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Microsoft (NASDAQ: MSFT ) (Nasdaq: MSFT ) is on a bit of a roll lately -- and not the good kind. After drawing the ire of the PC industry this summer by pushing into the tablet market, Microsoft sent another group of partners -- advertisers -- into a tizzy over the company's upcoming browser release. And on the heels of that corporate offense, Redmond & Co. surprised investors last week by reporting lower-than-expected revenue and profits, not to mention a big shift in corporate strategy.
These awkward moves have all been building up to one event with a potentially big payoff for Mr. Softy: Friday's twin releases of Windows 8 and the first wave of Surface tablets. With those product launches, Microsoft is stepping away from a PC/software focus. The end goal is a more integrated organization that dominates the mobile-computing landscape with hardware that's designed to marry tightly with Microsoft-branded software. But in its move toward that mobile nirvana, the company has angered quite a few groups. Let's survey the damage.
1. Hardware makers
PC manufactures such as Dell (UNKNOWN: DELL.DL ) (Nasdaq: DELL ) , Hewlett-Packard (NYSE: HPQ ) (NYSE: HPQ ) , and Acer, have the most to be upset about. Having partnered with Microsoft for years, they now have to welcome a new competitor into the crowded tablet market. According to The Wall Street Journal, many of these companies felt blindsided by the news that Microsoft was entering the tablet space, calling themselves "dumbfounded" by the move.
But PC makers have more than just their pride at stake. They worry that their new partner/competitor has a price advantage in the tablet market that will be tough to counter. It's reported that Microsoft charges hardware partners close to $100 to license out its operating system. According to the same WSJ article, the Surface's low price tag has fueled perceptions that Microsoft is giving itself a price break. While that's a plus for consumers, the game just got that much tougher for established tablet makers.
Chip producer Intel (NASDAQ: INTC ) (Nasdaq: INTC ) can't be happy, either. When Microsoft decided to release a power-efficient version of the Surface, which works on the scaled-down Windows RT, it opted for a mobile chip design that opens the door for ARM-based competitors such as Qualcomm but leaves longtime Microsoft partner Intel completely out of this week's tablet launch.
Tech hardware companies aren't alone in the Micro-hating that's surrounding this week's launch. Microsoft set the default privacy setting to "do not track" in the IE 10 browser that comes out with Windows 8, making it harder for advertisers to collect information and offer targeted ads. With that one setting, the company touched off a blizzard of complaints from brand owners as diverse as Ford, General Mills, and Verizon. In a letter to Microsoft protesting the move, the Association of National Advertisers called it "shocking" and "outrageous."
It's true that Microsoft doesn't have much directly at stake here. Advertising revenue from the company's Bing search engine is a tiny percentage of overall revenue -- just $655 million last quarter. But the company's Internet Explorer browser commands significant market share, so advertisers have good reason to worry that the new privacy settings could have an impact on ad effectiveness.
Investors have a bit to worry about themselves. In his letter to shareholders this month, Microsoft CEO Steve Ballmer outlined a "significant shift" for the software king, which plans to produce more devices like the Surface tablet. Ballmer said these design moves point to the company's future, in which Microsoft will build technology itself, rather than just license out software solutions to other manufacturers.
In case investors didn't get the message, Ballmer used the word "device" 19 times in the letter. He wasn't subtle about it, either, stating at one point: "Our business: devices and services." I think we get the picture -- Mr. Softy is not just about software anymore.
This strategic move isn't exactly a shock. Of the company's five operating segments, Microsoft's entertainment and devices division is the fastest grower, with revenue up nearly 60% in two years. It still represents just 13% of total revenue. Most concerning for investors, though, is that the segment contributes next to nothing to the company's profits. Software and services are the company's bread and butter, and this week's move stakes the company's future on something else entirely.
So was all of this drama worth it? We'll be a lot closer to an answer once consumers get their hands on the Surface tablets and the new operating system starting this weekend. If Microsoft can meet its goal of broadening the tablet industry and satisfying customers in the process, then just about all will be forgiven.
But I'm not optimistic. Initial confusion about which Surface models can and can't run Windows applications looks like a warning that we could see a surge of unhappy customers once the full-powered Surface versions are finally released. And the dramatic redesign of the Windows operating system makes it a tough sell to users who expect a lot from the desktop operating system they've been using for years. Microsoft has stepped on plenty of toes lately leading up to this launch. But the biggest risk it's taken is that of confusing its users.
It's been a frustrating path for a few groups, including Microsoft investors, who've watched their company fail to capitalize on the incredible growth in mobile over the past decade. However, with the release of its own tablet, along with the widely anticipated Windows 8 operating system, the company is looking to make a splash in this booming market. In this brand-new premium report on Microsoft our analyst explains that while the opportunity is huge, the challenges are many. He's also providing regular updates as key events occur, so make sure to claim a copy of this report now by clicking here.