Microsoft remains shackled to strategy after $US900M 'absolute abomination' of a blunder

Microsoft's massive $US900 million Surface RT gaffe may have been, as one analyst put it, "an absolute abomination" in operations, but the company will not - cannot - give up on the ARM-based platform, according to experts.

"They haven't given up, not yet," said Frank Gillett, an analyst with Forrester Research. "Maybe in a year or two if, in fact, they're still struggling, but this is a determined company with a lot of cash and a large market presence."

Microsoft took a $US900 million charge against earnings to account for a drop in the value of its remaining Surface RT inventory. As explained by Amy Hood, the company's new CFO, in a call with Wall Street, the charge accounts for a 25% to 30% discounting of the tablet as well as a write-off of an unspecified quantity of components and accessories, likely including some already-purchased parts that have not yet been used to assemble more devices.

But the company, which has repeatedly confirmed that it will remain in the hardware business, gave no hint that it would either dump the Surface RT specifically or scale back its plans to become a devices-and-services vendor.

Analysts don't see any other move for the Redmond, Wash. giant, whose decades-old core business -- selling operating systems and applications for personal computers -- is slowly draining away as consumers reject PCs in favor of tablets and smartphones, markets where Microsoft continues to struggle to reach double-digit shares.

"It really doesn't matter if they wrote down $US100 million or $US900 million, they still need ARM as a hedge against Intel, a guarantee that they can go to lower price points," said Patrick Moorhead, principal analyst at Moor Insights & Strategy.

Microsoft invested in Windows RT, the scaled-back cousin to Windows 8, because it needed an operating system that would run on devices powered by ARM-licensed processors. Most tablets, including Apple's iPad and the vast bulk of those based on Android, run an ARM processor.

And it will continue to support Windows RT, and roll out its own "hero" devices based on that OS, to keep Intel's feet to the fire, Moorhead argued.

"Microsoft thinks that if they don't hold something over Intel's head, they won't see solutions in the future as competitive as Bay Trail which, at least on paper, looks very competitive for holiday 2013 Windows 8-based tablet," Moorhead wrote in a blog post today (subscription required).

The firm also needs to stay in the ARM game for other reasons, Moorhead continued, including the lower prices of ARM processors and the eventual merging of the Windows Phone and Windows code.

"They see ARM-based SoCs [systems on a chip) from someone like Rockchip or Huawei providing that cost reduction necessary to enable them to charge more for software or lower the product street price," Moorhead said.

Intel's business model is much more predicated on high-margin silicon than is ARM or its licensees, a factor that makes it difficult for Microsoft and its hardware OEM partners to compete on price against Android tablets with Windows 8 devices that require Intel CPUs.

Likewise, Microsoft will keep working the Windows RT side of the street because ARM, whose processors power virtually every smartphone, is critical to the company's phone strategy. With Microsoft bullish on its ability to merge the code bases of Windows Phone and Windows on the desktop, it would be idiotic to walk away from Windows RT.

"The code is going to merge for mobility at some point," said Moorhead, referring to Windows Phone and Windows in general -- Windows RT specifically. "What good would it do them to abandon ARM [on Windows RT] now when they would have to come back to it in a few years anyway?"

Although Windows 8, Windows RT and Windows Phone share a kernel, they do not share a complete code base; apps written for Windows 8 and Windows RT, for example, cannot run on Windows Phone 8, and vice versa. A "write-once-run-many" model would give Microsoft an advantage even Apple doesn't enjoy, as its iOS apps are incompatible with OS X.

"We will have one technology base to enable us in core areas, as opposed to two, or more," Ballmer said during the call, referring to, at the least, Windows 8 and Windows Phone 8, but also Windows RT and perhaps even Xbox tossed in for good measure.

"The best way to get to one technical base or one technology base is to make sure that we're pulling together things and having people collaborate where they need to, not duplicating efforts," Ballmer said last week in explaining the corporate restructuring that brought all client operating system development under one roof: the Operating System Engineering Group led by Terry Myerson, who formerly headed Windows Phone.

Analysts have said that Myerson's group -- and the accumulation of all client OSes under his control -- was logical, although long overdue, if Microsoft intends to create a single operating system that would run on smartphones, tablets, traditional PCs and all the cross-breeds in between those categories.

Gillett took a different tack in explaining why Microsoft could not dump an ARM-based Surface tablet, even if it discards the first-generation Surface RT, as seems it is doing with the recent discounts.

"They're firmly a hardware company," contended Gillett, pointing to the massive reorganization last week to support the year-old devices-and-services strategy that CEO Steve Ballmer has committed the company to. "They don't need to play in the entire ecosystem, but they must have so-called 'hero' devices, one that show what their software can do."

Gillett saw the write-down as just one example of a much larger transition of Microsoft from packaged software to devices and services, the former exemplified by the Surface line, the latter by the push toward Office 365 subscription and other software as a service (SaaS) efforts.

"Even if Microsoft is making all the right decisions in the transition, it's still a fundamental shift," said Gillett. "No matter what, it's a messy process, although it's even harder if they're struggling."

Microsoft will move on, in other words, after the Surface RT flop, seeing it as not a company-killer or even a reason to change its strategy, but as one of several obstacles it will encounter in the coming years. "This is early in the [Surface] product cycle," Gillett observed "This is just the beginning of at least a two-year slog."

"What this really shows is that being an OEM is tough," said Moorhead of the Surface RT overstock. "It's certainly a lot tougher than Microsoft thought it was. Can you imagine what would happen if Dell wrote off $900 million [because of an operational blunder]? Their stock would get destroyed.

"[Microsoft's handling of] this is an absolute abomination," Moorhead said. "I don't think this is a surprise to many, that Surface RT didn't sell well, but what is a surprise is the magnitude of the write-down."

Lesson learned, or so one would hope.

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, on Google+ or subscribe to Gregg's RSS feed. His email address is gkeizer@computerworld.com.

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