Narrative: Microsoft’s Hardware Push

Written: January 24, 2017

In 2012, Microsoft launched its first Surface devices, and in 2014 it closed its acquisition of Nokia’s devices business. These two moves marked Microsoft’s first serious foray into computing hardware outside of the gaming space, with entries in the laptop/tablet and smartphone markets. Both flowed from Steve Ballmer’s Devices and Services vision for Microsoft, which in turn was a recognition that software might be eating the world, but fewer and fewer people were paying for it anymore. Devices and Services would be the business models that would pay in the coming years, and Ballmer felt that meant Microsoft needed to be a device vendor in key categories.

Looking back now, the Surface strategy has panned out pretty well, delivering a useful little revenue stream for Microsoft while also pushing OEMs to create more compelling hardware of their own. The Nokia acquisition has of course not worked out nearly so well. It may have earned Windows Phone a temporary reprieve, but the trajectory of the phone hardware business was inexorably downward almost from the moment the acquisition closed. Neither renewed investment in the hardware nor the Windows 10 convergence of PC and mobile operating systems has done anything to stem the decline. a little under three years after the acquisition, there’s basically nothing left to show for it – the feature phone business was sold off and the smartphone business has dwindled to nothing.

With hindsight, it’s arguable that Microsoft might have been better served giving up on Windows Phone and pursuing an Android strategy, either with or without Nokia on board, though given the struggles of the major Android vendors, it’s not entirely clear that would have worked out better, especially given the tensions between the Google services baked into Android and Microsoft’s own. Another strategy, which the company has essentially embraced several years later, is to become an agnostic provider of apps for all mobile operating systems rather than trying to own either a major mobile OS or smartphone vendor. In some ways, that strategy has now worked out well, with several Microsoft apps popular on both iOS and Android, though most of them aren’t monetized at all, raising the question of how Microsoft will make money from all this.

At the same time, Surface revenue is heading for its first period of revenue decline – something that should be confirmed when Microsoft reports its earnings later this week. That’s because it didn’t update the Surface Pro, by far the best seller in the line, this fall, while the minor bump to the Surface Book and the release of the more niche Surface Studio won’t make up the difference. There is an ongoing question about the role of the Surface line now that OEMs are stepping up their efforts and producing more compelling machines of their own – should Microsoft step back and allow OEMs to take over, or should it continue to pursue this market opportunity? If the latter, how does it justify its continued presence given its original rationale or prodding OEMs to do better?

Microsoft here faces the same inherent tensions as Google with its hardware push (see the relevant narrative here): its OEMs are its customers and partners and yet it has chosen to compete with them. In Microsoft’s case, my sense is that the focus of the Surface is narrow enough that it doesn’t present a broad threat – it’s targeted at creative professionals who value stylus input, rather than at the mainstream laptop user (or at least that’s the theory – I’m not sure it holds up in practice given those I’ve seen using Surfaces). In both cases, though, these erstwhile OS sellers are now targeting the most lucrative and profitable end of their respective OEMs’ markets with their own hardware. Microsoft is definitely going to have to gauge its strategy here carefully to ensure that it doesn’t put a smallish hardware revenue stream above the interests of its OEMs in the long term.