Surface tension: Can Microsoft keep Surface RT partners on board?

Microsoft says Dell, Lenovo, and Samsung will be making Windows RT devices, but can they realistically compete with the Surface RT?

As the October 26 launch of Windows 8 gets closer, Microsoft is disclosing more information about its biggest gamble: Windows RT, and the ARM-based touch-based devices that will run it, including its own Surface RT.

Windows RT represents a whole new business for Microsoft. For one thing, it leaves behind the world of traditional Windows software. For another, Microsoft is getting into the hardware business itself by marketing its own Surface tablets.

Can Microsoft walk the line between launching a new platform and competing directly with its long-time hardware partners? It’s still too early to say — but key parts of Microsoft’s strategy are becoming clear.

Saddle up, pardner

In a blog post, Microsoft’s Steven Sinofsky offered some new information on upcoming Windows RT PCs — and that terminology is significant. Microsoft is deliberately not calling Windows RT systems “tablets,” like the Apple iPad, Samsung Galaxy Tab series, Amazon Kindle Fire, or Google Nexus 7. In Microsoft’s mind, Windows RT devices are PCs — just PCs that can be more portable and embrace touch-driven applications.

Specifically, Microsoft says that Dell, Lenovo, and Samsung will be making ARM-based Windows RT devices: with that announcement, Microsoft brings the total number of committed Windows RT device makers to five: Asus has already committed to Windows RT with its Tablet 600, and, of course, Microsoft itself is in the game. All five device makers are expected to have Windows RT devices ready to go for the October 26 Windows 8 launch.

Interestingly, the world’s largest PC maker, Hewlett-Packard, seems content to sit this one out: HP says it plans to build Intel-based Windows 8 tablets, but has no plans for Windows RT. Considering the fate of the HP TouchPad, perhaps it’s no surprise.

Toshiba and Acer are also missing from the fray. Both companies have indicated they intend to make Windows RT devices, but won’t be bringing them to market until early 2013. In other words, they’ll be sitting out for at least the platform’s launch. Toshiba demonstrated Windows RT systems in June at Computex, but now says component shortages make it impossible for the company to enter the Windows RT market in a “timely” manner. Instead, Toshiba plans to launch Windows 8 devices. Toshiba’s Windows RT devices were based on system-on-a-chip components from Texas Instruments — so far, other manufacturers who will be ready for the Windows RT launch are basing their systems on chipsets from Qualcomm and Nvidia.

Acer has been the most critical of Microsoft’s decision to make its own Surface hardware, with CEO J.T. Wang urging Microsoft to “think twice” about ticking off hardware makers by competing directly against them. That said, Acer has indicted it plans to bring ARM-based Windows RT devices to market in the first quarter of 2013 — but it announced those plans before Microsoft unveiled Surface.

Surface is still a PC

As its very intentional naming scheme indicates, Microsoft really does see its own Surface devices as extensions of its existing PC ecosystem, not a new market unto itself.

To that end, Microsoft expects most (if not all) Windows RT devices will embrace a number of technologies that are more common in traditional notebooks than tablets, including physical keyboards and trackpads. (One example would be the Asus Tablet 600, which features a keyboard dock.) Users will continue to be able to use many PC peripherals with Windows RT devices, including USB drives, AV peripherals like webcams, HDTVs, and projectors, as well as output devices like printers. Windows RT devices will also support Wi-Fi (naturally) and Bluetooth for connecting to the world of notebook and phone peripherals, and some products will likely have WWAN options to connect to mobile operators 3G and 4G networks.

Microsoft says Windows RT PCs will weigh between 1.2 and 2.6 pounds. That’s quite a broad range: By way of comparison, the current iPad weighs about 1.4 pounds, and a MacBook Air comes in at 2.2 pounds. Devices screen sizes will range from 10.1 to 11.6 inches — no resolutions given — and Microsoft says Windows RT PCs will be able to handle full HD playback from anywhere from 8 to 13 hours on a single battery charge. These measurements are preliminary — the figures may get better as the systems get closer to manufacture. Microsoft says it has also worked hard to optimize graphics performance, with UI animations happening at 60 frames per second, and gesture recognition has been built into firmware for “incredibly fast” gesture recognition. Some (but not all) Windows RT devices will have NFC support, so users can do “fun and interesting” things like bump devices together to share information.

Perhaps most interesting is Microsoft’s estimates of how long Windows RT devices will be able to hang around in “connected standby” mode: 320 to 409 hours without a recharge. In connected standby, devices will sip power by performing only limited functions, like connecting to wireless networks and pulling in users’ latest email, calendar items, notifications, feeds, and status updates. They should also power up in less than a second, and since they’ll already be up-to-date with the latest information, users are less likely to have to fuss around with apps or tiles to quickly get to information they need.

Pricing and that $199 rumor

Microsoft still hasn’t had much to say about how much Windows RT devices will cost. When it unveiled its Surface devices, the company only indicated Surface RT would be priced competitively with comparable ARM devices. At the time, most industry watchers took that to mean the $499 Apple iPad, but these days it might equally apply to the $199 Google Nexus 7. Microsoft also indicated Intel-based Surface PCs running Windows 8 would be priced comparatively to Ultrabooks, although it’s not clear whether that meant the $1,000 prices where Ultrabooks started out, or the more-recent $799 price range where newer Ultrabooks are appearing.

The Surface price debate has been re-ignited by unconfirmed rumors Microsoft plans to price at least some Surface devices at $199, in theory putting the devices into direct price competition with the likes of the Google Nexus 7 and the Amazon Kindle Fire.

The argument for $199

At first glance, the report lacks credibility, simply because no one is making money selling $200 tablets. Estimates had Amazon selling the Kindle Fire at a slight loss, and Google’s Andy Rubin has admitted that the company is essentially selling the Nexus 7 at cost. Both companies hope to lock customers into their (paid) content ecosystems of apps, ebooks, music, movies, and television shows, and make money over the long term as consumers buy content.

Microsoft isn’t really in the same boat. First of all, the Surface RT units Microsoft has shown so far has higher hardware and manufacturing costs than either the Kindle Fire or the Nexus: Between the new hardware specs, the tight tolerances in fit and finish, dual cameras, and Microsoft’s new VaporMg manufacturing process, Microsoft’s Surface RT units are likely considerably more expensive to manufacture than either the Nexus 7 or the Kindle Fire.

Further, Microsoft doesn’t (yet) have the same array of content for same to reclaim the price difference over time. Yes, Microsoft can offer to let Surface RT users tap into its Zune and Xbox services, but the offerings don’t yet have the same depth and maturity as comparable ecosystems from Amazon, Apple, or even Google. Even on apps, Microsoft will be starting from scratch. Although it has inked a deal in April with Barnes & Noble that should bring ebooks, magazines, and other content to the table, there hasn’t been much public motion on that yet.

Why might Microsoft consider the $199 price tag anyway? To jumpstart the Windows RT market. Microsoft is notoriously behind in mobile — Windows Phone has yet to get more than a toehold in the mobile market — and Windows RT represents the company’s first attempt to even begin to compete with the market sparked almost three years ago with the iPad. If Microsoft can release a sexy, high-quality product that significantly undercuts the iPad’s price, it could disrupt the tablet market and unleash an avalanche of developer and content publisher interest in the platform. And, let’s face it, Microsoft has very deep pockets: It can afford to sell Surface devices at $199 a pop and eat the losses for years. After all, that’s exactly what it has been doing with its entertainment (Xbox) and advertising businesses since…well, since forever.

The argument against $199

The primary argument against a $199 starting price for Surface RT devices is that Microsoft would absolutely alienate its four current Windows RT hardware partners — Asus, Dell, Lenovo, and Samsung. Toshiba, Acer, and HP would never come on board. The $199 price would completely undercut the Windows RT market before it was even born, giving other hardware makers no room to innovate or even attempt to compete with Microsoft. The situation would be exasperated by Microsoft’s pricing for Windows RT licenses. Microsoft is reportedly charging OEMs in the neighborhood of $85 per unit for Windows RT. At that rate, OEM manufacturers would have to design, manufacture, ship, market, and support Windows RT devices capable of competing with Surface RT on a budget of $114 per unit. Just to break even. And OEM’s aren’t Microsoft’s only partners that would be hurt by a $199 Surface RT unit: Barnes & Noble might have a lot of trouble asking $199 (or even $149) for a Nook Tablet if Surface RT were to debut at the same price.

Furthermore, Microsoft actually needs its OEM partners to make Windows RT fly. Although Microsoft does manufacture some hardware, the company simply does not have the same supply chain, manufacturing, distribution, and retail expertise as its OEM partners. It will probably take at least a few years for Microsoft to get up to speed with its partners, much less to compete with Apple.

Microsoft initially plans to only offer Surface RT units through its own retail stores. Right now, there are 31 Microsoft stores operating or due to open soon. Yes, just 31. Microsoft says it plans to have 75 permanent stores up and running by 2013. Recent job postings seem to indicate Microsoft plans to roll out a significant number of “pop-up” stores for the 2012 end-of-year holiday season — temporary locations to support the Windows 8 launch over the holidays, but which will vanish in early 2013.

If Microsoft is determined to launch Surface RT with a Microsoft-only strategy and wants the platform to quickly gain footing with consumers, it needs OEM partners to put Windows RT devices into leading retail outlets like Best Buy, Walmart, Staples, Target, as well as online retailers like Newegg and even Amazon.

Is there a third way?

There’s a way Microsoft can sell Surface RT units with a $199 price tag and not alienate all its partners — and the answer might lie in the Xbox 360. Microsoft is currently selling a subsidized version of the Xbox 360 for a mere $99 — with the caveat that buyers agree to pay $15 a month for a least 24 months for an Xbox Live membership and other services. That raises the the total price of the system to about $460 before customers have even purchased their first game. But the price tag still says $99.

Now, imagine Microsoft offered a Surface RT device for $199 — with the caveat that buyers also agree to pay $20 a month for Microsoft cloud services along with video and music subscriptions. That would make the total cost of the Surface RT unit about $680. That figure that would give Microsoft’s OEM partners plenty of breathing room for designing their own Windows RT devices, but allow Microsoft to put a $199 price tag out for the holidays.

Similarly, Microsoft is designing Windows RT with 3G and 4G capabilities in mind, so it could offer deals on Surface RT devices that come with mobile contracts. Verizon Wireless currently charges iPad owners $20 a month for up to 1GB of data, without contract. Microsoft can probably convince carriers to make a similar deal for Surface RT devices, but if users were willing to commit to a two-year contract on a data plan, they might be able to walk away with a Surface RT device for $199 out of pocket.

Bottom line

Microsoft needs to be very careful not to alienate its hardware partners with its own Surface RT devices. Not only could undercutting OEMs kill Windows RT before it gets out the door, it could also damage Microsoft’s bread-and-butter Windows business. PC makers are unlikely to suddenly switch to Linux if they don’t like Microsoft’s efforts with Surface tablets, but they may be less willing to invest in PC development — meaning PCs will become less interesting than ever, and probably cede market share even more rapidly to tablets and other devices. Long term, that’s bad for Microsoft.

But don’t be shocked if Surface RT devices appear to have $199 price tags. Just be sure to read the fine print.