More Thoughts On Microsoft and OEM’s

The guys at ZDNet have a very interesting and insightful article on the Surface announcement. While it rightly points out the key weaknesses of the announcement (no availability date, no pricing, no word on available software, no details on battery life, months before we even see a machine in stores), it also brings up a key point: what does this mean to other PC manufacturers. One possible view: it basically screws them.

Competing With OEMs

To date, Microsoft has avoided competing with OEMs of desktops, laptops and Windows tablets. Microsoft does compete with the likes of Kensington and Logitech when it comes to peripherals, but when it comes to the mainstream machine market, the folks in Redmond have steered clear.

Monday’s announcement has changed that. If the Surface is as wildly successful as the iPad, it will have essentially taken the tablet market away from HP, Dell, Lenovo and other manufacturers hoping to make a Windows 8 tablet. All that will be left is the low-end/low-price/low-margin part of the business, and as in any other consumer electronics product, the big guys want more than the low-margin scraps. Sure, you’ll sell a ton more machines, but the profits are virtually zero in this space. High-end machines allow a great margin and help the overall bottom line. If the Surface sells well enough, then that market could essentially be gone.

Little Room For Meaningful Differentiation

And it isn’t like Microsoft left much room for variations. Better cameras, more ports, different case designs, aren’t going to be the key differentiators here. What it will come down to is either power or battery life, and the Surface has both of those covered. The entry level model is based on ARM, which should give it similar battery life to the iPad. The higher-end model is based on the Core i5, so while battery life won’t be on par with the iPad, it offers far more computing power.

Those two models cover a lot of ground, and all that really leaves for meaningful variation or differentiation is price. And what that really means is that Microsoft may have only left the bottom-end of the market available, and that market won’t be viable for Windows 8 for quite some time. Consider the tablet market as a whole: the cheaper Androids, in particular the Kindle Fire, have done nothing to gain marketshare at the iPad’s expense. The tablet market is still less sensitive to price. Compare that to the smartphone market: until the early adopters and customers that care less about price and more about the rest of the product were cleared out, Android struggled a bit. It had a slow start. But as the market started to mature, having low-priced models became more important, and having a range of models with a range of features and prices became an important factor. Early on, price isn’t a key factor for customers. It becomes important as the market matures.

The tablet market is still very new, and price sensitivity hasn’t become a major factor. Yet. That milestone is probably a year or more away. In the mean time, the goal to success is appealing to the higher-end of the market and some number of early adopters. That means selling premium or near-premium tablets, and from the design and features, the Surface certainly fits the bill. But it’s success could limit the chances of other OEMs getting into the game early, freezing them out until the market expands, and things like price or minor feature differences become important. What that means that companies like HP or Dell, who might have wanted to get into tablets to make up for lost sales in low-end notebooks courtesy of iPad, could be frozen out of the market by Microsoft.

Taking The Best, Leaving The Rest

In short, Microsoft appears to be trying to capture the cream of the market in its early stages, leaving “everything else” to the OEMs. This won’t sit well with the OEMs, because they count on some of the premium market to provide profit margins that offset the minimal to zero margins that exist on entry-level gear. If Microsoft is out taking the good bits of the market, that may not leave much for everyone else.

But won’t the strength of the OEM brands negate that? Perhaps, a little. But what this new tablet has as an advantage is that it is from Microsoft, leading some buyers to believe that it will “work better”. This same effect has helped Intel for years: despite the strength and capability of AMD and their processors, Intel is the “easy choice” because of its long and close relationship with Microsoft, and Intel’s part of the “Wintel” equation. Windows is Intel, and Intel means Windows. Even though AMD processors are perfectly good, people typically choose Intel unless price is the overriding factor. Only when “cheap” is the number one requirement does AMD seem to enter the equation. But when all things are equal, buyers choose Intel in part because it is “safe”.

Microsoft may benefit from this same sort of perception. People know that guys like HP, Dell and Lenovo make good PC’s. But a Windows tablets meant to go head-to-head with iPad is new, and none of the mainstream manufacturers have a history or have built a brand in this area. By buying a Microsoft tablet, people may believe it is “better” because they believe it works better with Microsoft’s software. Whether that is true or not won’t matter. It’s the perception that counts, and not the reality. Perception is the reason a company like Apple is seen as the outright leader in smartphones, even though they only have a bit more than half of Android’s marketshare. Whether a Microsoft tablet is objectively better than something from Lenovo or Toshiba won’t matter if enough people believe it is better.

A Slap In The Face

The Surface is also, in some ways, a slap in the face of the OEMs. The unspoken message is that Microsoft doesn’t believe that the OEMs are capable of building the “right” tablet, or a “good” tablet, so they had to go ahead and do one of their own. Again, whether that is true, and whether that is the intent, doesn’t matter. Up until the Surface, Microsoft put all their faith and support behind the OEMs to build hardware that will show Windows in a good light. They relied on the industrial design capabilities of companies like HP and Lenovo to make Microsoft software look good.

This new tablet, whether Microsoft likes it or not, sends a message: we can do a better job that you guys. This isn’t a prototype or proof of concept. These aren’t reference designs, like the ones Intel created for ultrabooks. It isn’t an example of what tablets could look like, and a guide for what Microsoft would like the end products to look like. These are the real deal. They are hardware you can buy (eventually) with Microsoft’s name and brand as part of the package. It looks like an expression of Microsoft’s lack of faith in the OEMs to build a product that showcases Windows 8 on tablets.

So, Was The Surface A Mistake?

Whether this approach works for Microsoft will be demonstrated in 6 or so months, after the Surface goes on sale and we get to see consumer reaction in the form of actual sales. If this thing takes off, and the potential certainly is there, then this will vindicate Microsoft and their entry into the end-user hardware business. If it flops, it could mean opportunity for the OEMs (because the flop may be due to the hardware, not the software). On the other hand, a tepid reaction could make it harder for the other guys, because it could be the software and not the hardware that is the problem. Android tablet sales aren’t moribund because of issues with hardware design or hardware features. It is the software and ecosystem that appear to be holding it back.

Unfortunately, this a drama that won’t start to play out until sometime later this year. In the mean time, Microsoft still has to deal with all of the other issues they’ve made for themselves. One is a potential backlash from the media. The juiciest quote from ZDNet was rather damning:

“You made journalists schlep across the country, no, the planet, for a product that might not ship for months? You’re lucky they didn’t burn the venue down.”

If the rest of the media world reacts this way, that doesn’t bode well for Microsoft. Having friends to help your cause is good. Alienating those that report on your products is not good. Doing that, plus pushing aside the OEMs that helped get you where you are today may also prove to be a bad idea. Even if it is a truly amazing product, it may not matter if people are turned off before they even look at the thing. Early indications are that the actual machines are quite impressive. But impressive alone may not help, and it may not be enough to unseat the leader, the iPad. Being better on hardware specs doesn’t matter. People don’t buy hardware specs. If they did, the iPod would never have completely dominated the MP3 player space. Linux would be a bigger deal on the desktop. The Lumia would be chewing up the smartphone sales charts.

Microsoft appears to have done a bang-up job on the hardware. But their far-too-early announcement, and their potential alienation of OEMs may have both short and long-term repercussions. They have to hope this thing sells in serious numbers. Because one way or the other, they may have pushed OEMs enough to look at alternative platforms a bit more seriously.

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