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'Perplexing' Surface pricing can be explained, analyst says

The software margin on which Microsoft thrived in the PC era, says Asymco's Horace Dediu, has been "captured in hardware."

The Surface tablet and its keyboards of many colors.

The more things change, the more Microsoft would like them to stay the same.

That's the gist of Horace Dediu's assessment of the tech giant's "perplexing" pricing strategy for its new Surface tablet, as its old mainstay, the PC market, becomes the PC-plus-tablets market. It's the tablet portion of that equation, you see, that's driving the growth in that combined marketplace. (See Dediu's charts.)

For the several decades of the PC era, Asymco's Dediu points out, Microsoft has benefited from the "tax" payments that accrued to it by way of Windows and Office licenses. He reckons that Windows revenues per PC have held steady for the last three years, currently sitting at $52 per PC, while the figure for Office has crept up somewhat during that period to $67 per PC.

Microsoft revenue model
Horace Dediu/Asymco

"The problem for Microsoft," he writes, "is that pricing systems software at $50 and a suite of apps at $67 for a tablet that costs $200 to the end-user is prohibitive."

That $200 figure is on the low end of tablet prices -- Google's Nexus 7 and Amazon's Kindle Fire HD, for instance, start at $199 -- but the low end has captured consumers' attention in recent months. The Surface starts at $499.

Market researcher IDC has said that in the latter half of this year, the Android sector of the tablet market "should benefit from the success of the Nexus 7 and Amazon's launch of new Kindle Fires," while Surface -- though it will make gains over time -- will suffer because "high prices and consumer confusion around these devices will limit their appeal."

But it's not just the cost of the tablet itself. There's also the hard reality for Microsoft that so many of the apps that people are using today are free, and those that aren't free typically cost less than $10.

With Microsoft's tablet, Dediu writes, the all-important software margin is "captured in hardware":

This explains the pricing of Surface. The price isn't significantly below what Apple charges because Microsoft wants to capture a comparable (30%+) margin. On a $500 product that amounts to $150. After subtracting hardware operating and distribution costs we can get pretty close to the $120 it currently obtains from a PC.

In other words, Redmond's hoping to have it the same as it ever was, more or less. And that may be good enough for Microsoft as it looks to shore up its dominance in a changing environment that many have described as the dawn of the post-PC era.

This also may help explain why Microsoft, not known as a hardware maker, is making the Surface rather than relying on its traditional OEM partners -- which, like Acer, were not thrilled to see Microsoft crowding into their line of work. It's all about the margins and how hardware makers might be tempted to cut corners, "compromising the experience and causing the platform to suffer," Dediu said.

PC shipments
There's been growth in the PC market -- if you include tablets (medium-screen, in blue) along with traditional PCs (large-screen, in brown). Horace Dediu/Asymco