What is Happening? To great fanfare, Microsoft announced its new Surface tablets this week. The demonstrations showed a well-designed piece of hardware that shows tremendous promise to help Microsoft establish and grow a user presence, and therefore ecosystem and revenue presences, in the fastest-growing computing segment today.

The Surface tablets offer a few innovations, including a built-in kickstand and combined keyboard/face cover, along with a solid set of functional capabilities that should be expected in any competitive tablet device today. Pricing has not been set, nor has availability. Given that the tablets will require the widespread availability and use of Windows 8, and that Windows 8 has not been released (and is still building early developer and support ecosystem presence), it’s really up in the air right now as to whether or not the Surface line will succeed. It certainly looks competitive from our point of view. The Surface specs and functional details are outside the scope of this Research Alert.

While most analyst and media reports have positioned Surface as a potential iPad “killer,” Saugatuck sees it quite differently. Microsoft’s Surface line is actually an indicator of the following strategic market shifts:

  1. Microsoft finally acknowledges and is ready to address the slow decline of the traditional PC market as a growth opportunity;
  2. Microsoft sees the need for, and is willing to make, significant yet incremental changes to its own business structure and positioning; and
  3. Microsoft sees its traditional PC partners as unwilling or unable to deliver what Microsoft needs to compete.

At the bottom line, Microsoft is positioning itself as squarely in the workplace/productivity hardware business, competing directly against its Windows hardware partners for a market that has not yet fully emerged.
Why is it Happening? Most obviously, Microsoft needs a way to protect and grow its core operating system business. Without Windows, Microsoft loses its direction, strategy, and core revenue stream. So rather than change its Windows-dependent business model, Microsoft is extending it to include the latest and greatest hardware trend.

This strategic approach is one of limited vertical integration, whereby Microsoft, like Apple, controls the operating system and the hardware design. Microsoft does not, and really cannot, control development of apps and interfaces to the extent that Apple does, mainly because Apple exerts much tighter control over its OS and development ecosystem. But the limited vertical integration approach makes sense for the market reality that Microsoft operates within. And it allows Microsoft to exert significant influence over pricing of, and therefore revenue from, the Surface line.

Underneath everything else, though, what’s driving Microsoft to design, build, and sell its own tablet line is that there is no such thing as a “work” device. This is confirmation of Saugatuck’s Boundary-free Enterprise™ market vision, established in 2008 and more recently laid out in a series of research notes for our subscription clients (“Master Brand Scrambles Spotlight User Shift to “Boundary-free” IT”; “Mobile and Social: Building the Boundary-free Enterprise”). Microsoft sees what Apple and most smartphone makers have discovered: The business and personal computing and consumption worlds are finally melding into a seamless reality of “free-range” Cloud+Mobile+Social adoption, use, and expectations.

Apple’s iPad and AppStore experiences are probably the most visible, and revenue-generating, example of this. With a so-far very limited smartphone market base, Microsoft has lacked a means of emulating the Apple AppStore revenue model (with its built-in 30 percent margins). The Surface tablet line enables a similar type of business model for Microsoft.

Meanwhile, partly because of its developer/AppStore ecosystem, the Apple iPad has slowly been maturing into more of a “work” machine – not a PC-level machine, but increasingly a threat to Microsoft’s office-space OS hegemony. And in a Boundary-free business and IT environment, the improving Apple iOS cross-device integration of UI, apps, data, function, and communication increases the competitive threat to Widows at all levels of IT and business.

Of course, the simple growth in adoption and use of tablet devices offers short-term, mid-term, and long-term revenue growth opportunity for Microsoft as a tablet vendor. While it will not profit immediately from the sale of Surface tablets, Microsoft should be able to develop a massive cash flow that will help to finance growth of the needed, supporting ecosystem of developers that will make Surface more attractive. Its strategy and success with the Xbox indicates an ability to do just that.

For an extended version of this Research Alert, visit Saugatuck Technology.

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