Below the surface

Where does Microsoft want to go today?

Imagine a company that has been licensing its operating system to third party companies so they can build hardware to run it. Imagine that company falls on hard times but sees itself tied to that model as essential to market share growth. Now imagine this company deciding that it will focus its energies on its own devices and, as a result, throw its third party integrators under the bus.

If it’s 1997 and that company is called Apple, the action is now seen as a genius move that allowed the company to be reborn. However, if it’s 2012 and the company is called Microsoft, pundits have decided that it is the worst idea a company could ever have and a guarantee of failure. Are the pundits right? Will Microsoft fail? Does it have a choice? Let’s investigate.

An expected move

For the past five years, the discussion around the future of computing has shifted drastically from one where Microsoft had the thought leadership to one where Apple appears to be leading the way. With the introduction of the iPhone, an iPod with phone capabilities, Apple plugged a potential challenge to its dominance in the mobile music space and launched a new era of competition in the phone space: at the time, companies like Sony and Nokia were starting to add music playing features to their phone so Apple effectively shut down those threats by entering their field. The success of the iPhone eventually led to the development of the app store and eventually the launch of the iPad, heralding a new era of tablet computing.

Meanwhile, Microsoft had tried long and hard to be a player in those markets. In 2002, Microsoft used its existing compact edition of Windows (named Windows CE) to create what it called windows smartphones. Manufactured by third party integrators and using an interface that looked a lot like that of a traditional PC, Microsoft’s offering allowed its users to make phone calls, run some light version of Microsoft’s Office suite, use a web browser, and send text messages, instant messages, and emails. But after almost a decade of attempts, the company had few people buying phones with those capabilities.

With the launch of the iPhone, the market shifted drastically as Apple provided an elegant way with a wholly different approach to the mobile device experience. This eventually forced Microsoft to realize that the mobile experience was drastically different from the PC one and to get rid of the old approach: born from these newfound insights was Windows Phone, a new operating system that entered a market where Apple was dominant in terms of thinking and where Google was dominant in terms of device penetration. Thus Windows Phone was born.

But by that point, a lot of the market had already shifted; By the time Microsoft started to play catch-up in the mobile phone business, Apple had started rewriting the rules of the computing world by introducing the iPad, a tablet that did most of what the majority of people used a computer for, and did it with the same panache as the iPhone did things in the mobile phone space.

Microsoft just had to respond and it was long rumored that Microsoft would need to do something in the tablet space (another area it had pioneered with the introduction of the Tablet PC in 2001, a device that had a lukewarm reception) in order to remain competitive.

This week, Microsoft announced its move, with the unveiling of an integrated strategy that takes the Windows OS it will offer on PC devices in the fall (Windows 8) and makes it available in a tablet form (called the Surface) as well as in a reduced form factor (Windows Phone 8).

Software is Free

To understand why Microsoft is having something close to a panic state at this point, one has to think of a number of warning signs. For starters, customers are moving off the traditional PC, where Microsoft has long dominated, and on to tablets, where Apple is clearly dominant. Along with that move, a substantial portion of Microsoft’s revenue are evaporating as fewer copies of Windows are being shipped by third parties. Fewer copies being shipped mean a first strike against the existing revenue model.

At the same time, there has been worries about pricing. Because Apple does not have to license anything when it offers a new Ipad or iPhone on the market, and because it is underwriting the R&D costs of new version of its iOS operating systems by selling newer hardware, Apple has essentially pegged the price of an operating system at $0 (remember that upgrades to iOS are free as long as your device can support them). Meanwhile, Google has been offering copies of Android to third party manufacturers for a price close to free (the common conception is that they are giving it away for free but software licensing and patent issues has moved the price of Android from $0 to somewhere in the sub-$10 range). Compared to the $50 or so Microsoft used to charge for licenses of its PC operating system, this is a radical market change and third party integrators are starting to complain.

So the increasing perception (and this is one that will affect anyone in the business of selling software) is that software is free or close to it. Just look at the prices on most software packages aimed at consumer and you will see some substantial drops. For example, if we look at the price of several well known application to complete similar tasks on a computer, tablet, or via a web browser, we end up with something like this:

Category Computer Tablet Web
Word Processing Word $40-50 Pages $9.99 Google Docs Free
Spreadsheet Excel $40-50 Numbers $9.99 Google Docs Free
Presentation Powerpoint $40-50 Keynote $9.99 Google Presentation Free
AAA Game Civilization V: Gods and Kings $30 Asphalt 7 $0.99 Bubble Safari Free

In each case, the computer offering is several orders of magnitude larger than similar offerings on the tablet and most have free equivalents on the web. Looking at similar data, it is not too hard to extrapolate that the consumer market will continue to demand lower prices for software as it makes the transition to new device type.

Meanwhile, the trend of consumer behavior being an early indicator for what will eventually happen in the business world has to be another warning sign for Microsoft, which invented and managed to leverage substantial profit from being one of the largest software vendors in the world. So what is true today in the consumer market (a substantial drop in price and equivalent psychological expectation as to the value of software) may translate in what will be true in the enterprise space.

Along the way, the move to cloud infrastructures is reducing the need for software from Microsoft when it comes to enterprise grade systems. Today, many software as a service vendors offer products that are competitive to some of Microsoft’s more complex offerings at a substantially lower price.

The burning platform

Microsoft is finding itself on the edge of a burning platform. Two of its biggest cash cows, Windows and Office, are about to be value ata substantial discount over what they were valued at in the past. And the rest of their business may end up suffering the same fate in the future.

In the meantime, however, it also finds itself in the enviable position of generating and sitting on mountains of cash. So what’s a company in that position to do? If it were a lean startup, someone would advise them to pivot. And THAT is exactly what Microsoft is starting to do.

This week, beyond announcing Surface (which, let’s face it, still looks a little rough around the edges), the company also jettisoned its early adopters on the Windows Phone platform by announcing that it was radically changing the core in the new Windows Phone OS and thus was not providing any upgrade path to current users. A painful decision to make as it is bound to hurt sales of the current devices and will probably create frostier relationships with current partners (especially Nokia) but a necessary one to move forward. Just as Apple did when it essentially decided to stop licensing its operating system to third parties, Microsoft is concentrating on doing what is right for its own future and what is right in terms of giving it control over direction in that future. By concentrating on a single operating system core (in this case, Windows Phone 8 shares the same core as Windows 8), the company is reducing its costs and creating a valuable offering for developers as code that runs on one platform (eg. the PC or Xbox) can relatively easily be ported to another (eg. phone or tablet).

But while it seems to have finally gotten its software house in order, the company still needs to do something drastic on the hardware side. With over $50 billion in cash on hands, Microsoft could buy its place at the table on the hardware side. While everyone sees Nokia as an obvious integration partner (and at under $9 billion, it seems to be well on its way to becoming an acquisition target), there are others Microsoft could look into.

For example, Microsoft should consider Lenovo as a potential target to beef up its hardware side. The company has a long tradition of solid hardware and hasn’t expanded into the software business, as companies like HP have. It is also a company that has learned to integrate cultures rapidly, as a substantial part of its business was born from the acquisition of IBM’s old PC business. Alternately, it could acquire a company like Flextronics, which is a competitor to Apple’s Foxconn partnership and may be a cheap way to acquire supply chain experience.

Along the way, however, it also needs to start thinking about subsidizing its entry in the tablet market. Surface, the product the company introduced to great fanfare this past week, doesn’t appear to be ready for prime time yet. And the lack of actual pricing will continue to make it a non-contender until it has been offered. But let’s look at different pricing scenarios for the company.

How much for a Surface?

Once again, we have to look here at the market in order to see where the Surface needs to land from a pricing standpoint. There are two products to consider: the tablet (ie. the ARM version of Surface) and the PC (ie. the Intel version of Surface). Each product is different: the tablet is low powered and will hopefully have a longer battery life, and the PC is a more powerful machine but comes at a cost and weight loss.

So if we were to truly consider where they sit, the tablet is a competitor to the iPad and the PC is a competitor to the Macbook Air. This would seem to dictate price points that top out at $499 and $999 but the math gets more complicated when the features come in. For starters, why would I buy a tablet from Microsoft if it is priced at the same level as an iPad? Or why would I buy a tablet from Microsoft when I can get a Kindle Fire for $199? In the same fashion, why would I buy a Surface PC for $999 when I can get a macbook Air? Or why would I pay that price when I can get an ultrabook for $700?

Each of those questions weigh on the pricing and the pricing will impact the future of Microsoft’s surface. But what if Microsoft decided that it would look at those markets in the same fashion as it did the Xbox? For years, Microsoft subsidized the cost of the Xbox, eventually sinking $4 billion in it before turning its first profit.

Let’s remember here that Microsoft has over $50 billion in cash. What if it committed one fifth of that to the new platform ($10 billion) and decided that its attack on the market would be on build quality and pricing. Doing so could push the tablet in the $100-200 range and the PC into the $400-500 range, making it substantially more competitive (messaging: you can get a tablet from Apple or you can get a PC AND a tablet from Microsoft).

Doing so would radically change the economics in the marketplace. The casualty list would be long: HP, Dell, Sony, and probably Lenovo would find themselves out of the PC business. Google would end up having a harder time convincing anyone to build a tablet using Android. And Apple would have to increase the level of innovation (and thus potentially reduce its margins) in order to retain its control in those categories.

 

About the Author

Tristan Louis

Writing and working on the internet since 1993, I've launched 6 companies, of which 2 (internet.com and Earthweb) went public and two were sold (Net Quotient and MoveableMedia). My latest, Keepskor provides tools allowing anyone to develop mobile and connected TV games without writing a line of code. This is my personal site and all opinions here are mine.

  • eye-pad

    the tablet comes with a full-fledged Win8 OS, does it not? id say that’s a significant advantage over the iPad if they have a similar price…

    • http://www.tnl.net Tristan Louis

      I believe the ARM version (ie. the tablet) does not have a full-fledge Win8 OS. It will only be able to run Metro apps and not the legacy Windows ones. So there’s no advantage there.

  • http://twitter.com/scottjgalvin scottjgalvin

    second sentence contains grammatical error. “Companies”

    • http://www.tnl.net Tristan Louis

      Oops. Thanks. Corrected.

  • Muddybulldog

    The Apple comparison is spurious. Apple made a strategic decision to “go back from whence it came” which allowed it recover enough to survive until they struck gold in an entirely new market segment with no established leader. Microsoft doesn’t have similar roots to return to and is concentrating in gaining share in established markets with clear leaders.

    As for jettisoning the current Windows Phone for 8, MS has pulled this screwjob on their partners and customers before with little to no success. Ask anybody who manufactured or purchased a “Plays for Sure” media device how that worked out for them. The OEMs continue to stick with Microsoft because there really is no choice. If they don’t sell PCs with Windows they don’t sell PCs.

    • http://www.tnl.net Tristan Louis

      You may have a point on the Apple comparison but it was seen as as drastic a change in strategy back then.

      In terms of jettisoning the current version of Windows Phone (7.5), one could draw comparison to Apple’s transition to OSX. The Windows Phone 7.x series would have been equivalent to OSX 10.1 through 10.3, with back-up compatibility for previous apps (in the case of Windows, this meant compatibility with Windows CE apps, in the case of OSX with Mac OS apps). With WP 8, Windows is making the decision of killing Windows CE altogether, just like Apple killed MacOS compatibility altogether. It’s purely evolutionary, and the right thing to do.

  • trans

    I don’t think M$ is that smart. Watch them match Apple’s price points dollar for dollar, but offer approx. $50 discount via the retails chains.

    • http://www.tnl.net Tristan Louis

      We shall see.

  • Wrenj

    Upon Steve Jobs’ return to Apple, his first moves involved restructuring Apple. Then came the introduction of the new line of Macs. All these kept Apple alive. Growth came when Apple decided to get into new markets. There it applied its legendary design and engineering skills and by the time Steve Jobs died Apple had entered into almost 15 distinct markets in almost as many years. The end result isn’t news.

    Microsoft, Nokia, RIM and many others face the same situation as Apple did in 1997 (albeit with a lot more cash!)

    From this interpretation of Apple’s history, it would seem like Microsoft is not trying to enter into a new market. One suspects that the results will be the same as it has been for Windows Phone 7 despite critical acclaim at launch. The market has long shifted and maybe unmoved to shift back.

    Markets get saturated. The established players lose their groove, customers move and the best bet is to shift to something different and maybe come back in a decade or so.

    Apple’s Ipod sales are beginning to flatten. But long before this happened, it had applied its capabilities elsewhere. The rumors of a TV is another indication that Steve Jobs had not hit the brakes until nature finally did.

    Relevant questions may be:

    - What are Microsoft’s sources of strength?

    - In which new markets could these be applied?

    Without doubt a person of cut of Steve Jobs is needed in Microsoft. The only one who comes close maybe the one who bested him once: Bill Gates.

    Alas! He’s moved on too.

    • http://www.tnl.net Tristan Louis

      There is another element to consider: Microsoft is now trying to be a consumer company (traditionally, it’s been more of a business focused one), which is where the biggest part of the pivot is. That’s quite a challenge.

      More important than bringing a new Steve Jobs in is bringing a new Tim Cook in, someone that understand supply chain and can make the release of hardware hum at the lowest possible cost to the company while keeping the quality up. It’s quite a challenge.

  • http://twitter.com/bbthorson Brad Thorson

    Consider Vizio as the premier partner of the future for Microsoft. Not only are they building beautiful PCs, they could build the complete Windows physical ecosystem. Converting their tablet presence to Windows 8, helping them get footing in the phone market and integrating XBox720 into Vizio’s already great TVs would be an incredible feat.

    • http://www.tnl.net Tristan Louis

      What a brilliant insight. And to boot, they are in Seattle too so it seems that it would make them a perfect acquisition target for Microsoft. What a coupling that would be.

  • Nick

    My problem with the lose billions to market the tablet theory is they are already doing this. You have to keep in mind they are spending quite a bit of money to promote the tablet. Its not actually just the loss in hardware they are taking, but the actual marketing costs.

    The question is, would it be better for Microsoft to just offer a deep discount on Surfaces instead of spending the billions on traditional marketing? I think the answer is clearly yes based on the grass roots marketing ability of the Internet and early Kindle sales Amazon had for a much worse device. Not sure Microsoft will do this though, and it could make their device appear “cheap”, not just in price.

    The other problem Microsoft has here is they are really fighting right now to be #2. Apple clearly is dominating the tablet space, but Kindle is still selling (although much slower according to reports), and both Amazon and Google will likely have “refreshes” or “restarts” this year. So the buzz from surface has a long way to go before the holiday season. Add to this that Samsung won’t want to be #3, and they can’t sell surface… yet, and this creates another problem for Microsoft.

    All in all, I think they have a shot just because I’m constantly asked how to get Excel for IPad. Microsoft can release the official version on their tablets, and many will be none the wiser. Its a big advantage, but its being played two years late.

    If the big 4 (Samsung, Microsoft, Google, Amazon) continue to fracture the market for a clear #2, Apple may end up having huge sizable ownership of the tablet space. The lesson of IOS vs Android was not that more devices was better and thats why Android won, it was the IOS wasn’t available to all areas fast enough, and so Android grew and its ecosystem was able to mature and become a serious player. Then more phones won.

    What an interesting time. :)

    • http://www.tnl.net Tristan Louis

      I think at this point, it’s a given that Apple will continue to dominate the tablet market so playing for #2 is the only realistic outcome any contender can hope for (they may secretly wish to be #1 but history seems to point to such leads being hard to change).

      From the Microsoft standpoint, it’s a question of whether they want to EXIST at all in the future so the stakes are substantially higher for them than they are for other players in the market: it really is a life or death issue (re-read the part about software prices).

      I agree with you that fragmentation is a horrible thing and herein lies the opportunity for Microsoft. While Amazon has built a decent lead in the low cost tablet market (with the Kindle Fire), Android as a whole has mostly failed because there are too many tablets in that space which are coming in at too high a cost and with too few differentiators. Surface is radically different from the iPad (in terms of user experience as well as features) so the main point they need to nail down now is the price and driving that to the lower end is their only chance at besting Microsoft. This means 2 things, though:

      1. Microsoft needs to subsidize the price initially (ie. sell them at a loss)
      2. Microsoft needs to locate its own Tim Cook and work on optimizing their supply chain to drive the cost of producing the Surface down to the point where they no longer have to subsidize its build.

      They are two humongous challenges but Microsoft has little leeway if it wants to remain relevant in the consumer space.

      • http://twitter.com/LJA_Computers Lewis Anderson

        software prices? that was more like, metal gear solid 4 for £30, angry birds for £4 or manic minor for free. No comparison there at all. All the great things are created on a windows pc. i.e nearly all games made. nearly all software made and much more. to think microsoft will ever be in a life of death situation is a joke.

        • http://www.tnl.net Tristan Louis

          There are some fantastic game titles being created for the iPad and Android these days, and they generally retail for substantially lower than PC or console games. As a rule, software seems to be getting increasingly cheaper, which is at the crux of Microsoft’s challenge.

  • http://twitter.com/LJA_Computers Lewis Anderson

    I think you should all realise your talking about different target markets. Desktop and tower systems will never be out of use neither will windows. This is how I see it.

    Tablets are a novelty, fashion accessory just like the Nintendo Wii. There really isn’t anything that great you can do with them when it comes to real hardcore computing needs. They are large phones which the common person does not need or really desire. It’s difficult enough just to post this comment let alone using it as a home entertainment system. Its good for accessing web based programs on the go but they lack every where else. Nothing s phone can not do.

    Apple: more and more people are realising the limitations involved with apple’s software and greed to dominate by restricting every user to what apple want them to do with there devices. When they try sending pictures via Bluetooth to a friend on android device they soon stop and think is it only iPhone’s? Yes sorry should of got an android. IPhone’s are dumbed down versions of smart phones and are targeted towards the less enthusiastic customer.
    Macs have huge incompatibility problems with professional devices, I.e dj equipment, musical instruments, etc

    I could go on but the point I’m getting at is if you want a computer to do whatever you need it to do you will never face difficulty with a desktop/tower pc running windows. That’s not including laptops.

  • http://www.tnl.net Tristan Louis

    I fully agree with you that computers are substantially more versatile but the trends seems to be to most consumers considering tablets to be “good enough”. I suspect desktop and laptops will continue to enjoy some power in the work world but we may see computers disappear from most homes in the next decade and be replaced with tablet or tablet-like devices.

  • http://twitter.com/carribeiro Carlos Ribeiro

    Apple has MORE money than Microsoft in the bank and could easily win over Microsoft if it ever tried to subsidize market to that extent. Microsoft is already doing that against Google and the results haven’t been decisive..

    • http://www.tnl.net Tristan Louis

      True but it’s not a comparison over the long run (to subsidize ad infinitum would make no sense) but as a driver over the short term. The goal for Microsoft is no longer to try to displace Apple (though Ballmer claims it is) but rather to ensure it’s not replaced in the #2 position by Google or someone else.