Surface's high profit margin reveals Microsoft's ape-Apple strategy

Computerworld - Microsoft makes more than $300 on each Surface RT tablet it sells, showing that the company has adopted the business model of its rival, Apple, analysts said yesterday.

According to IHS iSuppli, which disassembled a 32GB Surface to estimate a "bill of materials" (BOM), Microsoft's component costs were $271, with another $13 to account for manufacturing. The total of $284, however, does not include other costs, such as research and development or marketing.

With the Surface RT's retail price of $599 -- iSuppli examined the model that comes with a Touch Cover, Microsoft's least-expensive keyboard-cum-cover -- the $315 difference represented a margin of almost 53%, higher than any of Apple's W-Fi equipped full-sized iPads.

"Microsoft can make money on the hardware alone," said Andrew Rassweiler, iSuppli's senior principal analyst for teardowns, in a Monday interview. "The numbers speak for themselves."

Microsoft has taken the same approach as Apple, which prices its hardware at a premium to generate profit on the devices themselves.

Other tablet makers, notably Google and Amazon, have taken a different tack, pricing their wares at or near cost, expecting to make money on software, other digital content, and services.

For example, Amazon's Kindle Fire HD, a 7-in. tablet that launched in September, is priced at $199, just $26 above its materials and manufacturing costs, iSuppli noted Monday. The Fire HD's margin, then, is a minuscule 13%.

Google's Nexus 7, which was just upgraded to 16GB for the entry-level configuration, carries a BOM and assembly cost of $167, giving the search giant only $32 in profit on the $199 list price. It's margin: a slightly-higher-than-Amazon 16%.

When Microsoft unveiled the Surface RT last June -- months before it disclosed prices -- many experts speculated that the company would discount the tablet and try to make good on app sales from its Windows Store, from fees for beefed up services like its SkyDrive cloud storage, and from other software. Microsoft was, after all, a software company, the pundits noted.

That wasn't the road the Redmond, Wash. developer took.

It may not have had any other option, said Sameer Singh, an analyst who covers mobile technology on his Tech-Thoughts website.

"I don't think making money on the hardware was as much of a choice as it seems, even though it fits in well with their long-term strategy," said Singh in an email reply to questions. "While I think the Surface would have more success at $299, coming in at that price point would have forced their major OEM partners to immediately drop all Windows RT-based products. OEMs have to make money off of hardware and have to pay a license fee, so they could never have cost or price parity."

Both Rassweiler and Singh saw the pricing and margins of the Surface RT as indicative of a sea change at Microsoft, one that CEO Steve Ballmer announced last month.

"It truly is a new era at Microsoft," Ballmer wrote in his annual letter to shareholders about the U-turn from software to selling hardware and focusing on cloud services. "This is a significant shift, both in what we do and how we see ourselves as a devices and services company," Ballmer said.