It’s probably worth working through this thought before running out to buy Microsoft stock. For if the Surface really is more profitable than the iPad we might assume that Microsoft is going to rise through $600 and regain its position as the most valuable company in the world.
It’s true that it could be of course: anything is possible in business, even the idea that a solar energy company might one day make a profit. But our problem here is that we’ve actually got someone claiming that the Surface is indeed more profitable than the iPad:
Microsoft Surface More Profitable Than iPad, Teardown Analysis Reveals.
That’s what iSuppli tells us in their headline and it’s not actually quite true.
At an estimated total BOM and manufacturing cost of $284 and a retail price of $599, the Surface RT generates hardware and manufacturing profits that are, in percentage terms, higher than the low-end iPad. Even at a price of $499 without the Touch cover, Microsoft will generate a profit margin that is higher than the low-end iPad, in percentage terms and on a per-unit basis.
That probably is true. But we have to be very careful indeed in translating a per unit gross margin into the effect on the bottom line of the company. For we have two confounding factors: overheads and development costs. And the effects of both of those are at least heavily influenced even if not quite determined by the volume of sales.
Just to pick some numbers entirely at random. Imagine that is has cost Microsoft $1 billion to develop the Surface RT. I wouldn’t be at all surprised if the number isn’t around and about that but take it as an entirely made up number. Then imagine that they sell three Surface RTs. No, not 3 million, but 3.
Clearly, the Surface is not as profitable as the iPad. For the company is a $ billion in the hole with gross margins of $945 total. This is not widely regarded as being a profit. Of course, if Microsoft sells 3 million of them then their gross margin begins to approach their development costs (which, recall, is a number I’ve entirely made up). And if they sell 30 million then of course they’re making a gargantuan profit along the sort of lines that Apple does from the iPad.
Yes, I know, for some readers this is an entirely trivial point. Gross margin per unit isn’t the same thing at all as net profit from a product. For other readers it might be just a reminder or possibly even new information. The amount that Microsoft makes from one unit is interesting. But we need to multiply that by how many units they sell to find out whether it is going to be a profitable product at all: let alone whether it’s going to make the sort of splendiferous sums that Apple has been getting from the iPad.
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