Opposite end of the market tbh. Microsoft are aiming at large tablets, with or without keyboards. The idea is that, as the Windows Store gets better, many people will be able to replace their PCs with Windows tablets. This trend is already happening, but people are replacing PCs with iPads (the current most-viable alternative).
The Nexus 7 is impressive for the money, but it's very much a 'third device'. It's there for media consumption; movies, music, books, games. The term 'giant smartphone' very much rings true.
Microsoft has to worry about the price of the next iPad, the Asus Transformer series and Samsung's larger tabs. That's where direct competition will be found.