With Surface already out and a Windows Phone possibly on the way, it's clear that Microsoft means to become a big player in hardware -- but it will need to open up its checkbook.
Microsoft's move into hardware may see it "eating hard rice," in the words of one peeved partner, but moving it is. After introducing Surface, rumors are that more products are coming. But if Microsoft is to truly adopt the Apple model, it will need to bulk up. There are at least two vendors that Redmond is likely eyeing as it transitions from a software-only company into a supplier of all-in-one systems like the Mac and iPad.
First, some background. Microsoft last month shipped
the Surface RT tablet, its first real entry into PC hardware beyond peripherals. Surface runs a version of Windows 8 called Windows RT, which is limited to Metro-style apps that can be obtained only from Microsoft's online Windows Store. Now there are reports that Microsoft is prepping not only its own version of a Windows Phone 8 device, which would compete with models from partners like Nokia, HTC, and Samsung, but that it's also working on a 7-inch version of Surface, dubbed Surface Mini.
So Microsoft may be getting into the hardware game for keeps. What's behind the moves? For starters, the company is sick of watching Apple's beautiful new products draw raves and set fanboy hearts afire while its partners come out with Windows-based devices that, well, let's just say can be less than impressive.
Thanks in part to Microsoft itself (and its Windows licensing fees), the PC clone business has always been about volume over quality, and quantity over margin.
To be sure, some vendors, like
Dell and its XPS 12, have produced impressive Windows 8 systems. But on balance, the OEM community was never really geared for building showroom pieces. With Surface, and other possible hardware offerings, Microsoft wants to show what Windows can really do.
Second, Apple has proven the efficiency, reliability and commercial potential of the closed-loop app model. By limiting developers' access to its devices by forcing distribution through the App Store, Apple can control the quality and user experience of the software that runs on its platforms. It may not be Microsoft's fault that an application runs like crap on Windows, but the user who just shelled out for it doesn't care. It's guilt by association. Microsoft can see how well the closed-loop model is working for Apple, and it wants in on that.
To some extent, it already is. The Windows Store is the only source for Metro-style apps. Still, it's tough to exercise quality control without controlling the hardware environment. Currently, there are dozens of OEMs building Windows 8 systems.
Finally, Microsoft needs to change its business model because its existing one, selling software, will eventually go away. Android is the leading OS for smartphones, and Google charges exactly zero dollars for it. Google Apps for Business starts at just $5 per month, per user. And IBM's Lotus Symphony suite, which includes documents, spreadsheets, and presentations? That's also free.
Microsoft offers low-cost, cloud-based apps through Office 365. But it also rakes in big bucks for the client versions of Office, which start at $120. The days it can continue to do so are numbered. There's just too much free or low-cost stuff out there. So how does combining software, a business with diminishing returns, with hardware, which traditionally operates at razor-thin margins, help Microsoft?
In a couple of ways. One is by bundling. General Motors doesn't sell individual engines, or transmissions, or cup holders, because it can charge more than what those piece parts are worth by putting everything together in the form of a car. The other is that Redmond could drive a lot of players out of the industry if it expands into hardware, particularly if it decided to no longer license the Windows operating system to third parties. Less competition means higher prices, and fatter profits.
In the past, withholding Windows would have brought down the antitrust regulators down on Microsoft. But if you view today's computer market broadly, to include smartphones and tablets, it's hard to argue that the company is in a position to dominate. This is why Redmond's partners are getting antsy. Lingxian Lang, China operations manager for Acer, recently said that Microsoft's plan to compete with partners would ultimately see it "eating hard rice."
Perhaps, but Microsoft appears ready to take the risk. This is where acquisitions come in. If the company is to be a legit hardware player, it needs to do more than just contract out manufacturing to third parties. It needs to get in the game.
For hardware design and manufacturing, there is a huge global network just waiting to get scooped up. And it happens to belong to one of Microsoft's closest partners, Nokia, which could be had for a relative song. Nokia's stock price closed at $2.64 on Wednesday. Using the 42% premium that Oracle paid to get into hardware by purchasing Sun Microsystems as a guide (like Nokia, Sun's hardware business was failing but the company retained valuable software and IP assets), Nokia could be bought -- lock, stock, and worldwide production network -- for about $14 billion, based on Thursday's market cap of about $9.8 billion.
Acquiring chipmaker Nvidia, on which it has
first right of refusal, would give Microsoft a key strategic asset. Apple products tend to just work because it can fine-tune its software and chips to work together as much as necessary before launching a product. Apple's ARM-based family of mobile processors need to do only one thing well -- run Apple, and Apple-approved--software. That may be why Apple is reportedly contemplating ARM for the Mac as well, and dumping Intel.
Nvidia wouldn't go cheap, as it would likely have many suitors (Google?). It could sell for 50% or more over market cap, so figure $14 to $15 billion. But Microsoft, as of the close of its most recent quarter, was sitting on $66.6 billion in cash, equivalents and short-term investments -- enough to swallow up both Nokia and Nvidia.
Will these deals happen? Hard to say for sure, but it's a good bet they're at least under discussion as Microsoft moves closer to the Apple model.
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