Why a $100 Price Cut Can’t Save Microsoft Corporation’s Surface 2

Microsoft just cut the price on all three Surface 2 models by $100. Is this a desperate bid to grow RT’s market share, or a prelude to axing the product?

Aug 30, 2014 at 11:30AM

Microsoft (NASDAQ:MSFT) just slashed the price of all three models of the RT-powered Surface 2 tablet by $100 in the U.S. The 32GB model now costs $349, the 64GB model costs $449, and the top-tier 64GB LTE variant will run consumers $579.

Those steep discounts tell us that the Surface 2, which was launched last October as the successor to the Surface RT, is probably selling very poorly. The price reductions are scheduled to end on Sept. 27.

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Microsoft's Surface 2. Source: Microsoft.

The Surface 2 has impressive specs -- a 10.6-inch 1080p display, an NVIDIA (NASDAQ:NVDA) Tegra 4 processor, and 2GB of RAM. It can last 10 hours on a single charge. Unfortunately, the tablet runs on Windows RT, an operating system that is neither compatible with older Windows software nor Windows Phone apps. Since last September, Microsoft is the only company that still manufactures RT-based hardware, including the Surface 2 and the Nokia Lumia 2520 tablet.

The question now is whether Microsoft is reducing those prices as a prelude to axing the Surface 2 to focus on the Surface Pro 3, or if it's trying to gain market share by sacrificing margins, as the company briefly did last year with similar price cuts. If it's the latter, then Microsoft is in for a rude awakening -- a $100 discount won't save the Surface 2 at all.

It's still not competitively priced
Microsoft finished 2013 with an anemic 2.1% market share in tablets, according to research firm Gartner. By comparison, Apple (NASDAQ:AAPL) held a 36% share and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) Android devices claimed 61.9%.

The Surface 2 would have stood a better chance in that tough market if it ran a scaled-up version of Windows Phone, which (according to IDC) controls 2.5% of the smartphone market, instead of RT. Unfortunately, a merger of the two operating systems hasn't been announced yet.

Pricing the Surface 2 against Apple's high-end iPad Air instead of cheaper iPads or Android devices was another mistake. The Surface 2's original prices were slightly lower than comparably powered iPad Airs, but the Touch and Type covers -- the defining features of the Surface -- cost an extra $120 to $130.

This means that the cheapest 32GB Surface 2, with the Touch Cover, now costs $469 -- $30 less than the 16GB iPad Air and $130 less than the 32GB version. Unfortunately, that price difference just isn't enough to convince customers to buy a Surface 2 instead of an iPad. Moreover, customers looking for a cheaper iPad can buy the 16GB iPad with Retina display for $399, or a 16GB iPad Mini for $299.

The Surface 2 is also priced poorly against high-end Android tablets such as the NVIDIA Shield. The $299 Shield has a smaller 8-inch screen and only 16GB of storage, but it sports a superior Tegra K1 processor, the same amount of RAM, and battery life comparable to the pricier Surface 2.

Nvidia

NVIDIA's Shield handheld and tablet. Source: NVIDIA.

The only device the Surface 2 is actually priced competitively against is the Surface Pro 3 -- which costs between $799 and $1,949 -- but I doubt Microsoft's intent was to cannibalize its new flagship device.

The identity crisis
That brings us to the next point -- the Surface 2's identity crisis. Microsoft can't decide if it wants the Surface 2 to be a tablet or a laptop.

If it's meant to be a tablet, the device simply doesn't have the developers to support it. The Windows Store -- RT's only source of apps -- has about 170,000 apps, compared to 300,000 for Windows Phone.

Microsoft's new "universal apps" initiative for cross-platform applications across Windows Phone, RT, Windows, and Xbox One, might bring in more apps, but Microsoft's app ecosystem is still dwarfed by Google Play's 1.3 million apps and Apple's 1.2 million iOS apps. While quantity doesn't necessarily beat quality, the Windows Store lacks staple mobile apps such as Instagram, Vine, and Candy Crush Saga. That lack of apps, combined with its poor pricing, make the Surface 2 unattractive as a tablet.

If the Surface 2 is meant to be a laptop, it does not fully compete with standard Windows 8 machines because it can't run older Windows software due to its ARM-based processor. Users can get by with Office 2013 RT or Adobe's Creative Cloud, but plenty of popular Windows software -- like Valve's Steam -- can't be installed on RT.

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The Surface Pro 3. Source: Microsoft.

The Surface 2's identity crisis also hurts the full-featured Surface Pro 3, since the former is often mistakenly considered the cheaper version of the latter. That causes consumers to see the Surface Pro 3 as an overpriced tablet, instead of a full-featured Ultrabook and MacBook Air competitor -- a harmful misconception Microsoft must clarify as the Surface Pro 3 launches in 25 new markets.

A Foolish final word
Microsoft has already taken $1.7 billion in losses on the Surface line since its inception in October 2012. Cutting the Surface 2's price by $100 is a guaranteed way to pile on even more losses.

The discount doesn't accomplish anything -- it's still not priced competitively against iPads and Android tablets, can't compete against tablets nor laptops, and confuses consumers about the Surface Pro 3's capabilities. An RT-powered tablet is just a half-baked idea that everyone, except Microsoft, has turned its back on.

Microsoft doesn't need an independent tablet OS. It needs one that straddles and unites the smartphone, tablet, and phablet markets. The answer to that is a scalable version of Windows Phone that can match Android and iOS' flexibility. Let's hope that the cheaper Surface 2 and RT die out soon so Microsoft can focus more on that strategy.

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Leo Sun owns shares of Apple. The Motley Fool recommends Apple, Google (A shares), Google (C shares), and Nvidia. The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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