Why Software Firms Build Hardware – And What Microsoft Is Doing About It

Abstract

Many software companies build first-party hardware products due to the trend toward smaller, more highly-integrated devices, along with the fast pace of innovation in the technology industry. Building hardware products does not always lead to success and actually creates a financial risk for the company by significantly reducing profit margins as compared to the traditional profit margins to which large software companies are accustomed. Three specific strategies are observed which firms have used successfully in this area. First, the “Hardware First” strategy is described, wherein a company builds devices with the primary goal of selling those devices bundled with the company’s software. Second, the “Proprietary Devices” strategy is presented, in which a company builds a device that is targeted at a particular market or function and locks in the customer to the firm’s ecosystem. This strategy has been observed to succeed in markets where the technology is not yet mature, as well as in cases where the device has a particular purpose that cannot be achieved as effectively with a general-purpose device. Third, the “Service Funnels” strategy is considered, wherein a firm builds hardware devices whose primary intent is to drive usage and revenue of its core software and services products. Microsoft and its various hardware strategies over the years are especially considered, including products such as Xbox, Zune, Kin, and Surface, as well as its acquisition of Nokia’s devices business. Each of the three observed strategies has been used by Microsoft at various times, and analysis of these strategies is used to help explain why some products have succeeded while others have failed dramatically in the marketplace. Microsoft’s core capability is undoubtedly in software, and developing a mutually-beneficial relationship between its hardware and software products will be key to the long-term success of Microsoft in today’s technology landscape.

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Ryan Shaffer
PhD Candidate in Physics and Quantum Computing