On The Record With Microsoft’s Surface Bosses Panos Panay And Brian Hall

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Raw Stats And Hands-On Notes For Microsoft’s New Surface 2 And Surface Pro 2

TechCrunch flew to Microsoft’s Redmond campus ahead of today’s launch of the Surface 2 and Surface Pro 2. I spoke with Brian Hall and Panos Panay, the two leaders of the Surface team, about their new hardware, the OEM market, Microsoft’s larger device strategy, and a few other topics.

Between jokes and ordering sparkling water, we covered quite a bit of ground. What follows are excerpts of our discussion. Questions have been rewritten for clarity, preserving initial intent. Brian’s and Panos’s responses have occasionally been lightly edited for clarity (speech to written word is often a bit choppy), but any real insertion or change is marked in brackets. For fairness, the list of questions and answers mirrors our discussion temporally.

Margins

TechCrunch: Steven Sinofsky, when he was the head of the Surface team, specifically told reporters that the hardware was “a real business.” Is Microsoft preserving that same margin level with the new hardware?

Hall: We are running this as a business. But we also are running it as a long-term business. Which means that there are different priorities at different times.

Take dropping the price of [the first-generation Surface RT] to $349. That was to primarily get it into more people’s hands. That’s because we knew that the most strategic thing is more Surface users. People that used it loved it and became good advocates. And we had to get that seed planted, watered, and fertilized.

We want to have a great portfolio. We recognize that people start from price points in their head. And I think that they will see that each of these at its price point is an amazing value. If there is someone who wants a tablet that can really be productive.

Analysis: So, Microsoft is likely taking different margin points at each of the Surface lineup’s device marks. The $349 Surface RT probably isn’t very profitable, and the higher-end Surface Pro 2 likely is. However, the company appears willing to bear that mix of net margins to ensure that it can sell devices from low dollar amounts to the upper-crust of mobile hardware rates. If Microsoft can’t find a large customer base by straddling this broad of a device demographic, its bet on a productive tablet will have been defeated by market demand. We’ll know in six months how the gambit performed.

Surface Pro Sales  – Surface Pro 2 Sales

TechCrunch: Panos, you mentioned earlier today that the Surface Pro original edition had been among the most popular Windows 8 PCs. Can you expand on what you meant, and how it fits into the broader context of the OEM market? [Panos Panay had indicated that the Surface Pro sales had landed in their range of expectation, and that Microsoft felt "very good" about that fact given its estimations of how large the market for a computer that cost $899 might be.]

Panos: I think that we expect the trend to continue with [Surface] Pro 2. There is a whole group of people out there that are waiting for better battery life. [We continue to receive the following feedback:] “We hear it’s a great product but I don’t think that I can live with the battery life as it stands today.”

I get tweets on it, it’s part of Reddit [feedback], it’s everything that I hear socially as well as what we get in customer feedback. So I think that the market just got bigger for this product [by extending its battery life]. And the price point is not going up, and the product is getting better.”

Analysis: As reported earlier today, Microsoft’s Surface Pro 2 changes were essentially all internal. While the Surface 2 received both cosmetic and external updates, the Surface Pro 2 did not. This is another bet that we will be able to vet based on sales performance. Microsoft had the customer data and made product choices based on it. We’ll see. That said, if battery life were the only issue holding back the Surface Pro. Microsoft nailed its market friction.

 Surface Pro 2 As Your Main Machine

The discussion moved to second-monitor usage with the Surface Pro, and how important the new docking station might be for corporate customers.

Hall: I would just say that in addition to the docking station, that alone signals the right message: This is a laptop replacement that can be your one machine. And a lot of people – their excitement about Surface Pro was almost [as if] they had stumbled upon that [fact].

TechCrunch: So that was unexpected?

Hall: For a lot of people. Like, “Whoa, this is my main machine now!” You know, they thought they were getting a high-end tablet that could run all of their Windows software, but what they realized real quickly is between the quality and performance of the device [and] the keyboard experience, it was their main machine.

Analysis: For some, the Surface Pro becoming their daily computer was a surprise. The addition of the dock builds on that. Now, it’s simpler to have the thing be your main computer, by better integrating it into your desk. Again, this is another bet on enterprise adoption.

The Dock, And Who The Surface Pro 2 Is Built For

Panos: The real target is businesses, and enterprises that want, “Hey, I’m going to buy one PC, this thing can be a full-power workstation, and then I can travel with it like a road warrior.” It solves so many of those issues quickly – and the docking station kinda lets that happen.

Hall: Think about it from the perspective of who this device is really built for. Like in the business environment it is mobile professionals. Anyone who doesn’t live at their desk, is working from multiple locations during any given day or week, but when they do get to a desk, heck yeah they want a big monitor, heck yeah they want to use a full-sized keyboard and Bluetooth mouse and all of that.

We’ve talked to a lot of CIOs who, for their sales forces, for instance, they look at it and they say, “Can we get a docking station? If it had a docking station then it would be perfect.”

For people who lead sales forces in particular, tons of them don’t even have offices any more. They work around their clients; a tablet is so much better for meeting with a client than this [points at my Macbook Air]. This is impersonal! A laptop is impersonal. Even when you share.”

Analysis: This is a description of the potential use case for the Surface Pro 2, underlining the choices that Microsoft made in its second generation; nothing cosmetic was needed – instead, it required longer battery and better workflow integration. The company appears exceptionally confident that it has hit its marks.

Growth

TechCrunch: How quickly will the Surface Pro 2 sell into corporate environments?

Hall: Surface is going to grow very fast. Surface is going to grow very fast. Now that we are available in commercial channels, have the docking station, have addressed of their biggest requests, both at the device and accessory level. Surface is going to grow very fast.”

TechCrunch: How important are third-party resellers for that growth?

Hall: It’s important to the degree that for their customers, that’s how they buy. They are used to working with particular resellers who are their technology solution provider.

We’ve had big customers that, before we made Surface available through commercial channels, who said “we would really love to buy a bunch of Surface Pros, can you sell them to us through [a reseller]?’

Panos: If you think of it from gen 1 to gen 2, we come in eyes wide open launching this device, and [the reseller] channel ready for us, and to Brian’s point, this thing is going to have a very quick ramp into businesses.

Analysis: The line is a bit drawn in the sand: Despite early missteps, Microsoft is confident in its second-generation hardware. It is declaring high sales. We’ll be able to gauge its success. However, it is always pleasant to have a benchmark to measure against. If the new Surface Pro 2 does not (and they were discussing the Surface Pro 2 and not the Surface 2 in this part of our discussion) sell more quickly than its predecessor, we’ll have a measuring stick.

Surface As Part Of A Larger Microsoft

TechCrunch: Hardware is only one of Microsoft’s larger Windows 8 and 8.1 offerings. Ralf Groene of the Surface team stated that the first generation of Surface was built to make Windows 8 come alive. Is that still true for Surface 2 and Windows 8.1?

Panos: I think that it is important. What I would say is – and this is how the team focused on it, so perhaps it’s a good filter for us. Like we weren’t just building this product to bring [Windows] 8 to life, we were building this product to bring every single Microsoft property together.

And so you are optimizing this product. [...] Are you doing the right things for PowerPoint, and the right things for Word, [does it] have a great mouse for Excel, and [is] the input in Outlook kick-butt, yes or no? And the answer is yeah! Are the speeds and feeds on the product good enough so that this thing is seamless? The answer: Yes.

I could drop an F-bomb for you there but, truth. Dude Alex we get so into it and how important that is for us – we will not cut a corner on the product. [...]

Those decisions are made daily. It’s not just like a spec – it literally is “iterate iterate” until each scenario sings. It turns out the entire ecosystem benefits from it, the ecosystem being the software, the services and the hardware, because when you are making these decisions you are optimizing for basically all Microsoft properties. You are seeing the benefits.”

Analysis: This is an interesting shift, and one that underscores the maturing of Microsoft’s services vision. Previously, Windows 8 was the key client of Surface. Surface RT was built to make Windows 8 walk on its own two feet. Now, Surface 2 has a much larger prerogative: Make Windows 8.1 rock, along with the services that are its constituent parts, from Skype to SkyDrive. That is a much larger challenge.

Tying Services Into Hardware

Regarding the stapling of 200 gigabytes of SkyDrive storage to the Surface Pro 2 and Surface 2, Panos explained his strategy following questioning.

Panos: We are not only showing that the service is great on the device; we’re giving you the service with it to make sure you use it. [Laughs] And so that’s like the simplest way to say it.

Analysis: So by adding extended services support to its new hardware, the two are intrinsically tied at the hip. Also, once you get accustomed to Microsoft hardware and services, where will you go afterwards? Microsoft hopes that you stay on both.

Tying Software, Services, And Hardware Together

There has been a rising unity between hardware and software. Apple’s iPhone re-demonstrated the value of tying hardware and firmware closely together. Microsoft wants the same harmony, but with a third component: services. As part of a larger point of discussion, Panos explained what Microsoft is trying to do and how he views its progress.

Panos: I’ve given you the services as part of it, given you the hardware as part of it, and of course the software is singing right along on the device. So, I think it is that, if you were to say “what was the anchor?” That’s it. It’s super dramatic to say it, though, “Software services and hardware, all coming together!”

People have said it for years, but the truth is, with every aspect of what we do right now, it actually is, it actually is real now, Alex, coming together on Surface 2. One hundred percent. I’m excited about it. You can tell I get pretty passionate about it.

Analysis: There is direct unity between hardware and services in the view of Microsoft; on its devices it can best strap in and vend its services. So, by offering the two, it is pushing the paradigm. Not a bad strategy, provided that consumers take to the service offerings that come with its new devices, something that hasn’t been proven yet.

Continuation Of Old Products

TechCrunch: Let’s talk about the continuing of past product lines. We have the $349 Surface RT, and then we have the now discounted-price, original Touch and Type covers. Or is it just Touch Covers?

Panos: Type Cover [original] goes away on the basis of we want to bring you the quieter keys immediately. We want to bring colors – people really want them. Like anything we are managing inventory. Mind you Alex we also run the mouse and keyboard business. [...]

So, we have that cadence of accessories where we bleed out one and keep one — roll it out and so that’ll be good. But that’s just business as usual, rolling through Type Cover [inventory].

Touch Cover [original] will stay in market because we want to give people – we are able to discount Touch Cover 1 and still have a good product. We want to give people an affordable solution if they want to click in and be more productive. If they want to spend less, then we give them that option to do so, and I think that that is a great option for our customers. It gives choice, which is always a good thing.

TechCrunch: And I’m assuming that this logic applies to the $349 Surface RT?

Panos: Yeah so if you are going out for a $349 Surface RT, and you don’t want to spend $119 on the new Cover because that is not your thing, you don’t need backlighting, you don’t need the faster sensor – but you can go to [to the original version] and pay significantly less and marry up with the value you are getting with the [original] Surface.

Analysis: Microsoft has spare inventory of both the Surface RT and first-generation Touch Cover. Why not sell the extra at a low price point, recover costs, and get Windows 8.1 into the market in larger scale? Also, it doesn’t hurt for Microsoft to have lower-cost units in the market to combat Chromebooks, which are attacking the low-cost computing realm.

Why Keep Selling The Surface RT For $349?

TechCrunch: Where does the $349 Surface RT fit into the Surface family, and who is the product aimed at?

Panos: Surface RT still brings, for its value, a lot of the qualities of being productive. Now keep in mind that it will upgrade to Windows 8.1, and it will take on Outlook, and it will give you the features of being a productive tablet.

It’s not as fast, but you are also not paying as much. Doesn’t have the second stop in the kickstand, it doesn’t have the better screen, but you are also not paying as much, so it truly is a value. If you want the most productive tablet from a value perspective what you are getting there, or from a cost perspective, I think that is what we are offering.

Hall: We do think that we’re establishing a variant of the category. To date people have thought of tablets entirely through the iPad lens. We’re doing a variant of the tablet, which is the productive tablet. And so at the iPad level, if they come in and say do you want an iPad or a productive tablet, and we have Surface 2, it is the most productive tablet at its price point.”

Analysis: This fits into the above. More hardware at more price points leads to more sales, and Microsoft has the inventory – in my estimation – to continue to vend these devices at recovery price points.

Upcoming Price Cuts To Touch Covers?

The discussion landed on the cheaper Touch Cover, and I asked its starting price point to confirm prior notes. Allow the humorous interlude.

Panos: There are variants and discounts but $79 is the coming-out price.

TechCrunch: Do you see that price declining in the next 12 months?

Hall: Don’t expect to.

Panos nods his head in the affirmative as Hall responds.

TechCrunch: Well he nodded and you said no.

Hall: Don’t expect to.

TechCrunch: Alex make note to self [that the] price will go down in next 12 months.

Panos: If I were you I would make some smart predictions.

TechCrunch: I just did.

Panos: I’m validating that making smart predictions is a good thing to do.

TechCrunch: [Gets cut off]

Hall: [to Panos] Don’t you have to go to the bathroom or something?

Panos: Yeah, I was going to get him a Coke. [To me] You should come with me!

TechCrunch: Yeah, I should.

Panos: Ok I’ll be right back

TechCrunch: I was kidding about the Coke.

Panos: Yeah I’m going to get you one anyway

Analysis: Expect normal hardware price cycles downward in price to impact current Surface hardware in the next 12 months.

200 Free Gigabytes For Two Years

TechCrunch: What happens after the two-year period, and I have lots of information stored on SkyDrive, and my free 200 gigabytes are no longer free?

Panos: Here’s what I would recommend. I think that you should buy the next generation of Surface because I see the stuff that we are building to years out, and it’s pretty [rockin’]. So, at the end of the day, you need nothing more than at the end of two years, to have a reason to buy the next one, and I’m going to give that to you.

TechCrunch: So, you are saying that the 200 gigabyte deal will continue for all future Surface devices?

Panos: No, no, you said all that. But I love that you led with that.

 Analysis: Microsoft appears set to continue the 200 gigabytes of free SkyDrive storage for coming devices. It didn’t want to directly confirm, but it seems likely.

What Is Surface 2 Missing?

Panos: There is a book of [opportunities] that you can think about when it comes to innovation and technology products. There is always going to be that. What’s it missing? It’s not missing anything. It delivers on the promise for sure. And what you are paying for you are getting great value for sure. Opportunities to think about different sizes? Opportunities to think about different use cases? They all exist. [...] It’s got what you need.

This product for what you are getting it’s not missing anything. It’s got what you need, for sure. And when I say more sizes, I don’t know that I am reflecting only on smaller, for sure. So you have to be thinking about this product as a holistic product line for sure. But what you are getting here, in its true form, and the fact that you are getting that in gorgeous screen, thinner, lighter, USB 3.0, Dolby Digital speakers, you’re getting this full package where we didn’t have to make the tradeoffs we made on the first generation.

Analysis: Honestly, they didn’t have much to say about what Surface 2 might be missing. The pair seemed quite confident in their device. It’s a darn fine-looking little thing, I’ll admit, but the Windows 8.1 question remains unanswered.

I hope that the above helps you understand the Microsoft perspective on what it is building. We can disagree, even strongly, on any single point, but I think that companies don’t often detail their thought processes to the public. Instead of taking their words, and shaping them for you, I felt it better to share what they told me, and then put it into context.

What do you think?