Surface Changes the Microsoft, OEM Dynamic Forever

by Patrick Moorhead   |   June 19th, 2012

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Yesterday, Microsoft announced Surface, a Microsoft-branded line of Windows tablets and convertibles. While details on battery life, pricing and availability were not available, Surface looks very impressive at first glance. The most unique feature is the thin keyboard case that converts the device into an extremely portable notebook. By competing with their own PC customers, Microsoft has changed the customer dynamic forever and will cause ripples all the way down the value chain.

Microsoft has a mixed history of making their own hardware products. On the plus side, we have the XBOX, mice and keyboards. XBOX is the dominant gaming and entertainment living room platform with one of the most innovative input devices, the gamer with Kinect. Microsoft has also had some big failures, too. The Kin phone was on the market a few months and the Zune was just recently discontinued. Both the Kin and Zune were nicely designed hardware, but both had certain fatal flaws, too. Kin consumer pricing blew it out of any reasonable price range for its target market. Zune forced users into a content acquisition model consumers just weren’t ready for and also faced intense competition from Apple’s iPod. While Surface details like pricing and availability were not available, assuming enough high-quality Windows Metro apps are available, the tablet looks very compelling… and that’s a problem for OEMs.

Since the days of DOS, Microsoft has never crossed the line and competed with its own PC customers in PCs, the HPs, Dells, Toshibas, and Lenovos of the world. When Microsoft got into Xbox, their customers did not want to get into that market. The only major friction point was discussion around Microsoft under-investing and deprioritizing PC gaming in lieu of Xbox game investments. When Microsoft launched Zune, PC OEMS did participate in the PMP market, but the Zune took the premium spot and left some differentiation room for its OEMs.

Before Surface, many OEMs I research were planning to launch Windows 8 and RT tablets. Some would be out for the October Windows launch, others would be out in Q1. Some tablets would be focused on the consumer market, others commercial and designs were in final prototype stages. Those designs could be in serious jeopardy now, but key details do not exist on Surface that would give better indication of an OEMs response. These are details like pricing, bundled software and services, target markets and distribution. Given Microsoft did not share details, one must now play out scenarios and do what-if games.

Microsoft could price Surface $100 above their OEMs. This would be a halo product strategy where Surface was the best of the best and aspirational, but wouldn’t sell that many. That is, unless it came pre-bundled with key services up front. This could be dangerous given consumer reaction to Zune’s all you can eat music plan. It would though “prime the pumps” like Ballmer indicated, paving the way for other OEMs to slot in. Microsoft could also narrow the target market, like going consumer only and not adding tools and features that would make it desirable to IT. This is an unlikely scenario given the Windows 8 and RT enterprise feature set and the popularization of BYOD. Surface will be in the enterprise on its own or get dragged in there by CIOs given the Microsoft brand and backing.

All the above scenarios are muddy and net-net only enable OEMs to participate in a low price leader position. This is similar to what the Android tablet manufacturers are experiencing today, which is ugly at best. A few companies are rising to the surface like Asus and Samsung, but still no one I talk to likes this market as no one is making any money in it and return rates and low levels of satisfaction run rampant. This is why OEMs were so excited by Windows 8. They saw how Android and in HPs case webOS turned out for them and came back to Microsoft.

With Surface, the dynamic between Microsoft and its customers changes…. forever. The announcement yesterday may be known as the day Microsoft delivered the iPad’s first real competition, but may also be known as the day Microsoft crossed the line with OEMs. Microsoft now is competing directly with its customers. Some OEMs will contemplate exiting the PC business entirely or exit the consumer market. Others will re-engage with Android. Some will run after Tizen, webOS or even plan to double down on their own OS like Samsung’s bada. Regardless, the PC market as we know it will be different from here on out. In some ways, that is a good thing, but long term could be a very dangerous game for Microsoft if the conclusion is that they have less customers for Windows.

Patrick Moorhead

Patrick Moorhead was ranked the #1 technology industry analyst by Apollo Research for the U.S. and EMEA in May, 2013.. He is President and Principal Analyst of Moor Insights & Strategy, a high tech analyst firm focused on the ecosystem intersections of the phone, tablet, PC, TV, datacenter and cloud. Moorhead departed AMD in 2011 where he served as Corporate Vice President and Corporate Fellow in the strategy group. There, he developed long-term strategies for mobile computing devices and personal computers. In his 11 years at AMD he also led product management, business planning, product marketing, regional marketing, channel marketing, and corporate marketing. Moorhead worked at Compaq Computer Corp. during their run to the #1 market share leader position in personal computers. Moorhead also served as an executive at AltaVista E-commerce during their peak and pioneered cost per click e-commerce models.
  • http://chris.pirillo.com/ Chris Pirillo

    Spot on.

    Perhaps most interesting to me is how Ballmer has adopted Apple’s ethos (hardware + software = experience). He’s essentially saying that ALL Windows PC OEMs can’t fairly compete – with anybody.

    • FalKirk

      Right. Check out this quote from Balmer at last night’s event:

      “We believe that any intersection between human and machine can be made better when hardware and software are considered together.”-4:18:10 PM PDT

      Say what? You mean you’ve completely reversed your 37 year long mantra that licensing was better because it added variety, choice and ubiquity to your product line?

      The quote, above, sounds a lot more like Steve Jobs than it does Steve Balmer.

      Microsoft is going the integrated hardware route. And you can’t partner with hardware manufacturers and compete against them at the same time.

      • Rich

        No, the hardware manufacturers aren’t likely to give you much love when you bash them in the marketplace.

  • FalKirk

    “With Surface, the dynamic between Microsoft and its customers changes…. forever. The launch yesterday may be known as the day Microsoft delivered the iPad’s first real competition, but may also be known as the day Microsoft crossed the line with OEMs.”

    Agreed.

    Pity the poor OEMs (Original Equipment Manufacturers). When Windows Mobile started its long slide into oblivion, they grabbed the life raft that was Android. But Samsung is the only manufacturer who has been able to make substantial money on Android and with Google’s purchase of Motorola, the Manufacturer’s have to be scrambling for an exit strategy.

    HP appeared to take another course. They saw that owning their own operating system was the only way to regain control of their destiny. But then a sudden change in leadership, and a sudden change in priorities, turned a 1.2 billion dollar investment in webOS into a multi-billion dollar boondogle. They buried webOS stillborn and now they’re right back in the drink with everybody else.

    Finally, Windows 8 came along and promised to be the salvation for both Windows manufacturers and struggling Android manufacturers. It promised to be their salvation, that is, until last night when Microsoft torpedoed the good ship OEM.

    The only thing that is keeping manufacturers hanging on to the wreckage of their Windows 8 dreams is that they have no where else to go. There are no other viable competing platforms that they can build for. And creating their own platform, especially in the face of competition from Apple, Microsoft and Google, is a task beyond measure.

    Yes, pity the OEMs. No platform of their own and every platform they turn to competes directly against them. Where shall they go from here?

    • Rich

      Maybe RIM will sell them QNX as a last resort. I’ve read it’s a promising OS.

      • http://twitter.com/qka qka

        QNX has been around for decades, but it is a real-time OS, suitable for industrial control, etc. If it were a desktop candidate, it would have been done long ago. Tablet OS? How is RIM doing with it?

  • Donald Michael Kraig

    “The launch yesterday may be known as the day Microsoft delivered the iPad’s first real competition…”

    Uh, no. MS didn’t “launch” anything. As typical, they simply announced what they CLAIM they’re going to do months from now. They showed a few prototypes, one of which crashed completely and had to be replaced.

    MS has a history of this exact procedure: announce a product months or years in advance with all sorts of claimed features in order to spread FUD (Fear, Uncertainty, Doubt) in consumers so they won’t buy competitors. Nothing has changed.

    What is LIKELY, based on past performance, is that they will produce a product with poor quality control (Xbox had a 50%+ failure rate http://goo.gl/vR7yD) and missing some of the key features they announced.

    It is only when they actually sell units to consumers that we’ll see if they can compete with the iPad. Personally, I hope they do: competition results in lower prices and greater innovation. History, however, makes me doubtful. If anything, they will compete briefly with various Android tablets and then go the way of WebTV, Kin, and Bob.

    • steve_webb

      “The most unique feature is the thin keyboard case that converts the device into an extremely portable notebook.”

      Notice that they did not actually use the keyboard to type anything. The presenter’s hands never left the home row either. The fact that they have two keyboards flies in the face of any claim that either of them is “perfect”. I wonder how well the keyboard will work on your lap.

      Similarly another presenter actually apologized for how terrible his handwriting was with the stylus. Even the Newton could clean up poor handwriting. Instead, Microsoft demonstrated how “perfectly” Surface can scale sloppy handwriting.

  • http://www.facebook.com/eric.rachner Eric Rachner

    Patrick,

    You’re spot on, but it’s like you’re afraid to say it: the OEM PC business is circling the drain. Moribund.

    The dominance of Windows in the desktop space was made possible by the commoditization of every component in the desktop PC solution that complemented the OS. With every generation of hardware, vendors offered better components at lower prices, making PC’s the no-brainer choice for value-oriented consumers. All the while, the cost of the OS remained basically fixed, increasing as a percentage of the total cost of the complete PC over time.

    Moore’s law has finally taken us to a place where a killer general-purpose computer system looks like a tablet and has a COGS of $500 and falling. From here on down, there’s simply no more room for a +/-$75 Windows license.

    Something’s gotta give, and MS is damned if it’s going to come out of their margins.

    What happens now:

    The remaining Windows OEM’s will head for the exits. Fewer Windows notebooks and desktops until there’s nobody left except Microsoft themselves, having absorbed a hardware vendor or two to some unknown degree.

    At that point, there won’t be much left for Dell, Toshiba, et al. in the traditional PC space. Expect them to start flirting with Android notebooks and desktops just in time for Samsung and HTC to arrive in the same segment, but from the other direction. If Google can hold the Android developer base together through all this, they’ll profit nicely as the hardware vendors continue the race to the next level down.

    In the end, Dell & HP’s hardware businesses will be based on selling commoditized server components, with Amazon AWS as their biggest customer.

    • FalKirk

      “The remaining Windows OEM’s will head for the exits.”-Eric Rachner

      I would heartily agree with you if only you would tell me where they were exiting to. I agree that both Android and Windows 8 are becoming untenable. But where can they turn; where can the go?

      • synthmeister

        Most will simply go down the drain.

        Just look at HP. 5% margins on their PC business. Now that hardware components are commodities, owning the OS and/or strategic apps is where the real value lies.

        That’s where HP’s acquisition of WebOS had some potential, but HP completely botched that potential.

        • FalKirk

          “Most will simply go down the drain.”-synthmeister

          Maybe so.

      • http://www.facebook.com/eric.rachner Eric Rachner

        I’ll attempt to answer your question with a little prophesizing:

        The “exit” pathway for Windows OEMs is narrower product lines in the desktop/notebook space. Also expect Android-based offerings, but when they run into competition from the incumbent Android players (HTC, Samsung), that’s when the buyouts will start happening (with HTC & Samsung doing the buying.)

        As I said above, the OEM’s with server businesses will end up in commodity hardware, selling to the big cloud player(s), of which Amazon AWS is the only credible one right now. Maybe MSFT Azure will mature into a strong AWS alternative, but it’s hard to say.

        • FalKirk

          Good prophesizing.

          I was listening to a podcast with Horace Dediu of Asymco and he was talking about how some companies are pursuing exit strategies but others have no plan “B”. They’re stuck.

  • Joe05

    It’s always easy to take Microsoft actions yesterday at a superficial level, but this seems to point to some goings on behind the scenes. Microsoft seems to be signaling that it feels that for it to compete against the iPad, it needs to take matters into it’s own hands and control.

    And obviously this may also be signaling that the hardware OEM’s aren’t executing to the level that’s needed to launch Windows 8 successfully and create excitement and uptake around this new OS.

    • FalKirk

      “Microsoft seems to be signaling that it feels that for it to compete against the iPad, it needs to take matters into it’s own hands and control.”-Joe05

      Agree completely.

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