I expect there are a lot of high-fives in Redmond these days as Microsoft (MSFT) celebrates glowing reviews for its new Surface Book.
MSFT is finally taking some of the spotlight off Apple’s (AAPL) extremely successful line of MacBook, MacBook Air and MacBook Pro notebooks.
The Surface Book is being called one of the best laptops on the market and a showcase for what Windows 10 can do.
After years of watching PC makers flail and fail in an attempt to duplicate Apple’s portable PC success, MSFT has co-opted the strategy used by Alphabet’s (GOOG, GOOGL) Google. It’s designing and selling a showcase device itself that illustrates just how good the Windows 10 laptop experience can be.
Like Google’s Nexus 6P smartphone does for Android, the Surface Book is getting plenty of media attention, it’s helping to promote Windows 10 and at the end of the day, it stands a decent chance of stealing some computing customers back from Apple.
MSFT Must Be Cautious
However, MSFT has a delicate balancing act to maintain. It’s charging original equipment manufacturers, or OEMs — companies like Hewlett-Packard (HPQ) and Dell — a fee to install Windows 10 on their own laptops, and that license is a big contributor to Microsoft’s bottom line.
In its fiscal year 2015 earnings wrap, MSFT reported $14.97 billion in revenue for its Devices and Consumer Licensing division. Much of that is the OEM Windows license fees PC manufacturers pay for when they sell a new computer. This represents a considerable chunk of Microsoft’s revenue. As a high-margin line of business, the $13.87 billion in profit represents 23% of MSFT’s total earnings for the year.
The spotlight on the Surface Book may well have the desired halo effect on overall sales of Windows 10-equipped laptops, but Microsoft’s strategy could also backfire. If the company is seen not as a promoter of the platform, but a direct competitor against its own OEMs — and one that has the key advantage of controlling the operating system and its features — that could result in hardware manufacturers reducing their own PC efforts in the face of what they perceive as unfair competition.
Re/code reported that the chairman of Asus, for one, was less than impressed by Microsoft’s move to selling its own laptop, saying “I think we are going to have a serious talk about that.”
Many MSFT OEM’s — including HP, ASUS and Dell — have already been kicking the tires with Chromebooks. With average PC profit margins sliding to less than $15 per box and the fee Microsoft charges to license Windows, being able to sell a laptop with an operating system they can install for free already has to be tempting.
When Microsoft released the first Surface tablets in 2012, Windows-powered tablets and the 2-in-1 laptop category barely existed.
Despite the fact that the Surface and Surface Pro marked the first time MSFT was actually designing and building its own PC hardware, the move wasn’t seen as a competitive threat so much as a proof of concept that helped to kick off those product categories.
The Surface helped to spur innovation and open new markets for Windows PC makers, but the Surface Book isn’t a new category — it’s MSFT schooling its OEMs on how to do a laptop right. And that’s a different story.
Instead of opening up a new product category for these OEMs to sell in, MSFT is pushing hard with one of the best laptops around; one that’s likely to eat into their premium (high margin) laptop sales, while making their offerings look second rate in comparison.
If the strategy backfires, the number of different Windows laptops for consumers to choose from (a key Windows advantage) could shrink. The Windows license revenue from OEM hardware partners could also begin to dry up.
In a worst-case scenario, Microsoft could find itself in the same position as Apple — being both the developer of the operating system and the sole manufacturer of laptops that run it.
I don’t think Microsoft wants that.
Bottom Line
It will be interesting to see how MSFT proceeds with its PC hardware strategy. If it’s able to keep the script close to Google’s Android approach, the Surface Book could succeed in being the showcase that helps to boost overall demand for notebooks running Windows 10.
If the company isn’t careful, though, buyers may leap to the conclusion the best laptops are from Microsoft, alienating its OEM PC partners, cutting into Windows licensing revenue and putting pressure on MSFT to ramp up production and offer a full line of Windows 10 laptops.
As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.
