More Surface Devices (Part 1)

I listened in on Microsoft’s Q2 conference call, and when I started seeing articles about what was said regarding lower priced Windows 8 devices I really started scratching my head.  It seemed to me that reporters and bloggers were trying to read what they wanted to hear into what was said, rather than taking what was said at face value.  Before I get into my own take on this here is the exact exchange as taken from the conference call transcript:

PHILLIP WINSLOW, Credit Suisse:  Hi.  Thanks guys and congrats on a good quarter in a pretty tough macro environment.

I just want to spend a moment on Surface.  You obviously talked about ramping up production and distribution of that.  Just what are some of your goals as you look at Surface RT and Pro for this year?  And within that context how should we think about the profitability of the Surfaces?  Thanks.

PETER KLEIN:  Thanks, Phil.  As we said, we think of Surface as one part of the overall Windows 8 story.  Certainly this quarter it was a contributing factor to the revenue growth in the Windows business.  And what it does is it sort of highlights some interesting innovation that can happen to sort of demonstrate the power of Windows 8 when tightly integrated with hardware and software and some new categories of devices.  And we’ve obviously had some limited distribution this quarter in our stores and as you know we’re excited about expanding that.  So, you know our goal is to continue to build that business, to highlight the incredible power of Windows 8 in an interesting set of devices.  We’re going to expand geographically.  We’re going to expand the product lineup.  We’re going to expand retail distribution and capacity.  So, we look forward to sort of continuing the growth of that business.

WALTER PRITCHARD, Citi:  Hi, thanks.  I’m just wondering, Peter, if you could talk about, obviously one of the big differences here between your devices in the market and some of the competing devices, I think the price point of touch machines, Windows devices are much higher?  And I’m wondering if you could just talk about what you’ve learned here in the first three or four months of the Windows launch, how important price is to the customer base in terms of driving units and what do you think the outlook is in terms of getting price points down the devices in aggregate, in order to potentially drive some demand?

PETER KLEIN:  Thanks, Walter.  We learned a lot this quarter.  We learned a lot about the types of experiences and scenarios and to some extent the price points customers are looking for from their devices.  We saw some really great demand for some of the touch devices that we’ve brought to market.  In some cases we didn’t have the supply that we needed to satisfy that demand.  I think from a price point we learned I think what we’ve always suspected, which is there’s segmentation and differentiation.  One of the powers of the Windows ecosystem, obviously, is the variety of devices and form factors and experiences at a variety of price points.

And I think we learned that that continues to be important.  And as I said, we’re working very closely with both our chip partners, as well as the OEMs, to bring the right mix of devices, which means, to your point, the right set of touch devices at the right price point, depending on the unique needs of the individual.  I think we learned a lot about that and one of the things you’ll see is a greater variety of devices at a bigger variety of price points that kind of meet the differentiated needs of our consumers.

Somehow these two answers to two different questions got sploshed together in many people’s interpretation of the conference call results.  In one case this got interpreted as Microsoft working with OEMs to produce more Surface devices.  I can’t see that being implied in any way in these exchanges.  In others it was reported that Microsoft said they’d be producing a lower cost (Surface) device, which while a perfectly good assumption was never actually said or implied.  Others read into this that Microsoft was going to leave the lower price points to OEMs, something else that you really can’t take away from what was actually said.

Peter said two independent though not unrelated things.  First he acknowledged that there would be further expansion of Microsoft’s own family of devices that highlight Windows 8-related innovation.  And then he talked about working with partners to hit the
“right set of touch devices at the right price point”, where partners are the chip partners and OEMs.  But that was part of the response to the second question, not the first.  Microsoft certainly is working with OEMs to get the OEMs to offer the right set of devices and the right price points.  The are also working with chip partners to make sure that chip sets suitable for all the price points are available.  But nowhere did he say or imply that Microsoft was working with OEMs to create Surface devices nor that Microsoft itself was going to address all the price points.

Having lower cost chip sets that meet the Windows 8 and Windows RT requirements is something needed by Microsoft’s OEMs if they are to address lower price points.  And they are something needed by Microsoft should it choose to address lower price points with a member of the Surface family.

Microsoft’s approach with the Surface is not to try to cover the spectrum of devices that customers might want and that OEMs already address.  They are very specifically looking for areas where they can identify scenarios and user requirements that are going unmet by both competitors and the OEM community.  Scenarios that Microsoft sees as being uniquely addressable by Windows 8 and the rest of their software.

The Surface is optimized for users who primarily want a tablet, but need to do enough content creation that they find the iPad and other tablets frustratingly insufficient.  The OEMs are addressing this segment with devices where you need to decide in advance if you might be doing content creation, and if so turn the tablet into a clamshell notebook that you carry around with you.  Microsoft addressed this by having a tablet with a cover that gives you a keyboard and trackpad “for free”.  The Surface is optimized for unique scenarios in other ways.  The rear camera, for example, isn’t for taking pictures so much as for conferencing.

The Surface Pro is optimized for users who primarily need a notebook, but don’t want to carry both a notebook and a tablet around with them.  OEMs address this, again, by having clamshell notebooks that allow you to convert to tablet usage or by detaching the tablet when you don’t need the keyboard.  But again you are carrying around a clamshell notebook rather than a tablet unless, in the case of detachable devices, you know you won’t need the keyboard and leave it behind.  Microsoft went for a design that would allow you to have a good, but not great, keyboard with you at all times without the size and weight penalty of clamshells.

If you really want a pure tablet and don’t care about having a keyboard always at your beck and call, the ASUS VivoTab RT is a better tablet optimization than the Surface.  If you really want a notebook with touch support, or that can be used as a tablet on occasion, then numerous really cool offerings are available from the OEM community.  Offerings that may be far more optimized for your usage pattern than the Surface Pro.

So what can we expect from future devices in the Surface family?  I’ll save speculating on device specifics for Part 2, but one thing we can be sure of is that they won’t be “me too” devices.  Microsoft will choose areas where it believes it can address user requirements that are going unmet by both competitors and its OEMs.

 

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15 Responses to More Surface Devices (Part 1)

  1. Ira says:

    Is it any wonder reporters were confused? Truly cobbeldygook answers to simple questions.

    • halberenson says:

      Ira, it’s the usual financial people answers to financial analyst questions

    • Info Dave says:

      Thanks for breaking the ice, Ira. I read all this and didn’t have a clue what to make of it, but didn’t have the courage to admit ignorance.

      I find it interesting that Microsoft is getting into the hardware business just when I read that Apple and Samsung think that the future profits are in software. No wonder I’m confused.

      I’m drawn to the statements that Microsoft is looking to its chip partners for price concessions. That’s a level playing field, unless you’re talking quantity discount, or, you’re Apple. Apple is now designing their own ARM chips. Apple in taking vertical integration to a new level by design its own chips. Only Samsung can compete with this.

      Microsoft is vertically integrating to the software + device + service concept, while once again, Apple is skating to where the puck is going to be.

    • Info Dave says:

      Thanks for breaking the ice, Ira. I read all this and didn’t have a clue what to make of it, but didn’t have the courage to admit ignorance.

      I find it interesting that Microsoft is getting into the hardware business just when I read that Apple and Samsung think that the future profits are in software. No wonder I’m confused.

      I’m drawn to the statements that Microsoft is looking to its chip partners for price concessions. That’s a level playing field, unless you’re talking quantity discount, or, you’re Apple. Apple is now designing their own ARM chips. Apple in taking vertical integration to a new level by design its own chips. Only Samsung can compete with this.

      Microsoft is vertically integrating to the software + device + service concept, while once again, Apple is skating to where the puck is going to be.

  2. there was a third reference to low price points later; “the kinds of touch devices at the right price points that consumers want”. For me it’s not that he even implied a lower-cost Surface, it’s that he so clearly showed that low price is a priority for Microsoft for 8/RT that it seems entirely logical that expanding the Surface family would go in that direction – especially as the 7″ space is where there is a huge hole in the Microsoft lineup. Kindle, Kindle Fire, iPad Mini, Nexus 7 – nothing from Microsoft or any Microsoft partner. If Microsoft actually means it about being a “devices and services” company, that’s a hole they should want to fill themselves.

  3. I very much agree with your take on it, Hal. In fact, ever since the first Surface announcement I keep getting this interpretation from the overall MS comments as a new “family” of hardware + software. In this day and age, to me that means Surface will eventually consist of 5 different products:

    Surface WP8
    Surface 7″
    Surface RT
    Surface Pro
    Surface Laptop
    Surface All-In-One desktop

    Such a family of well built, high-quality, pure Windows devices would create a strong, focused line-up that would cover everything MS needs. What I don’t know is how they would differentiate their devices, as you said, addressing those user requirements that have been unmet so far. I can see the 7″ as an Xbox focused device, the RT as what it is now (strong consumption, light creation), the Pro as you described it, the laptop as MS’s take on the Ultrabook (emphasis on “take”, as in not a me-too but addressing a consumer need that I can’t imagine right now) and the AIO as, well, an excellent touch desktop that doesn’t suck like the Dells and HPs of the world.

    If anything, I keep thinking of Steve Jobs and his philosophy of, if a person has never seen something how would they ever know they want it? I find it exciting that MS is adopting this very philosophy, not just copying but doing their own thing according to what they think is missing in the market. Just look at the Surface RT: as an employee in an academic institution, nobody has met my needs better than MS; a lightweight but capable hybrid that allows me to use full-featured internet browser and the Office that I need (Word, Excel, Powerpoint). All that without the weight and awful build quality that I see in competitors.

    I think MS is on the right track and while much of the media is too focused on analyzing sales figures right now, they’re not seeing what’s actually happening: MS is innovating and many people will only realize this 3-5 years down the road, once we have all these Surface products that cover our needs better than any prior products ever did.

  4. WaltFrench says:

    Peter Klein said, “we’re working very closely with both our chip partners, as well as the OEMs, to bring the right mix of devices…at the right price point” and @Hal noted, “lower cost chip sets that meet the Windows 8 and Windows RT requirements is something needed by Microsoft’s OEMs.”

    This is curious. RT tablets compete against many tablets; with the exception of the iPad, those tablets use off-the-shelf chips from any of a large number of CPU providers. The SWAG price for a CPU is somewhere around $15; while the bill for NAND Flash and RAM chips might be a bit more, this is a huge competitive market, where Microsoft and its OEMs together are neither too small to get a decent off-the-shelf quote, nor so big that they need special accommodation.

    So it’s not clear how any huge efforts by Microsoft would affect the selling price of Surface RT or potential OEM products by more than a couple of dollars; a potential revenue impact to the all the manufacturers combined of maybe $2million. Yet Microsoft called it out in a quarterly call amongst tens of billions.

    The impact of CPU prices on the Pro is rather more; I’ll leave it to others to document/SWAG. But as you note, the Pro is more in competition with traditional laptops, which OEMs have for years sold at prices well below the Pro’s. Again, it’s not clear why touchscreen devices are impacted by “chip” prices against the stated competition. More likely, many people are comparing the Pro not against laptops but against iPad type pricing, and not seeing that the built-in laptop-class capability of the Pro is worth the combined price of a Windows laptop plus an iPad.

    Net-net, if Microsoft and its OEMs are really cost-constrained on innovative Windows8 devices, it’s not due to chip prices but the product definition, the hybrid design, not meeting people’s needs enough to cover the ordinary costs+profits.

    • dafowler says:

      I agree with most of what you say but I’d point out that buying a Windows 8 tablet is a different buying proposal than buying an iPad in that it is a PC and not just a modern tablet

    • halberenson says:

      It is either less curious than you note or less relevant that its mention deserves.

      In the 10.1″ space the Surface (32GB $499) is priced right on target with competitors such as the iPad (16GB $499, 32GB $599) and Samsung Note 10.1 (16GB $499, 32GB $549). So it isn’t that Microsoft is expensive, it is that they aren’t cheaper than the competition. There are a few reasons Microsoft would not have wanted to, nor should have wanted to, compete on price with that device. But that won’t stop people from believing that Microsoft should have tried to buy market share.

      When we get into the 7-8″ class devices things get more interesting. Currently those devices generally are living at the $199 price point through heavy subsidization (in other words, a razor + blades model) or through less than bleeding edge componentry. The iPad Mini is at $329 for the 16GB model and $429 for the 32GB model. This is arguably the right (where right means you can still make money from device sales) price point for an unsubsidized first tier componentry 7-8″ tablet. And note the rather modest price difference between the 32GB iPad Mini and the 32GB Surface.

      But the game changes further when you take ARM out of the picture, as with the Ainol Novo 7. This is an unsubsidized 7″ tablet using a non-ARM chipset designed by MIPS. Nothing about it screams bleeding edge, but it demonstrates what happens when the silicon guys focus on SoCs for low-cost instead of pursuing the ever increasing performance track. Right now the ARM licensees are following the historical Intel model of using Moore’s Law to push performance ever higher while maintaining or increasing the prices for their chips. “More Cores, More Clock”. I had a discussion with a MIPS executive who pointed out that the ARM guys just were never going to push on cost, and so if you want low cost you need to go with MIPS. A self-serving comment obviously, but one where the empirical evidence supports his assertion.

      TI was an ARM licensee who was paying attention to cost (and it shows in the updated Kindle Fire vs Nexus 7 teardowns where the TI processor Amazon uses costs $6.50 less than the Tegra 3 in the Nexus) but is now exiting the business.

      So one way to read Microsoft’s comments on working with chip-set partners is that they could be encouraging them to produce constant performance/lower cost offerings in addition to their current push for higher performance. This would be one of a number of steps that would help Microsoft, its OEMs, and even Android tablet makers offer lower cost tablets without (or obviously in addition to) the need for subsidies.

      I should also point out that we aren’t necessarily talking about just lowering the cost of the SoC, we could be talking about integrating more functions in to them and improving some Windows-specific capabilities. And we could be talking about other silicon beyond the SoC. Better DirectX support is an example of something that would benefit Windows but not Android. Lowering the cost of radios and sensors is an example of something Microsoft could be talking about that would benefit everyone. Providing silicon support for new capabilities (e.g., Kinect-like capabilities) that may be unique to Microsoft is yet a third example.

      Yet another part of this is likely continuing to pressu…I mean work with Intel on making Atom more competitive so that Windows 8 and not just Windows RT can run at lower price points.

      So perhaps the point about working with chip partners is gaining too much focus. Microsoft could compete at iPad Mini price points without a subsidy, and at Kindle Fire price points with a subsidy, without the need for major changes in what the chip vendors are doing. But working with the chip vendors to produce silicon more tuned to what Microsoft and the OEMs want to build can yield much better results over the long term.

      • WaltFrench says:

        @halberenson wrote, “perhaps the point about working with chip partners is gaining too much focus.”

        Which was pretty much my point: the reality is that Microsoft is not in a position to dictate silicon features that’d allow Windows apps (ARM or X86) to shine. Intel has spent the last few decades tuning X86 for Windows (what could Microsoft tell Intel that they don’t already know?), but it’s not clear that RT will ever sell enough that they’ll have any leverage to even SUGGEST a different path.

        Your point about TI is good. Allow me to add what I think is a relevant one about nVidia. The company continues to sink a LOT of money into Tegra, and to my eyes much of it has been wasted due to some unfortunate feature choices. Tegra2 featured units practically dedicated to running Flash efficiently. nVidia engineers noted a popular function that ran poorly on competitive products, but the business people failed to get commitments from Adobe that decent Flash software would be available for the specifically-tuned CPU/GPUs. And in part because of that, the Xoom bombed, taking down Tegra’s best shot at fame with it.

        I don’t know how much money nVidia sunk into Flash- and tablet gaming-oriented features, nor how much incremental business they got from it. But it smells like Adobe’s fulfilling Steve Jobs’s sneering expectations to a tee, cost nVidia a boatload. The failure on the client end is so bad that nVidia has announced it’s going to manufacture its own white-label boxes, to try to get ANY sales for chips that they sunk so much into.

        High-performance gaming on Android tablets is still in the starting blocks because competitively-priced phones can’t afford premium GPUs. If, like Apple, you control enough of the market, you can afford to tailor chips and work with the game developers to get the best results. nVidia’s approach might work.

        But if, like Microsoft, your best chance at critical mass is to leverage Enterprise apps and/or games that require the upper range of X86-class chips, you are not going to get ARM chip manufacturers to tune for you—not graphics, not 3D, not proprietary audio or video formats. The End of Silverlight is recognition of the fact that the #3 entrant into mobile can’t dictate what you’re calling for. Not until Microsoft shows that it’s gotten a toehold in the ARM market, and can credibly claim that RT will generate millions of tablet sales. Until then, please see the Nice in Concept Dept., just down the hall from We’ve Been There Before.

  5. dafowler says:

    I think last year and this year will mark the end of the PC market as we know it. OEMs have for a while now been moving towards other platforms (Android, Ubuntu, Chrome, and WebOS) and seem determined to bring Microsoft to heel. I think it is smart for Microsoft to start now and build up a hardware presence as OEMs try to learn to serve two masters

    • halberenson says:

      So far the OEMs only toy with other operating systems. Often, as has been the case with Dell, they make a big splash and then back off dramatically from those other OSes. Or you can be like HP and almost tank the company by trying to focus on another OS. But in general I agree that they no longer are totally beholden to Microsoft and Microsoft can no longer trust them to put their best ideas and efforts into Windows devices.

      • WaltFrench says:

        Companies will put another dollar into engineering for Windows if it gets them an extra penny of profit (net of the dollar). For the past few years, the sad story is that you’re better of cutting a dollar of engineering because it only reduces 99¢ of revenue, so you increase your profit that way.

        Today, there are some interesting opportunities in Windows, but they require a LOT of dollars up front, and the history has been that those dollars are ill-spent. Much better for OEMs to sink just a few dollars into a generic Chromebook, which will generate some press, and the unknown is mostly skewed to the upside. This trend has now gathered a fair amount of steam; Microsoft will find itself competing against ultra-cheap X86 and ARM laptops for desktop functions, and against highly-tuned (nonfat) tablets from Apple. (I can’t quite imagine a buyer choosing between a Kindle, or Playbook, and a Surface Pro.)

        I don’t think it’s helpful for Microsoft to pretend that its challenges are different than they are. They have a low-end rival on the desktop/laptop in Chromebook that’ll be nibbling away in typical Disruptive Technology fashion. They have the surprising juggernaut of Apple in Mobile, a now-well-established disruptor. Microsoft has very few incentives to offer OEMs for why to move to a new, untested and low-volume alternative, so we can expect them to milk the old cow for what they can get, and expect them to hope they’ll figure out a new model over the many years before the old cow dies.

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