Microsoft needs a new business model for Windows 8 tablets
Microsoft’s Windows division is still a monster: Over the past year, it has generated $12 billion of operating income on $19 billion of revenue. A big part of that is because of Microsoft’s continued dominance of the PC operating system market, with more than 400 million Windows 7 licenses sold cumulatively.
But as the industry shifts toward tablets, the story gets less certain for Microsoft. With different economics and pricing for tablets than PCs, how will it build a meaningful growth business? It may need to figure out a new model. Or it may just shrink.
With iPad-style tablets, not only is Microsoft entering late, but it’s starting from scratch, both in terms of software and market presence. Because of that, it missed the chance to structure the industry’s economics in its favor. And that doesn’t bode well for a Windows-style business model.
Today, for each PC bought, figure that somewhere between $50 and $100 goes to Microsoft for a Windows 7 license. The exact amount varies on manufacturer, region, and version of Windows, and doesn’t matter for this argument. The point is: It’s a decent chunk of money per device, and it’s a lot of devices.
But for tablets that need to be $500 or cheaper to compete with the iPad, the idea of manufacturers spending $50 to $100 per device for a Windows license is a non-starter. Especially if tablet makers are choosing between “free” Android as the alternative. (Who knows how competitive Android will be in a year, when Windows 8 tablets are supposed to be ready.)
How much could Microsoft charge? Perhaps $20 to $30 per device? Even less? That means that even if Microsoft’s partners can sell 25 million to 50 million tablets in a few years — which would be considered a huge success — that’s still barely a $1 billion business for Microsoft.
Considering its last 12 months of revenue — almost $70 billion — that’s hardly a growth driver, especially if it’s combined with a shrinking PC industry and Apple’s continued dominance in tablets. (If Microsoft somehow comes from behind to eventually have PC-like dominance over the tablet industry, it’s a different story. But that’s unlikely.)
This is the beauty of Apple’s iPad business, where it’s selling an integrated package of software and hardware (increasingly, via its own retail empire). Yes, Apple is limited in the sense that it can’t spray its OS across dozens of hardware vendors the way Microsoft can. But it’s also in the position to capture all of the device’s revenue, and potentially hundreds of dollars of profit per device.
Already, Apple has generated more than $16 billion in iPad revenue over the past year — almost as much as Microsoft’s Windows division. (Though it’s likely far less profitable.) If Apple were to sell 50 million tablets in a year, it could generate more than $30 billion in revenue — or roughly 30 times the amount that Microsoft’s Windows tablet licenses might fetch.
So, how could Microsoft make tablets a better business?
- It could sell integrated hardware and software, like Apple. But it’s not particularly good at hardware — remember the Kin? — and would risk alienating its key Windows partners like HP, Dell, and others. Then again, given the economics outlined above, that might be worth it.
- It could go for Office add-on revenue, the way Microsoft’s “Business” division (Office) already generates more revenue and profit than Windows. But Apple has also helped reduce how much tablet “office” software sells for — its entire iWork suite is $30 from the iPad App Store, with individual apps available for $10. That won’t help Microsoft much. And who’s to say that tablet owners need or want Office, anyway?
- It will generate some revenue from its cut of Windows 8 app store sales. But that isn’t much, and it’s generally not very profitable. Apple runs iTunes as a roughly break-even business on purpose, to drive more hardware sales, which is how it makes money.
- It could try to make money from some sort of “cloud” services. But Apple’s forthcoming iCloud and other services are driving those prices down pretty low.
- It could try to make money from advertising, both in tablet apps and on Bing. But that’s not likely to contribute much money per user, per year.
- It could try to make tablets that give people a strong incentive to continue buying Windows PCs with full versions of Office, preserving its current business. But how’s that going to happen?
These are just a few ideas. I’d love to hear more, and any flaws in my reasoning.
But it seems that Microsoft does need to do something new and different here, or Windows 8 tablets won’t be close to making up for whatever damage that the iPad and other tablets cause to the PC industry and Microsoft’s existing near-monopolies.
Related: How does Apple make money?