It took a few iterations, but Microsoft's (NASDAQ:MSFT) Surface business can safely be called a success. During Microsoft's fiscal fourth quarter, Surface generated $888 million in sales, and the back-to-school and holiday seasons should help drive Surface revenue even higher. While its phone business is struggling, Microsoft has found a niche with its Surface tablets.
During an event earlier this month, Microsoft unveiled the Surface Pro 4, an update that was widely expected. What wasn't expected, though, was the Surface Book, Microsoft's first foray into building an honest-to-goodness laptop. The Surface Book has a detachable screen, but the keyboard acts as an actual dock, making it a laptop that's also a tablet, instead of a tablet that's also a laptop.
Initial impressions of the device were generally very positive, but this addition to the Surface family raises some important questions. Is Microsoft becoming a competitor to the OEMs that manufacture Windows PCs? And if so, can it still be an effective partner, licensing Windows while simultaneously selling its own devices?
Walking a fine line
It's important that Microsoft doesn't upset the companies that manufacture PCs. The success of Windows 10 ultimately depends on the devices coming from these OEMs, and moving too far toward Apple's business model of controlling both the hardware and the software could jeopardize Microsoft's Windows licensing business. Microsoft apparently didn't tell any of its PC partners about the Surface Book before it launched, leaving them just as surprised as everyone else.
I don't believe that Microsoft has any intention of becoming a mass-market PC manufacturer. The PC business is rough, and margins are extremely low. Hewlett-Packard, for example, managed a pre-tax profit margin of just 3% selling PCs in its last reported quarter. As has been true in the past, licensing Windows is a far more lucrative endeavor.
All of Microsoft's Surface devices aim at the high end of the market, where there's both a good chance of generating meaningful profits and minimal competition from other Windows devices. Even the cheapest Surface device, the Surface 3, is priced at $629 with the keyboard attachment, while the T100 Chi, a 2-in-1 device from Asus that provides mostly similar performance, is about half that price.
The Surface 3 provides a well-defined alternative to the iPad, standing out among the sea of Windows and Android devices. In this way, the Surface 3 strengthens the Windows ecosystem by introducing customers to Windows tablets. The Surface Book, which starts at $1,499 and goes all the way up to $2,699, is a direct competitor to the MacBook Pro, with the potential to bring customers back to Windows.
Because the Surface Book is so expensive, it doesn't really compete all that much with devices from OEMs. A customer who has already decided to buy a Windows laptop would get more bang for their buck going with a comparable model from HP or Dell, likely saving a few hundred dollars. But for someone considering a MacBook Pro, the Surface Book provides a well-defined alternative. Instead of the decision being between a MacBook Pro and a slew of devices with various specs and prices from multiple manufacturers, the choice is now between a MacBook Pro and the Surface Book, the best that Windows has to offer.
The Surface Book has the potential to draw users back to Windows, and that benefits all PC manufacturers. The price is high enough that OEMs shouldn't feel all that pressured by Microsoft's new laptop, and I suspect that the benefits of the Surface Book, strengthening Windows, will ultimately outweigh any negative effects from the additional competition.
Microsoft is walking a fine line with its Surface devices, and making them too mainstream could backfire. But I believe that the company can have its cake and eat it too, at least to a degree. As long as Surface devices remain targeted at the high-end of the market, aimed at competing directly with Apple's expensive products, Microsoft's Surface strategy shouldn't disrupt the company's relationships with OEMs.
Timothy Green has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of 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.