Reuters New Surface tablet computers with keyboards are displayed at an unveiling by Microsoft in Los Angeles.

When I read Engadget’s report that Microsoft may sell its Surface Windows RT tablet for just $199, my first reaction was to write a silly tweet about it, then move on. No disrespect to Engadget, but the story seemed far-fetched.

That didn’t stop some news outlets from recirculating the rumor without much skepticism. A few sites, like Wired and Ars Technica, approached the news with a sharper eye, but overall the buzz reminds me of last month’s rumor that the very same Surface RT tablet would cost about $1,000. (That story turned out to be made up.)

So now I feel compelled to take a realistic look at the chances. Engadget’s reliable, after all, so when it reports that an anonymous source heard about Surface tablet pricing at Microsoft’s TechReady15 conference in July, there may be a kernel of truth involved. I just have a hard time believing it’s the whole story.

Doing the Math

Tablets priced at $200 aren’t unheard of. That’s the selling price for Google’s Nexus 7, Amazon’s Kindle Fire and Barnes & Noble’s Nook Tablet. Instead of making money on the hardware, they all hope to profit on sales of apps and content. Maybe Microsoft could pursue a similar strategy with the Surface RT tablet, which is its first true answer to the iPad and runs a new, tablet-friendly version of Windows.

The problem is that the Surface RT will be a lot more expensive to build than any of those 7-inch tablets. It has a larger screen (10.6 inches) at a higher resolution (specifics unknown, but at least 1366-by-768), which will cost more in itself but also require a larger battery. The Surface RT comes with a minimum 32 GB of storage, compared to 8 GB for the Kindle Fire and its closest competitors. It also has front- and rear-facing cameras, while the Nexus 7 only has a camera up front.

How will these souped up specs affect the build cost of the Surface RT? We can take an educated guess using iSuppli’s bill of materials estimates for the Nexus 7 and the iPad:

$21 for the Tegra 3 processor

$33 for 32 GB of storage

$97 for the display and touchscreen (assuming the cost is similar to the second-generation iPad)

$23 for the battery (same assumption as above)

$5 for the cameras

$40 for various other parts, like the box and sensors (assuming the same as the Nexus 7; the iPad’s parts are pricier)

$7 for manufacturing costs

That would bring the total cost to at least $226, not counting other costs such as distribution, marketing, licensing, royalties and tech support. Google’s 8 GB Nexus 7, by comparison, costs about $160 to build, and the company admits that it basically breaks even in the end. The cost difference between the Nexus 7 and Surface is probably even greater, because Surface will use magnesium instead of cheap plastic for its casing, and includes HDMI, microSD and USB slots.

Short version: Microsoft would lose at least $50 on $199 every Surface RT tablet sold. And that’s a conservative estimate.

Is Microsoft Crazy Enough?

Even though Microsoft would lose a lot of money by selling the Surface RT tablet for $199, you could argue that the company is desperate enough to do it. The iPad, after all, was a home run for Apple, and it’s already uprooting the PC market as we know it. Windows is still a workhorse, but for casual uses, such as web browsing, reading, gaming and videos, the iPad is a better option for a lot of people. Microsoft needs to win those people back. What better lure than a low price?

At $200, however, Microsoft would be playing with fire. Not only would Microsoft lose money, it would also wipe out third-party hardware makers and all the licensing revenue they provide. It also sets a dangerous precedent: Once consumers start to expect large-screen Windows tablets for $200, they’ll never want to go back. Microsoft would have to give up making money on sales of Windows. And for what? The odd chance to make a few bucks back on apps and accessories?

Subsidy Is Key

Earlier, I said there may be a kernel of truth to Engadget’s report. What if, instead of selling the Surface for $199 with no strings attached, Microsoft subsidizes that price with a subscription service? As Ars Technica points out, Microsoft already has a similar offer for the Xbox 360, which is available for $99 up front, plus $15 per month for 24 months of Xbox Live service. With this package, the Xbox Live service is more expensive than it would be normally, so Microsoft actually gains in the long run when people take the subsidy.

With Surface, the subscription possibilities are already in place: There’s SkyDrive, the cloud storage service that’s thoroughly entwined with Windows 8; there’s Xbox Music, which looks to be a Spotify competitor; and given the rumors that the free version of Office 2013 on Windows RT devices will be just a preview, Microsoft could also tie in the new subscription-based version of Office. Right now, there’s a battle brewing over online services. It makes perfect sense for Microsoft to get people on board with its services while jump-starting the new version of Windows. Two birds with one stone, and all that.

So here’s my prediction: $200 for a Microsoft Surface RT tablet with a mandatory 24 months of SkyDrive and/or Office 2013 and maybe some kind of Xbox entertainment; $400 for the non-subsidized Surface RT, just to undercut the iPad.

Right or wrong, bogus or not, I had fun thinking about the whole thing. And come October, if Microsoft does set the Surface RT price at $199 with no strings attached, I promise to come back to this post and admit how dumb I was.

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