Can Microsoft Avoid Compaq’s Fate?

In the 1990s, there was a company named Compaq in Houston, Texas. Compaq had many friends who liked to sell its stuff, which were mostly PCs. The friends, called VARs and retailers, made a little money, too. Everyone seemed happy, and Compaq grew and grew.

Founded in 1983, Compaq Computer became the largest PC maker in the world. In 1998, Compaq held 13.8 percent of the global PC market share, followed by IBM with 8.2 percent.

Then came a new kid on the block named Dell, and Dell didn’t like Compaq’s friends. Dell liked the Internet, especially the e-commerce part of it. Dell could sell its PCs directly to customers cheaply because it didn’t have to go through Compaq’s friends.

In 1996, Dell began selling computers through its website. In 2001, Dell took over the top PC maker spot from Compaq.

What was poor Compaq to do? Sell its stuff directly just like Dell? This would mean abandoning friends who stuck by it over the years. Compaq thought hard and long about this – until it was too late. While Compaq was thinking, Dell was selling. Compaq quickly became vulnerable as business waned. Hewlett-Packard bought Compaq in 2001.

Compaq’s continuing decline led to Hewlett-Packard acquiring the company for $24 billion.

Now, a modern counterpart…

There once was a giant company named Microsoft in Redmond, Washington. Microsoft had many big friends – a gang, really – who liked to put Microsoft’s expensive software into their hardware and sell these PCs at various street corners. The friends, called OEMs and retailers, made bank.

Last year, Microsoft posted $18.7 billion in Windows revenue and $23 billion in Office revenue. According to former Nokia executive Horace Dediu’s math, Microsoft gets a total of $78 operating profit per PC.

Enter the new “loner” kid on the block named Apple, and Apple didn’t want to play with anybody when it came to its PCs, not OEMs or retailers. Apple didn’t want to play by the same rules. In fact, Apple wanted to change the game and created a magical device in 2010 called the iPad – a consumer tablet that competes with PCs yet is not a PC.

Apple gives away software but still gains $195 in operating profit per iPad sold, according to Dediu. While PC sales still dwarf iPad sales, iPads are catching up. Piper Jaffray predicts tablets could overtake notebooks by 2015 and total PCs before 2020.

More importantly, Apple did not put expensive software into the iPad. Instead, Apple made iPad apps dirt cheap and iOS upgrades free. Dollar apps? WTH? This made Microsoft, which charged a lot for its software, look like a chump who’s stealing other kids’ lunch money.

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What was a disrespected Microsoft to do? Create a tablet all by itself just like Apple? This would mean abandoning buddies who stuck by it over the years. Well, Microsoft did just that. This week, Microsoft showed off its cool Surface tablet with software and hardware coming out of Redmond.

Microsoft had to build Surface on its own in order to collect higher margins, Dediu contends. Under the old model, tablet makers would have had to pay $55 for a Windows license and $68 for an Office license per tablet for Microsoft to sustain its margins – but they’d never be cost competitive with the iPad.

With Surface, Microsoft’s hardware gang wasn’t happy. The felt like Microsoft kicked them to the curb. So will they leave Microsoft to fend for itself in the rough-and-tumble world of computers? No one knows what the consequences will be, or how Surface will do against the iPad.

One thing, though, is for certain: Unlike Compaq, Microsoft chose not to wait around for its fate.

The end.