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Is Microsoft Considering Killing the Surface?

Microsoft's  (NASDAQ: MSFT  ) Surface tablet has been a money loser since it was launched in 2012. The losses are starting to pile up, which may have new CEO Satya Nadella thinking about discontinuing the hybrid tablet.

The company has lost an estimated $1.7 billion on the various models of the Surface from launch through the end of its just-concluded fiscal 2014, according to estimates calculated by Computerworld's Gregg Keizer. Though Microsoft reported revenue for the Surface line -- but not the cost of revenue -- in its most recent quarter, Keizer used information from a recent 10-K filing to determine the expenses.

His calculations showed that the Surface's cost of revenue for the quarter was $772 million. The company reported revenue of $409 million, meaning that the beleaguered product line lost $363 million for the quarter -- the largest one-quarter loss for the Surface since Microsoft began providing quarterly revenue numbers.

The numbers are going in the wrong direction with little reason to believe that a major turnaround is pending. The Surface has its fans, and the latest model -- the Surface Pro 3, marketed as a laptop alternative -- has gotten generally strong reviews. But it's simply not selling fast enough. In the face of the obvious, Nadella may lose patience and decide that the company has more than enough OEM partners making devices.

Nadella seems behind it ... for now
During a conference call discussing the last quarter and the fiscal year, Nadella made some comments that suggested that while he was not opposed to making hardware, he wants to do so only when no partners step up. 

At times, we will develop new categories like we did with Surface and we will responsibly make the market for Windows Phone. However, we are not in the hardware for hardware sake, and the first-party device portfolio will be aligned to our strategic direction as the productivity and platform company.

As I said before, going forward, all the devices will be created with an explicit purpose to light up our digital work and life experiences. Good examples of this today are what we are doing with Surface Pro 3 for note taking and PPI for meetings. You can expect to see this type of innovation in our hardware, including phones.

Those statements do not close the door on the Surface -- Nadella clearly throws the Pro 3 some praise. His remarks, however, make it clear that the company won't keep making the Surface, or anything else, indefinitely if customers don't agree with the role it should play in their "life experiences."

Nadella already killed a planned Surface Mini that was supposed to launch alongside the Pro 3. Part of the logic of spiking the smaller device was to focus on the Pro 3, which is the company's answer to Apple's  (NASDAQ: AAPL  ) popular MacBook Air. 

The product fills a niche in the Windows world, which suggests Nadella will give it a full chance to succeed or fail. If Pro 3 fails to become at least a bigger seller, the product line could go the way of the Zune and Microsoft Bob.

What's at stake here?
When Surface launched, it came in two versions. The first, cheaper product ran Windows RT -- a slimmed-down version of the operating system that only used apps designed specifically for it. The RT line was supposed to be Microsoft's answer to the iPad and various tablets running Google's Android. Those devices were stealing market share from Windows, and Surface products were supposed to help the company take it back. 

That has not happened. IDC, which tracks the tablet market, does not list Microsoft as a top-five vendor in the category as of the first quarter of 2014.  Amazon held fifth place on the list, with only a 1.9% market share. Wherever Microsoft fell -- and the company has been secretive about the number of Surfaces it has sold -- it held less then 1.9% of the market during the first three months of the year. 

The second version of the Surface is a full-fledged Windows machine. These products have a tablet form factor but the power of a laptop. The original Pro and the Pro 2 were marketed as tweener devices -- more than a tablet, less than a laptop. The Surface Pro 3 has been specifically marketed using the tag line, "the tablet that can replace your laptop." Reviewers have largely agreed that the device can do that, but that does not mean consumers will pay for a product that starts at $799, before even adding on the keyboard/cover, which runs another $129.99.

The Pro 3 may be lovely, but it's competing with the elegant MacBook Air, which starts at $899, and pretty much every other laptop on the market. When viable alternatives start under $300, it becomes awfully hard to sell a high-end device unless you have been able to carefully market it, as Apple has done with its lightweight laptop.

The Surface has been an expensive failure for a company that can afford one -- or 10. Since it launched, the reason for its existence has also gone away. There are now numerous low-cost Windows tablets, a bunch of Surface-like hybrids, and tons of Windows laptops. If Surface Pro 3 catches on, then perhaps Microsoft should continue the line. But if doesn't, there is very little at stake for Microsoft, other than pride. Killing it makes sense.

There was a time when abandoning the Surface meant abandoning the tablet market to Apple and Google. With that no longer being true, it may be more logical for Microsoft to kill the Surface and focus on helping its partners build the strongest devices possible.

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Read/Post Comments (8) | Recommend This Article (2)

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 August 08, 2014, at 10:19 AM, toph36 wrote:

    The Surface Mini hasn't been killed, merely delayed at this point. Not that completely killing it isn't still a possiblility

  • Report this Comment On August 08, 2014, at 11:13 AM, PhillipDeCooch wrote:

    The price is it's biggest downside. The Pro has it's place as a business tool, but the average user does not need the power and extras for the expense. Unless the price can be cut deeply, it will probably not catch on. Most business owners would rather buy a $400 laptop instead of an $800 to $1500 tablet.

  • Report this Comment On August 08, 2014, at 11:19 AM, Hoptopia wrote:

    We'll be hearing about Windows phones finally meeting their demise before long too. Focus on what you do best or used to do best, applications... not hardware and not operating systems.

  • Report this Comment On August 08, 2014, at 11:23 AM, YippySkippy wrote:

    The CEO, currently Nadella, can make this class of decision on anything whatsoever, provided they also sell it to the BoD. So, will Satya kill the Surface? Hard to see that in the near-to-middle future given the position it provides MSFT to show how hardware + Windows can be designed to provide far more functional value than competing offerings. Will there be a Surface X? Who knows? If the i86 (full Windows) class of processors can continue to evolve with ever greater miniaturization and vastly improved energy savings, it could be that the processor moves to become the phone in a very real sense, and that how that phone communicates with various types of screens and input peripherals allows for the diversity of the user experience. When I can have a device in my pocket or on my wrist support my 4K 42" monitor in my home office, my 80" TV in the entertainment room, the touchscreen in my cars and the various screens in restaurants I visit, my office at work, etc... then having a "PC", a laptop/tablet (surface) and a phone becomes less interesting. Until then, these are discrete experiences that need different devices to support them. I think MSFT will stay in the game and evolve the hardware as it sees the opportunity shifting along with the engineering capabilities.

  • Report this Comment On August 08, 2014, at 12:18 PM, deltafool117 wrote:

    The assumption that companies will not pay money for a quality product is most assuredly wrong. At my company, Watlow, every desk based job at our manufacturing company is issued a Lenovo Workstation laptop which usually retail for between 1400-2300$ depending on if your an engineer or not. (Engineers get the bigger specs). Surface Pro 3 is going in the right direction and in a few iterations I can see it being a tablet that would be acceptable to the 'heavy use' mobile engineering community. Even if the model that could tackle those intense programs costed 2k.

  • Report this Comment On August 08, 2014, at 2:34 PM, dratsablive wrote:

    Considering the author's prediction of Guardians of the Galaxy, I see the Windows Surface doing quite fine (I'm no fan of Microsoft Windows, I use Fedora Linux on my laptop.)

  • Report this Comment On August 08, 2014, at 4:32 PM, Sunpowergo wrote:

    Zippyskippy you are overlooking a few things. For one the iPhone went 64 bit last year, that means they are way ahead of everybody (because IOS as well as the chip are 64 bit) achieving the horsepower to put 4k on your phone and 80 inch monitor. Next, for somebody in IT it is a safe bet that the iPhone will be around and get support in a few years so recommending it is easy. Microsoft has been throwing platforms at the wall for many years and none of them have stuck, Surface may be the next orphan hiding in the few MSFT fans closets. If I was an IT manager with a few of those in my closet I would be reluctant to make another bet any time soon. The desktop race had one winner, the portables race seems to have two, with one of them taking most of the cash. Meaning Apple has the most money to invest in the future which makes it the safest bet for IT.

  • Report this Comment On August 12, 2014, at 1:58 PM, mcworkinbee wrote:

    I think the high end Surface pro 3 fills a growing need for portable devices capable of running serious work / school related software as opposed to entertainment software. I am adult returning to school. It has been painful to watch the 18-25 year olds around me trying to deal with assignments requiring MS Word or Excel with their Mac or android devices. Invariably, the Mac devices have old installations of word that do not understand recently created word docx. Those with android devices, try to store everything on a share at school and have to come into a lab to get any serious work done.

    The market for portable entertainment/social devices is becoming saturated. But as laptops age out and feel heavy in the backpacks/messenger bags of students and the employed, the market for lightweight highly capable work devices is growing. One cannot write a term paper in APA format on most tablets. I recently sprang for a surface pro 3 with a 512 gigabyte hard drive because it is the only device on the market that incorporates a touchscreen (with stylus), an SSD hard drive with enough room to store anything locally that needs to be off line, and the ability to run mainstream productivity software, all in a lightweight tablet format that is easy to carry around.

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Daniel B. Kline

Daniel B. Kline is an accomplished writer and editor who has worked for the Microsoft's Finance app and The Boston Globe, where he wrote for the paper and ran the business desk. His latest book "Worst Ideas Ever" (Skyhorse) can be purchased at bookstores everywhere.

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