Alan Kay once famously remarked, "People who are really serious about software should make their own hardware".I believe the repercussions of this are even more interesting. Where does it leave the PC OEMs in the mix? And what does this hold for the future of Windows? As it turns out, part of the answer lies in understanding the simple math behind distinctive business models of Apple and Microsoft.
MICROSOFT'S FUNDAMENTAL BUSINESS MODEL IS UNDER ATTACK AND PUSHING IT TO ROLL OUT IT'S OWN HARDWARE
Horace Dideu of Asymco does basic math here to arrive at some very cogent arguments - Microsoft makes a total of $78 operating profit per PC sold through it's Office and Windows products combined (expensive software on commoditized cheap hardware). On the other hand, Apple by the virtue of fat margins along with nominal software pockets $195 in operating profit for each iPad sold (nominal software with premium hardware). So what - Microsoft has over 90% of the PC market share, so they can make up for this shortage in volumes, isn't it? Well, that's the fundamental problem.
As long as PC sales had momentum, Microsoft's business model made perfect sense. But since 2010, tablets and smart phones have started making a visible dent in the PC demand. We're just in the 3rd year of tablets and already many traditional PC vendors seem to be struggling in their strategy. Imagine what happens 5 years down the road!!!
Microsoft understands that the days of expensive software and cheap hardware are over and that their current business model may no longer viable in the long term.Now combine this with a curve ball which pushes Microsoft to the hilt. It's widely believed that Microsoft is charging somewhere in the region of $75-85 per Windows 8 RT copy to OEM vendors. If you've seen bill of materials (BoM) reports for contemporary tablets, you'll know that $75 can represent a chunk that's as big as the most expensive component on a tablet - touch-screen panels. Given the fact that an acceptable price tag for a tablet these days is considered around $500, an additional $75 top-up on cost through software license puts PC OEMs at a huge disadvantage when competing against the iPad's $499 pricing.
It's not very difficult to imagine a potential situation where the Windows 8 RT tablets could end up at $600 and upwards. Any price tag above iPad territory can be prohibitive and spell doom for the vendor - we've seen this happen before. Under such circumstances, it becomes imperative that Microsoft seizes the initiative to launch it's own Windows 8 tablet hardware, leverage the licensing fee and create buzz in the market. I can't see if there was any other option but this.
DEPENDENCE ON THE OEM RELATIONSHIPS
Microsoft has created it's monstrous empire based on the relationships with hardware OEMs. One would've been right if one predicted the same relationship to apply in the case of Windows 8 too. Unfortunately, this doesn't seem to be working out as expected for Microsoft. Part of Windows 8 appeal is it's grounds-up thought process of re-imagining the entire user experience, especially around touch usage cases. For the first time, there's a genuine opportunity to have innovation infused right from the basic hardware. This is entirely different than past efforts with introducing touch on Windows 7 and backwards.
Having said that, there's a feeling that Windows 8 hardware announcements (especially around tablets) have left a lot to be desired. It's important to make a note of the fact that with Windows 8, Microsoft isn't just re-imagining Windows but pretty much it's entire future business strategy - tiles everywhere.
If there is one place Microsoft cannot afford to screw up, its Windows 8. And they know it.Which is why they aren't taking any chances - another plausible rationale behind their Surface move. In a lot of ways, this echos Google's move behind launching it's own tablet recently. General market sentiment around Android tablets has been fairly lukewarm and by bringing the tablet under it's Nexus program, this is Google's way of saying to it's OEMs - let us show you guys how to build a great tablet. A reference design creates a lot of buzz and paves the way for innovative design and features to be incorporated in the product. Microsoft might as well be following this strategy.
SO WILL REDMOND DO IT? IF SO, WHERE DOES THIS LEAVE THE PC OEMs - A BILLION $ QUESTION
Well, the assumption that Microsoft may enter the PC hardware business (based on the above situations) sounds audacious to begin with. The stakes are pretty big - can Microsoft afford to compete with the same OEMs it has worked with in the past to create the hugely profitable Wintel empire and in the process ruin it's franchise? Here are a few likely scenarios.
Highly unlikely that Microsoft is in the game for making PCs. Given the huge supply chain and distribution challenges, margin pressures and shrinking profit pools, it's difficult for Microsoft to sustain in this space. However, it's tablet hardware ambitions shouldn't be ruled out completely. This is an industry in which rules of the game that matter are the ability to attract 3rd party app development, strong R&D, a potent content services eco-system and having enough cash to throw around for components procurement. Whereas most PC makers struggle on these new rules, Microsoft checks all the list. It's also supposed to be doubling-down on it's retail strategy. Then again, Microsoft is known to have persisted with it's hardware programs by burning cash - XBOX 360, Zune make good cases. It isn't constrained by the same margin pressures that PC OEMs face and hence can afford to run it's tablet program at a loss for a few quarters if it wanted to.
All this puts the OEMs in an interesting position. Media reports seem to suggest that many OEM partners are not happy with the Surface move and have either cancelled their Windows RT products or are considering delaying them.
At this point, I don't see any leverage that OEMs have on Microsoft. Microsoft owns +90% of the PC OS market share - where else are you going to go???On the other hand, we may have a scenario where Microsoft makes it's move on the Windows RT tablet segment (essentially killing the entire OEM ecosystem) and leaves the general Windows 8 Pro as well as Windows 7 (and earlier installed base) to the PC OEMs. Windows 7 still has good momentum and Microsoft would like to continue selling as much of it as it can for the next 18-24 months (till major consumer cycle refreshes have adopted Windows 8). Research suggests that most enterprises could stay on to Windows 7 (if they've not moved from XP) and skip Windows 8 altogether.
And then there's the 'official' boiler-plate scenario that played out - Microsoft says that the Surface program isn't intended to compete with it's OEMs but just a reference pilot. Here's a question for you - do you really expect Microsoft to reveal it's true intentions to it's OEM partners???
All in all, I think the next couple of quarters make for a superb case study of how Microsoft changes its business model. In the meanwhile, PC OEMs must take this move very seriously and examine their preparedness to meet the 'post-PC' era (which by the way wasn't coined by Steve Jobs. Lou Gerstner talks about post-PC era in his 2001 book "Who Says Elephants Can't Dance" - go check it out).
Image credits:
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Interesting point of view. But I really wait for the Surface release to see what are they and if they are really competitive.
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