The dilemma of pricing - What should Microsoft charge for the Surface tablet?

The Zune Debacle

In another life, I worked on the Microsoft Zune. I joined the team just after the v1 launch. The team was ramping up quickly, and the decision to start from scratch had just been made. This meant a whole new manufacturing process, new software libraries, new syncing software, new *everything*. Microsoft was going to pull out all the stops - leave no proverbial stone unturned - to unseat Apple as the king of music players. The team built a great product (hardware/software/desktop), with arguably better features than the iPod/iTunes offering. But Microsoft made one mistake in the execution - it got the list price of the Zune device wrong. Each Zune was priced exactly as its equivalent iPod.

If you were into music players in about 2007-08, you know how the rest of this story unfolded. The Zune never got traction in the market, and the product was finally taken off the market in 2011. Prior to quitting Microsoft in 2008, I interviewed with the Windows Live Hotmail team. The final interview, the Product Unit Manager or General Manager of the team, asked me what I thought was the biggest mistake Microsoft made with the Zune launch. I said that they suffered from hubris, that they thought people would fork out the same amount of money for an unheralded product as they would for the mighty iPod. This answer upset him, and we got into a protracted discussion about pricing and the perception of quality. People equate a lower price point with kitsch - a product of questionable quality. A few weeks after this discussion, Microsoft dropped the price of the Zune by $20 (to $179), but it was too little too late. Needless to say, I did not get the job either. My fate, it seemed, was intricately tied to that of the Zune.

The iPad is King

Fast-forward to 2012. Microsoft is on the verge of releasing a new hardware product. It is called the Surface, and many claim that it is the first real competitor to the iPad. It looks rugged yet gorgeous, touts a number of differentiating features, and is one of the pillars of the Windows 8 story. Like 2007, there is another Apple product on the Tablet throne - the iPad. Introduced in 2010, the iPad has become the de facto tablet product today. Its appeal spans every age group on the planet - toddlers, children, teens, geeks, guys, girls, suits and grand-parents: they all love the device. A huge iPad ecosystem has materialized out of thin air. Samsung, Amazon, Google, Motorola, et al have failed to shake the device's market dominance. Most of all, no company has been able to make a profit from a 10" tablet device at the $499 price-point. Apple, on the other hand, has leveraged its lead in operational excellence and supply-chain management to eke out a measly 40% profit on each iPad sold.

The Surface pricing dilemma

The Surface is to hit the shelves on October 26, 2012. Microsoft is once again faced with a difficult decision on the device - how much should a new Surface set a customer back? Let me play out the options Microsoft has for the entry-level Surface's price:

1. > Equivalent iPad ($499): Great product; wrong price; device will fail

2. Same as equivalent iPad $499: Great product; wrong price again; device will fail.
Microsoft will be remiss to repeat the Zune mistake with the Surface. There is no way a new product can compete with the established market leader at the leader's price point.

3. Lower than equivalent iPad ($449, $399): Great product; great price; good chance to become #2 player in first year.
Microsoft will end up losing money at this price point. Additionally, this will leave its ODMs in a tough spot. Most ODMs are not cash rich to the point of booking losses. But Microsoft can and should. There is a precedent for this - the XBox 360 continued to lose money until the end of 2011 when economies of scale and technology maturation allowed the hardware costs to drop below the sales price of a new console. With more than US$ 15 Billion in the bank, this is a loss Microsoft should take in order to build a new business.

Let us see how this plays out. These are exciting times for customers!