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By | Gavin Clarke 30th January 2013 10:02

Microsoft's Dell billions have Windows 8 strings attached

If you can't convince them, buy them...

If you can't beat them, join them, or - if you're Microsoft - infiltrate them. Just be careful not to go in too deep.

Microsoft has recently developed a clever approach to launching into markets where it has previously failed or is currently failing: rather than buy an existing name, Microsoft has become its partner.

To boost Bing, Microsoft got Yahoo! to swap out its native search and ads engines under a 10-year deal - where Microsoft pays Yahoo! more than 80 per cent of what's made from Bing searches on Yahoo properties. Meanwhile, Nokia's incoming chief exec Stephen Elop made Windows Phone the operating system of choice, killing Symbian and Linux. Elop had been a Microsoft group president running business apps and Office, and the Nokia flip was so in your face you had to wonder whether Elop was a Trojan Horse.

Partnering up is a cheap and clever way to do business, and it means Microsoft can keep hold of its $63bn cash while avoiding the fallout of a hostile takeover and avoiding taking on new risk. If something goes wrong at Yahoo! or Nokia, well, it's a management execution issue, and nothing to do with Microsoft's business development, marketing or technology. Acquisitions haven't exactly worked for Microsoft: last year it wrote off its 2007 $6bn purchase of aQuantive, which was Microsoft's answer to Google's purchase of advert-delivery network DoubleClick for $3.1bn in April of the same year. It's also spent $8.5bn on unwanted web telco Skype.

Meanwhile, Dell looks like it may be a prime candidate for the latest infiltration. With PC market sales falling, Dell's in talks with private equity to go private, a move that would allow for a restructuring by the world's number-three PC maker without coming under pressure from the market.

Dell has calculated that buying out its shareholders would cost just over $20bn and Microsoft is reportedly interested in putting up to $3bn, a stake which the report suggests would put a Redmond representative on Dell's board and give Microsoft a chunky 10 per cent stake. Michael Dell currently owns 15 per cent.

As a stakeholder with a board representative, Microsoft would want to exert the kind of influence that ensures Dell best represents Redmond's own interests, and those interests mean churning out more touch Ultrabooks, hybrids and simple laptops running Windows 8.

Microsoft: Be more like Apple

As we learned last week, Microsoft is in a state of denial over why Window 8 has failed to sell. It seems that inside the self-reinforcing bubble of Redmond, it's the OEMs that got it wrong for not following Microsoft's advice and building enough PCs that maximised on Windows 8's touch.

The OEMs, meanwhile, tell a different story: they say if they'd followed Microsoft's carefully considered and self-serving advice they'd have built some very expensive Ultrabooks that would have gone unsold, because people were browsing at the high end but buying sub-£300 laptops. Also, The Reg was told, when consumers walked into shops expecting to see Windows 8 machines and didn't see any, they bought PCs running Windows 7 instead.

On Windows 8, Microsoft wants PC makers to become more like Apple: making a PC or tablet that absorbs higher hardware margins by attaching a bigger price tag.

IHS iSuppli reckons the bill of materials on Apple's lowest iPad Mini priced at $329 is $188; with an additional $10 to cover manufacturing that means a margin of $131 - or 40 per cent - on even the smallest iPad. Microsoft's Surface is more expensive to produce, $267 excluding the optional keyboard cover, but comes with the promise of slightly more profit: 47 per cent margin on a machine priced at $499 with 32GB memory.

Surface - more cost, more risk

Surface was meant as design concept, to inspire PC makers, but Surface is more expensive to make than an iPad and it has no track record. It is, therefore, a big risk. Worse, the existence of Surface has pitted Microsoft against its partners - PC makers who use its OS. As with Yahoo! and Nokia, before it, Microsoft wanted to outsource the risk and cost.

If it took a stake in Dell, Microsoft would likely try to exert more pressure on the PC maker to take the kinds of risk Redmond believes are worth taking - for example by producing the kinds of Windows 8 devices that its PC maker partners failed to churn out at Christmas time.

Would it work?

According to Gartner, the current dynamic of the PC market is this: consumers are replacing old PCs with brand-new tablets. That means the PC market as it has been traditionally defined - a place of high volume/low-price when compared to Apple - is a bad place to be. But how could the PC-makers break into the high-end/high-margin market and achieve volume?

The 2013 Consumer Electronics Show saw several high-end Ultrabooks, hybrid tablets and laptops that were all destined for high-price points. Many of them were priced at over $1,000 - with some coming in at $1,200 and $1,500. Those are some pretty Appley prices - the kinds of prices laptops where during the '90s, not what they became in the noughties.

Until recently, the PC market has rested on two principles: high-priced systems from Apple in a niche surrounded by a mass-market of low-priced PCs running Windows from any and all OEMs. The question is, how many PC makers could the niche support? The answer, logically, is "not many" - and certainly not the same number of "mass-market" PC makers operating now.

Never mind that PC makers must offer something more compelling than Apple, they'll also need to re-structure - cutting costs to support the new pricing model and possibly fewer sales - while diversifying sufficiently so that their businesses aren't reliant solely upon high-priced touch tablets. There will also need to be a significant culture shift, from the current mass-market-low-price mindset to which high margins are an afterthought.

Planes, cars and PC makers

Those who don't shape up face an uncertain future. The logic is that current PC-making companies will either go out of business, exit the PC sector (a la HP's threats of 2011), or be bought out through one of the ever-more-desperate acts of consolidation that have been working though the US car and airline businesses. This has only postponed the inevitable in these sectors, with corporations lurching on buying each other and taking on more costs along with additional new customers and periodically taking shelter from their creditors in bankruptcy protection as they indulge in periodic fits of cosmetic restructuring.

The implied objective for Dell's decision to go private is to whisk it away from the scrutinising gaze of Wall St and the pressure of share-price fluctuations so that a few brave corporate souls can implement the kinds of changes needed to reposition the PC business and better exploit operations that include servers, software, services and cloud.

Microsoft will have to tread carefully: while it will want to ensure Dell churns out more and more Windows 8 touch tablets, it should also avoid prescribing the kinds of haughty "we know the customer better than the PC makers" advice that proved so wrong - burning both OEMs and Microsoft - during the run-up to Christmas.

If Microsoft hands over the cash and infiltrates Dell, there are still two ways that its efforts could result in a giant fail. One would be if its voice was ignored inside Dell; the second that - if it was heeded - Redmond provided Dell with poor guidance, ensuring it took one bad decision after another and lost its chance being rescued from the mire of the struggling PC market. Either way, Microsoft would have wasted $3bn. ®

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