Microsoft Vs. Hewlett-Packard: The Economics of Frenemies

Could it be that the most interesting battle in technology is not Apple ( AAPL ) versus Google ( GOOG ), but rather Microsoft ( MSFT ) versus its long-standing hardware partners?

Yesterday at the company's analyst meeting, Hewlett-Packard ( HPQ ) CEO Meg Whitman acknowledged the growing heat with Microsoft, saying, "Current, long-term HP partners, like Intel ( INTC ) and Microsoft, are increasingly becoming outright competitors."

Now the idea of partners being rivals isn't exactly new for the technology industry, particularly when it comes to mobile.

For example, Apple and Samsung (OTCMKTS:SSNLF) have quite a nasty rivalry in smartphones. Yet Apple is a major buyer of Samsung chips. And Google, under its own name and its Motorola unit, produces Android-powered smartphones and tablets that compete with models from hardware partners like HTC (TPE:2498) and Samsung. Heck, Google even uses LG (KRX:066570) (a key Android smartphone player) to produce its Nexus smartphones.

Microsoft has been embracing the concept of competing with hardware partners for some time.

For example, its Surface tablets directly compete with models from HP and Dell (DELL), and its recently announced acquisition of Nokia's (NOK) handset business made it clear that it's more or less going it alone in smartphones. And we can even go back to products like the Zune music player and the Kin smartphone for earlier examples of Microsoft's attempts to emulate Apple's end-to-end solutions.

Why is Microsoft going it alone?

Simple -- it wants the whole enchilada.

Let's focus on smartphones for a minute.

We learned something utterly fascinating when Microsoft announced that Nokia deal. For each Windows Phone unit sold, Microsoft earned a gross profit of less than $10. As I have explained, this was unsustainable :

As of April 2013, Gartner forecast global smartphone shipments of 1 billion in 2013. At 3.3% of the market with a $10 per unit (rounding it to $10 to keep it simple) gross profit, Microsoft could be expected to generate $330 million in gross profit from Windows Phone royalties this calendar year.

Heck, bump the market share number up to 5% and it still does not come remotely close to moving the needle, as Microsoft had $14.3 billion in gross profit last quarter. When factoring marketing and development costs into the equation, Windows Phone almost certainly loses money.

Can the financial situation be much different in tablets?

And look at what's happening in the PC market.

Gartner said yesterday that PC sales dropped 8.6% in the third quarter, a record sixth straight quarter of decline, and the worst quarterly volume number seen since 2008.

The best way to offset this weakness is to bet on the burgeoning tablet market that is hitting PCs.

Think about the iPad. A 2012 court filing showed that Apple's gross margins on the iPad were in the range of 23-32%, meaning that the company squeezed out something in the neighborhood of $100-$140 per unit.

iPhone margins are even higher at 49-58%, meaning that gross profit per unit is in the $300+ range.

Now Microsoft does not have Apple's brand prestige, but it's obvious that it can do better than $10 per unit if it goes it alone in hardware. It forecast $40 per unit on a Windows Phone with the Nokia deal.

And let's face reality: Microsoft can afford to tick off partners like Hewlett-Packard and Dell, who have no doubt seen this coming. Both have experimented with other operating systems like Android, and in Hewlett-Packard's case, it bought Palm to gets its hands on WebOS.

The big Windows PC manufacturers can't abandon the OS without giving up a ton of revenue, and frankly, Microsoft wouldn't be hurt much by a big partner leaving.

Why? Because Windows PCs are commoditized and largely made by contract manufacturers -- the slack would be picked up immediately by the remaining brands.

Related stories:

GE Joins Forces With Cisco, Intel, and AT&T for 'Industrial Internet' Revolution

Google Chromebooks Are Deadlier to PCs Than iPads

Is Apple Wasting Its Time With the iWatch?

Twitter: @Minyanville

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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