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.  

Component Yearly 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.)


  1. jc says:

    Mullet, !! do it 🙂

  2. MobileHudson says:

    You and I can both wear the mullet wig, Charlie. Personally I look forward to the Surface. I am cautiously optimistic.

    BTW – I saw that Samsung showcased a Win 8 phone in Berlin. Don’t know the specs, but the picture looked great!

  3. I don’t think there’s any question that a $199 Surface wouldn’t be subsidized by subscription. I think, however, that there are a number of indications that Microsoft may indeed be getting ready to offer a subscription model.
    First is the presence of Surface itself. Microsoft’s entry into the tablet business makes a lot more sense if it’s tied to selling Xbox Music/Office 365/SkyDrive etc subscriptions. It’s close to not making sense without such a business model.
    The recent Xbox subscription trial run ($99 Xbox w/ a 2 yr Xbox Live sub) was just that, a trial run, and the model fits right into a Surface subscription scenario.
    Another indicator is the veil of secrecy around Xbox Music. Microsoft has allowed Zune Music Pass to flounder, and for what reason? If Xbox Music is solely Zune Pass rebranded, then why not get out and sell it this past year? This too, makes much more sense if the Xbox Music model is built for a Surface subscription.
    Microsoft has moved, and is continuing to move into a consumer subscription model, enough so that it’s willing to sell Windows 8 for a $40 upgrade price, and making it up on subscriptions. Surface is a big part of that plan, and indeed the Surface might not exist at all if a subscription model weren’t on the way.

  4. nimatra says:

    Zune Pass is 99$ for a year, 10$ for a month.

    1. I just did $10 & 12. Makes my case stronger though.

  5. Andrew Tobin says:

    I think the problem here is, Apple tell people the OS is free, it’s the hardware that costs… and Microsoft not having been selling hardware, and Android giving it away free, makes it difficult to keep suggesting the price of the OS should be ~$100 when Apple are saying it’s worth $0.

    That said, Apple don’t have to sell their OS to anyone else and they include the cost in the hardware – but I have heard it reported so often that Apple don’t charge for their OS, so why would I pay for Microsoft’s?

    It’s a difficult argument because no one wants to hear the reasoning, they just don’t want to pay.

    Same with Apple saying software should be $2, and so many web companies struggling over each other to give their products away free and recoup by being bought or through ads, and people have an entirely skewed view of what software costs.

    I should note I specifically mean iOS, I know they charge for their full operating system, but they release more often at a lower rate and people think they’re still not being charged as much.

  6. Erno Newman says:

    One thing though, you calculations seem to assume that this is the RT version of Windows at $85 and Office at $120 but the Windows RT already includes Office so how would MS justify the extra $120 for Office? Even is that a subscription to Office 365 would you need it if you’re already paying for the extra SkyDrive space?

    1. Erno, you are right. I have a wild fantasy playing out in my head that Microsoft has actually built a new, tablet version of Office (the one in Windows RT is the desktop version crammed in) ready to go; waiting in the wings as it were. It runs on iPad, Android tablets and Win8.

      If this fantasy of mine is true then that is worth something.

      However, if I’m wrong (and I likely am on this point) then it just makes my “no $199 subscription or not) argument stronger because it makes the possible subscription offering even weaker.

      1. Tristan Dyer says:

        Microsoft has been cagey with how they worded office is included. I remember MJ Foley complaining that they never said it was free, and wouldn’t say it is free.
        http://www.zdnet.com/blog/microsoft/office-15-on-windows-8-on-arm-three-guesses-how-it-could-work/11896 It is entirely possible that it is based on a office365 sub.

  7. factormystic says:

    cf. https://twitter.com/ckindel/status/241204650152448000

    Your pricing for Windows RT is flawed. First of all, the $85 point is highly debatable and even your quoted source says there’s a range. However, even if other OEMs are forking over $85 per, the dollar amount irrelevant in this analysis because the marginal cost of issuing more Windows RT licenses is zero, and the price Microsoft pays to issue more Windows RT licenses to itself is zero.

  8. MarcelDevG says:

    It was said that the pricing would be comparable with other tablets. I think that includes the ipad price range and the other windows 8 tables that are coming.
    So a price range from 550 to 699.
    Comparing it to android tables prices is difficult/impossible. It’s a complete other product/experience.
    The surface exsists only to show everybody (including oems) what is possible and that they are really going to push the integration of products and the 3 screen experience. And people are buying it, just nog the media.
    I think the subscription formula for windows is still a generation (or 2) away.

Debate this topic with me:

This site uses Akismet to reduce spam. Learn how your comment data is processed.