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Surface's high profit margin reveals Microsoft's ape-Apple strategy

Gregg Keizer | Nov. 7, 2012
Microsoft makes more than $300 on each Surface RT tablet it sells, showing that the company has adopted the business model of its rival, Apple, analysts said.

Both Rassweiler and Singh saw the pricing and margins of the Surface RT as indicative of a sea change at Microsoft, one that CEO Steve Ballmer announced last month.

"It truly is a new era at Microsoft," Ballmer wrote in his annual letter to shareholders about the U-turn from software to selling hardware and focusing on cloud services. "This is a significant shift, both in what we do and how we see ourselves as a devices and services company," Ballmer said.

Tablet margins illustrate the business strategies of the major players, ranging from Amazon and Apple to Google and Microsoft. (Data: IHS iSuppli.)

"The Surface represents a key element in Microsoft's strategy to transform itself from a software maker into a devices and services provider," said Rassweiler in a post to the iSuppli blog yesterday. "Key to this strategy is offering hardware products that generate high profits on their own, similar to what Apple has achieved with its iPad line."

Singh echoed that. "I think Ballmer's been pretty clear that he wants Microsoft to focus on devices and services going forward," Singh said. "[But] I'm not sure how smart that strategy is. OEMs are clearly unhappy about the move and Acer's been pretty vocal about it. It's one thing if you're moving into hardware and your software's free. It's a whole different story if you're selling your software to OEMs and then competing with them."

After conducting a Surface teardown and producing a BOM estimate, Rassweiler said the tablet's most interesting component was the Touch Cover, the flat and flexible cover-slash-keyboard that comes with the $599 and $699 models, and is available separately at $119.99 for the $499 tablet.

"The Touch cover actually has quite a bit of its own electronics," said Rassweiler. "There's a motherboard and at least two ICs [integrated circuits]. It's pretty cool."

And it's a money maker for Microsoft.

Rassweiler pegged the Touch Cover's cost at between $16 and $18, making the margin a whopping 85% when purchased separately, and contributing almost a fourth of the profit from the sale of each $599 32GB Surface RT.

He applauded Microsoft's business acumen, noting that the addition of the Touch Cover lets the company charge an extra $100 -- what he called "a very healthy upgrade" -- and gives it an additional upsell tactic beyond the usual memory upgrades that Apple popularized in tablets.

The Surface's large margin also gives Microsoft plenty of maneuvering room down the road, just as the high margins on the iPad Mini provide Apple pricing alternatives.

"They came to the conclusion that they didn't have to give away the Surface, but if [the current pricing] doesn't work, they have room to drop it, or even subsidize it," said Rassweiler.

 

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