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Is Microsoft Corporation About to Pull the Plug on Surface?

By Ashraf Eassa – Oct 12, 2014 at 2:37PM

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Digitimes claims that Microsoft is about to pull the plug on Surface due to poor Surface Pro 3 sales.

According to DigiTimes, Microsoft's (MSFT 0.07%) Surface Pro 3 tablet isn't selling all that well. In fact, the Taiwanese newspaper believes that the sales are so far below expectations that the company is considering pulling the plug on the product family altogether.

While this is just a rumor, it's worth taking a closer look to see whether it would actually make sense for Microsoft to put an end to its Surface tablet product lineup.

What exactly is the Surface Pro 3 trying to be?
For those of you unfamiliar with the device, the Surface Pro 3 is a tablet/laptop hybrid designed and built by Microsoft that runs Windows 8.1 Pro. It comes powered with an Intel (INTC -6.41%) Core processor (low power Core i3, i5, or i7), is configurable with up to 512 gigabytes of storage and 8 gigabytes of RAM, and ranges in price from $799 to $1,949.

It's essentially a tablet that sells at a midrange to high-end PC price point.

While the reviews of the device have generally been positive, it's not a surprise that it's reportedly not selling all that well.

Tablet trends don't favor expensive
Generally speaking, Apple (AAPL 1.37%) is regarded as the premier premium-tablet vendor. However, even the company's powerful brand and, arguably, best-in-class products haven't been enough to halt the two-quarter year-over-year decline in iPad unit shipments.

Keep in mind, too, that Apple's iPad average selling price last quarter was $444 and $465 in the quarter before that.

Further, while the tablet market as a whole is still growing (likely in the low-cost portions of the market, though), IDC recently brought down its worldwide tablet unit growth estimates to just 6.5%, down from prior expectations of 12.1%.

"But wait," one might conceivably ask, "isn't the Surface Pro 3 really more like a PC?"

PC buyers aren't exactly big spenders, either
The Guardian reported in an article published earlier this year that PC average selling prices were approximately $544.30 in the third quarter of 2013. Note that this average includes Apple's Macs, which routinely enjoy average selling prices of above $1,200.

This implies that Windows PC average selling prices are actually quite a bit lower than the $544.30 overall PC selling price.

Further, I would imagine that customers that spend over $1,000 on non-Mac PCs are buying them for a more specific purpose such as gaming (where fully loaded gaming desktops and laptops can run north of $2,000).

So, Microsoft is essentially trying to sell a hybrid Windows PC/tablet into either a tablet market that doesn't really support devices at the Surface Pro 3's price point or it's trying to sell a Windows PC into a market that doesn't exactly want PCs at the Surface Pro 3's price point.

It's not a surprise, then, that the Surface Pro 3 is, according to DigiTimes, on track to sell fewer than 1 million units during its lifetime.

Adding competition to the mix
Finally, it's not as though Microsoft has a monopoly on devices like the Surface Pro 3. There are plenty of two-in-one convertible designs based on Microsoft's Windows 8.1 and Intel Core processors available from many PC OEMs.

Further, as the PC ecosystem rolls out convertible and/or detachable PCs based on Intel's Core M, Microsoft's Surface Pro 3 will be at a significant disadvantage. Not only is it expensive, but unlike the Core M products, has fans and is fairly bulky.

Examples of products that, in my view, could be much more compelling two-in-one Windows-based offerings include the ASUS T300 Chi and the Lenovo Thinkpad Helix.

Foolish bottom line
Microsoft is flush with cash and generates a tremendous amount of cash flow, so any losses that it incurs in continuing to develop its Surface strategy are unlikely to be all that meaningful overall.

However, in light of the discussion above, it's hard to see a good business case for Microsoft to continue to try to play in what will ultimately be low-margin, commodity Windows PCs. It should instead focus on really rocking Windows 10 and working with its OEM partners to make sure that Windows 10 systems of all form factors are compelling.

Ashraf Eassa owns shares of Intel. The Motley Fool recommends Apple and Intel. The Motley Fool owns shares of Apple, Intel, and Microsoft. 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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