From: Steven Sinofsky Sent: Saturday, November 3, 2012 3:17 PM To: Steve Ballmer Subject: RE: Surface sales physics after a week Daryl, Vince, and Jeremy and their managers as far as I know. Tons of meetings this week. They are anxious to go. From: Steve Ballmer Sent: Saturday, November 3, 2012 3:13 PM To: Steven Sinofsky Subject: RE: Surface sales physics after a week Who on the retail team worked this up Sent from my Windows Phone From: Steven Sinofsky Sent: 11/3/2012 2:31 PM To: Steve Ballmer Subject: Surface sales physics after a week We're at a point where we have enough data about the velocity and potential velocity for Surface sales to need to make a change. We're really in a very tough spot and I feel like we're on the verge of an unrecoverable situation. This is really just about the physics of how much we can sell through our store presence and online, and the number of units we have and will have. We are going to be sitting a very large inventory very soon and there's no real potential to have sales keep up with inventory growth unless we stop manufacturing, and the implications of that are significant. This is decidedly not a statement of our stores and popups. The traffic is crazy. We are holding steady in terms of traffic and at the limits of sales execution per square foot given traffic, associates, and time with customers (all assuming traffic holds). Here is the San Fran store this morning at an opening: The only major learning is that we're not selling the units through online that we expected—the physics were such that we had to sell upwards of 70% of the units through online to make the overall sales match inventory/production and we're not even close. While we've had significant problems with the merchandising and selling motion on the site (and fulfillment) and this is likely to taint sales at least in UK and Germany given the breadth or reporting of these issues. 13 EFTA_R1_01741996 EFTA02572400

But the core learning and challenge is really that people want to touch Surface—does it type, how does it feel, etc.. Even when available, our experience centers are suffering from a low conversion rate because of frustration that you can't give us money and receive a unit right then and there. So all we can do is look for ways to get the product into people's hands when they can conduct a transaction and receive a PC right away. The solution is to broaden our retail footprint as fast as possible outside the US, and to extend our retail presence in the US. These are two different choices. Outside the US is much like China and that we just decide to work with partners or not if we want to sell the PCs. Inside the US there are deeper implications. So these are separate choices. In all cases, we have a plan we can execute on starting Monday that will have a footprint on 12/1 in store and expanding the footprint from a merchandising perspective through the boxing day and sales selling season. It is obviously less than a black Friday presence but it is too late for that. We know retailers are anxious and willing. My suggestion is to rapidly move on this starting Monday—putting people on planes to make deals. There's not a lot of data beyond the selling data that we can gather. It is about faith we can do something credible. We have structures to maintain margin and pricing, accessory attach, and so on. We will not undermine the pricing and value proposition to land this. If we don't want to do this right away then we are going to need to do something about production as we will reach an inventory level that cannot be sold through in 2013. I would recommend we stop production and reconsider GTX (which we believe is likely to be low volume at this point). After reading this if you have any other ideas we should consider them now. We have literally spent the entire week looking at velocity and I really don't see another path. From my view, this is conservative because it does not add aggressive online distribution which would move units— Amazon and pure play tech online. Let's look at the specifics of what we want to start on. Approach: We will start to engage retailers in each of our current markets starting next week. Each region with a slightly different purpose. The negotiation theme is the same for each- in order to get the best margin possible, we will only offer 14 EFTA_R1_01741997 EFTA02572401

exclusives to key retailers (list below). We will have walk away points for each retailer and will do so if we can't strike the right deal in margin, placement, and volume (the deal would include a minimum commitment of volume that they own so we don't put a bunch of inventory out there we have to take returns on). We push to hold our margins as best as possible, yet still get assorted (much like the Suning deal we struck). Background: The feedback that people believe this is a great product and the desire to touch and feel our device is cool to see. There are many questions about whether the touch cover really works and for a device that people want to carry around with them, understanding the feel of Surface in their hands is very important. Surface is also at a price point where most customers (with the exception of a small group of tech trendsetters) will want to be sure they want this product before they purchase it. We are seeing that today in that all of our Stores are FULL daily with folks that want to see and play with Surface before they purchase. And we're basically selling as fast as we can in the store without sacrificing the whole store experience. Chart- If we take our current per week sales numbers and assume an increase of 10% growth each week, we would sell about 260K units between now and Jan 1. (These averages remove the peaks of preorder and launch date as well as Black Friday, but have a consistent growth each week). That leaves an inventory of —1 M units (about $500M plus accessories). It is difficult to model the increase in online—there's a network effect of sorts so 10% a week as a linear growth is likely not the right model for online as there might be a steeper curve that kicks in later. Physical Stores US & Canada Online International Online Total 3-Nov 13391 4606 868 18865 10-Nov 14730 5067 15 EFTA_R1_01741998 EFTA02572402

955 20752 17-Nov 16203 5573 1050 22827 24-Nov 17823 6131 1155 25109 1-Dec 19606 6744 1271 27620 8-Dec 21566 7418 1398 30382 15-Dec 23723 8160 1538 16 EFTA_R1_01741999 EFTA02572403

33420 22-Dec 26095 8976 1691 36763 29-Dec 28705 9873 1861 40439 Total (11/30-1/1) 181,843 62,547 11,787 256,177 Based on our manufacturing rate against the current throughput from the stores and online, we believe we will have about 1M units in inventory at the end of the calendar year. While we have opened commercial orders, these will likely take some time before getting to significant volume and that model still must be proven out as we walk a delicate balance with OEMs and manage through an enterprise sales cycle of evaluation, requirements, etc. The approach is to go to EMEA retailers in the next week, this will enable us to get into stores by 12/1 and still affect the majority of the holiday shopping season. In addition, a meeting with retailers now would help position us more positively when the RSPs are talking to consumers (obviously right now this is fairly ugly as the basic answer from an RSP is "the product is so bad we don't even stock it"). Optimistically, They can then tell customers to come back on 12/1 to buy it, rather than it's not a good product. Over time as our reputation grows among broad consumers and more and more have experience with Surface that they talk about, we hope online will also continue to pick up. 17 EFTA_R1_01742000 EFTA02572404

For reference- Suning had an original sell in of 50K with a forecast submitted this week of 225K additional units over the next 3 months (550 stores) as Chinese New Year is their largest selling season. If we go into Europe/Australia Brick and Mortar, we believe we would sell in 200-400K across the four retailers (MSH, FNAC, Dixons, Harvey Norman) with possible upside through holiday. This also is a great time to capitalize on these retailers being excited and the momentum we have in the channel. The Approach: * Europe and Australia- Conceptually, here is how we think this can play out. We will engage in Europe and Australia with a target to get assortment by 12/1. We believe this is possible and it will help move the needle before Christmas. This is an opportunity for us to tackle with assortment at MSH, FNAC, Harvey Norman, and Dixons (Each with an exclusive in their primary region of France, Germany, Australia, and UK). It would also increase the amount of countries we are in immediately as they have retail presence are in over 18 Countries throughout EMEA. We are sure that if we start the manufacturing of fixtures today (using a similar footprint we used for Suning), we can have them up and running by 12/1. We also know that we can move product from the DTV and China in time to support a launch in each of these retailers. Naturally, this is aggressive from a timing standpoint, so timing is critical we get started quickly. You can see below, the investment is about $3.8m to make this happen. I am not worried about the cost as much as the need to start executing. • Japan and Russia- Fairly simple. Engage now, and be ready for the 1/26 launch. This also coincides with the media buy timing we already have in place, so I think this one is reasonably straight forward. I would expect some cultural challenges with Japan retailers as well as some need to find a way to merchandise differently to account for PIPC. • US and Canada- Start the conversations now with both Best Buy and Staples. We will engage on the exclusive conversation and test the waters. Staples is easier because they are clearly hungry. Best Buy will take some time. The target for assortment in US would coincide nicely with a couple of factors: we target an End of January launch in US retail to coincide with the launch of Pro and it maintains our commitment to stores as the exclusive retailer in the US through holiday. My view is that BestBuy will grind to a halt quickly as the ask for money will be so high and while we would like the potential of '1000 outlets, many are so sick that it is not likely there is an approach that works other than having a lot of poorly displayed and "dead" units in stores. * Commercial: Stores started this engagement already, we are supporting through our EPG efforts and Kevin is aligned with this. As of yesterday the pipeline for commercial has opened (Verizon has already purchased 1,800 units). There is work here to make sure that the SA coverage model is clear and we don't inadvertently end up in pricing negotiations or have a mistake on the rights of usage because of Office Home & Student. This is the details of the plan we want to start on presented in a tabular format: Region Approach Date to Start EMEA & Australia: in-store presence on 12/1 18 EFTA_R1_01742001 EFTA02572405

Retailers and store counts: FNAC - 75 MSH - 350 Dixons - 500 Harvey Norman - 170 In-person retailer assortment discussions = wk of 11/4 19 EFTA_R1_01742002 EFTA02572406