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.
Daniel Kline is long Apple and Microsoft. He owns an original Surface and likes it a lot. The Motley Fool recommends Apple and Google (C shares). The Motley Fool owns shares of Apple, 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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