How Microsoft Does and Doesn't Care About Hardware

Image source: Microsoft.

Believe it or not, but Microsoft's (MSFT -1.27%) hardware strategy is actually something of a paradox right now. There are ways that Microsoft cares very deeply about hardware, but in other ways it continues to detach its business from hardware. It's a fine line that Microsoft hopes to walk going forward, but so far the company is executing quite well on this vision.

Microsoft cares about hardware
The software giant's hardware strategy has really taken off in recent years following the introduction of the first Surface tablet in 2012. In no uncertain terms, Microsoft's jump into first-party hardware was directly catalyzed by Apple (AAPL -1.22%). After seeing how successful the Mac maker has been making devices with integrated hardware and software, Microsoft is acknowledging the viability of this strategy by doing the same thing. Although Microsoft must also balance these ambitions with the interests of its many OEM partners.

And Microsoft's marketing of its own devices has made it quite clear that it is trying to compete directly with Apple. In just about every ad, Microsoft compares its devices to MacBook Airs or iPads. And judging by recent positive reviews of the forthcoming Surface Book, Microsoft is really devoting an Apple-esque level of focus on industrial design.

Microsoft is also devoted to its phone hardware strategy, despite the massive $7.6 billion writedown that it ate earlier this year. It's not an exaggeration to say that Microsoft now makes more hardware than it ever has before.

Microsoft doesn't care about hardware
All the while, Microsoft continues to transition its core fundamental business model away from hardware reliance. This is true for both Windows 10 and the Xbox. The PC market has been stagnating for many years, and Microsoft has been working for a long time on delinking Windows and Office from new PC sales and upgrades.

Microsoft has fully embraced the whole Windows-as-a-Service revenue model. Just look at the language in the most recent 10-Q: "We launched Windows 10 as a service." By offering Windows 10 upgrades for free for the first year, Microsoft is simply trying to get the new operating system on as many PCs as possible. This is a response to Alphabet (GOOG -1.10%) (GOOGL -1.23%) offering all of its operating system platforms for free as well. Apple's free OS X upgrades add a little more pressure, too. The days of selling operating systems are fading -- fast.

The good news is that this is already working. Roughly three months after launch, the Windows 10 install base has already soared to 110 million devices. That adoption curve utterly crushes the disaster that was Windows 8. Heck, Windows 10 is even outpacing Windows 7, with three times the upgrade activity in the first 10 weeks.

Meanwhile in the Xbox business, Microsoft is changing how it reports its results. Tellingly, Microsoft neither disclosed how many Xbox One units it shipped during the quarter nor does it intend to going forward. This indicates a shift in its priorities. Instead, Microsoft is focusing on Xbox Live subscriptions. Xbox Live monthly active users grew 28% last quarter and now stand at 39 million, and Xbox Live Gold members pay $60 per year for the service. Gaming consoles have notoriously high component costs in the early years, with manufacturers often absorbing losses until the cost curves come down, underscoring the importance of subscription services. Xbox One and Xbox 360 are now merely delivery vectors for Xbox Live.

Windows 10 is less about selling new OS licenses and PCs than ever before (although it still charges OEMs for Windows 10 licenses), and Xbox is less about selling consoles than ever before. The game has changed: Everything is now about monetizing users through a wide array of other methods, including advertising, cloud services, and subscription gaming services.