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Surface Tension: The effect of Surface on Windows revenues

According to Strategy Analytics 3 million Windows-based tablets shipped in Q1. That is not inconsequential. It would add 4% to the total Windows-based computers and reduce the decline in Windows PC growth to -8% (from -11%). You can see the effect of those units on share in the following graphs.

Screen Shot 2013-05-02 at 5-2-2.06.21 AM

Note the “boundary layer” of pale blue Macs between the brown-hued Windows and the green-hued tablets.

Including tablets of all kinds, here is the market share growth in Windows PCs.

Screen Shot 2013-05-02 at 5-2-2.06.30 AM

As the post-PC disruption evolves, Microsoft has made an effort to shift its business model. I discussed this some time ago and there remain quite a few questions about the sustainability of the strategy.

However, there might already be evidence that it’s working. The clue is in the growth in Windows revenues at a time when PC shipments (at least traditional ones) are declining rapidly. Some of that might be due to deferrals and software assurance revenues which are insensitive to shipments. However some have to be due to the Surface.

Remember that Surface launched with an RT version priced starting at $499 (which did not sell well) but received a boost in Q1 with the Pro version priced at $899 to $999. If we assume a 80:20 mix of Pro to RT and an average price of $950 for the Pro and $550 for RT, 3 million units would generate at least $2.5 billion in gross revenues. Accounting for retail margins of 20%, Microsoft could still be recognizing $2 billion in revenues. That’s a significant portion of $5.7 billion in Windows revenue.

We can back into this figure from another direction: Prior to Surface launch, the Windows revenue per PC shipped (combining Microsoft’s revenues and Gartner’s estimates) was about $50. After the Surface Pro shipped the revenue climbed to $73/PC.

Screen Shot 2013-05-02 at 5-2-2.06.38 AM

Assuming the same pre-Surface revenue/PC and given the shipment figures for Q1 we would get about $3.7 billion for Windows. The difference to actual revenues is about $2 billion.

So the extrapolation of Windows royalties approach yields $2 billion in Surface sales and the Price x Units estimate also yields $ 2billion. It would suggest that Surface has had a significant impact already: More than a third of Windows revenues depend on it.

[UPDATE: I’ve been informed that not all the Windows tablet sales reported by Strategy Analytics are Surface products. As many as 1 million might not be. That would reduce the revenues as calculated to about $1.4 billion. In addition, not all Windows revenues are current with much of that deferred. Actual revenues were $4.6 billion. With both of these adjustments considered, the impact of Surface might be only 30%.)

  • http://twitter.com/bennomatic bennomatic

    $2B in Surface sales and I have yet to see one in the wild.

    • http://www.arekdreyer.com/ Arek Dreyer

      That’s one danger of relying on anecdotal evidence.

      • mjw149

        Well, research also require careful observation. Windows Server sales were spiking a couple years ago – anecdotal evidence was that Microsoft was building out Azure and Bing. Anecdotal evidence was right, and sales have since normalized.

        In this case, they announced that Surface would sell only at Microsoft Stores, then they switched to a normal retail model – a model where they ‘sell’ devices to retailers. There is evidence they did one limited manufacturing run and then were done, so moving the devices to alternative retailers suggest they had lots of inventory leftover after the early adopter sales. MS DID say they would only sell at their stores and then changed the strategy, that is evidence as much as numbers are.

        Also:

        http://www.zdnet.com/microsoft-employees-start-collecting-their-free-surface-rts-7000008712/

        Analysis needs to be based on empirical evidence, and that doesn’t mean only numbers, it’s events, too, otherwise the numbers have no meaning. Trying to determine what Microsoft does right now and why has descended into Kremlinology. They’re opaque and with Surface, Yahoo, Skype and Windows 8, also surprisingly unpredictable. It’s just Kremlinology, we HAVE to read between the lines on things like Surface and Windows 8.

        As to Dediu’s mistake, I think it’s likely that Lenovo’s Yoga and Thinkpad twist did better than other tablety designs, but I don’t know how they’re counted, there’s a lot of confusion even in the research institution figures right now.

    • Jeremiah

      I live in one of the most computerpacked countries in the world. I have not seen a Microsoft Surface yet on a bus, tram, in a park, not at work (northern europas largest hospital), not an any office I have visited. Zero, null, zilch, nothing.

      Where are they hiding all these Surface’s

      • Mark Jones

        They’re being used in businesses that hold large meetings involving dancing, and in universities with outdoor campuses for dancing.

        So I’ve not seen any either.

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

        All that’s left is being in the living room with your family & dancing.

    • Walt French

      Microsoft made a critical, and very conscious decision, to leverage its existing Windows expertise — and therefore, customer-savvy business that they are, to sell to buyers who favor Windows the most: the Enterprise.

      Dunno why the dancing ads. Guess Microsoft didn’t want the IT guys to think of Microsoft treating them as drone nerds, that Surface would be new & exciting. Still, no ads of bloggers in cafes, people Skyping from the kitchen table.

      ‘Cuz realistically, the Surface is a different form factor for those of us (including me) who use workstations all day long. It’s not the easy-to-self-administer, media-rich, fun apps-centric iPad, built for non-corporate functions. I personally don’t see much of a role for it except for when we corporate types go out on the road on business.

      I fly about 50X per year, often on the flights favored by Bay Area consultants who wing around the country for their on-sites. Lotsa iPads mixed with the laptops now. Lots of smartphones in coach. Still no Surfaces, although a couple more quarters at current rates & I’m bound to see some.

      Mostly, though, they’ll stay at work, where they belong.

    • Bruce_Mc

      They could be sitting on shelves at BestBuy and Sears.

    • Walt French

      Just back from a conference where several of us were taking electronic notes. I caught a couple of Surfaces (RT/Pro? Don’t know.) in addition to several PCs, a couple of Macs and probably the single most-seen device, iPads.

      My first sightings.

  • Bruce_Mc

    So Microsoft (plus other manufacturers) are shipping almost as many Windows tablets as Apple is shipping Macs? That’s an interesting comparison.

  • http://sumocat.blogspot.com Sumocat

    Do we know how Microsoft counts Android royalties? Could they be rolling that amount into Windows revenues?

    • http://sumocat.blogspot.com Sumocat

      Found it. Entertainment and devices division.
      http://www.nasdaq.com/article/android-licensing-pacts-ring-up-microsofts-phone-revenue-20130426-00607
      Interestingly, not only is this the only mention I’ve found of this, but it was reported just last week, so I don’t feel so bad about not knowing this.

      • Tatil_S

        Well, “I think the bulk of the increase came from licensing,” is not all that definitive.

        I am hearing MS offers substantial discounts to Android makers if they keep making WP handsets. That might be why companies other than Nokia still bother offering WP, despite anemic sales.

  • handleym

    I don’t buy the implications of this.

    As I’ve said many times, there are multiple markets for computers, based on different human form factors.
    In the tablet/phone market, there is no obvious way MS can maintain their price. Android devices have a price that creeps closer to zero every year, and Windows has to follow that or become irrelevant.

    They can (in theory) avoid this by tying their mobile devices so well to desktops and laptops that those people who use desktops and laptops find it worth paying a Windows tax for the convenience of what a Windows tablet/phone gives them.
    But I don’t see that they’ve done a good job of this so far. The wholesale destruction of goodwill in the laptop/desktop market engendered by Win8 has hardly helped this business model.
    AND MS have the problem (oh, the sins of the past have long term consequences…) that they simply cannot get away with a unilateral tight level of integration between their desktop and mobile OSs — if they don’t provide APIs and SPIs that allow Google (and Apple) to also hook into that integration, Justice and/or Europe will be all over them.

    What I see is that MS can maybe tread water via tablets, but they have to track the falling price of tablets. They had one shot to make a splash, a must-have impression with Surface and, as far as I can tell, they blew it, so when the next round of negotiations for Windows tablet licenses (RT and Pro) occur, the vendors are going to demand lower prices — and IMHO they are going to get them.

    • obarthelemy

      Yes. Smatphones tablets, laptops, desktops, and servers are different (though related) markets. I’d argue that the difference between entreprise and consumer is bigger though, and Apple’s current success mainly reflects their success in the consumer segment, which has ballooned

      No, MS don’t have to price-match Android to succeed. Same as BMW don’t have to match Skoda. MS could also provide added value, which can be, but doesn’t have to be, easier melding into MS’s desktop monopoly. Off the top of my head, they could also target security, manageability, and ease of use. Apple has opened a boulevard for them by lagging so much on features, and Android has a (perceived IMHO) management/security problem.

      MS never are good with version ones, then everybody dismisses them, while they keep grinding, and grinding, until they either succeed or ruin it for the competition. This doesn’t work quite as well in the consumer segment as in the entreprise, which kinda advocates MS aiming at entreprise, if entreprises still have a say in mobile devices, and want to.

      • jeff

        But they are well past version ones in both phones, tablets and mobile devices in general. Microsoft’s only calling card is the management tool and integration with its other enterprise servers such as Exchange but so far they haven’t had much success with it.

        They probably will have to match Android in price. The higher price market is already taken up by Apple and enterprise is adopting iPads at a fast rate and they provide security and ease of use by default.

        Who considers Microsoft to be BMW? Unless they can convince enterprise they have the perfect enterprise solution, it’ll be a very tough road for them.

    • neutrino23

      “Android devices have a price that creeps closer to zero every year”

      Interesting concept. If the OS is free and if the maker doesn’t feel they are adding any value then the price will be close to costs.

      MS should be able to command some sort of higher price as a fair number of people still value MS Office for business.

      • handleym

        But Office is not an especially desirable product on a tablet. (This is not a slur at Office or its existing tablet implementation, it is a conceptual point. A product like Office is VASTLY more desirable on a system with keyboard, fine-pointing device, and larger screen.)

        This was the point of my noting different segments.

        The point is not whether or not people will pay to use Office, it’s whether they will pay to use Office on tablets. I don’t believe they will. The best you can realistically hope for, IMHO, is to have people pay something $10 for Pages on iOS — a substantially lower price for a product which is substantially less powerful than its desktop cousin. And to get even that $10, you have to

        (a) ADMIT that the tablet version needs to be something different from the desktop version and THEN
        (b) IMPLEMENT something which works well enough in the tablet environment that people don’t hate it.

        Look, if you believe that people are going to write fifty page reports, or create anything larger than 20 cell spreadsheets on a tablet, using a touch interface, I can’t dissuade you. But I look at this and it strikes me as utter nonsense. Computers are ridiculously cheap — why waste hours and hours using a suboptimal tool? And it is in THAT world, where people are using tablets for the tasks tablets are good at, not everything in the world, that I see Office having no place on the tablet.

      • neutrino23

        I’m not sure I disagree with you. My point wasn’t to promote the utility of office but to suggest that it has perceived value (mostly in corporations) and could command some price more than zero.

        I was intrigued by the concept that unbranded tablets with no-name software could have a perceived value near zero. I’ve long wondered what happens to Apple and MS when hardware prices approach zero. That is a discussion for another day.

      • obarthelemy

        I think there are to cases, and in both, Office is required, but not enough:
        – in the entreprise, x86 compatibility is also required, along with AD, Outlook, remote management… SPro has all that, not SRT.
        – in the consumer/prosumer market, a regular app ecosystem is needed: media servers and clients, social ‘net apps, games… those are missing on SRT.

        That makes WIndows RT mostly a no-go product. Windows 8 tablets have fewer drawbacks, but are pricey, the Core ones have a short battery lie, the Atom ones are underpowered (comparable to ARM tablets, but still, not to desktops).

        Both version of Windows handle mouse and keyboard beautifully, so that argument doesn’t fly.

      • BoydWaters

        Must disagree here: Micrsoft OneNote can be a “killer app” for Windows tablets. The Surface Pro has a very nice Wacom stylus/digitizer. ( I’m typing this on an iPad, for which a limited OneNote is available, but without the stylus hardware it is not particularly exciting.)

    • JohnDoey

      So far, Android tablets are just big phones or big media players, not PC’s. Android runs Java phone apps — PC apps are native C/C++ like iPad, Mac, Windows, Linux, and game consoles.

      And Android tablets are already too cheap. The batteries fail almost immediately, and the user is left paying much more per hour of use than if they bought an iPad. (In other words, over 2 years they get a small fraction of the use out of a $199 Android tablet as their neighbor gets out of a $329 iPad mini.)

      The question is whether Microsoft can create a stable, successful touch PC line in the way that Apple did. Nobody but Apple is even making a touch PC yet. Everybody else is making PC’s with a mouse or making big phones or media players.

      I know Android tablets are made to look like iPads, but you have to look at the functionality, because that determines usage, and usage determines repeat sales and software sales.

      • obarthelemy

        Wild Apple fanboi claims… any data to back that up ?

        – The language in which an app is written is irrelevant. Many PC apps are written in interpreted Java, .Net… What count is what the app does, how it does it, performance isn’t even a concern in most cases.
        – You’re assuming Java performance is bad, but performance tests regularly show cheaper Android devices going faster than iPhones/iPads.
        – Battery quality, and quality in general, cannot be generalized with such a broad stroke. Some batteries are crap, some are good. Some Android phones and tablets have batteries that last longer than iDevices, and many Android phones have user-upgradeable batteries. Batteries on brand-name Android devices are OK. There are issues, both about capacity and quality, on no-name tablets, but those cost $100, not $200.

        Apple fans can keep their heads in the sand about Android tablets, that doesn’t change the fact that Android’s hardware is better and more varied, the OS is more modern/easy/powerful/flexible, and the apps are the same.

        The market has already voted, with Apple’s share taking a dive.

      • Space Gorilla

        The data you want to look at is iOS device share in enterprise, it’s dominant and growing. Please don’t try and pretend you’re not aware of the difference in usage between iOS and Android. How a thing is used helps define that thing. iOS is fast becoming a mobile computing platform (or ‘touch PC’, that’s a good phrase) while Android is settling in as the default smartphone platform.

      • simon

        Space Gorilla, it doesn’t matter what logic you argue with obarthelemy. His conclusion is inevitably Apple is bad and it’ll fail.

      • obarthelemy

        You can keep moving the goalposts if it can sustain your delusion for just a little while longer… It’s probably the entreprise segment lagging the consumer segment by a couple of years, as it usually does because of project lifecycles. Plus, Entreprise is the segment where MS will have the biggest impact.

        We’ll discuss this again in 2 yrs I guess.

      • Space Gorilla

        The reality is Apple continues to sell more and more iOS devices and continues to dominate the best customer segment of the consumer market while also making big gains in enterprise. The iPad year-over-year increase was amazing, they went from selling almost 12 million iPads in the recent quarter last year to almost 20 million this year in the same quarter, and you’re trying to argue that this is somehow bad? I’m not even sure what your point is. The iPad is what I look at, it’s a ‘touch PC’, the key to Apple’s mobile computing platform, and sales continue to be great. Yes, yes, when you throw together every ‘technically Android’ tablet (Kindle, etc) that gets made and shipped, and if you believe shipped estimates, you could stretch and make an argument that Apple’s share has decreased, but that’s laughable. The reality is Apple has created a mobile computing platform which is dominating. There’s no other way to describe it.

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  • obarthelemy

    are MS counting the gross revenue of Surface as windows revenue, regardless of COGS that are wildly different than those of a software license ?

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  • Alfiejr

    strategy analytics stats are really just guesstimates at best. and shipments at this scale mainly fill inventory channels. how many are real sales to users is anybody’s guess, since MS and all the OEM’s refuse to say – not a good sign. it could be damn few. HD, you should know better.

  • http://financial-alchemist.blogspot.com Turley Muller

    IDC said today 900K Windows tablets, many of them the Pro model after launching in Feb. 1.8M total Windows tablets since introduction. So, maybe 2M aren’t Surface products. Then, again, IDC and SA maybe way of in their estimates.

  • http://aaplmodel.blogspot.com/ Daniel Tello

    In the first chart, right hand side, Macs are included within the arrow labeled Tablets.

    • Johnny

      You are correct, but the reason is to show the market share that doesn’t use Windows, therefore doesn’t contribute to MS OS revenues? Does it make more sense with that line of thinking?

  • Walt French

    This analysis might also benefit from converting the first pair of charts to a revenue basis. Apple’s share of customer dollars is quite a bit more (as you’ve earlier shown) than its unit share.

    Internally to Microsoft, where decisions about pricing, bundling, integration and features are made, revenues would be more determinative than units, although obviously they are promoting Surface as a way to get many units of Office and Windows licenses without impacting their other revenues.

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  • BoydWaters

    No 2013Q1 Galaxy Tab numbers. Does it matter for a Windows revenues discussion?