Editorial

Despite the write-down, Microsoft's Surface strategy makes sense

When Microsoft announced it would write-down $900 million in Surface RT inventory, many thought it could signal Microsoft’s exit from the market and that the company would return to its old model of leaving its hardware partners to build Windows devices. Yet Microsoft defied those who called for the exit and forged ahead with the Surface 2 product line.

On paper, it seems like a foolish move and that Microsoft is throwing its money away on creating a product that consumers do not want. But if you look at the market as a whole in tandem with Microsoft’s new strategy, you can begin to see why the company is willing to lose money in this segment up front in a bid to secure long-term success.

Right now, in the mobile market, Microsoft does not have a strong footprint, and the time has come to make heavy-duty investments to ensure that Windows is part of the tablet conversation. If they don't move now - if they do nothing - despite the losses, they will end up in worse shape than in the smartphone segment, in which Microsoft has only managed to gain roughly 3% of the worldwide market.

To secure its mobile strategy, Microsoft is going to purchase the smartphone business unit from Nokia and take the Lumia line in-house to make sure that Windows Phone always has quality hardware on the market. By making this move, the company will have a line of products, with strong brand perception, in its portfolio. Sure, they have a long way to go to claim serious market share, but the pieces are falling into place. With Surface, Microsoft is using its own home-grown product to find market share, and to abandon that approach now would be a serious mistake.

Image Credit: Readtechnews.com

There is no hiding the fact that, even though it was first to the tablet space, Microsoft was late when consumer adoption snowballed after the announcement of the iPad. Because it was late, the $900 million write-down is the price that it must pay to build brand equity.

The losses are hard to ignore, and the fact that Microsoft is building a Surface 2 likely has many shareholders on the edge of their seats to see if Microsoft can find a way to break into this market in a way that is profitable. If Microsoft is forced to write-down another massive loss against Surface inventory, the company will come under intense pressure from its shareholders.

The critics of Microsoft are out in full force and offering up advice at every earnings release. The fact remains, though, that Microsoft is still extremely profitable and has strong footings in the enterprise and the consumer space. But the time has come to expand its profitable consumer line of goods, and that will not come cheaply. The $900 million write-down is the tax that they must pay to build brand equity Unlike Apple, which can put its name on nearly anything and sell them in the millions, Microsoft has to build out its consumer chops once again in the hardware space. Because of this, simply branding a tablet as being “Made by Microsoft” does not guarantee success, as we learned with the first Surface products.

Microsoft’s bank account does not exist solely to appease shareholders; there are times when the company must make tough and sometimes controversial decisions about how to spend its capital to secure future revenue. That is what we see here - Microsoft burning capital to build and strengthen Surface branding and its future revenues, and the company will do this at any cost, rightfully so.

Microsoft has, as of July, roughly $77 billion in the bank. While the company has spent some capital on the purchase of Nokia's smartphone line of business and increased its dividend, it is not struggling with cash reserves by any means.

If you find yourself in the camp that says building hardware as a first party is a foolish move for Microsoft, look at Apple and now Google: They have proven this model. It is important to note that Microsoft is not directly copying Apple or Google's business models as Microsoft has many streams of systemic revenue on its enterprise and consumer sides. Despite Microsoft being late to the party, they are willing to pay the late adoption tax and force itself into the market.

Remember, it’s easy to make decisions when your business unit is profitable; the tough decisions come at securing future revenues of unprofitable business units.

Ultimately, for Microsoft’s device and services business model to work, Surface must survive its initial woes and find a way to become profitable. Without the Surface, Microsoft will be missing a key piece of the puzzle, Without the Surface, Microsoft will be missing a key piece of the puzzle as they now have mobile (with the acquisition of Nokia’s smartphone business), entertainment with the Xbox One, and of course, the consumer line of tablets/PCs with the Surface lineup.

Right now, Microsoft is able to make mistakes and recover from them as they have several lines of business that are consistently profitable by a wide margin. But if Microsoft continues to misjudge the consumer market, it may not have many more chances to come from behind.

How Microsoft utilizes the Surface 2 and Pro 2 in advertising will be an interesting spectacle from the sidelines. We will be curious to see how Microsoft changes its strategy from the first Surface as the new devices offer up new opportunities to build brand awareness with consumers. One thing is for sure: Microsoft needs the Surface brand to resonate well with consumers as it is a cornerstone of its ‘device and services’ model.

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off course it does. google's nexus 10 failed harder than surface RT and google is still going to make another one which will likely fail too. surface was overall much more successful than google's product in every way and so it makes sense to continue. after all, if google keeps chromebooks despite no marketshare, and google glass when nobody will every buy one, why should msft just quit when they are more successful than google? if msft released a surface phone, it will undoubtedly outsell the nexus 4 in a heartbeat.

plus let's not forget. it was a write down of 900 million, not a write off which would be a loss. a write down just means they will make 900 million LESS than they thought, it doesn't mean they LOST that amount for they never made it to begin with. msft could very well break even with surface and still have a write down of 900 million if that was the profit they wanted to earn but couldn't.

Edited by neonspark, Oct 9 2013, 5:03pm :

Chromebooks are put out by OEMs though and they do sell pretty well in their target market. The only one that made little sense was the Pixel.

Nexus tablets (and phones) are designed to showcase their latest OS versions as well as provide a development platform. They aren't designed or meant to be successful.

Google knows full well that the success of these products doesn't matter as much as getting people online for ad revenue and purchasing android apps (in which they get a piece of the pie). They also don't make a profit with Google fiber, but they do with those who are brought online for an affordable cost.

{quote]Chromebooks are put out by OEMs though and they do sell pretty well in their target market.[/quote]
Do they? I know 3 developers who bought Chromebooks, and they each bought them with the intention of putting Windows 8 on it. I don't know a single person who uses a Chromebook with Chrome OS.

Of course, Chromebooks are not meant for any purpose a developer would need it for...

Buying something with the intention of using it for something it isn't built for isn't really a target market, right?

Chromebooks are more geared towards the low end netbook market, for people who just use a computer for very basic activities.

It's in the USA, it's a publicly traded company, high frequency trading is a wide practice, shareholders want returns, unfortunately not many people care about the long view anymore and are mostly interested in sucking trends dry.

I find it stupid when people chose to ignore Surface RT over the write down issue, or similar products from other manufactures make based on how much that company makes in profit or sales.

Wapoz said,
I find it stupid when people chose to ignore Surface RT over the write down issue, or similar products from other manufactures make based on how much that company makes in profit or sales.

1) Bad Publicity 2) OEM's have abandoned it which means people around the world cannot buy it 3) Since users are not buying it, devs have no incentive to make apps.

Vicious circle.

StandingInAlley said,

1) Bad Publicity 2) OEM's have abandoned it which means people around the world cannot buy it 3) Since users are not buying it, devs have no incentive to make apps.

Vicious circle.

This argument should be attributed to the 'public' perception of Windows 8 itself, more than the devices and tablets.

If 8.1 gets a public kick like Windows 7 did over Vista, the popularity will also apply to all Windows 8 devices outside of the normal notebook market.

You realize that Windows RT and Windows 8 run the exact same Metro apps right? Windows RT could have only 1 sale but if Windows 8 does gangbusters, the guy with the Windows RT tablet isn't complaining about apps. It's the entire point of Windows 8 having Metro apps.

We will see how long MS can afford to burn its cash reserve. By the time MS catches up, technology would have moved toward something else for example Zune. Tech landscape is totally different than what it was 10 years ago. MS is going toward the route of Dodo bird.

Auditor said,
We will see how long MS can afford to burn its cash reserve.

You're implying that Microsoft is not a profitable company. They have stated earnings of $26.76 billion for this year so far.

Leopard Seal said,

You're implying that Microsoft is not a profitable company. They have stated earnings of $26.76 billion for this year so far.

Kodak and Xerod were once great company and were reaping billions of dollar of profit in today's price value of money. A bad strategy and clueless management brought company to bankruptcy which might be unfathomable by people at that time. Competitors are gaining foothold now and it will be tough battle for MS in future.

Last year, Microsoft wasn't ready with Windows 8 as the built in apps were borderline unusable, and the hardware OEMS were just trying to dump all the old inventory. Who can blame them. Windows 8 was extremely immature as well.

This year, there is a TON of exciting new hardware, at all the right prices, and Windows 8.1 is much more solid of an OS. The built in apps, particularly the mail app are really nice, and now we have Outlook 2013 included on RT.

This years Surface 2 is a much more compelling product at $50 cheaper. Too bad we can't wipe away the link bait headlines that are sure to accompany this launch. If MS would only just offer some way to include that keyboard at a much cheaper price, they could really make this launch take off. Last year I think they were worried to P-off the OEM's. This year, F the OEM's.

jimmyfal said,
Last year, Microsoft wasn't ready with Windows 8 as the built in apps were borderline unusable, and the hardware OEMS were just trying to dump all the old inventory. Who can blame them. Windows 8 was extremely immature as well.

Indeed, Apples own OSX was a dog when it was first released. Yet now with 10.9 right around the corner, and is a far better OS then it was.
These days people are too short sighted. 2000 and ME became XP, Vista became 7. 8 is the foundation work and 8.1 is the house its built on.

Given the short term memory of the internet, Windows 8.x (or 9) will probably be proclaimed "teh best OS evvaaarrrr", yet quietly forgetting the bumps of 8. I mean XP was perfect at launch right?

right?

With the money Microsoft makes from other companies, they can afford another astrocious year with their tablets.

JHBrown said,
With the money Microsoft makes from other companies, they can afford another astrocious year with their tablets.

Only I don't think year 2.0 will be atrocious.

MorganX said,

Only I don't think year 2.0 will be atrocious.

I also believe this year may be a bit better. I almost pre-ordered one.

If MS only would include a touch cover with the Surface with the current prices, I think it would be a much bigger success.
If you promote the **** out of the keyboard in every commercial, it shouldn't be a paid add-on.

For $449 incl the KB I would buy one for my girlfriend in a heartbeat

Stoffel said,
If MS only would include a touch cover with the Surface with the current prices, I think it would be a much bigger success.
If you promote the **** out of the keyboard in every commercial, it shouldn't be a paid add-on.

For $449 incl the KB I would buy one for my girlfriend in a heartbeat

I am sure your girlfriend will like Android more than surface

Conspiracy theory here for a moment: What if the $900M write-off was to scare OEMs in making RT devices. Now it is safe to say that only Microsoft makes RT devices. And see what just happened: Delta Buys 11,000 of these devices. Once 1 airline company shows the way to save fuel, the rest will follow. In the end, the airline industry alone might buy 50,000 of these RT-2 systems. If business can give iPads, they for sure can give the cheaper Surface, since that meshes better with their future Win8.1/9 strategy, where enterprises are moving away from desktop only apps to WinRT-Metro apps. Ballmer is smart. He buys Nokia, and Delta buys 19,000 of these phones for the stewardesses. It's just a matter of time before FedEx, UPS & DHL will follow suit where Windows rules..... End of my theory

If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.

Now, if Surface looks like a fail, burned money like a fail, sold like a fail... ;-)

The article makes very valid points for why Microsoft should continue to push their mobile platform. However, it fails to give reasons why Windows RT still needs to exist. Microsoft IS making a mobile push. Unfortunately, the only thing that's getting pushed is more x86 devices.

Dell's new Venue Pro 8 is debuting at $349 and runs full Windows 8. Sure, it's not a powerhouse but it can do everything most corporations need it to. Plus smaller devices come with Office 2013 installed. And if Bay Trail isn't powerful enough, Haswell is there in waiting.

So again, why does Windows RT need to exist? It's out-matched and out-priced at every corner. I have a Surface RT and use it nearly every day. I very much like the hardware inside the Surface 2 but it worries me that I can't see Microsoft's long-term strategy for RT.

I've been with Windows Phone 7 since launch and the strategy there seemed simple. Get apps; undercut the competition with low-end but quality devices, profit. What's the strategy with RT? Sell an inferior device at a higher price point?

Microsoft is killing RT by offering a better version of Windows for cheaper. IMO, what RT really needed to offer consumers is a price advantage plus the stability and security of only running apps from the Microsoft Store. RT has already lost the price war and with x86 it loses the apps war too.

So it looks to me like Microsoft's mobile push is still going strong only it's coming from Microsoft's own Surface Pro line, Dell's cheaper Venue devices and Acer/HP whom are both getting ready to release Bay Trail tablets. Seems like RT is getting left in the cold yet again.

It's a shame because I really want the Surface 2 but I don't want to spend the next year begging for more apps. Heck, I don't even know if Microsoft has a plan to get more apps on RT.

Windows RT exists because giving the average user what is essentially a Windows 8 PC in tablet form does them a disservice when you have so many people saying that they want to buy an iPad "because it's simpler". When you ditch the desktop in Windows RT and it further differentiates itself from Windows 8, then it'll make more sense to more people.

As of right now, the best advantage of Windows RT is no viruses or malware which is actually pretty huge considering the previous reputation Windows has had.

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