A week ago, Engadget published a thinly sourced report that Microsoft would sell its new Surface tablet for an improbable $199. Despite a lack of any further confirmation, the report was endlessly repeated, commented upon, and used as the basis for endless speculation. My colleague Tim Bajarin did a very effective job of puncturing the rumor, based on supply chain reporting and his extensive knowledge of the industry. What very few others did was to look at the report with a jaundiced eye and ask whether such an action made any business sense for Microsoft.
This is a rampant problem in technology journalism today, whether in print, online, or broadcast. Many technology writers appear to have little interest in the business side of their industry and little background or training in the intricacies of operations or finance. If they ever read financial reports, it doesn’t show in their work. I doubt that most of them know an S-2 from a 10-K. And this is unfortunate because it often produces shallow and uninformed reporting.
Let’s go back to that $199 Surface. The Surface is the most interesting product announcement from Microsoft in many years because it represents an important break with the company’s core business model of licensing software while leaving the hardware business to its OEM customers (Yes, Xbox is an exception, but a very limited one. We’ll get to that in a bit.)
Microsoft makes nearly all of its money from three roughly equal revenue streams: Windows and Windows Live, Servers and Tools, and Microsoft Business. The first is the core Windows business, the second all the back-office software Microsoft sells to enterprises, the third is mostly Office. Recent trends in the industry, especially the rise in tablets and the accompanying collapse of consumer software prices threaten the first and third streams.
Microsoft is getting into the hardware business because it wants to shake things up–a bit. But its position is not so threatened that it wants to destroy the ecosystem that it has spent the last 30 years creating. A $199 high-quality tablet would have two drastic effects on Microsoft’s business. It would produce enormous losses of perhaps $150-200 per unit; modestly successful sales of 5 million units–about the number of iPads Apple sells in a month–could knock a billion dollar hole in Microsoft’s earnings. And it could make it impossible for OEMs such as HP, Lenovo, Dell, and Acer to enter the market. With the traditional PC market beginning to shrink, a Microsoft loss-leader tablet would be an existential threat to these OEMs–with no guarantee that Microsoft rather than Apple or Google and its partners would pick up the pieces.
Some speculation (for example) focused on the possibility of typing that $199 price to a subscription to–something. But again, this reporting failed to do any real business analysis. Wireless carriers provide up-front subsidies for phones, so why not Microsoft for Surface. For one thing, contracts for smartphones bring in around $100 a month, leaving lots of room to pay for the service and recoup the subsidy. A similar model was tried for both some notebooks, especially netbooks, and Android tablets, but it has been a dismal failure to the point where carriers are abandoning it. And the availability of free services is so great that it is hard to see what would get Surface buyers to pay a monthly fee.
The Xbox has also inspired a lot of bad business analysis. It’s true that that the Xbox was introduced at a price well below its cost in the hopes that game licensing feeds and outright sale of Microsoft games would make it profitable. Fortunately, the Xbox has never been a huge part of Microsoft’s business because this strategy took years to pay off. It’s true that today you can buy a $99 Xbox if you agree to pay $15 a month for two years for an Xbox Live subscription. But this is really a financing alternative rather than true subscription, since you will pay $359 for a subscription that could be bought on its own for $120. The Xbox is simply a very different kind of business than Windows, aimed at a very different audience.
The big problem here is the fact that too many tech writers don’t look at the numbers or don’t know what to make of them if they do. In an earlier generation, it was common for tech writers to have put in some time on the business beat, and the most of the best still have that experience. The quality of tech writing would improve immeasurably if such skills were more widespread.