Microsoft Surfaces A Whole New Business Strategy

What is Happening?  To great fanfare, Microsoft announced its new Surface tablets this week. The demonstrations showed a well-designed piece of hardware that shows tremendous promise to help Microsoft establish and grow a user presence, and therefore ecosystem and revenue presences, in the fastest-growing computing segment today.

The Surface tablets offer a few innovations, including a built-in kickstand and combined keyboard/face cover, along with a solid set of functional capabilities that should be expected in any competitive tablet device today. Pricing has not been set, nor has availability. Given that the tablets will require the widespread availability and use of Windows 8, and that Windows 8 has not been released (and is still building early developer and support ecosystem presence), it’s really up in the air right now as to whether or not the Surface line will succeed. It certainly looks competitive from our point of view. The Surface specs and functional details are outside the scope of this Research Alert.

While most analyst and media reports have positioned Surface as a potential iPad “killer,” Saugatuck sees it quite differently. Microsoft’s Surface line is actually an indicator of the following strategic market shifts:

1. Microsoft finally acknowledges and is ready to address the slow decline of the traditional PC market as a growth opportunity;
2. Microsoft sees the need for, and is willing to make, significant yet incremental changes to its own business structure and positioning; and
3. Microsoft sees its traditional PC partners as unwilling or unable to deliver what Microsoft needs to compete.

At the bottom line, Microsoft is positioning itself as squarely in the workplace / productivity hardware business, competing directly against its Windows hardware partners for a market that has not yet fully emerged.

Why is it Happening?  Most obviously, Microsoft needs a way to protect and grow its core operating system business. Without Windows, Microsoft loses its direction, strategy, and core revenue stream. So rather than change its Windows-dependent business model, Microsoft is extending it to include the latest and greatest hardware trend.

This strategic approach is one of limited vertical integration, whereby Microsoft, like Apple, controls the operating system and the hardware design. Microsoft does not, and really cannot, control development of apps and interfaces to the extent that Apple does, mainly because Apple exerts much tighter control over its OS and development ecosystem. But the limited vertical integration approach makes sense for the market reality that Microsoft operates within. And it allows Microsoft to exert significant influence over pricing of, and therefore revenue from, the Surface line.

Underneath everything else, though, what’s driving Microsoft to design, build, and sell its own tablet line is that there is no such thing as a “work” device. This is confirmation of Saugatuck’s Boundary-free Enterprise™ market vision, established in 2008 and more recently laid out in a series of research notes for our subscription clients (1076RA, Master Brand Scrambles Spotlight User Shift to “Boundary-free” IT, 30May2012; 1061CLS, Mobile and Social: Building the Boundary-free Enterprise™, 27April2012). Microsoft sees what Apple and most smartphone makers have discovered: The business and personal computing and consumption worlds are finally melding into a seamless reality of “free-range” Cloud+Mobile+Social adoption, use, and expectations.

Apple’s iPad and AppStore experiences are probably the most visible, and revenue-generating, example of this. With a so-far very limited smartphone market base, Microsoft has lacked a means of emulating the Apple AppStore revenue model (with its built-in 30 percent margins). The Surface tablet line enables a similar type of business model for Microsoft.

Meanwhile, partly because of its developer / AppStore ecosystem, the Apple iPad has slowly been maturing into more of a “work” machine – not a PC-level machine, but increasingly a threat to Microsoft’s office-space OS hegemony. And in a Boundary-free business and IT environment, the improving Apple iOS cross-device integratability of UI, apps, data, function, and communication increases the competitive threat to Widows at all levels of IT and business.

Of course, the simple growth in adoption and use of tablet devices offers short-term, mid-term, and long-term revenue growth opportunity for Microsoft as a tablet vendor. While it will not profit immediately from the sale of Surface tablets, Microsoft should be able to develop a massive cash flow that will help to finance growth of the needed, supporting ecosystem of developers that will make Surface more attractive. Its strategy and success with the Xbox indicates an ability to do just that.

Market Impact  Will Microsoft succeed, and what will its impact be on user enterprises, software markets, and hardware vendors?

Many industry watchers have focused on the fact that, with the exception of the Xbox (which required years of non-profitable support), Microsoft’s user-oriented hardware efforts have failed recently. Saugatuck doesn’t see the Kin phones and Zune music player as relevant examples here. The Surface tablet line is being positioned as a device that meshes within the Microsoft Windows productivity universe. Microsoft in fact emphasized in its announcement that it sees Surface as a PC rather than as a consumer-centered media consumption/interaction device. It can be both, and Microsoft will be well-served to market it as such.

Saugatuck sees a gap between what the iPad delivers and what the rapidly-emerging/evolving user today requires. Apple relies on AppStore developers to overcome that gap through productivity and connectivity apps that are rarely built to work together, or with widespread Windows/Office productivity apps, simultaneously and seamlessly. A device engineered and built to work within the Windows universe – by Microsoft – has a much greater potential to bridge the work and consumption environments. Microsoft already has a greater, and more integrative, presence in the home, in cars, and in work environments than does Apple or any other vendor. If they can deliver affordable Surface tablets with suitable apps and interfaces, Microsoft could be the sole vendor to seamlessly bridge these environments and enable true free-range IT use.

There are still too many questions to answer before we can crown Microsoft the rulers of the Boundary-free IT and business universe, though. The Surface tablets were demonstrated in tightly-controlled conditions; at this point, no one even knows if the keyboard covers work, let alone the wireless networking, security, apps interfaces, and everything else required to enable and deliver a seamless free-range experience. We don’t know the pricing.

And we don’t yet know if Windows 8 will work the way it needs to. Windows 8 is a titanic engineering and design departure for Microsoft, and until it rolls out and gets used in real-world conditions, we don’t know how it will be accepted. Without a complete and accepted OS, developer base, app store, pricing, or channels in place, Microsoft is building strategic new business on an incomplete foundation.

What about Microsoft’s traditional PC hardware partners? None have established major tablet presences, so Microsoft is not directly competing for critical parts of their business at this point. If the Surface line is accepted and widely used, Microsoft will have cut off some potential competition from its partners before they were able to even get to market, and those partners will no doubt be unhappy. But Microsoft’s Windows OS business is likely to suffer only marginally, as it has no real competition among Microsoft’s established hardware partners.

Apple is unlikely to lose any established users; few Apple users willingly switch to other platforms. Many developers selling through the AppStore will build Windows 8 versions of their offerings, but this will add to their revenue streams, and not detract from Apple’s. And since Apple has its own vertically-integrated distribution channel, Microsoft and Surface are most likely to just draw some attention and sales away at the margins, most likely among wireless telephony carriers that offer iPhones and iPads. Surface tablets will flesh out these carriers’ mobile portfolios, and may help boost carriers’ positioning as SMB IT and service providers (1081RA, Verizon Shared Data Plan Signals Carrier Business Model Change, 13June2012).

On the enterprise IT front, if the Surface line works, and is affordable, and if/when Windows 8 becomes widely accepted, then Microsoft will have a chance to re-establish itself as the ruling, dominant IT Master Brand. If Microsoft can deliver a seamless, home-to-car-to-office/work user and IT management environment, why would enterprise IT organizations and leaders standardize on anything else? Standardization reduces risk and reduces costs of management – fundamental opportunities for Microsoft (and its development and service partners).

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