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A Surface Mini Could Be Risky

Rumors are now floating around that Microsoft (NASDAQ: MSFT  ) could be planning to launch a Surface Mini -- yet another device in Microsoft's lineup of Surface tablets. The initial rumors indicate that this is probably going to run full Windows 8.1 and pack an Intel (NASDAQ: INTC  ) quad-core Atom system-on-chip, which -- from a broad-strokes perspective -- makes it similar to the recently released Dell Venue 8 and Lenovo Miix 2. While such a device could be interesting, it seems almost unnecessary, and it could be a long-term mistake.

Competing with partners is tricky business
The biggest issue with Microsoft's tablet strategy is that it directly competes with the companies that license its Windows operating system and Office productivity suite. It's not difficult to see what the problem is: While Microsoft gets the OS and Office at cost, the device vendors need to pay a non-trivial sum for these. This means that Microsoft either ends up with a real gross margin advantage over its partners, or it ends up with the ability to undercut its partners at the same gross margin level.

It's not hard to see why Microsoft would initially be attracted to this; selling a $250-plus device and collecting the hardware margin is much more lucrative on a per-unit basis than simply selling a set of software licenses. Unfortunately, the flip side of this is that hardware vendors may end up reluctant to compete in the Windows space and could end up putting their collective weight behind Google's (NASDAQ: GOOGL  ) Android. While Google does compete here with its Nexus-branded products, the search giant doesn't charge OEMs to use the platform.

A Surface Mini could be interesting, but Microsoft needs to be careful
Microsoft's tablet offerings today consist of a bulky, hybrid PC/tablet Surface Pro 2 as well as a much thinner, but more limited, Surface 2 that runs the RT platform. These are generally well-made devices, and thanks to Microsoft's deep pockets, it has been able to market them successfully. It would make sense, then, that Microsoft plans to extend its product lineup to include a 7-inch or an 8-inch device running Windows 8.1.

On one hand, this will probably sell pretty well, as the demand for the smaller Windows 8.1 tablets from Dell and Lenovo seems to be healthy and the reviews positive. On the flip side, if Microsoft's new Surface Mini ends up taking away market share from the tablets that its vendors are putting out, then those major OEMs will probably significantly scale back their Windows efforts. There would be little point in investing the engineering resources and marketing dollars to try to fight Microsoft -- a behemoth much larger than any traditional PC OEM. Microsoft needs to be careful.

Foolish bottom line
Microsoft will eventually need to choose between wanting to be a device vendor or an ecosystem provider. The former has the potential to be more lucrative if the mobile device market doesn't see continued margin erosion and a shift toward lower-priced parts. The latter is safer, very profitable, and allows the company to go after a much broader swath of the market with comparatively little risk.

As long as the OEMs are willing to work with Microsoft -- and as long as Microsoft can provide a meaningful value-add with its Windows OS over Google's Android -- then it makes more sense for Microsoft to take the role of ecosystem steward. However, if the device vendors don't want to pay for Microsoft's software, it makes sense for Microsoft to go at it on its own.

Microsoft's final course of action won't be be apparent for years to come. But for now, Microsoft should take note of the fact that its ecosystem partners want to work with it, and then run with it.

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