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What was clear even back in June is that to compete with Apple, Microsoft is willing to do whatever it takes -- including blowing up the partner network it has worked decades to build.
There are countless companies that owe their success to Microsoft, but those days are over. And regardless of whether Microsoft is successful with its new strategy -- which is a huge question mark -- like toothpaste, it can't be put back in the tube.
Microsoft understands this and is going all out. CEO Steve Ballmer is now openly evangelizing that Surface is just the beginning of the company's foray into hardware.
Shortly after the announcement of Surface in June, in a letter to shareholders, Ballmer underscored the importance of the company's new strategy: "It truly is a new era at Microsoft. This is a significant shift, both in what we do and how we see ourselves as a devices and services company."
In an interview with the BBC during the October launch, Ballmer put an even finer frame around the magnitude of the strategy shift: "This is one of two or three big moment's in Microsoft's history." He continued, "It is fair to say we're going to do more hardware. Obviously, we are."
As if on cue, The Wall Street Journal reported a few days later that Microsoft is working with Asian component suppliers to test its first smartphone design.
So what should Microsoft's hardware and mainline distributor partners expect going forward?
For starters, Microsoft will cherry-pick the types of hardware it will make and what it will leave to partners. For example, desktop and laptop PCs today are commodities. Margins range from 4.5 percent for Lenovo in its latest reporting quarter to about 7 percent for HP. So don't expect Microsoft to go there.
In contrast, according to HIS iSuppli, which has disassembled a 32-GB Surface tablet to estimate a bill of materials, Surface margins are 53 percent, the highest in the industry. Surface margins are even higher than those of full-sized, Wi-Fi- equipped iPad models, which range from 37 percent to 48 percent. (iPad mini margins range from 40 percent to 57 percent.)
The fact that Microsoft has chosen to make money on Surface -- as opposed to being a loss leader for its software or services -- is proof of the company's seriousness. This is a model that Apple has honed, and to compete at the same game, Microsoft must play it in the same way.
The high margins also signal that inevitably, Surface price points and gross margins will decline, creating even greater competition for its traditional hardware partners and distributors.
As for Microsoft's mainline distributors, today they provide low-value and low-margin services that Microsoft can easily duplicate -- multivendor time and place, inventory and credit -- and so it will. It is notable that Surface is being sold only through Microsoft retail stores, at least in the U.S. And as a low-value product with minimal configuration options, Surface is ill suited for mainline distributors anyway.
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