If Microsoft puts "real" Windows 8 on tablets, how will OEMs deal with that $70 Windows license?

While we've had a lot of conversations on BrianMadden.com over the past few weeks about Microsoft's plans for Windows 8 and tablets, there still a few open questions that we haven't talked about yet.

While we've had a lot of conversations on BrianMadden.com over the past few weeks about Microsoft's plans for Windows 8 and tablets, there still a few open questions that we haven't talked about yet. The one on my mind today is about the business model of Windows itself. Microsoft charges OEMs about $15 for Windows Phone 7 and about $70 for Windows 7. So how much will they charge a tablet maker to put Windows 8 on their tablet? This is actually not an easy question to answer yet the ramifications are huge.

Let's dig in!

In my January 4th posting called "Microsoft's Windows 8 tablet strategy is based on their desktop OS and not their phone OS. That's stupid," I argued that Microsoft should base a tablet OS on their phone OS instead of their desktop OS. That argument was based around the technical merits of each OS and the capabilities of the tablet versus PC.

Many of the people who commented on that article wrote that they like the idea of having desktop-like features in a tablet--"real" disk access, peripherals, less lock-in, etc. And if Microsoft can make a killer touch-based Metro UI for use in tablet mode and a "real" Windows experience for docked use cases, all the better. (Though officially at this point it's looking like Microsoft will not enable the traditional "non-Metro" UI for the ARM-based version of Windows 8 that will most likely power these tablets.)

So if Microsoft decides they want to do this, the million (billion?)-dollar question remains: What does Microsoft charge for that OS?

To understand that, let's first look at how the Windows OEM world works today.

What does Microsoft charge OEMs today for Windows 7?

In situations where someone buys a new device with Windows preinstalled, the device maker pays a license fee directly to Microsoft for the right to install Windows on their device. The exact amount is a closely-guarded secret of Microsoft, though we know it varies based on how much the device costs, which OS is used, and how good of a relationship the manufacturer has with Microsoft. (For example, some people have suggested that Microsoft offered Dell a few dollars off of Windows licenses if Dell agreed to only sell Windows-based laptops and desktops on their website. Is this some grand conspiracy theory? Maybe. But go to Dell.com and try to find a PC without Windows preinstalled.)

If you want to waste the good part of a Sunday afternoon, try figuring out what Microsoft charges OEMs for copies of Windows. One blogger shared a story about using the "live chat" feature of the Dell website to get quotes for a laptop with and without Windows. The result? The laptop without Windows was $158 cheaper than the one with Windows preinstalled.

Of course not every laptop with Windows means that $150 is going to Microsoft. Back when netbooks were all the rage, Microsoft publicly stated that they charge OEMs $15 to have Windows XP preinstalled on the netbook (which makes sense considering netbooks could be as cheap as $300). We also know that the "starter" edition of Windows, a heavily-crippled version for certain markets where piracy is rampant, only cost OEMs $30.

Still, we don't know the exact price of Windows 7 for OEMs or what Microsoft plans to charge for Windows 8.

Microsoft has said that the average cost of Windows across all versions and all OEMs is $50 for a $1000 PC. But that's the average for everything, including XP for netbooks and the starter edition, so the OEM price for real Windows 7 is north of that. (There's also speculation that Microsoft charges a varying amount depending on the price of the PC.) In casual conversations with people close to Microsoft, I've heard the $70 price point as a general estimate for what the large OEMs pay for Windows 7 Home Premium.

Windows Phone 7 is a different story altogether since it's a different OS. Still, they're charging about $15 per phone for it.

What should Microsoft charge for Windows 8 on an ARM tablet?

When it comes to Windows 8 running on a tablet, will that be more like a $15 copy of Windows Phone, or a $70 copy of Windows 7 Home Premium? And why are we even having this conversation? Since a tablet is somewhere in between a phone and a PC, why doesn't Microsoft just split the difference and charge something like $30-40?

First, ironically, while people might perceive a tablet to be in-between a phone and PC, from a cost-standpoint tablets are about the same price as phones. (It's just that people don't usually notice since phones' true costs are hidden in the monthly plans.) But if you look at the full price of Microsoft Windows phones, Verizon's only model is $429. The Samsung Focus S and HTC Titan are both $549 from AT&T. Compare that to the iPad which is $499 and the Kindle Fire which is $199. (Sure, people argue that the Kindle Fire isn't really $199 since Amazon sells it at a loss with the hopes that you'll buy content from them. That may be true, but the reality is that you can just go out and buy a Kindle Fire for $199--you don't need to sign any contract or anything.)

So if Microsoft were to keep the same ratios of "Windows OEM license to device cost," then they're still looking at somewhere around $15 for Windows 8 on a tablet.

If the version of Windows 8 that ran on a tablet was based on the Windows Phone OS, we'd have no issue. The Windows tablets would be just like a "big smartphone" (like the iPad and Android tablets), they'd run smartphone-like apps, Microsoft would get their $15, and everything would be fine.

But if the version of Windows 8 that runs on tablets is based on "real" Windows, then what's Microsoft charging for it? Can Microsoft really move to a world where they're getting $15 per OEM copy of Windows instead of $70? I can see it both ways:

Yes, Microsoft should only charge $15 for Windows 8 on a tablet

Charging a small fee for the Windows OS on a tablet makes sense when you first think about it. It allows the tablet makers to be price-competitive with iPads & Android tablets, and it's a model that's generally working with the Phone OS.

But if Microsoft charges a small amount for Windows on a tablet, what happens when the user connects a keyboard and hooks the tablet up to a big display? Do they now have a real copy of Windows that they just paid $15 for?

Some people have pointed out that Microsoft has not committed to enabling the legacy desktop experience for the ARM version of Windows 8. (In other words, Windows 8 on a tablet with an ARM-based processor would only have access to the touch-based "Metro" UI.) So maybe that's a way that Microsoft can differentiate the "real" version of Windows ($15) verses the "tablet" edition ($70). But how do they do that exactly? They offer a Windows OEM license for $15 on ARM devices and $70 for x86 devices? If they do that then they instantly kill Intel's efforts to compete with ARM in the tablet space. So there's no way that's happening.

Maybe instead Microsoft can charge $15 for Windows with the Metro UI only, and then the full price if you also want the legacy UI. But that's really weird because it would essentially be a "legacy tax." Can you imagine paying 4x the price just for the right to run your existing apps?

Then again, if Windows 8 on ARM is Metro only, then why exactly aren't they going with Windows Phone OS as their baseline for tablets?

Or is Microsoft just going to continue to assume that people will buy tablets in addition to their primary computing devices, so $15 for Windows on a tablet is ok because Microsoft is also making $70 on the user's real computer?

No, Microsoft should charge the "full" price for Windows 8 on a tablet

Based on the above list, you might think that it makes sense for Microsoft to charge the full desktop price for Windows on tablets, especially since many commenters over the past few weeks talked about how they'd be excited about a tablet than ran a "real" OS and not a "phone" OS. But unfortunately that doesn't really work out any better for Microsoft.

Right off the bat, there's the shear cost issue. If Microsoft charges $70 for a copy of Windows to run on a tablet, now you're looking at tablets in the $700-800 range. And Microsoft is already going to have a hard enough time competing against the iPad, so what chance to they have if they come out with these awesome Windows 8 tablets that are hundreds of dollars more expensive?

(And as we discussed last week, while there will be an App Store for tablets running Windows Metro, it will be run by Microsoft, not the tablet makers. So it's not as easy for Microsoft to convince the tablet makers to sell their tablets at a loss with the idea that they'll make money on the apps and content later.)

So if Windows 8 tablets end up being a premium product at a $700+ price point, sales volumes will be low. And low sales volumes mean developers aren't going to want to build Metro apps, which will lead to fewer reasons to buy the tablets in the first place (since they won't even be able to run the old apps) and pretty soon we've got another Zune.

What do you think Microsoft will do?

So what do you think they'll do in the end? Jack the price up and go for the premium space? Or drop the price down and take the hit on revenue? Or some third option that I'm not thinking about?

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There a couple more questions that need to be asked here:

Will Microsoft attempt to sell Software Assurance to enterprise customers for ARM-based devices? The same question applies equally to any possible Metro only device that it may be offered regardless of processor.

If SA is available will Microsoft Microsoft offer parity with SA for Windows 7 with respect to VDI licensing?

Microsoft has an opportunity here to address the "VDI tax" and in so doing create an incentive to enterprise customers to adopt Windows 8-based tablets and smart phones over Android and iOS.