Microsoft Surface tablet

Devices + Services? What About Software?

Is Microsoft's devices and services strategy just a pipe dream?

Correctly sensing the shifting tides of the personal computing industry, Microsoft has chosen a questionable path to solve its problems: Rather than doubling down on its biggest strength (i.e., software), the firm has instead declared itself a devices and services company. This move is alienating the company's partners and customers. Is this the wrong direction for Microsoft to take?

I'm hoping to see a transparent and objective assessment of this direction from Microsoft's next leader: Sometime in the next several months, the company will choose a new CEO, a move that will either cement its current strategy—which is actually the direction I expect—or unleash a new wave of change that could see the reversal of Steve Ballmer's biggest-ever bet: Microsoft recast as a devices and services company.

If I were calling the shots in Redmond, I'd call a Mulligan. Smartphones, tablets, PCs, and other electronics devices have no real future. Not at Microsoft, and most certainly not at Amazon, Google, or any other company not named Apple. These devices all have exactly one thing in common: They become commoditized and devalued so quickly that it's almost impossible to make a good business selling them. Again, unless you're Apple.

Ignoring why Apple is different for a moment—this one has been analyzed to death, no?—let's instead examine the devices businesses that Microsoft is desperate to break into.

Living Room

Many cite Xbox as one of Microsoft's big successes—and the company's rare consumer success, no less. But this assessment ignores some harsh realities, key among them that the Xbox business has been running deeply in the red since day one. Thanks to several billion dollars of R&D on each of the three Xbox console generations, Microsoft will never actually break even or earn money on this sink hole. Never.

Of course, many also point to the dedicated cadre of Xbox gamers, as if they represent a sizable or important audience that will bleed goodwill elsewhere. But the Xbox Live service has only 48 million users, a number I feel closely parallels the actual Xbox installed base, a tiny figure compared to 1.5 billion Windows users, 1+ billion Office users, 700 million iOS devices, and over a billion Android devices. And those subscribers? Many—Microsoft won't say how many, tellingly—are just using the freebie subscription, and not the paid version.

This year, Microsoft is launching a $500 Xbox One console that is more expensive than the technically similar Sony PlayStation 4 and an incredible $400 or more expensive than the Roku and other devices that consumers are understandably flocking to for living room entertainment. This is like bringing a nuclear weapon to a knife fight. And it shows that although Microsoft might be serious about the living room, the company is also ignoring the mass market for a small audience that will pay a lot for a premium experience. Even Apple offers a $99 living room option.

PCs and Tablets

If any trend has marked the past decade in personal computing, it's the race to the pricing bottom that started with the netbook and has accelerated thanks to the tablet. What this means is that consumers are no longer buying expensive PCs because they're conditioned to low-cost devices instead. Netbooks. Tablets. Sub-$400 PCs. This is a business that is so price-constrained that the world's biggest PC makers can't even make money selling these devices and must resort to bundling crapware—and thus harming customer relations—in order to turn a tiny profit where possible. The biggest expense on some PCs is the Windows license, which explains why these companies are actually building Chromebooks now, too: Chrome OS is free. The PC business model might be irreparably broken.

Of course, consumers have moved past not buying expensive PCs to just not buying PCs at all. Today's PCs work reliably for longer, and consumers are purchasing companion devices—netbooks at first, but now tablets—that they can use for light duty computing tasks. Which, by the way, is all most of them need anyway.

Naturally, Microsoft had to have a part of this market. So it jumped in feet first with Surface, a device lineup that was so unpopular with consumers that Microsoft took a $900 million write down on hardware inventory at mid-year, just 9 months after the products launched. The problem? Microsoft priced the devices at Apple-like levels. This is a lesson Google, Amazon, and other Android licensees learned long ago: To beat Apple, you have to lower prices. A lot.

This week, Microsoft is back with a second generation of Surface devices, which are mostly modest updates to the original lineup. What bothers me is that the company doesn't seem to have learned anything from the first generation. It's focusing on what it got right, not what it got wrong. And the pricing is still far too high.


Launched 3 years too late, Windows Phone was nonetheless a breath of fresh air, with a modern, superior design that routinely makes Apple mobile releases—even the recently-shipped iOS 7, in some ways—look childish by comparison. But that's only on paper. In the real world, Apple's iPhone is outselling Windows Phone 10 to 1, and Android is collectively destroying the iPhone. So in a world in which Android is number one and Apple almost makes more money than the rest of the industry combined, how can Microsoft compete?

By announcing its plans to purchase Nokia for $7.2 billion. Nokia makes 80 percent of all Windows Phone devices sold to customers, which makes it the biggest fish in a very small pond. Microsoft's plan is to make Nokia's Lumia devices like the smartphone version of its Surface devices. Which of course they are already, in the sense that neither has taken off in any meaningful way with customers.

Not coincidentally, Nokia has seen modest success with—wait for it—low-cost devices like the Lumia 520, which can be had for just $99 without a contract. Compared to the $550 starting price for a no-contract iPhone 5C, this sounds like—and is—a bargain. What do you think the unit sales differential will be between the iPhone 5C and the Lumia 520? Or the revenues? Right. Not even comparable. Apple sold more iPhone 5 handsets—a mix of iPhone 5C and 5S models—in its first weekend (9 million) than all the Lumia handsets Nokia sold in its most-recent quarter (7.2 million).

Now What?

Microsoft is diving head-first into hardware—"devices"—at a time in which these products are becoming commodities and loss leaders. (Again, for everyone but Apple.) That's bad enough, but in doing so, the firm is also ignoring its core strength: software. Microsoft isn't just the world's biggest maker of software—a fact that the company seems curiously embarrassed by these days—it's also the world's best maker of software. Embrace this core strength, Microsoft. Quickly.

Embrace this new (old) strategy by unleashing the software hounds. That means first-rate versions of Office that work on the most popular platforms—Android, iOS, and Windows, in that order—and not limp-noodle Mobile versions. That means making up the difference in declining Windows revenues—Windows is now just Microsoft's third biggest business, behind Office and Server—by spreading your wares aggressively to the hardware endpoints that your customers actually use. And it most certainly means not spinning your wheels, and wasting time and money, on projects like tablets, phones, and video game consoles that will never drive growth. In fact, such ventures only highlight the futility of the current strategy and serve to undercut your reputation.

You'll notice I didn't denounce the services part of devices and services. That's because services are just software that are delivered, managed, and updated more efficiently. And some recent Microsoft efforts such as Windows Azure, Office 365, Windows Intune, SkyDrive, and point very nicely to how successful the firm can be in migrating its traditional software wares to services in the cloud—for both consumers and businesses.

This effort, not devices, is Microsoft's real future. It's the software, stupid.

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