Software giant Microsoft (NASDAQ: MSFT ) has never had a good track record with consumer hardware. That's why the company's departure from its modus operandi with Surface is such a big deal. The new tablet is arguably Microsoft's biggest and boldest attempt at first-party hardware. Considering Steve Ballmer's proclamation of Microsoft's future as a "devices-and-services" company, Surface is of paramount strategic importance, even if its financial results are negligible right now.
However, one analyst is now making an unflattering comparison for Surface and also expressing skepticism about Microsoft's bigger picture. Is Surface destined to be the next Zune or Kin?
Microsoft Zune was doomed from the get-go. Launched five years after Apple's (NASDAQ: AAPL ) iPod, it only lived for five years before Microsoft killed it off. Meanwhile, the iPod lived on and is now approaching its 12th birthday. Apple's iconic music player is still the market leader with over 70% share domestically, but units are declining in lockstep with the broader music player market. Apple continues to update the lineup even though sales are being cannibalized, since the iPod now serves as a strategic gateway into the broader iOS ecosystem.
Kin was even sadder. The poor thing will always go down in smartphone history as the worst launch for a consumer device. The phone was axed less than 50 days after launch, which wasn't surprising since Microsoft was fully aware of its fatal flaws after some internal testing -- and still decided to ship it anyway.
The last thing that Microsoft wants is for Surface to stir up memories of these dearly departed products.
The price is not right
MKM Partners' analyst Israel Hernandez thinks Surface RT is "on track to join Zune and the Kin in the great consumer electronics discount rack in the sky." The Surface Pro model that carries a more powerful Intel chip and full-featured version of Windows 8 has better prospects, but that doesn't say a lot, since Surface RT sales have been uninspiring. The uncompetitive price points dampen Surface Pro's chances; buying a 64 GB model along with a requisite Touch/Type Cover sets you back over $1,000, far more than comparable competing Windows 8 convertible devices. That's twice the cost of an entry-level iPad (excluding external keyboard).
In the fourth quarter, IDC estimated that Microsoft shipped roughly 900,000 Surface units into the channel. This was before the Surface Pro launch, so all of those were RT models, and sell-through to end users is a different story altogether. For the current quarter, Hernandez has lowered his Surface forecast from 800,000 units to 600,000 units. He's also lowered his estimates for the fiscal year from 2.9 million to 2.3 million, with next fiscal year's Surface forecast moving from 6.6 million to 4 million.
Hernandez predicts that in order to spur Surface Pro sales, Microsoft will inevitably be forced to cut prices since it cannot currently appeal to the mainstream market. Unfortunately, such a move will hurt margins and make tense OEM relationships even tenser. The analyst goes as far as to characterize OEMs as "currently in open revolt."
There's some credence to this idea. Hewlett-Packard (NYSE: HPQ ) , the largest PC maker in the world by volume, continues to increasingly tap Google (NASDAQ: GOOGL ) for its software fix. Just in the past month or so, HP has launched both a Chromebook and a Slate 7 Android tablet. Both of those corresponding launch announcements emphasized a "multiOS approach" and intention to "leverage an array of operating systems."
Windows 8 is "dangerously close to being permanently rejected by consumers," according to Hernandez. The platform was always a bold bet, but perhaps too bold. The reports that Microsoft is offering discounts to OEMs in order to spur touch-based form factors also threatens to undermine Windows profitability in the long run.
Overall, the analyst rates Microsoft at "neutral" alongside a $27 price target, which is right about where shares are now.
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