The Real Reason Microsoft Is Losing Money On Its Surface Line Of Tablets

Aug.14.14 | About: Microsoft Corporation (MSFT)

Summary

Microsoft Surface Pro lost $1.7 billion, with most of it driven by inventory-related charges.

While the device is necessary in order for Microsoft to offer a complete product ecosystem, they need to make a lot of changes to make it competitive.

Microsoft needs to be decisive about what they want to achieve with the Surface line.

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I just read Alex Cho's article about the Microsoft (NASDAQ:MSFT) Surface Pro 3 and I couldn't disagree more.

His summary was the following:

  • Microsoft Surface Pro lost $1.7 billion, with most of it driven by inventory-related charges.
  • These problems aren't insurmountable, and while the Surface is losing money currently, the device is necessary in order for Microsoft to offer a complete product ecosystem.
  • Going forward, a better managed supply chain paired with falling variable costs will allow Microsoft to at least break-even or even earn profit.

Mr. Cho's analysis of the problem's with the Microsoft Surface Pro 3 are a little off the mark. He says (emphasis mine):

The bulk of what's making the Surface lineup un-profitable was the over-production of Surface tablets. Assuming Microsoft is able to manage its supply chain more effectively, and go for product shortage rather than product abundance, it can create an "Apple-like" effect with consumers. Forcing consumers to stand in line is way more effective than always communicating to consumers that there will never be a shortage.

I believe the problem is a lot more dire. The primary reason the Microsoft Surface Pro 3 is not selling well is that it's way too expensive. In addition, it's an untested product trying to sell Windows 8.x at premium pricing - a recipe for disaster.

While the vast majority of reviews categorize the Microsoft Surface Pro 3 as a major improvement over previous generations, it's still priced way too high for the average consumer to buy. I had a chance to review the device and my summary was simple:

If you're a Windows fan and need to have the latest and greatest, this is it. If you're a budget conscious shopper it will be hard to justify spending the money on this device and once again, that's a shame.

Another part of the problem is that while Microsoft fans may argue that the Surface tablets are full blown computers, the average consumer sees a tablet. With Android tablets going for $199, it's a stretch to ask for almost $2000 for something that looks similar.

The devices also run Windows 8.1. I don't need to go into detail about why this might be a problem for consumer perception. I continue to insist that Microsoft is making the Surface Pro 3 a loss leader but for the wrong reasons. In my humble opinion, it's far better to lose money by:

Lowering the pricing and running out of units.

than

Overproducing tablets at higher prices and having them gather dust in a warehouse.

The other major problem that Microsoft has with the Surface line of tablets is that it's not clear exactly what it is trying to achieve.

The rationale for the tablets has been:

  • Inspiring partners and OEMs
  • Microsoft being a devices and services company
  • Creating a premium device for the consumers
  • Creating a new category of device.

All of these are OK but my take on this is that Microsoft has not ever gotten the story straight on why it is building Surface and upsetting its OEMs.

It's simple. As a company:

  • Either you want to build a device that serves as a guide to your OEM's and doesn't ever compete too hard; or
  • You want to build a device that is groundbreaking and competes 100%;

Microsoft is trying to have it both ways and the result is predictable - losses and confusion. Ultimately Microsoft has to decide what to do about pricing and what direction they want to take this tablet in before the Surface line ever goes anywhere.

The tablet would do very well if priced aggressively but Microsoft continue to ignore the realities in the marketplace. At this point, with or without Windows 9, if there are no changes to the fundamentals, there is no reason to expect the Surface line of tablets to ever be a bestseller.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. I am the CEO of Learn About The Web Inc. (learnabouttheweb.com). Learn About The Web™ is an online business education platform dedicated to providing universities and businesses with the tools required to credibly teach online business. I teach and discuss online business companies (including Microsoft) frequently. I also own and monetize several Microsoft-related online properties like Eye On Windows (eyeonwindows.com ) and Windows 9 Update (windows9update.com). I also own a PeopleSoft-related web property (peoplesoft-planet.com).