Microsoft Surface: Where does it go from here?

Digging beneath the Surface, here's what the numbers tell us so far, plus why the slowing tablet market might actually be a good thing for Microsoft's tablet.
Written by Steve Ranger, Global News Director
Microsoft's Surface Pro 3 tablet PC still has a mountain to climb. Image: Microsoft

The latest version of Microsoft's tablet PC, the Surface Pro 3, goes on sale in the UK, the rest of Europe, and Asia later this month. While the new model has seen some good reviews, it still has a mountain to climb.

Microsoft built its own tablet at least in part to prove that Windows could live perfectly happily on the slate form factor. But so far the device hasn't made the breakthrough that Microsoft will have hoped for on the sales front.

Gartner calculates that around 600,000 Surface tablets were sold in the first quarter of this year. "In terms of the market that's still very small," said the analyst's research director Ranjit Atwal. "It's struggling to make real inroads in the market."

In contrast, Apple sold 16.3 million iPads over the same period, along with just under three million MacBooks (the Surface is pitched somewhere between the two).

Looking into Microsoft's financial reporting sheds more light on the story. While in its most recent quarterly numbers Microsoft didn't break out the 'cost of revenue' for Surface (which includes the costs of manufacturing and distributing the devices), it has historically cost Microsoft more to build and sell the devices that it made in revenue from them.

In the previous quarter, for example, Microsoft generated $494m in Surface revenue but spent $539m in order to do so — an overall loss of $45m for the line.

Of course, creating, manufacturing, and marketing a new type of computing device takes big bucks, and Microsoft has deep pockets. Spending billions in order to generate demand for a new product format isn't trivial for a technology company, but it's also not that surprising.

What the Surface set out to prove is that there's a new, and so far largely unaddressed, way of using tablets. The launch of successive models has given the concept of the hybrid tablet a boost (at least on Windows 8 if not Windows RT), with a number of hybrid devices being due out this year from Microsoft's hardware partners — companies that have been criticised in the past for a lack of innovation.

If the existence of Surface can help make those partners more ambitious around Windows tablets and hybrids, that's a potentially big benefit for Microsoft because it will boost Windows even if it doesn't show up in its Surface sales figures.

"The market did need someone to go out and show it could be done. Microsoft may be one of the few who could take the losses as well in the near-term whereas the PC vendors really can't, they have to be more certain because of the margins that they work on," Atwal said.

Another issue for Microsoft is that Surface sales — at least according to the available figures — have been largely flat in recent months, after a promising start. Over its last four quarters financial quarters, starting with the most recent, Surface revenue was $409m, $494m, $893m, and $400m. However, it's still something of a step up compared to the previous financial year, when Microsoft said Surface revenue hit $853m in total.

So apart from one bonanza quarter where sales hit $893m, Surface revenue didn't break the $500m barrier in any quarter over the past financial year — making it hard to see any clear momentum behind the device.

There are plenty of reasons for this: confusion around Windows RT put off some buyers of the consumer model of the tablet, Windows 8 put off others, as did the high price of the devices, and not forgetting the strong competition from well-entrenched iPads and Android devices.

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To be a viable long term platform Surface has to start selling millions of the devices, said Atwal. The latest iteration, the Surface Pro 3, has won praise from several quarters, so Microsoft's next set of sales figures will be carefully scrutinised for any signs of growing Surface demand.

Microsoft also faces another complication from the dynamics of the tablet market as a whole. While Microsoft has been finessing Surface, the once white-hot tablet market has been cooling — there just aren't that many first-time buyers out there anymore. So has Microsoft (which has a long history of building tablets) missed the boat again?

Perhaps not – the first big tablet replacement cycle is just kicking off as owners tire of their three- or four-year-old tablets, and that could actually be an unexpectedly good thing for Microsoft. It means that tablet owners have now had long enough to understand what they do and don't like about their devices and the form in general, meaning the Surface's bigger screen and keyboard may find some new fans, especially among those looking to replace a tablet and a laptop around the same time.

Surface won't in itself make or break Microsoft — it's only one small product among many. But if Surface doesn't start building momentum soon, it will send a powerful message to the market — if Microsoft can't build a Windows tablet that people want to buy, then who can?

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