Microsoft's Ballmer: Surface a 'tougher' bet than the Xbox

"Nobody ever buys Windows. They buy Windows PCs."

Many Microsoft customers, partners and competitors would no doubt agree with this statement. But many also might be surprised to hear this admission comes from Microsoft CEO Steve Ballmer.

When I interviewed Ballmer at the end of November, 2013, in his office in Redmond, a lot of our conversation focused around his role in overseeing Microsoft's software and services, past and present.

But Microsoft is in the hardware business, too, with Xbox, Surface, Windows Phone and Perceptive Pixel (plus mice and keyboards). Its executives, from Ballmer on down, are increasingly playing up the reasons they believe Microsoft needs to stay in hardware to remain relevant -- in the face of calls by some company watchers for Microsoft to split off its Xbox and/or its consumer-hardware business.

"One of the things tech companies really do terribly is build new capability," Ballmer told me during our recent sit-down in Building 34. "Unfortunately, when the industry changes, if you haven't built any new capability, you can become less relevant because the thing you were good at becomes less relevant and you didn't built capability in a new area."

"We've had to do it a couple of times, in fact, from platforms to apps, from now software to services, from OS (operating system) royalties, to OS royalties and devices," he said.

Ballmer called Xbox  -- in which he played an instrumental role in shepherding -- a "sort of a signature about building new capability in hardware and devices." Because of the Xbox, Microsoft had to build a custom-silicon team. Microsoft had to staff up a supply-chain team. And because of the existence of this body of knowledge, Microsoft was able to make the decision to get into device-manufacturing with its Surface tablet/PC line, Ballmer said.

Microsoft's first-generation Surface devices got mixed marks. The Redmondians ended up having to write down nearly $1 billion worth of Surface RT devices and component parts in 2013.

"We still need to upgrade and we still need to upgrade and improve, and that's part of the Nokia acquisition," Ballmer conceded.

Microsoft will be adding 30,000 or so Nokia employees, many of whom will bring with them hardware manufacturing and distribution know-how, as part of its $7.2 billion purchase of Nokia's mobile devices and services business. (Ballmer noted that he was unable to talk specifically about Nokia because Microsoft's purchase still has yet to close. That's expected to happen by early 2014.)

Ballmer: 'We had areas of vulnerability in competing with Apple'

Ballmer characterized Microsoft's initial decision to build first-party tablets as "in a way... a tougher bet" than the decision to build the Xbox.

Surface "was less different (than Xbox), you could say," Ballmer noted. "But, I also knew that it would not be the simplest discussion to have with our partners, who(m) I wanted to stay our partners."

As expected, Microsoft's OEMs, some of whom said publicly they felt blind-sided by Microsoft's decision to make its own devices, were none too happy about the move. But Ballmer insisted Microsoft had no choice.

 "I was concerned that we had areas of vulnerability in competing with Apple and without any (first-party) capability, that we were not transacting that well just through our OEM partners."

Ballmer said management's area of concern was in the high end of the device market.

"High end was an issue. There were just a lot of reasons to think Apple was going to be a tough competitor to deal with, just with our OEM model. It was a higher-end brand," Ballmer acknowledged.

"Our OEMs were having a hard time investing in competing with the higher end brand. The (Microsoft retail) stores were (starting) to take off, but they hadn't taken off. It turns out that was also an issue, because now there's a different kind of a presence. And without a product to fit -- a product, a brand, a price point -- to really go head-to-head, it looked like an area of exposure," he continued.

"So I won't say we said 'Let's go do Apple compete.' We wanted to go do our own thing that was uniquely ours," he said.

Ballmer said Microsoft didn't set out to build a "classic 13-inch laptop or a $500 desktop." In those categories, "our OEMs do a great job," he maintained.

"On the other hand, there was an area of vulnerability," Ballmer said. "The vulnerability we have is not just on phones, where we're buying Nokia, but it's on tablets. And our OEMs do great work, but there are places their brands and investments don't travel. And so we wanted to supplement the work of our OEMs, hopefully make our OEMs stronger through the process, by making our overall competition with Apple" -- and more recently -- Samsung.

Ballmer portrayed Microsoft's differentiator with its tablets and phones as "tools," specifically "tools that make people more productive, IT people, developers, and end users." (Given Microsoft's heritage as a development-tool maker, "tools" is an interesting word choice.)

"Are we a productivity company or are we a software company? Well, what we are is a company that knows how to create great software for productivity and serious fun, but the expression will be through services, and through devices increasingly. And maybe it always has been. Nobody ever buys Windows. They buy Windows PCs," Ballmer reflected.

"There's no question Windows defined a class of a device. The problem is in new classes of devices, it's hard to get leverage simply through the OEM model -- whether it's phones or tablets -- and so we're doing more first-party hardware than we used to. But we're trying to express our creativity writing software, particularly software that helps people be productive, communicate, and have serious fun."