Microsoft's money pit: Surface has lost $1.2B

CEO Nadella will unveil new tablets Tuesday, but can he stop the bleeding?

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Analysts weren't optimistic.

"I expect premium price points," said Patrick Moorhead, principal analyst with Moor Insights & Strategy, in an interview last week.

He explained why by citing rivals' business models. "Both Google and Amazon have models for their tablets where they make it up on the back end," Moorhead said, referring to the advertising and product sales that the two rely on to offset their lower-priced tablets. "But I don't feel like Microsoft has achieved scale in their tablet content to offset [lower prices]."

Higher prices means lower sales volume. And that's a problem. "You have to have scale to buy cheaper components. Microsoft doesn't have the scale to be profitable or to hit interesting price points," Moorhead argued.

In other words, because Microsoft will be forced to stick with premium prices for the Surface, it's unlikely to sell in enough volume to be able to strike bargains with component suppliers. If it was able to make those deals, it could either use the lower costs to turn a profit in the short-term, or more likely, immediately reduce prices, recognizing that would delay profits but expecting the losses to turn into even larger, and more sustainable, gains.

Others also expected the new Surface tablets to retain their high prices. Independent analyst Sameer Singh, for example, pegged the likely price of a "Surface Mini," a 7- or 8-in. tablet, at between $249 and $299. "I don't think Microsoft can afford to compete with low-end Android and 'white box' manufacturers on price," Singh said recently.

Singh's price range was closer to the established first-generation iPad Mini -- which lists for $299 -- than to the current crop of 7-in. tablets from the likes of Amazon and Samsung, priced at less than $200.

Rumored prices of a new slate of Surface Pro tablets -- the models that run legacy Windows applications -- also tilt toward the high end. A report Saturday by Windows Phone Central claimed that the next-generation Surface Pros will start at $799 and run up to $1,949.

Those prices are minus the keyboard that Microsoft virtually mandates in its marketing. A Surface keyboard currently runs between $80 and $140.

Although the $799 base price is $100 less than the lowest-priced 64GB Surface Pro 2 sold today, the combined tablet + keyboard package equals an out-of-pocket expanse around $900, still stratospheric for tablets, and in the realm of premium notebooks and the 2-in-1 hybrids Microsoft aggressively trumpets.

Minus a price-reduction strategy, Microsoft faces an uphill battle against the also-premium-priced iPad and a bewildering array of low-cost Android tablets. The smaller losses in the last two quarters are encouraging signs. But there are some other signals that the Surface is gaining ground, and doing it organically.

"Surface Pro is making some headway in corporate environments," contended Ross Rubin of Reticle Research. "One of the big draws for Surface versus competitors is legacy Windows compatibility, and its pricing is more geared toward corporate customers."

Fidel Deforte, the infrastructure and communications technology manager for the city of Cape Coral, Fla., agreed. In an email last week, Deforte outlined how he has begun replacing some senior managers' hardware -- typically a combination of an iPad and a Windows notebook -- with the Surface Pro. And saving money as he did.

"I replaced [a manager's] HP laptop and iPad (total value $2,600) with the Surface Pro 2 ($1,300) and she not only loves this, but sees that it is more flexible and efficient," Deforte wrote.

All that Nadella needs is millions more stories like Deforte's.

Microsoft will webcast the Surface event Tuesday, starting at 11 a.m. ET (8 a.m. PT).

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, on Google+ or subscribe to Gregg's RSS feed . His email address is

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Copyright © 2014 IDG Communications, Inc.

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