Apple 2.0

Covering the business that Steve Jobs built

Why Microsoft is building its own tablet computers

June 21, 2012: 9:39 AM ET

There is no longer enough profit, writes John Gruber, in selling software alone

Microsoft's Surface

FORTUNE -- Having apparently concluded that Microsoft's (MSFT) new tablet computer initiative -- dubbed Surface -- is not in fact a "hoax," Daring Fireball's John Gruber took a hard look Wednesday at the company's decision to turnĀ against its manufacturing partners and build its own hardware.

The heart of Gruber's analysis is some math posted earlier in the day by Asymco's Horace Dediu.

Dediu calculated that the software licenses for Windows and Office generate about $78 in operating profit per PC sold. Apple (AAPL), by contrast, generates about $178 per unit operating profit just from the iPad. Microsoft used to make it up in volume, but tablet sales are on a trajectory to overtake sales of traditional PCs, which are in decline.

"So Microsoft faces a dilemma," Dediu concluded. "Their business model of expensive software on cheap hardware is not sustainable. The future is nearly free software integrated into moderately priced hardware."

That, writes Gruber, is why Microsoft has decided to compete with the manufacturers that have been its partners since the dawn of the PC era:

"This move was driven by the iPad, but competitively it directly pits Microsoft not against Apple but against Dell, HP, Toshiba, et al. The intention is obviously to slow the iPad down, but the radical shift in Microsoft's strategy is about the fight over the profits that remain after Apple's. The math no longer works out for the Windows you-sell-the-hardware-we-sell-the-software model. It works for unit share (cf. Android), but it doesn't for profit share. Nothing works sustainably in business without profit — profit is the oxygen companies breathe.

"Even if Apple's growth soon slows, Apple already reaps a massive share of the industry's profits. And if Apple's growth doesn't slow in the next year or two, look out. All of Apple's competitors in the phone industry, save Samsung, are now starving for profit. They're dying, all of them — HTC is breaking even and the rest are deep in the red.

"Microsoft Surface is not fundamentally about Microsoft needing to control the entire integrated product in order to compete with the iPad on design. It's about Microsoft needing to sell the whole thing to sustain its current profitability."

Its a thoughtful post. You can read it in full here.

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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