Could rumors of a 7-inch version of the new Microsoft Surface tablet and a Windows Phone 8 handset model of the device be true? Microsoft CEO Steve Ballmer is certainly hinting as if they are, recently noting the company will have big hardware releases in 2013 and beyond.  

Just as sales for Microsoft's first-ever tablet, the Surface RT, are beginning to take off, the Microsoft CEO said that it is "absolutely clear that there is an innovation opportunity on the scene between hardware and software and that is a scene that must not go unexploited at all by Microsoft," reported Reuters.

Ballmer also addressed whether the company's partners would "build the lion's share of all Windows devices over the next five years."

"The answer is, absolutely," Ballmer said.

Microsoft is said to be working on its own version of a Windows Phone 8 smartphone that would compete with products sold by its existing partners, such as Nokia and Samsung. Citing unidentified sources, The Wall Street Journal said the company is currently testing prototypes with Asian component suppliers.

The newspaper's sources said the device would feature a screen measuring between 4 and 5 inches diagonally. That would put it somewhere between Apple's new iPhone 5 and the larger Samsung Galaxy S III.

The report contradicts statements that a Microsoft executive made to InformationWeek earlier this year. Asked if the company planned to make its own phones, Greg Sullivan, senior marketing manager for Windows Phone, said, "No, we do not." Hardware makers building Windows Phone 8 devices include HTC, Nokia and Samsung.

"We have a strong ecosystem of partners that we are very satisfied with," Sullivan said in an interview, in July.

In addition to the Surface-style smartphone that Microsoft is rumored to be developing, the company is also thought to be creating its first handheld game console.

Microsoft is planning to release a 7-inch tablet under its Surface brand, a device that could go head-to-head with the iPad mini in a growing segment that lies between smartphones and full-sized tablets, according to a report from tech website The Verge.

According to The Verge, the tablet is being produced at Microsoft facilities in California. It's said to carry a customized version of Windows and is powered by an ARM SoC (system-on-a-chip) processor. It might also carry Microsoft's Xbox brand, making it a hub for personal gaming, social networking and entertainment.

Microsoft has not commented on the report. "We don't comment on rumors or speculation," said a company representative who spoke to The Verge.

If the report is accurate, the move would be consistent with other recent activity at Microsoft. In October, the company introduced Surface RT, its first entry into the PC hardware business. Surface RT runs a version of Windows 8, Windows RT, which is restricted to running Metro-style apps available only from the company's online Windows Store. The device starts at $499, the same entry point for Apple's new iPad 4.

Microsoft plans to ship a more fleshed out version, Surface Pro, in January 2013. It will run Windows 8 Professional on x86 chips and will be compatible with the full suite of Windows legacy applications.

If the 7-inch tablet is co-branded with Xbox, it's likely the device would follow its larger brother, the recently launched Surface RT, which features a 10-inch display and runs a stripped-down version of Windows called Windows RT. The Xbox Surface would reportedly run on its own version of Windows as well.

An Xbox Surface would follow up to perhaps the hottest brand Microsoft owns. The Xbox 360, with the added innovation of its Kinect motion-sensing device, remains a powerhouse in the video game industry and continues to be a draw for consumers. The 7-inch tablet would also be consistent with CEO Steve Ballmer's letter to investors earlier in 2012 than company was in the midst of a transformation into a company that does hardware just as much and as well as software. A concept perfectly illustrated by the Surface tablet.

"Aside from content (which will be the key to selling an Xbox tablet), Microsoft faces one immeasurable challenge: how to sell the device at a fair (but profitable) price. If the MSRP is too high, Microsoft will run the risk of alienating consumers in the same way that Sony has with its latest device. Since February, Sony has only sold a few million PS Vita units worldwide," noted Forbes.

We first began hearing whispers of a Surface gaming tablet from Microsoft back in June.

ZDNet reported in October about the possibility of an Xbox Surface, saying it could be Microsoft's first entry into the 7-inch mini-tablet segment.

"A tablet could take advantage of the move by consumers to mobile games played on smartphones and tablets, which have steadily taken market share away from the traditional video game consoles," said CNET.

The Xbox Surface gaming tablet would likely include a custom ARM processor -- the same kind used in other tablets and smartphones -- and more RAM to handle more intense games, The Verge reported. Specifications could be changed to include an Intel system-on-a-chip processor instead, the website noted.

According to The Verge, Microsoft is developing at least part of the Xbox Surface in the company's offices in Silicon Valley, adding that the offices have recently been locked down, most likely for increased security as the company begins intensely testing the tablet.

Microsoft has been hinting at transforming into a company that specializes in integrating hardware and software experiences since a note to investors earlier in 2012.

"This is a significant shift, both in what we do and how we see ourselves - as a devices and services company," wrote Ballmer in the letter.

"It impacts how we run the company, how we develop new experiences, and how we take products to market for both consumers and businesses. The work we have accomplished in the past year and the roadmap in front of us brings this to life," Ballmer said.

Microsoft's hardware ambitions aren't sitting well with all of its PC- and phone-building partners. Lingxian Lang, China operations manager for Acer, reportedly said that Microsoft's plan to compete with partners would ultimately see it eating "hard rice."

But with the growing abundance of free software that competes with Microsoft's paid offerings, from Google's Android operating system to IBM's Lotus Symphony suite of productivity apps, the company may have little choice but to enter the hardware business in a bigger way.