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Microsoft's Surface Pro 3 Is Flawed, but Part of the Correct Strategy

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Microsoft is aiming to fuse the tablet and laptop.

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Microsoft's (NASDAQ:MSFT) new Surface Pro 3 is here.

I've spent the whole morning trying to figure out where this new tablet/laptop hybrid fits in the marketplace, and I've come up with a conclusion: It's a flawed product that's part of a correct strategy.

Microsoft wants a bigger foothold in mobile computing to hold off the Apple (NASDAQ:AAPL) iOS and Google (NASDAQ:GOOG) Android/Chrome camps.

And the Surface Pro 3 is certainly compelling in that it can function both as a fully powered Windows laptop running applications like Adobe (NASDAQ:ADBE) PhotoShop and Office as well as a tablet.

However, tablet sales growth has collapsed and Microsoft's tablets have minimal market share.

Plus, PC sales have been weak for years. The Windows 8 upgrade cycle never happened, and it's questionable whether Windows 8.1 is even a selling point.

So both markets are weak, and in any case, there's an inherent challenge in marketing the Surface Pro 3 as a replacement for both laptops and tablets -- it doesn't include a keyboard.

That means, to the average person, it's mostly a $799+ tablet that looks awfully expensive next to a $499 iPad Air.

And for the Surface Pro 3 to fully function as a laptop, consumers have to pony up an extra $129.99 for the keyboard.

On top of that, storage space will be an issue for some users.

In the fine print on the Surface Pro 3 home page, it says "system software uses significant storage space."

Anyone buying the $799 entry-level model with 64 gigabytes of storage is not getting anywhere near 64 gigabyes of storage.

The 64-gigabyte version of the predecessor Surface Pro 2 only had 37 gigabytes of storage available. If we assume the Surface Pro 3 is in the same neighborhood, it won't cut it for those with sizeable software or media libraries; those people will have to pay for an upgrade.

So, for anyone really wanting to use the Surface Pro 3 as a serious laptop replacement, the cost of entry is well above $799, technically putting it at a premium to the $899-and-up Apple Macbook Air.

The Whole Revenue Enchilada

The PC supply chain is diversifying away from reliance upon Windows. For example, Intel (NASDAQ:INTC) makes processors for Google Chromebook and Android tablets, which are produced by mainstays of the Windows world, like Hewlett-Packard (NYSE:HPQ), Acer, Dell, and Lenovo.

Heck, by putting Office on the iPad, even Microsoft is signaling a lesser reliance upon the Windows juggernaut in favor of Office.

In the event the Surface Pro 3 is a big seller, it will likely do more damage to traditional Windows hardware partners like Hewlett-Packard (NYSE:HPQ) and Lenovo than Apple.

And maybe that's the point.

Microsoft might as well go for big hardware revenues to offset the long-term decline in Windows licensing revenues that would come with declining relevancy.

It's not a perfect offset; hardware margins are lower and Microsoft will have to spend a mountain of cash on marketing. But it may still be a superior alternative to shrinking, especially since anyone who is a fan of Microsoft hardware is unlikely to defect to Apple/Google platforms.

Inherently, Microsoft increasingly emphasizing hardware will create friction with partners. But even if a major PC seller completely abandoned Windows, it wouldn't matter because other competitors would quickly step in to pick up the slack.

Ultimately, the Surface Pro 3 is a flawed product, but it's part of the right strategy for Microsoft longer term.

Twitter: @MichaelComeau

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