Microsoft Windows RT price cuts don’t stop the death spiral

Analysis: Drain circling picks up speed, flush inevitable

2012 Microsoft Logo 87x31 Microsoft Windows RT price cuts dont stop the death spiralSemiAccurate went in to detail about why Microsoft’s Surface could not compete against real tablets, and the new price cuts are not going to help. Windows RT and Surface RT have absolutely no chance of surviving much less thriving in a market that Microsoft needs to stay even marginally relevant. It was game over before launch.

The problem is simple, Surface costs too much relative to every competitor on the market. This gem of wisdom will probably not stun the average observer, painfully low sales numbers are a clear indication that they actually understand this point consciously or not.

What most people don’t understand is story behind that, the why not the what. Microsoft can never compete in tablets and phones, period, and this is not a qualified statement, it is an inherent property of the choices the company made over the last 3 decades. Microsoft has no chance in mobile no matter what they do, their very business model precludes sucess in a world they still fail to understand.

There are two problems here, both financial in nature. To be fair, there is a third and fourth problem that are technical in nature, but they are actually solvable. These don’t preclude success, just make it extremely unlikely, and the very business model of the company stops them from even attempting a fix. These technical problems can be summed up pithily by the phrase, “The OS is awful”, and “Devs hate it”. If you have tried Windows 8, be it in WART (Windows/ARM RT) or x86 guise, there is no need to explain the first one to you. We will assume you have tried it and like the majority of others SemiAccurate talked to, gave it a chance that Windows 8 failed on merit.

You may have heard that the sales figures were a meager 1.1 million and 0.4 million for Surface RT/Pro respectively, but probably didn’t think about whether they included returns or not. These numbers are so painfully horrid that Microsoft still won’t release them even with the damage that they are doing as whispers. Windows 8 has failed, and Microsoft is withering with it.

Why developers hate it is a completely different story that we won’t get in to here, but lets suffice it to say that the Win8 app store has very few apps in it. Most of these are not what anyone wants, and what they want is not coming either. This tally is advancing glacially because of one thing, money. No one is voluntarily writing for the Win8 store for both solid technical and financial reasons. If this last GDC was any indication, Microsoft has hit the death spiral of paying devs per app made, a game that even their massive wallet can’t win.

Back to the financial problems, we consider the lack of development to be technical in nature so it is not one of the financial problems even if some consider it to be. The first financial problem is the bloat of Windows. Although this may sound like a technical issue, it is not. As SemiAccurate has been saying for over a year, Windows 8/WART needs many times the hardware that iOS or Android needs to deliver a similar experience. Assuming that Microsoft does not want to deliver, or does not allow their partners to deliver, a device that is painfully slow, stutters, runs out of memory, and crashes a lot, they have a big problem.

To give the user the same experience as even a cheap Android tablet, much less a high end Apple iPad, Microsoft needs to put in significantly more powerful hardware. They need to have a more powerful CPU, more powerful GPU, and vastly more storage. We chronicled this problem last year here, but it is worth a re-read if you don’t completely understand the problem because it is absolutely fatal for WART and Windows 8 mobile devices. To do the same job as an Android or iOS tablet, Windows 8 needs to use so much more hardware that it increases the hardware cost to such a degree that the device can not be competitive in the market.

Remember when SemiAccurate exclusively brought you news that HP dumped Microsoft over Surface? This wasn’t a mere spat like some insist, it goes far deeper than that. Microsoft can only compete by doing things that their partners can’t, basically getting for free many things that “valued partners” need to pay Microsoft for, and pay dearly. This puts HP, Acer, Lenovo, Dell, and the rest at such a price disadvantage that there is no point in continuing with WART. HP bailed, Acer bailed, Dell sees the writing on the wall and is trying to go private, and many others are not even bothering. HP Slate7 means Surface will sink below its namesake.

The knife in the back is personified by a tablet that HP calls the Slate7, and it costs $169 at the moment. Sure it may have a smaller screen, lower resolution, less memory, but it has more performance, more usable space, and an app store that actually has apps people want in it. There are no technical specs up, but even if the Slate7 has zero flash storage, adding 32GB would bring the price to <$200. Did we mention that a 32GB Surface costs $499?

Sure Surface comes with a keyboard but you can buy those for $20 or less and it is hard to spend $100 on one even if you go for the high fashion iDevice compatible models. A 16GB Slate7 will likely have more usable space than the 32GB Surface RT once initial mandatory patches are installed. And the killer blow? Slate7 runs Android 4.1. When SemiAccurate said OEMs were dumping Microsoft, everyone assumed we meant WART. We didn’t, we said OEMs were dumping Microsoft like never before, and we meant it. Disregard this data point at your own peril, it is a different world now, and others will follow soon. Don’t tell me you thought the Slate7 was already in planning when Microsoft announced Surface, it wasn’t.

You might now understand why Microsoft can’t compete with Android and iOS, they are bloated to the point that their tablets and phones are in a different price category. This is not a fixable problem and the gap will never close enough to be a non-issue for consumers. This is terminal to Microsoft’s mobile ambitions and there is no possible fix barring Microsoft selling Android tablets in lieu of Windows ones.

Bad as this sounds it actually isn’t the worst problem, that would be the business model that Microsoft uses. Remember Microsoft’s illegal bundling of software that they paid fines and more fines for?  In echoes of that, Microsoft is only selling WART with OfficeRT. This is an obvious play to leverage the Office monopoly, specifically Outlook, to force business buyers to buy a Surface or live without their near-monopoly messaging suite.

There are two problems here, first is that Microsoft’s biggest weakness in mobile is in the consumer space, and Office/Outlook doesn’t mean much if anything there. Trust me when I say that teens worldwide care more about the hot social thingy app that is on Android and iOS, but isn’t on Win8, than they do about their Fortune 500 corporate calendar. They use Google, Gmail, and Facebook, Bing and Outlook are not on the top 10 list much less actually desired. Consumers play games and use social networks, Win8 has few if any important apps relevant to these markets. If your corporation hasn’t already standardized on an iPad or Android, they might be swayed to Windows though. Did we mention Surface RT can only run Office RT? Did we mention that Office RT doesn’t have Outlook? Just as a lark, if you read the OfficeRT EULA, you might notice that it precludes the use of Office RT in a corporate setting. This isn’t an own goal, it is just basic incompetence in a multi-billion dollar market.

Adding Office has bloated the cost of Windows RT, a vastly inferior version of Windows 8, from ~$35 to ~$90, or about the cost of adding a volume OEM license of Office to a volume OEM license of Windows 8. You save nothing but you have no choice, that is why we called it forced monopoly bundling. This means that a WART tablet made by an OEM has to pay $90 to Microsoft for every one sold. How much does Android cost? $0.

Actually an OEM gets a percentage of the app and content sales that Google makes from every sale, so that $0 cost actually means the OEM will get an income stream post-sale for Android device sold. iOS has a development cost but Apple doesn’t pay a per-unit royalty and keeps around 30% from each transaction made on the devices. Given the tens of billions of content sales that Apple has made, we will presume that the revenue stream more than pays for the OS development. In summary, the competition is revenue positive for the OS, Microsoft charges $90 per device.

Microsoft charges app devs 30% of sales like Apple and Google do, something that may seem like a neutral thing on the surface, pun not intended. Android and Apple however give devs an audience of hundreds of millions of users for that percentage.  Microsoft can offer less than 2 million after about six months presuming zero returns. Apple sold a multiple of that in iPad Minis on launch day, Samsung likely did about the same at the launch of the last Galaxy. This situation is not likely to get better for Microsoft in a meaningful time period either, it is a development Catch-22.

So if you are an OEM, what is your incentive to make a Windows 8/WART tablet? HP is making a 7″ tablet for $169 retail, and it is rumored to have a quad-core CPU and 16GB of flash. If you tried to hit the same price point with a WART tablet, you would have $90 of the BoM taken up by Microsoft leaving $79 for everything else. Take $20 out for the extra flash you need, $10 for the uprated CPU, and another $10 for the added battery and cooling necessary for the higher spec CPU. This leaves you with $39 for everything else like screen, RAM, packaging, cables, and the rest, not to mention PCBs, sockets, and other plumbing. Want a Wi-Fi radio? That will be a tight fit.

If Microsoft tries the same thing, they have roughly a $129 BoM to work with against the $39 of the OEM. Any guesses as to which one will be better, or in the case of Windows 8 will suck less? OEMs can’t play this game and compete against Microsoft much less win. Even with this massive price advantage, the disadvantages vs Android and iOS are completely insurmountable. Surface RT cost $499 retail, the same as an equivalent iPad but with far less functionality. To say it was a painfully slow stuttering mess with anemic storage would be kind, and OEMs like HP would be hard pressed to do that for $100 more.

The obvious answer is that Microsoft needs to cut their prices so the OEMs can compete. In light of the cuts them made earlier in the week, you might think they get it. You might also remember that the point of this article is that the aforementioned price cuts both mean nothing and cannot be sustained. Sustaining them another key issue problem, and is the second fatal problem for Microsoft in the mobile space. What does Microsoft make? Surface aside they make software, specifically OS software. What is their main product? Windows. They must sell Windows at a profit to stay in business. Since their other big money maker, Office, only runs on Windows, the two have their fates intertwined.

If Microsoft gives away their OS for free, it would lop $90 off the cost of a WART tablet, not nearly enough to make a difference. This might erase much of the BoM cost differential, but since 10″ Android tablets max out at $299 on Newegg, it won’t be enough. Sure you can find higher priced Android devices, but you can’t go lower with usable Windows 8 devices. Since all of the Windows RT tablets just had between $50 and $100 lopped off the price en masse this week, it is likely that the drop was Microsoft subsidized, not a real OEM savings.

It is likely that the form of this savings came in the time honored format, MDF funding. This is essentially a per-unit kickback officially intended to be used for things like advertising or promotions, but in reality it is just a cash funnel. That said, it means that Microsoft sees the woeful Surface and greater RT sales debacle and is jumping in to action. Five months after the disaster was obvious to anyone watching. Five months after RT was labeled as a failure. For Microsoft however this is refreshingly swift action, but even that is detrimental to their survival. Why? The kickbacks are roughly equal to the money Microsoft gets for the OS itself, the only income it has from OEM device sales.

So if Microsoft is giving 100% or more of that income on RT tablets back to OEMs as kickbacks, getting effectively no income from software or content sales, and doesn’t have the market share to temp developers, how can it be sustained? How can they grow a market with a $200+ and growing price disadvantage on equivalent functionality to their much more popular competition? They have no advantages in software offerings to tempt users either so price remains their only lever to add installed base.

The biggest potential draw, Office RT, is laughably wrong for consumer and business users alike too. Worse yet it is a forced sale with every WART tablet, you can’t not buy it. That means no potential income from their biggest selling non-OS software title on WART either, Microsoft is still shelling out more per device than they receive in Office plus Windows revenue. More troubling is the fact that even with the lever of, “If you want Office in a tablet you need to buy a Windows Tablet”, monthly sales are far lower than iPad daily sales. And from this, Microsoft has no net income, no potential income stream, and that is before general spending on marketing or development is taken in to account. The author would be surprised if gross Surface sales even paid for its tooling costs. Losing money on every unit while trying to make it up in volume may be a time honored business strategy, but it is rarely successful.

This is why we say that the price cuts that Microsoft just instigated mean nothing. They are too small to make a difference, at best they erase the OEM’s cost disadvantage to Microsoft but not to Android or iOS devices. They do nothing to alleviate the BoM cost handicap, it is not a problem that can ever be fixed. Customers are staying away in droves, installed base is not just tiny, it is hurting the mainstream Windows sales and software development at this point too. There is essentially zero software cross-compatibility with the desktop ecosystem to benefit from, but all of the legacy bloat the desktop entails is carried as BoM cost for mobile. Developers have to be paid to port because they can clearly see the potential for income is both lacking and unlikely to every grow substantially either. This is the classic platform death spiral.

If Microsoft makes this week’s price cuts permanent, they are essentially ceding all income from Windows and Office on the ARM platform in a desperate attempt to hold the meager low single digit mobile market share they have now. If the cuts are temporary, they have the potential for income but will lose even the meager pretense of OEM involvement they have now. The BoM cost problem, post-sale income stream, installed base to tempt software developers, and all the rest are insurmountable problem for Microsoft in the mobile space. Unless Microsoft wants to subsidize all WART tablet sales by several hundred dollars per unit indefinitely, a number that can not possibly be recouped, then all of these problems will only get worse. These price drops are both inconsequential and woefully inadequate.S|A

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 Microsoft Windows RT price cuts dont stop the death spiral

Charlie Demerjian

Roving engine of chaos and snide remarks at SemiAccurate
Charlie Demerjian is the founder of Stone Arch Networking Services and SemiAccurate.com. SemiAccurate.com is a technology news site; addressing hardware design, software selection, customization, securing and maintenance, with over one million views per month. He is a technologist and analyst specializing in semiconductors, system and network architecture. As head writer of SemiAccurate.com, he regularly advises writers, analysts, and industry executives on technical matters and long lead industry trends. Charlie is also a council member with Gerson Lehman Group.