- Associated Press - Tuesday, October 16, 2012

LOS ANGELES (AP) - With the launch of its Surface tablet computer, Microsoft is becoming a genuine “frenemy” _ part friend, part enemy _ to its longtime manufacturing partners.

Since its founding 37 years ago, the Redmond, Wash., company has had a mutual understanding with makers of computer hardware: Microsoft creates software. Companies such as Dell, HP, Acer and Lenovo pay Microsoft a licensing fee to place the Windows operating system on the desktop PCs, notebooks and other gadgets they market to consumers.

Now, Microsoft is complicating the cozy relationship by making and marketing its own tablet computer. The company announced Tuesday that the Surface will start at $499 when it goes on sale Oct. 26. The new tablet is set to invigorate an already hotly contested market for touch-screen computers. But for first time, Microsoft will be in head-to-head competition with partners that help generate sales for its $14 billion-a-year Windows software business.

Microsoft is no stranger to manufacturing hardware, but it usually does so in businesses that are sideshows to its mainstay computer software. It has made the Xbox game console since 2001, for instance. It also made the Zune music player and Kin line of phones, although both were short-lived.

CEO Steve Ballmer insists Microsoft Corp. must move into manufacturing to bring consumers “delightful, seamless experiences” that they can enjoy “right out of the box,” according to a letter he wrote to shareholders recently.

Of course, it’s not just for the sake of consumers. The strategy of making both gadgets and software could pay off for Microsoft, too.

The company is coming out with a new version of Windows next week, one that is optimized for touch-screen devices and will run on tablets and PCs. Every time it sells a Surface, analysts say, Microsoft will record some revenue for the Windows 8 operating system. Manufacturers that build competing Windows 8 tablets will pay Microsoft a fee, estimated between $30 and $80 per device.

That’s a big expense, especially considering that manufacturers are allowed to use Google Inc.’s Android operating system for tablets and smartphones for free. The extra cost of making Windows 8 tablets could put Microsoft’s partners at a disadvantage in a cut-throat tablet market.

“It’s always tough when you’re competing with your partners,” says Shaw Wu, an analyst with Sterne Agee. “That’s what Microsoft has decided to do.”

The expense also comes at a time when tablet prices are dropping.

In the past few months, Google Inc. and Amazon.com Inc. have undermined tablet leader Apple Inc. with 7-inch-screen tablets using Android. The cheapest goes for $159, which barely covers manufacturing costs.

Apple, too, is expected to downsize its iPads with a mini version that might also give consumers a less expensive tablet option ahead of the holidays.

Having a product that is priced well above these smaller offerings will give Microsoft’s partners a better chance to make a profit. The downside? Windows tablets may be too expensive to become a popular stocking stuffer this Christmas.

Microsoft’s Surface has a 10.6-inch screen, slightly bigger than the iPad’s 9.7 inches. Unlike the iPad, Surface also has the ability to run Office and other Windows applications. That, plus its optional touch keyboard cover for $100 more, may enable the devices to cross the productivity gap between tablets and PCs.

Several of Microsoft partners are trying _ at least publicly _ to remain upbeat about their coming competition with the Surface. At a recent event showcasing Windows 8 tablets in San Francisco, a Lenovo executive said Surface highlights the advantages of Windows 8 and encourages the development of more applications for the system.

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