Surface Pro 3 Will Lose Out to Amazon Kindle

Source: Thinkstock

Source: Thinkstock

Microsoft (NASDAQ:MSFT) recently made its Surface Pro 3 tablets available for pre-order. Microsoft has aggressively promoted its Surface as “the tablet that can replace your laptop.” The Surface Pro 3 landing page even features a tab for comparing the new tablet against the MacBook Pro. Beyond the Microsoft marketing apparatchik, the technology commentariat has often juxtaposed the Surface Pro 3 up against the Apple (NASDAQ:AAPL) iPad.

Wall Street, of course, cannot afford to marginalize the presence of the Amazon Kindle (NASDAQ:AMZN) within the tablet space. A May 2012 deal between Microsoft and Barnes and Noble (NYSE:BKS) may serve as evidence that the software company itself was once serious about bringing an e-reader to market. Going forward, the Surface Pro 3 will lose the sales war upon multiple fronts.

The E-Reader Market

In 2012, Microsoft committed to a $605 million investment in the struggling bookseller Barnes and Noble. As part of the deal, Microsoft would take a 17.6 percent stake in a new e-book subsidiary. At the time, it was assumed that Barnes and Noble would license Windows software as the primary operating system for its Nook tablets. From there, both Microsoft and Barnes and Noble would sell content out of the e-reader platform. Be advised, however, that this Microsoft-Barnes and Noble partnership appears to have been quietly wound down. On June 5, 2014, The Wall Street Journal reported that Samsung and Barnes and Noble had entered into its own agreement to co-brand e-reader tablets beneath the Nook label.

Most likely, Microsoft walked away from the Nook in order to throw even more of its weight behind the Surface Pro 3. Surface Pro 3 tablets begin at $799.00, with separate keyboard-covers retailing for $129.99. The top-of-the-line 512GB Surface Pro 3 tablet running on the Intel Core i7 chip now retails for $1,949.00. The Surface Pro 3 screen presents graphics at 2160 x 1440-pixel resolution. On paper, the Surface Pro 3 would compete directly against the Apple iPad and MacBook Pro. Consumers, of course, do not make buying decisions according to technical specifications alone. The Apple brand represents both cache and a gateway into an extensive ecosystem of applications that fully customize the user experience. The Windows ecosystem may be described as a third wheel, at best, alongside the dominant iOS-Android mobile duopoly.

The Amazon Kindle is a yet another formidable wing of the Google (NASDAQ:GOOG) (NASDAQ:GOOGL) Android ecosystem that has also befuddled Microsoft executives. Both Google and Amazon are notable for leveraging the bait-and-switch business model where both companies often give away product at cost in order to drive traffic toward higher margin online businesses. The Kindle runs upon a special version of Android that smooths out transitions between making purchases and reading books through Amazon. As a standalone e-reader, the Kindle begins at $69.00. From there, more technically advanced consumers may opt to purchase the Kindle Fire tablet at $119.00 for web browsing, checking email, watching movies, and playing games. In any event, the Kindle line offers significant cost savings relative to the Surface Pro 3 machine.

The Bottom Line

On May 1, 2014, research firm IDC published a report that identified the top five tablet vendors, in terms of units hipped, for calendar Q1 2014. Last quarter, leading vendor Apple sold 16.4 million tablet units, which also calculated out to a 32.5 percent share of the market. For the sake of comparison, fifth-ranked Amazon claimed a 1.9 percent marking share, after having posted 1 million tablet shipments. Microsoft, despite its hefty cash pile, was shut out of the top-five tablet vendor list. On average, Microsoft has generated $26.1 billion in annual cash flow from operations for five years running.

Microsoft, at its core, is a software company that licenses its wares to enterprise customers. Most recently, the Microsoft Commercial Licensing operating segment generating $9.4 billion in operating profits off $10.3 billion in quarterly revenue. Be advised that the Consumer Licensing division folds server products alongside the volume licensing of Windows and Office software beneath none tent. Meanwhile, the Devices and Consumer Hardware division, which would include Surface and Xbox sales, posted a mere $258 million in operating profits upon $2.0 billion in Q3 2014 segment revenue. In all, Microsoft closed out this latest quarter having banked $14.5 billion in operating profits and $20.4 billion in revenue.

On April 9, 2014, research firm Gartner published a report claiming that global PC shipments had contracted by 1.7 percent between calendar Q1 2013 and Q1 2014. Gartner analysts also highlighted the fact that their latest report marked the seventh straight quarterly decline of the PC market. As such, prospective investors should consider avoiding Microsoft stock. At best Microsoft shares may simply track the S&P 500 Index, while financial managers return larger portions of capital back to investors through buy backs and dividends.

More From Wall St. Cheat Sheet: