When I travel all day (like yesterday) I sometimes miss some pretty cool things that come out. I am finally caught up on most of it. The most interesting analysis I saw had to do with the math underlying Microsoft’s tablet. Or rather, the margins and sales projections behind their thinking.
John Gruber at Daring Fireball raises this point about Mister Softee’s decision to manufacture their own tablet:
The only hard decision they made was the big one: to turn against their OEM hardware partners.
The reason underlying for that decision comes from Horace Dediu of Asymco:
Now let’s think about a post-PC future exemplified by the iPad. Apple sells the iPad with a nearly 33% margin but at a higher average price than Microsoft’s software bundle. Apple gives away the software (and apps are very cheap) but it still gains $195 in operating profit per iPad sold.
Fine, you say, but Microsoft make up for it in volume. Well, that’s a problem. The tablet volumes are expanding very quickly and are on track to overtake traditional PCs while traditional PCs are likely to be disrupted and decline.
So Microsoft faces a dilemma. Their business model of expensive software on cheap hardware is not sustainable. The future is nearly free software integrated into moderately priced hardware.
Anyone with an interest in technology or tech investing are strongly advised to go read both pieces . . .
See:
Daring Fireball: Surface: Between a Rock and a Hardware Place
Asymco: Who will be Microsoft’s Tim Cook?
Category: Corporate Management, Investing, Technology
Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.
I have been a regular reader of Horace Dediu’s blog at asymco.com and his podcast ‘The Critical Path’. I have learned a lot from his blog and podcast and am happy to see his work get wider distribution/recognition.
Horace studied at Harvard under Clayton Christensen (_The Innovators Dilemma_). Horace seems to really understand industries under disruption and to see clearly in the tech space in general and Apple in particular.
Current Microsoft customers are not asking for the moon from Windows 8. They merely want the same operating system on their desktops, laptops, tablets and phones. Shouldn’t be that complicated to provide that. If the only way to make the tablets and phones competitive is to cut margins, do so. Result will be reduced revenues, but not necessarily reduced profits if R&D can be cut. Microsoft will thus transition from a growth company to a cash cow, with a long future gliding down the slope of constantly reduced revenues, squeezed R&D expenses, profits paid out to the shareholders. A formula that Buffett used many time to become fabulously rich.
Microsoft can’t lose big money as long as they remain a software only company and the software is okay. Hardware is another story. It takes a lot more working capital to pump hardware into the distribution channel than software, and there is always the danger of the inventory in the distribution channel being made obsolete suddenly by a competitors innovation. Software can be made obsolete even quicker than hardware, but then software can be easily upgraded and there is no inventory problem.
Going from hardware-software combo to software-only would have been a way for RIMM to save itself. RIMM could have put their software architecture on Android phones as an app, while scrapping their hardware division. Yes, revenues would have collapsed, but expenses also, profits might even have increased. Pay those profits out to the shareholders and the result would be a big win. Cash cows can be very lucrative if done properly. Warren Buffett is the go-to man for how to best milk a cash cow.
GRUBER: “It was all over the place: Here’s an ARM tablet. Here’s the clever keyboard cover that goes with it. Now here’s another tablet that looks much the same but a little thicker but in fact is running a different and incompatible OS. Oh and here’s another keyboard cover, this one with moving keys. Design is about making decisions, and Microsoft could not decide. ARM or Intel”
This is rather silly criticism. Microsoft could not decide ? Hello, there are two distinct products:
* The thinner lighter RT version will run on an ARM CPU, only run the Metro apps, but will include a special version of Office. In other words, a tablet with Office.
* The slightly thicker Pro version will run an Intel Ivy Bridge CPU, and operate the full version of Windows 8 Pro. In other words, a full PC in tablet form.
Was that really so difficult to grasp ?
GRUBER: “imagine, for a moment, that the company still to this day had not shipped a tablet – Apple would still be thriving, based on huge (and hugely profitable) iPhone sales”
Except that sales of Android phones blew past sales of iPhones last Summer, and have never looked back.
GRUBER: “Skepticism about these things doesn’t require knee-jerk Apple fandom.”
Of course not.
Joe Friday:
“Except that sales of Android phones blew past sales of iPhones last Summer, and have never looked back.”
How does that refute the first point? Apple makes gobs of money on the iPhone. While I’m sure they would like to have both market share and profit share, I know which one they prefer.
> The future is nearly free software integrated into moderately priced hardware.
I’m far from convinced of this model . . . as I am that the iPad exemplifies the post PC world.
Here’s MSFT’s problem as I see it:
Microsoft is a deeply technical company. They’ve enjoyed a business model where they have not needed a huge sales staff – their lock-in on the PC market for decades has meant that they could just keep minting money while the PC platform kept increasing penetration and they could have a company where they just cranked out code. All MSFT had to do was keep competitors from shipping something else that could run as well as PC hardware and their business model worked. Many of their attempts at new ventures could crash and burn, and the financials wouldn’t be hurt all that badly.
More to the point, however, is that MSFT’s corporate model worked as well. They could have a overbearing stooge like Ballmer running the show, and it didn’t really matter. The technical battles had been pretty much won, they had achieved their lock-ins and dominance in their market.
Ahhhh…. but now along comes a disruptive force in tablet computing. The various morphodite versions of Windows for embedded/phone/etc devices would need a lot of work before they could come up with something remotely as slick as iOS. They need a single platform across non-PC devices quickly now. They need to have phones, tablets, in-home and in-car systems looking/acting/talking the same.
Now MSFT needs a technical leader to execute a pivoting move, much as Gates pivoted the company when this Internet thingie became a real issue about 1994 or so. Well, Gates is in the background. Ballmer isn’t going to get them there. Their cash cow is threatened, they need a technical leader and they don’t have one… yes, I’d be nervous if I were in MSFT right about now.
BTW, in Dediu’s piece, I found this howler:
“To suggest that “hardware” could be more operationally profitable than either software or services is akin to heresy in technology analysis.”
To people who have never worked in actual computer companies, yes, it probably seems non-intuitive. But to those of us who have worked in both hardware and software companies – it’s a no-brainer. Hardware wins over the long run. Hardware companies that ship their own software… they have far better margins than software-only companies in the long run. Why? Because hardware costs go down as you go forward in time. Software development costs go up as you go forward in time.
BR – you’ve made it very clear over the years that I’ve read your blog that you are pro-Apple and anti-Microsoft. I take everything that you remark on this matter with a grain of salt while understanding your bias.
MSFT indeed has flaws; as does Apple. Time will tell how this all works out.
~~~
BR: Anti-Microsoft bias? You are understating it — I hate those evil bastards.
I hope this clarifies things . . .
Agree with Joe and the later posters that the Apple Fanzine created confusion where there was none. It was perfectly clear what they were presenting in the models and that these trumped Apple’s corresponding products IF they worked as well as claimed. They were also clearly prototypes without the extensive testing you would expect of a product about to be released. Otherwise, there would have been no way that this news would not have leaked.
It was also clear that the presentation was aimed at the tech press who understands such things, cept maybe the Daring Fireball, and not at consumers. The part that was not clear was what MSFT’s intention is: to really compete with partners, or to light a fire under partners by presenting a reference platform a la Google which enthusiasts could buy but would only sell in limited volumens? See Topolsky’s video recorded while he was still at the event posted on the Verge where he notes conversations with Ballmer et al.
Not having a good salesman who understands the product, like Jobs, to do the announcement is one of MSFT’s biggest handicaps. Ballmer comes across as an oaf, even though he has led the company while it doubled it’s profits. They need someone to talk to consumers if they want to play in consumer space; they need someone with a reality distortion field like Jobs, although it doesn’t need to be as powerful.
How long that situation lasts is anyone’s guess.
The message is clear, Microsoft is on (yet another) failed quest.
This will not end well for Balmer’s team. They had their chance to retire him (several chances), and instead they are going to let him take Microsoft down with him.
Barry have always been bias towards Apple.
I thought it was a good announcement and they do have a lot of time to work out the kinks. the mindshare in windows servers, business products, desktops and office is huge. but the prob is that the software competition costs is going down drastically. even if they have the share they cannot maintain that margin.
MSFT has performed quite well this year, up 16% despite BR’s call early in the year that it was going to tank. I’ve been a long time stockholder and am happy to continue collecting my dividends and price appreciation. Will their tablet work? Only time and the market will tell. The one problem that they did not promptly address was getting “good” phone/tablet software out in time to compete against Apple iOS and Android.
The only Apple product that I’ve ever purchased is an iPod because there were not any good alternatives at the time. I find that Apple computers/phones/iPads to be overpriced and why should I pay the extra money for the hardware when the alternatives do everything I need them to do.
The final point is that phones & pads, at least the way they are configured today, are not computers in the sense that you cannot do the basic tasks you need a computer for: spreadsheets, word processing, power points, etc. They are digital content managers and nothing more (at least at the present and that possibly can change). Since I work out of my home, all I need is my trusty desktop PC and nothing more (though I do like my Kindle for reading).
dsawy –
I like your point about “Because hardware costs go down as you go forward in time. Software development costs go up as you go forward in time.”
What does this say about companies like IBM and HP, that have/are abandoning manufacturing products for service oriented businesses (which scale horribly and are even worse than software)?
“Apple gives away the software … but it still gains $195 in operating profit per iPad sold.”
Apple does not “give away” its OS or software, when you buy an iPad you are buying a bundle of software and hardware. Since neither are sold independently it is silly to say or imply that Apple is making its revenue off of the hardware not the software.
“So Microsoft faces a dilemma. Their business model of expensive software on cheap hardware is not sustainable. The future is nearly free software integrated into moderately priced hardware.”
This is the immediate future because Android is the leading OS being licensed to independent hardware manufacturers in this space, they have a lot of market share, and they are choosing to give away their software. They may well choose to license this software for lots of money in the distant future.
The dynamics of this industry are driven by economies of scale and network externalities (i.e., (a)people buy the OS with the most and best apps, and app developers tend to develop for the OS with the highest sales; (b) it takes a lot of time and energy to learn how to use a new OS and its bundled applications; (c) people like to use the same platform that their friends are using so they can share knowledge about how to use it).
Microsoft’s problem in the smartphone and tablet space is that they have tiny market share and so they are getting killed by these two key forces. Google and Apple are pretty much neck and neck in market share, so they are pretty much neck and neck with respect to these two dynamics – but they both know that these two forces tend to result in a single dominant OS eventually so the race is still on between them.
Microsoft started to betray their OEM partners by making Nokia their favourite. They did this out of desperation to gain share. I am sure they are doing their own tablet hardware for the same reason (“sorry partners, but we need to gain share in this space NOW and no hardware partner will be as committed to sacrificing everything to make this happen as we are”).
I come to this with impeccable credentials: I detested Microsoft for years, having had to work with their products early on in my business dating back to the beginning of the Web. I have to say, despite all their missteps in the past, I think they’re finally starting to put out some very competitive products. I also was a big fan of Google early on, but they’ve had some fizzles of their own. Everyone knows Apple and Nokia’s story . . . I think it’s pure folly, especially today, to anoint anyone a permanent marketplace leader.
James Cameron Says:
June 22nd, 2012 at 12:54 am
> The future is nearly free software integrated into moderately priced hardware.
I’m far from convinced of this model . . . as I am that the iPad exemplifies the post PC world.
reply:
———
I use a lot of open source software and prefer it unless my need are specific and require paid software. Right now I’m using iTunes to digitize my CD collection for MP3 (320k VBR highest quality, hardware error correction) and it’s doing well. Nearly CD quality and free. A lot of free versions of paid software are also adequate for common needs.
The iPad is a convenience and a hobby machine, not a productivity machine. My Xoom is far more capable and it is only a convenience. No tablet is adequate for day to day work for most people. You need a keyboard and a more powerful operating system. Neither Android nor the iPad can handle business processing. Microsoft can jump this hurdle if the Surface runs Office as well as a laptop.
“The future is nearly free software integrated into moderately priced hardware.”
I actually agree with that. The only thing stopping the dam from breaking is familiarity.
As another interesting case study in this situation, take a look at handheld video game devices; e.g. the Sony Vita and Nintendo 3DS are trying to sell $40 games, when smart phone uses can easily get 40 $1 games. The keys for them are going to be 1) Hardware and B) AAA quality.
apollo_creed,
“How does that refute the first point?”
It wasn’t meant as refutation, merely a real-world comment on the meme that the iPhone is the Holy Grail of smartphones.
@constantnormal – holding HP forward as any sort of competence in the computer business isn’t something that anyone did after Dave and Bill were gone. Fiorina wrecked the company and everyone since that idiotic twit has merely shuffled deck chairs on a sinking ship. HP used to be one of the best, steadiest tech companies because they not only did hardware, they used to do so much more than just computers. HP used to sell quite a bit of highly technical test equipment, medical equipment, etc. As of today, HP is a printer company, giving away printers to peddle ink cartridges, and oh, yea, they can sell you a computer to go with your printer if you wish.
As for IBM: They do much more than just software and services. People who don’t work around computers forget that IBM still ships mainframes, they still make chips and they have one of the most advanced chip libraries out there for rapid system development. Quite a bit of IBM’s services and software revenue is based on their hardware systems…
The argument that goes… “The future is about…”
Its pretty silly, even stupid. The future is about execution. About giving customers great products and experiences at a better price. Its NOT about “open vs closed” or “hardware vs software”.
Microsofts problems are fairly obvious – 3-10 minute boot times?!?, malware and viruses causing awful user experiences, layers of software (HP+MSFT+McAfee) that are purchased yet seem to mimic malware!
Apple is killing it because it offers users an awesome experience, its focus was always on the consumer. Eliminates most or all of the above problems. And occupies a niche no one else cared about – PREMIUM hardware. Still… no one hard a brand in PREMIUM hardware. Now back in the 80s and 90s… a $4000 MAC computer VS a $2000 PC was a tricky business decision… now its $1500 versus $1000… 20 years later! Seriously!!
Oh, and they invented the iPod (huge CF).
Then they invented the iPhone (I/O… touch/screen). Device of the next 100… if not 100,000 years. Seriously! Samsung… Android… these are just mimic copies. Its gross. Steve Jobs would’ve said… “smart people work for you creating lousy copies of this? Why? Why don’t they want to make great products or invent something?”
Really… its a good critique. Why does GOOG waste so much energy doing half-ass versions of Excel… which costs $25/yr? They hire smart people to write software to try and save people $25/yr? But now Im ranting…
@dsawy — I think you misunderstand Dediu’s comment regarding heresy and hardware. He actually agrees with you when you say, “Hardware companies that ship their own software… they have far better margins than software-only companies” That’s Apple and he has talked about this at length the past year (although it is not apparent in that one article).
Apple has a 12 PE ostensibly because they are a hardware company. Apple’s PE is closer to Intel than Google’s (pre Motorola Mobility) even though by every other measure their financials are better than Google’s and should be valued more than they are.