Microsoft Borrows From the Google Chromebook Story

Microsoft's (NASDAQ: MSFT  ) operating chief Kevin Turner made a key announcement at this year's Microsoft Worldwide Partner conference. Mr. Tuner said that Microsoft, and its partners, will not cede the low-end PC market, and are willing to sacrifice Windows licensing margins to achieve this. The COO revealed that Microsoft plans to release a low-cost PC, although he did not provide its specs and price point.

Mr. Turner talked about low-cost laptops by Acer and Toshiba which retail at $249, which could be a pointer to where Microsoft is aiming its guns. This means that Microsoft's laptop will compete directly with Google's (NASDAQ: GOOG  ) (NASDAQ: GOOGL  ) Chromebooks, since most Chromebooks sport price points in the $200-$350 range.

Learning from Google
Microsoft appears to have borrowed a few plays from Google, even as it tries to become a ''mobile first, cloud first company.'' Microsoft is now more willing to make little or no money on its hardware, just like Google makes next to nothing on its hardware. Additionally, Microsoft has pre-configured Windows 8.1 with Bing as the default search engine, just like Google has pre-configured Chrome OS with Google Search as the default search engine.

But there are still some key differences between the two. Google does not sell Chromebooks directly or make money directly from the devices. Additionally, Google also does not license its Chromebook OS to manufacturers, unlike Microsoft which licenses Windows OS to OEMs. Google simply dictates the specs and price points of Chromebooks. ABI Research estimates that about 2.1 million Chromebooks were shipped in 2013, and shipments will grow at a CAGR of 28% through 2019 to reach 11 million units.

Chromebooks run on Chrome OS which is designed to work with Google services. A majority of Google web apps such as Gmail, Docs, Calendar and others have an offline mode that operates much like traditional computers do.

Chromebooks have developed a reputation for providing great web surfing experiences. Google has developed a rich ecosystem of web apps that makes for a better web experience. Making online experiences easier encourages people to surf more and view more ads, which in turn swells Google's coffers.

Google goes to great lengths with Chromebooks by maintaining frequent updates for all its 19 Chromebook models, including the earliest version--Chromebook CR-48.

Google operates this way because the search giant is still by and large an ad company. Google made 83% of its 2013 revenue came from advertising. Google makes money indirectly from Chromebooks when users connect to its cloud through the devices, or download apps from Google's web store.

Source : ZDNet

Microsoft as an ad company
Microsoft has also set its eyes set on Google's core revenue source--digital ads. The company is rapidly morphing into one of the top online ad companies. The company's share of the $140.2 billion digital ad market is expected to reach 2.54% in the current fiscal year, surpassing Yahoo's share for the first time. Google still dominates the digital ad space with an expected market share of 31.5% in fiscal 2014. Search engines such as Google Search and Bing make revenue when users click on ads that are displayed alongside their search results.

There is a strong likelihood that Microsoft's new laptop will sport Windows 8.1 as its OS. Since Windows 8.1 comes bundled with Bing as its default search engine, the new devices have the potential to grow Microsoft's ad revenue by increasing Bing searches.

Microsoft's Bing search revenue grew 38% year-over-year in the third-quarter of fiscal 2014, while Bing search U.S. market share reached 18.6%. Microsoft has been spending a lot of money building out its Bing infrastructure. That's the main reason why the company's Online Services segment has been consistently losing money. But the company said that it has built out enough infrastructure for the search engine, and would now only make small incremental investments going forward.

Judging by the healthy revenue growth for Bing search, coupled with less infrastructure spending on the platform, the service could be close to turning the corner.

What is the potential downside for the low-cost laptops?
Microsoft loses money on its Surface tablets. For instance, the company lost $300 million on Surface sales in the first three quarter of the current fiscal year, giving an annual run-rate of $400 million loss for the full year. Although the company does not reveal the number of Surface tablets it sells each quarter, we can use an ASP of $600, which gives us the figure of 800,000 units sold per quarter. This in turn means that the company has an operating margin of about -20% on Surface tablets.

Assuming the laptops cost $250 each, and Microsoft is willing to stomach a similar operating loss on its new laptops, the company will lose roughly $50 per laptop. If the laptops turn out to be as successful as Chromebooks, and Microsoft sells around 2 million units by the third year after their launch, it will lose about $100 million per year. That's not too much since the company will quite likely make up for that loss by increased revenue from Bing, OneDrive, and Office 365.

Conclusion
Microsoft may not necessarily be looking to wow buyers with its low cost laptop, but is rather trying to increase usage of its cloud and web services. Although there is a risk that the devices might lose the company money just like the Surface tablet, the company would likely more than recoup it losses elsewhere.

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