units sold worldwide. That shouldn’t kill the other PC manufacturers. HP and Dell can make competing units with bigger screens or hard drives instead of SSDs. Lenovo and Asus can make devices with built-in keyboards. There are numerous form factors that are not being addressed by Surface, so there should be no reason for manufacturers to panic. They should be able to take Microsoft’s lead and go from there. Whether it’s enough to stop the bleeding to Apple will depend on execution. That’s the biggest unknown of many unknowns.

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  • http://twitter.com/SeanMastersons Sean Masterson

    Tim Cook’s supply chain voodoo has been studied and widely reported on for years, so any competitive edge from the past is gone when it comes to sourcing components and locking up supplies. We get it: buy huge lots of components = cheaper price & lock out your competition. Surface will come in two forms: ARM chips and Intel, so MS can compete at each tier of the marketplace. What some folks are missing here is that MS is actually announcing two products: an Ipad challenger and a Mac Book Pro replacement. For the average (non-fanboy) consumer at a certain point: a tablet is a tablet (ie: Amazon Fire/B&N Nook). If MS hit’s a double/triple in execution that may be more than enough (at a lower price point) to do some damage and gain huge market share. As for the notebook replacement that doubles as a tablet? All I see is upside.
    MS might likely accept 5%-10% profit margins for the first few years in order to gain market share. Is Apple’s lead insurmountable? Of course not. This is Apple’s first, real direct competition in the tablet market, so anything is possible.
    Keep in mind, the Tim Cook-era Apple just made a HUGE mistake in it’s execution of the new Mac
    Book Pro. Retina screen aside (although we could argue who needs/wants it) without the unit being repairable it’s a $2200 disposable laptop. I’m into year seven
    with my current MBP, with many upgrades and repairs over the years, so
    the new one is obviously not for me. I’m sure many other weekend tech
    types will feel the same way. The Surface design group should take note
    of this and tout their products expandability & ease of repair (if
    this is the case). My point is: Apple is slow to innovate (USB3? Blu-Ray? SD Card slots?) and they do screw up. If MS is going to start manufacturing tablets they need to learn
    to take advantage of these instances in real time. Competition will make the marketplace much more interesting, regardless of whether you enjoy Apple or MS products. Good times.

    • Walt French

      @Sean M wrote, “MS is actually announcing two products: an Ipad challenger and a Mac Book Pro replacement.”

      I think you meant “a MacBookAir competitor.” The cute (and as yet, untested) keyboard notwithstanding, the X86 Surface shares specs pretty much one-for-one with the Air, the big differences being of course the OS (Legacy X86 with a Metro option) and to my mind the most important one, the choice of simple personal versus sophisticated/complex corporate clouds.

      • http://www.facebook.com/people/Shameer-Mulji/1685212657 Shameer Mulji

        The biggest difference is, is that the Surface Pro doubles as a full-fledged computer and a tablet pretty seamlessly. I can hook it up to my monitor and use my bluetooth keyboard and mouse. I don’t need to buy two devices which means money in my pocket. I’ll pay MB Air prices for that.

      • http://www.asymco.com Horace Dediu

        Why not pay MB Air prices for an MB Air? You’d get the option to run OS X for free.

    • Walt French

      Sean M wrote, “Tim Cook’s supply chain voodoo has been studied and widely reported on for years, so any competitive edge from the past is gone when it comes to sourcing components and locking up supplies. We get it: buy huge lots of components = cheaper price & lock out your competition.”

      And there are only 4 strings on a violin: Hold them down at the length you want, and stroke with a bow. Presto! You’re Itzhak Perlman!

      Microsoft has very little in the way of supply-chain resources, and lots of skill in software (duh). Yet, in the Surface demo, trying to go to bing.com froze the demo machine for Sinofsky. I wouldn’t claim supply-chain optimization is quite as hard as OS development management, but it DOES require intense coordination, coping with floods and earthquakes, last minute changes when yields of a part aren’t good enough, or a software component needs more than a part provides, and a new comm chip has to be swapped in.

      In the case of Surface, journos were prevented from looking at the screen specs at all; that’s a signal of extreme volatility of the software, possibly also the display hardware or driver chips, shortly before introduction. Of course, the Xoom, which *also* used a Tegra chip, as the Surface/ARM is rumored to, had a major problem with Flash graphics, despite nVidia claiming the Tegra line was designed to run Flash efficiently (and had demo’d Flash a year before the Xoom debuted without it). It delayed availability of the as-specced product for months, effectively killing it. Working with industry-leading suppliers and lots of “pad” in schedules, a fatal miss.

      You might think about Olympics gymnastics or figure-skating: getting the gold requires taking a chance on a jump that you might very well not land, because a nearly-as-good computer WILL land it. Consistently landing those jumps really marks you as head-and-shoulders better than your competition.

      As I say, it takes something more than just a 15-minute scan of the blogs.

  • Ryan irvine

    How can the future be in the hardware business? There are almost zero barriers to entry and it is completely replicable (just look at the success of Samsung, or alternatively, the failure of Nokia). This is why Microsoft has never been in the hardware business in a big way. With software, you have network effects, larger economies of scale, etc. Apple doing both makes sense when they are quickly innovating, but as the slow death of the Mac business vs PC showed, once the innovation is no longer new and exciting, the hardware becomes a commodity. The question then is whether or not most of the innovation has peaked. My guess would be innovation is slowing……

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  • westech

    I have thought long and hard about MSFT’s surface computers. I question whether Microsoft are capable of defining a market-successful product and focusing on its development and marketing. It seems weird to me that they would even consider a computer which had a touch screen, a mouse and a stylus. They should be able to choose the optimum approach, meaning that they should know with a high degree of probability what the majority of customers freally need and want. They seem to believe that the optimum approach is to preserve the legacy applications, yet the successful Apple product (the iPad) does nothing of the sort.

    They certainly have a strong and deep technical resource. They spend 14.4% of their sales revenue on R&D, compared to a paltry 2.1% for Apple. Spreading money around may be good for the economy but is is a lousy way to be innovative and disruptive. It’s what a company does when they don’t know where the are going. I fear that surface computers are DOA because they have no idea what to make.

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  • Andrew

    Is it too late to ask the OTHER important question:
    If Microsoft needs to build hundreds of millions of devices,
    who will be Microsoft’s STEVE JOBS ?
    i.e. the person who makes these devices insanely great, both on their own merits, and in the eyes of the market?

    (watch Larry Ellison’s recent AllThingsD interview for some perspective)

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  • c.c.

    It’s amazing that so many folks took the bite. There’s no such thing. The surface event was nothing but a windows 8 commercial. It’s a brilliant marketing ploy, but nothing else.

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  • Paul Mansfield

    the problem is that once the tablet and smartphone market starts to saturate, the people who bought their ipad with “free” software will expect software updates to continue to be free, and Apple’s revenue’s will suffer.
    Luckily Apple don’t own factories so they won’t have to worry about having billion dollar fabrication plants on their books which are no longer needed!

    • http://www.asymco.com Horace Dediu

      Once the smartphone and tablet markets saturate the replacement market will be over two billion units a year.

  • http://whereandynerds.net/ Andy Assareh
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  • kiran bhanushali

    Brilliant, getting down to the meat and potatoes of it all. Thanks for the insight Horace

  • fstein

    MSFT problem is Ballmer’s ‘drunken sailor’ syndrome. He has been denied gratitude for so long he spends like crazy for instant gratification. We saw this with Yahoo, Kin, Skype, and other reactive moves. Horace’s chart prove this nicely – We see a modestly growing business, top chart. But we see inconsistent net income in the bottom chart. The drag is due to on-line and corp activitiy.
    The latest re-action, Win8 faces big challenges: 1) playing catch-up to iPad, already embraced by enterprises. 2) late arrival in this holiday and enterprise year-end purchasing. 3) enterprises are already busy managing “BYOD” – meaning all the other non-windows devices. – This is a big deal, because historically a new MSFT release was #1 in the IT department to-do list and I doubt that Ballmer psychologically ‘gets this’. 4) Lack of forcing function – no applications that force migration.
    Apple, by contrast, invests in technology to gain breakthoughs, long before they release them as products. Many of these (image processing, Anobit, etc.) are buried inside to enhance performance or reduce cost.

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