Microsoft's (NASDAQ:MSFT) Surface Pro 3, announced about 8 months after the Surface Pro 2, demonstrates an enviable level of business agility, marketing savvy and technical prowess. Only slightly thicker and heavier than its ARM-based Surface 2 sibling, the Pro 3 packs full 64-bit Intel Haswell capability and a new 12-inch screen. In its quest to unify tablet and desktop computing, Microsoft has finally found the sweet spot, sending shock waves throughout the industry.
At 9.1 mm thick and 1.76 lbs, the Pro 3 is lighter and thinner than the Pro 2 despite its larger screen. The Pro 3's 12 diagonal 2160x1440 screen compares favorably to iPad Air and is much better than what Apple (NASDAQ:AAPL) currently offers in the MacBook Air line. At a starting price of $799, it also appears to be targeted at the notebook "sweet spot" I recently wrote about.
For some time, I've been predicting that Microsoft's Intel-based (NASDAQ:INTC) tablets would cannibalize sales of Surface RT (even Surface 2), and I even predicted the demise of Surface RT last year. That didn't happen, largely because of the higher price tag of Intel's mobile processors leading to higher prices for Pro (not to mention its greater girth). Consumers found neither offering particularly compelling, and Gartner's market share data for 2013 backs this up. Microsoft's tablet market share (including all Win8x tablets) stood at just 2.1%.
I think that's about to change on the Intel side of the Window's tablet market, not only for Microsoft, but for other Windows tablet makers. Intel's aggressive pricing, combined with the superior performance of its 64-bit mobile processors, makes the value proposition of a Wintel tablet very appealing. Wintel tablets can now achieve the form factor and price of ARM tablets while competently running legacy Windows apps.
The importance of this cannot be overstated from the standpoint of Microsoft's need to build a viable mobile ecosystem. Building such an ecosystem around ARM (nearly) from scratch has proved difficult, as sales of ARM-based Windows Phones and Tablets have demonstrated. The more viable option, and the one that is also more pressing, is to transition Microsoft's existing 1.5 billion Windows users to mobile Windows platforms. For existing PC users, a tablet that can run legacy Windows software is much more attractive.
Why has Microsoft persisted in pursuing ARM tablets? When Microsoft first announced its Windows on ARM initiative at CES in January 2011, it wasn't clear when Intel would have mobile processors competitive in price and power consumption to ARM. At the time, Microsoft's leadership probably thought that it had the time and marketing clout to create an ARM-based Windows ecosystem.
Even now, it's not clear that Intel can compete on price, but even with a price premium, Intel-based mobile devices will still be more compelling for Windows users, and an easier platform to transition to for Windows developers. I've long advocated and expected that Microsoft would move to an all-Intel approach for mobile, and I still expect this because it's the path of least resistance for Microsoft.
But it's clear I haven't had a good calibration of Microsoft's pain threshold with respect to RT. Last year, I thought RT would be dead by now. Part of the reason Microsoft persists with ARM must have to do with Windows Phone. As long as Windows Phones needed to be ARM-based, it was logical to get a little more economy of scale from an ARM tablet platform.
Intel's forthcoming 22 nm Merrifield (dual core) and Morefield (quad core) phone offerings may change that. It's clear that at 22 nm, Intel mobile processors can be performance competitive with any ARM offering, so it really comes down to price. Intel has been very aggressive on price, so I don't see much keeping Microsoft from abandoning ARM-based phones for Intel, especially now that most of Windows Phone manufacturing has been brought in-house with the Nokia acquisition.
When will Microsoft finally give up on ARM? Intel has indicated a move to 14 nm in the second half of the year. If Intel makes good on this, it will probably weigh heavily in its favor in the eyes of Microsoft. I expect Microsoft to give up on ARM early in 2015.
The advent of the Pro 3 probably heralds the end of losses on Surface, and the continuation of significant market share gains for Windows tablets. According to Gartner's data, the overall tablet market grew by 68% between 2012 and 2013, and Android tablet sales grew by 127%. Given the explosive growth of Android tablets, I don't see Wintel tablets making much of a noticeable dent in Android tablet sales.
There's also the difference in market segment orientation. The Pro 3 is clearly oriented toward the top end of the tablet segment, where the iPad has ruled. The impact on Apple could be much more noticeable. In my recent article "Apple's iPad Problem," I pointed out that iPad's market share and usage share has been squeezed by Android sales. Surface in all its various forms hasn't been much of a threat, but the Pro 3 is positioned to take sales away from both the iPad and the MacBook Air. Probably the greater impact will be on MacBook Air. Despite dropping the starting price by $100, Apple hasn't really been able to get into the laptop price sweet spot ($500-$700) with the Air.
How many Surface Pro 3s will Microsoft sell? Microsoft doesn't release specific sales numbers for Surface devices, but for calendar Q4 2013, it's been estimated that Microsoft sold 1.275 Surface devices. Gartner's estimate of 4 million Windows tablet devices for all of 2013 implies that Microsoft sold about 2 million surface devices for 2013.
Windows tablets have also had considerable unit sales momentum, increasing by 246% from 2012. I believe unit sales of Surface Pro 3 could easily reach 4 million over the coming year. This won't add much to the bottom line in the Consumer and Devices division, but I believe it will mark the beginning of Microsoft's transition to an Intel-based mobile ecosystem.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.