Will Microsoft's New Hardware Scratch the Surface of the Tablet Market?

By Tom Gibbs - June 21, 2012 | Tickers: AAPL, GOOG, MSFT, NOK | 0 Comments

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What’s Happened?

Following much ado regarding Microsoft’s (NASDAQ: MSFT) secret Monday afternoon event, the corporation has announced Surface – its first major push into the tablet market.  To be released this fall, the 10.6-inch, 1.5-pound Microsoft Surface is not only a product obviously directed toward Apple’s (NASDAQ: AAPL) similarly sized iPad, but it will also represent one of the first launches of the upcoming Windows 8 operating system on a mobile device.  Microsoft shares traded up slightly more than 1% after hours in response to the announcement.

Does it Matter?

Although traditionally labeled a software enterprise, Surface will not be Microsoft’s first push into the hardware market.  Aside from the wildly popular Xbox entertainment console, the corporation has dabbled for years in the highly fragmented computer peripherals market and has more recently paired with Nokia (NYSE: NOK) as a means of getting Windows into the burgeoning smartphone market.  The corporation’s hardware division has, however, only represented slightly more than 11% of sales and 2.5% of operating profits over the past three years. 

The launch of the Surface represents one of the first pages in a new mobile-based chapter for Microsoft, and as such, the product could not be released at a more important time for the corporation.  Slow PC sales, which have been affected by reduced consumer/enterprise spending, slight inroads made by Apple’s computer lineup, and the troublesome tablet cannibalization trend, have had a large impact on Microsoft’s performance.  Last week’s 2012 PC shipment projection cut by Gartner Inc. – now 2.7% annual growth from original projections of 4.4% -- indicate that few expect the industry to see a meaningful rebound in the near future.  Microsoft’s bread-and-butter Windows sales, as well as the closely attached sale of Office products, will be closely tied to the outcome of such projections.

The successful launch of the Surface tablet may not only usher in a new robust era for the Windows operating system, but will also add an attractive hardware revenue stream to supplement slowing software and Xbox sales.  With an estimated 118 million tablets expected to be sold this year (source: Gartner Inc.) – a near 98% increase from 2011’s worldwide sales – it is very difficult to imagine Microsoft not enjoying some success with the Surface, even if initial demand is somewhat lackluster.  There is no doubt that with a current collective hold of around 99% of the worldwide tablet market, Apple and Google (NASDAQ: GOOG) are due for a legitimate third player. 

Will it be Successful?

First, what defines “success” for this particular product?  Although a new source of revenue and a piece of the huge tablet market pie are attractive end goals, the most important milestone for Microsoft going forward will be the establishment of a cohesive ecosystem between all of its hardware/software offerings.  Much like the raving success of Apple – there have been many debates on whether it is a software or hardware company…isn’t it both? – Microsoft may have the opportunity to create a full lifestyle of sorts around its products with the integration of Surface. 

With more than 67 million Xbox 360s sold to date, for example, Microsoft already enjoys a meaningful penetration into America’s living room.  Inter-hardware integration – Surface to Xbox to upcoming Windows 8 smartphones – is what the recently announced SmartGlass initiative is all about and could represent a suitable competitor to the hardware/software ecosystem in the Apple camp. 

Microsoft does have a long way to go before such a dream is realized, however, and the first step is reliant on the positive reception of the Surface tablet this fall.  There are several headwinds that the corporation may face with the product’s release:

• Microsoft management stated that the product would initially be sold in its own retail outlets and its web store.  With only 20 stores currently open (5 more are coming soon), initial demand has no chance of mimicking an Apple iPad-like splash.  As its first entry into the tablet market, Microsoft does need all the sales hype it can get.
• Historically a software corporation with some plays in the hardware market, Microsoft is not necessarily known for its hardware prowess.  One does not need to delve too deep to uncover the corporation’s shaky hardware past with the muted Zune reception and the $1 billion charge related to Xbox 360 hardware issues.  Facing Apple head-to-head with the Surface launch, product quality will be of utmost importance.
• Being late to the tablet game, Microsoft still faces the hurdle of teaming with a crop of app developers.  Some of the primary strengths of the iPad stem from Apple’s fleet of third-party developers that supply iPad users with the primary filler for their content needs.  The success of the Surface will not only depend on hardware quality but also will be heavily driven by the third-party content offerings. 

These points being raised, however, the Surface unveiling did showcase some attractive features that may give the iPad a run for its money – the Touch Cover (detachable keyboard/cover for Surface), USB port, flash capabilities, optically bonded display, and up to 128 GB storage.  Due to the corporation’s future riding so heavily on the popularity of Windows 8 on both PCs and mobile devices, Microsoft investors should hope that some of these features are enough to make the Surface a successful contender in the highly competitive tablet market. 

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