A $199 Surface? I Will Wear a Mullet

A few weeks ago I jokingly tweeted “If MSRP on Surface is really $199, I will shave my head.” It was a joke, because as you’ve probably already figured out I’m pretty much bald.

But I was completely serious that I think the idea of Microsoft selling the 10” Surface with a MSRP of $199 is completely ludicrous.

Someone tweeted back that instead I should promise to grow a mullet instead. I’m not quite sure I’m capable of growing a mullet anymore, but if I were, I’d take that bet.

(I just wrote another post on retail pricing; if you are not sure what MSRP is and how it relates to products that are sold with a subsidy or subscription you might want to read it first).

There is one possible scenario where consumers may be able to pay $199 and walk out of a Microsoft Store this fall with a Surface: If Microsoft has built a subscription based offering that includes XBox LIVE Gold, Xbox Music Pass (the new equivalent of the Zune Pass), 20GB of SkyDrive storage, and some sort of Office offering that provided the equivalent of Office Home and Student.  This hypothetical offering would require a term of 2 years.  

ComponentYearly Price
XBox LIVE Gold$50
XBox Music Pass$120
20GB SkyDrive Storage$10
Office$120

Microsoft would never lower prices across the board, so I’m going to assume they would keep the service prices the same. Thus the bundled subscription would be be $300/year or $25/month subscription.

A Surface will cost Microsoft about $400 to manufacture (the iPad’s BOM is estimated to be about $350 and Apple has far more experience with supply chain management and managing BOM costs, so I think this is a perfectly reasonable assumption).

A Windows RT license is $85. Thus, excluding other sales and marketing costs, the real cost to Microsoft for each Surface is $485.

Therefore a subsidized price of a Surface of $199 would mean that Microsoft would be spending about $286 in customer acquisition cost (CAC). 

The lifetime value of the customer (LTV) would be $600. 

Assuming there are no other costs (ahem!) this would be $364 per Surface in Microsoft’s pocket after 2 years. It is impossible to estimate accurately what Microsoft’s COGs are for each of the components of the above subscription bundle, but consider the license fees MS pays for content in the Zune Pass means it probably barely breaks even, you can throw out that $120. For the others assume a generous 30% gross margin and the total profit would be $19

Just for fun, compare that to the estimated 23 to 32 percent gross margin Apple makes on each iPad.

These back of the envelope calculations mean to me that it’s possible that Microsoft could do a $199 Surface with a 2 year $25/month subscription.

I actually believe this is where Microsoft is going long term (see all my posts & discussions of Experience = Stuff / Time). And I hope Microsoft is actually ready to do this.

But I doubt they are. I just don’t think they are ready.

I think it is far more likely that Microsoft will sell the Surface for $599. They’ll sell every one they make at that price and earn a respectable 20% margin (maybe 3 million in 12 months; maybe). And in so doing, will support the broader ecosystem that is required to keep the existing Windows business profitable by shipping 350 million PCs next year.

Ok, so I’ve granted that a $199+$700 subscription is possible.

Now let me illustrate why a pure $199 MSRP is just about the most stupid suggestion anyone could make:

The current Windows business model is very profitable. PROFITABLE.  Not just big revenue but PROFIT. As in $11.4 BILLON in FY12. Do you understand the difference between revenue and profit? Steve Ballmer does.

I don’t know what the current per PC Windows license is. I know what it was about 8 years ago when I was in the Windows business. I don’t think I can disclose that number due to confidentiality. But we can back into something reasonable by assuming what OEMs pay is ‘wholesale’ and use the generally accepted wholesale->retail price multiplier of 40%. Windows 7 Premium’s MSRP is $199 thus the wholesale price is probably about $80. Probably a good proxy for what OEMs pay.

8 years ago that price was a LOT higher. 15 years ago it was even higher.

Linux (and Android) had a horrific effect on the Windows business model by forcing this price erosion. Why? Because those products were free and they enabled OEMs to negotiate a lower price on Windows with Microsoft. Moores law and the resulting plummeting cost of hardware didn’t help either. SteveB knows there is nothing he can do to STOP this erosion. It will eventually approach $0. But he would be insane to accelerate this erosion. In fact, Microsoft shareholders expect him to do whatever he can to slow it.

Undercutting the Windows partners who will make 99.99914% of the PCs that ship next year will do NOTHING for Microsoft’s business but accelerate the price erosion of Windows eradicating the $11B in profit it generates.

So just stop. Stop suggesting it. You sound like an idiot when you do.

However, if I’m wrong. And Steve Ballmer turns out to be a complete moron by selling Surface for a $199 MSRP I will wear a mullet wig to the //build conference.

Please discuss…

(Updated: I had the XBox LIVE Gold subscription at $100/year.  It’s $50/year.)

© Charlie Kindel. All Rights Reserved.