Is Microsoft Corporation's Surface Redefining the Tablet Market?

Apple 's iPad and Microsoft's Surface have been on diverging paths over the past two years. Apple's iPad sales have fallen year over year for six consecutive quarters, with revenue plunging 23% year over year to $4.5 billion last quarter. Meanwhile, Microsoft's Surface revenue more than doubled from $400 million to $888 million between the first quarters of 2014 and 2015.

Source: Company websites.

Apple's overall iPad sales still exceed sales of Microsoft Surfaces by a wide margin, but the numbers clearly indicate that 2-in-1 devices are gaining ground against traditional tablets. What's causing this rift, and should Apple release a 2-in-1 device to capitalize on that growth?

Why the Surface keeps risingThe Surface and similar 2-in-1 Windows devices are popular replacements for traditional laptops, especially among enterprise customers. The iPad's main weakness in enterprise is its incompatibility with older Windows software. As a result, many companies upgrade older computers to 2-in-1 Windows devices instead of iPads. For certain jobs that require mobility -- like healthcare professionals or factory floor managers -- 2-in-1 devices eliminate the need to use both a PC and a tablet.

Thanks to that demand, research companyGartner expects worldwide sales of 2-in-1 devices to soar 70% annually to 21.5 million units this year. It also believes that the launch of Windows 10, which has scalable tablet and desktop modes, and new fanless processors from Intel will support that growth.

The growth of the 2-in-1 market defies the slowdown in worldwide PC shipments, which plunged nearly 10% annually in the second quarter. That's why many Windows hardware manufacturers -- like Asus and Hewlett-Packard-- are launching Surface-like devices.

Asus' 2-in-1 Transformer Book T300 Chi. Source: Asus.

Why the iPad keeps fallingThe iPad, along with the rest of the tablet market, is being crushed by long upgrade cycles, the rising popularity of phablets, and the overall commoditization of the market. Because of those factors, research company IDC expects global tablet sales to rise only 2.1% annually to 234.5 million units this year, compared to 4.4% growth in 2014 and 52.5% growth in 2013. During the second quarter, global tablet shipments fell 7% annually.

Apple CEO Tim Cook stated that he was "still bullish on iPad" during last quarter's conference call, and that business and consumer upgrades will "eventually occur." Last year, Cook expressed hope that the iPad's enterprise market share could rise from 20% to 60% over the next few years.

However, Apple hasn't introduced many compelling new features -- beyond Touch ID, slightly thinner frames, and new colors -- to convince current users to upgrade. The enterprise apps that it recently launched with IBM also work fine on older iPads. Meanwhile, strong sales of the iPhone 6 Plus are cannibalizing sales of the iPad Mini.

What's Apple's next move?The decline in iPad sales, which accounted for 9% of Apple's top line last quarter, is easily offset by strong iPhone sales. But if the iPad fades away like the iPod, Apple's business would become even more dependent on the iPhone. Therefore, there are two possible ways that Apple can boost the iPad's appeal.

First, it can introduce a 2-in-1 device of its own. IDC analyst Philippe Bouchard recently told Computerworld that he expected Apple to launchone this year. Another IDC analyst, Ryan Reith, expects Apple to launch an attachable keyboard with the long-rumored 12" to 13" iPad Pro. That design might appeal to businesses that don't mind using an entirely iOS-based ecosystem.

Second, Apple could merge iOS and OS X into a single scalable operating system, similar to what Microsoft did with Windows 10. That way, the Mac and iPad would have different-looking UIs, but share common apps. Last year, rumors indicated that Apple would merge the two operating systems, starting with the iPad Pro. If it did so, it could blur the lines between Macs and iPads with "2-in-1 touch Macbooks" that convert into iPads.

In every quarter that iPad sales have fallen, Mac sales have risen. If Apple can let the iPad hitch a ride on the Mac's coattails with hybrid devices, sales might recover.

The iPad won't fade away (yet)Although sales of the iPad have been fading, it still controls nearly a fourth of the global tablet market, according to IDC.

If Apple seriously believes that the enterprise market can boost iPad sales again, it should consider launching 2-in-1 devices and merging iOS and OS X. Those moves would make both iPads and Macs more appealing to businesses that are currently buying Surfaces and other 2-in-1 Windows devices.

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Leo Sun owns shares of Apple. The Motley Fool both recommends and owns shares of Apple and Intel. The Motley Fool recommends Gartner. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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