Greed Will Be the End of Microsoft's Surface

Microsoft (Nasdaq: MSFT  ) will apparently be sitting pretty if its new tablet is a hit. The crafty deconstructionists at IHS iSuppli took apart the Microsoft Surface to value each of its components, and the results are surprising. Just $284 in components and manufacturing costs go into making the $599 tablet with its attachable keyboard cover.

By IHS iSuppli's math, that makes the Surface more profitable -- with a 53% profit margin -- than Apple's (Nasdaq: AAPL  ) industry-leading iPad.

"It's about time," Microsoft fans may rejoice. They've seen the company reportedly sell its Xbox consoles at a loss. They've seen desperate tablet makers sacrifice margins to get below the critical $200 price point on smaller 7-inch gadgets to gain market share. Why can't Microsoft -- which until just two years ago was worth more than the iEverything company -- feast on Apple-esque tablet margins?

Well, before we get into the dim chances of the success of that strategy, let's start with a more problematic development: Surface buyers may be getting what Microsoft is underpaying for.

Get ' em while they're not hot
We don't know how many Surface tablets have been sold, but the number probably isn't impressive. Microsoft is selling them only through its dedicated website and the dozens of permanent and pop-up Microsoft Store mall locations.

Since there are fewer than 70 places in the country where somebody can physically try the tablet before buying one -- and nearly half of those places are temporary holiday kiosks -- it would seem as if Microsoft's online store is getting slammed with orders.

Yet when the Surface hit the market two weeks ago, Microsoft's store showed a three-week delay on new orders, and now, just two weeks later, there's no indicated shipping delay.

Was Microsoft simply trying to orchestrate an illusion of scarcity?

"It controls the supply," I wrote at the time. "It can blur the demand."

Frayed and stuttering
It also doesn't help that Surface reviews have been generally mixed. The knocks are now growing beyond the first wave lamenting the learning curve of Windows RT or the tablet's uninspiring response times.

The Verge is reporting on "widespread reports" relating to audio stuttering and random muting on the tablet. These could very well be issues that can be corrected through an operating system update, but then we get to the build-quality issues on the actual covers.

The Guardian reports that some owners' magnetic covers are splitting after just a few days of use. The Verge also has a screen cover whose cover itself has frayed to the point where the wiring is exposed.

Microsoft is offering replacement covers, but why should those be any better? Furthermore, IHS iSuppli is reporting that these touch covers cost between $16 and $18 for Microsoft to make. So why is it charging as much as $120 for them?

Adding insult to injury, the original Surface television commercial played up the magnetically attaching touch covers. Everyone was clicking covers to tablets. It certainly seemed to portray these covers as sturdy. Come on now, Microsoft. Tell us how many touch covers were harmed in the filming of that commercial?

More than just the mistakes
We live in the golden Internet age, and an IHS iSuppli report can do more harm than good, especially since there were already plenty of good reasons to wait on a Surface purchase.

  • Let the early adopters suffer through the bugs.
  • The few examples of tablets selling at similar price points that weren't running iOS or Android -- Research In Motion's (Nasdaq: RIMM  ) PlayBook and Hewlett-Packard's (NYSE: HPQ  ) TouchPad -- quickly slashed their aggressive pricing within weeks of release.
  • The more PC-centric Surface -- the one running Windows 8 Pro -- hits the market in two months.
  • Why risk buying an orphan? Microsoft was surprisingly quick to pull the trigger on the Kin smartphone two years ago.
  • Given the weak app support, there's no harm in waiting until developers embrace a platform before following suit.

However, now that folks know they're paying twice as much for these devices as they probably should be, will that nip this revolution before it had a chance to get started? Consumers don't have a problem getting gouged by Apple because they know that lower prices or discontinuations aren't coming.

Apple isn't perfect, of course. Antennagate, anyone? However, the Surface is coming up short beyond the initial sticker shock.

It's one thing for Microsoft to misprice the Surface because it doesn't want to upset future Windows 8 RT hardware licensees. It's another thing entirely to put out a product that isn't worth its ransom.

Scratching the Surface
It's been a frustrating path for Microsoft investors, who've watched the 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.


Read/Post Comments (10) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 10, 2012, at 4:10 PM, 0gre wrote:

    Don't forget there is also already a critical security patch out there to remind folks that while it's a nice pretty package... it's still Windows.

    http://www.theregister.co.uk/2012/11/09/nov_patch_tuesday_pr...

  • Report this Comment On November 10, 2012, at 4:40 PM, RandomMeaning wrote:

    Apparently Microsoft's "attention to detail" only went so far as making a clicking sound with that absurd kick stand. They didn't bother to test it enough to notice the audio problems reported by several sources. Loved the posters who speculated that it was Microsoft trying to add a dub step to your music and movies. Or use it long enough to notice that the cheap keyboards they're pushing don't even last a week.

    Not that the price Microsoft is charging is cheap by any means. Over a $100 for an $18 piece of colored plastic? And Microsoft fans accuse Apple of over charging. I guess they should be thrilled that Microsoft is going even further with them. For a device that doesn't even work as well as a low end netbook!

  • Report this Comment On November 10, 2012, at 8:25 PM, Cagnous wrote:

    Why do I have a feeling your a die hard apple user? Truth be told, the surface is awesome. It must have been difficult for you to ride apple from $700 to $550 and have to accept that big softy is coming up big with Surface. Sell Apple while your ahead. Surface is here to stay.

  • Report this Comment On November 10, 2012, at 10:16 PM, UncleSerene wrote:

    The observation of a computer scientist, MBA, and informed-consumer:

    The writer seemed unprofessional and dubious.

    The article is a manipulation of perceptions.

    It is like a paid, sponsored piece of ...

    There are propaganda wars and smear campaigns crafted to deprive consumers of competing emerging promising fine major products.

    Brutal, ruthless, deceptive, unscrupulous, and repulsive.

    Discover and think for yourselves, if your brains are still in good working condition.

    Let us ditch the dissimulator ; )

  • Report this Comment On November 10, 2012, at 11:55 PM, morelipservice wrote:

    I can understand why you might want to come to the conclusion that Microsoft is greedy. However, if Microsoft were greedy, wouldn't it have produced more than only a few million? What about distribution? Microsoft is only selling the Surface through its handful of stores, kiosks, and its own online store. More likely, Microsoft needed a reference architecture for Windows 8. It knows that its best chance of success is by an inspired and motivated ecosystem, who are embattled and reeling with the broader PC market. With Android tablets only finding niche markets and not competing effectively against market leader Apple. Windows 8 is its best chance and many are betting on it. So, I counter, Microsoft isn't being greedy at all, it just doesn't want to undercut its OEM partners but, rather, give them plenty of room to innovate and build devices at profitable price points. Always ask yourself if your seeing it from all angles and all possibilities and balance your analysis. Of course, it may just be greed, but it just doesn't make sense with only making a couple of million units and not selling it through retailers.

  • Report this Comment On November 11, 2012, at 4:51 AM, jbelkin wrote:

    Their profit margins discounts the $6 billion spent on developing WIn 8 ... plus, after Christmas returns, MS should sell about 800,000 of these so what's $280 per in hardware + RT's portion of the OS development cost and you hae another WIN boondoggle (like Xbox, spend $40 BILLION to make $20 BILLION) - but hey, MS shareholders don't seem to mind or notice that MS has had zero consumer successes in 15 years ...

  • Report this Comment On November 11, 2012, at 7:18 AM, Murnende wrote:

    I find it curious that you gloss over what is likely the real reason for the Surface being priced like it is:

    "It's one thing for Microsoft to misprice the Surface because it doesn't want to upset future Windows 8 RT hardware licensees."

    Given the very public comments by Acer's CEO and the likely private comments to the same effect coming from their other hardware partners, I don't think Microsoft had much of a choice in pricing the Surface. As it is, with the exception of Dell (whose XPS 10 is likewise priced starting at $499 - plus $189 for the optional keyboard), the Surface comes in $100 less than their nearest RT competitor.

    What sort of result can we imagine would come from Microsoft pricing their OEMs out of the market? Do you think the OEMs would return to Windows in the future, or would they retreat into the arms of Android, placing Microsoft into an Apple-like quandry of competing against the world (which always seems to work for Apple early in new markets, but leads to declines in market share and ultimately, niche status). By grossly overpricing the Surface (and we can agree that it's priced at least $200 too high), Microsoft is placating the OEMs who will eventually give them an opportunity to leave the hardware development game, should they choose to do so in the future.

    As has often been suggested, I believe that the Surface has been less about competing with the OEMs and more about providing those same with a reference design, letting them know what Microsoft expects from them. The Surface has created the tablet buzz that Microsoft needed for Windows 8 (or RT), though in that sense it may have been too successful; you never seem to hear about the OEM Surface analogues from Dell, Asus, and HP, all anyone talks about is the Surface (and maybe a little about Samsung's offering).

  • Report this Comment On November 11, 2012, at 8:42 AM, mikeodoulle wrote:

    Why would anyone by a piece of HW from Microsoft? The only thing they have continously supported in HW is the mouse & keyboard business. Everything else has been a nightmarish flop.

  • Report this Comment On November 11, 2012, at 11:49 AM, azmnbull wrote:

    Why are so many "smart" people unable to see what MSFT is accomplishing. Is it the fog of being a lemming? Another" me to" article telling MSFT they should give away a product that kick's Ipad's ass. No wonder these guy's write articles instead of being captain's of the industry. Making 30k a year telling successful companys that they know better. Perfect!

  • Report this Comment On November 11, 2012, at 1:58 PM, RandomMeaning wrote:

    Gotta call BS on the whole "Microsoft is just making a reference design" along with "that's good for their partners" malarky.

    In reality, if all Microsoft wanted to do was raise the game for its hardware partners with great design (which the Surface clearly is not) they could have much more easily just handed the blue prints to one (wasn't Nokia their "special" partner), some, or all of their partners. Then the partners could make whatever margins they could while Microsoft reaped the much higher margin software profits. They could even charge them a reasonable design fee.

    Secondly, those same "partners" are being massively outspent and buried by Microsoft's 1 Billion (some articles state 1.5 Billion) dollar ad campaign. As can be seen in the huge amounts of Surface commercials plastered on TV. Which are exclusively focused on the detachable (and debatable) keyboard and ridiculous kickstand. How exactly does this help the OEMs? It doesn't. It hurts them by placing all of the focus on Microsoft's Surface. Not Windows 8 tablets or even Windows 8 the OS. Just the Surface.

    As a side note, I personally think they are getting negative returns from those ads now. The first few times I thought it was very slick and rhythmic although I wondered why that school girl looked so angry and why it didn't spend any actual time with the software. After three ads during the same 1 hour TV show and then dozens more since then, it has become annoying. Nothing against Microsoft advertising, they should. But at least give us some variety that demonstrates more than dancing to clicky sounds.

    The truth is far simpler. Microsoft saw Apple making profits from both the software and the hardware so they decided they wanted the whole pie too while figuring that the OEMs had nowhere else to go anyways. And they may be right about the OEMs. But I think Microsoft is taking on a lot of unnecessary risk getting into the hardware side. They've abandoned their very business model that made them successful. Because they got greedy. In the long run, I suspect it will do them more harm than good.

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