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Microsoft Dominance Declining?

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By elan19
March 20, 2008

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I haven't been able to get much discussion going on Microsoft at VIC, so I'll try to do it here. Over the past half year, I have been developing increasing conviction that Microsoft has peaked and is now entering a period where its dominance of the modern computing environment is about to go into permanent decline. Though I'm not aiming to invest either long or short in MSFT, I have been fascinated by the Microsoft story from both the perspectives of investing and technology - and am honestly curious as to why some value investors have such a high conviction in Microsoft's ability to hold on to its market dominance and pricing power over the next few years. Here are my notes:

MSFT operating system market share has already slipped from approximately 95.5% to 92.5% over the last 3 years. But I believe this will accelerate and reach a "tipping point" some time between late 2008 and late 2010 where Microsoft dominance is no longer a given and they will be forced to lower prices in order remain dominant in computing for a longer period of time - or maybe there is nothing they can do to avoid losing share.

While I like to cite the Asus EEE PC as the big threat - it's actually more about a number of trends all coming together, and the Asus EEE is where most of these trends come together in a way which obviously threatens MSFT.

TRENDS:

Macintosh platform growing fast (Gartner now predicting rise to 12% market share by 2011 from current level of around 6% or 7%)

Lower hardware prices (software an ever greater % of cost to the point where over half the cost of mainstream budget PCs is MS Vista/Office)

Open Source/Linux maturing

Greatly increased development for the Linux platform over last 2 years (Evans Data)

Move to web based applications and storage - eventually will just need a good browser like Firefox - most web aps are free and the amount of free storage is in the GBs/user and growing fast. In other words, the web is becoming ever more important, while the desktop is gradually growing less important.

Fragmentation of traditional form factors for accessing the internet: Ultra-mobile devices are proliferating (miniaturized hardware is less powerful so cannot run Vista or XP in most cases). Most run Linux - Windows mobile cannot be adapted quickly or cheaply enough to suit this purpose. Amazon Kindle, iPhone, and Asus EEE PC are three prominent examples but there are others and there will soon be many more. The trend here is more special purpose "thin client" devices and this could eventually be at the expense of harder to use and maintain thick clients (traditional PCs and laptops). This trend has been predicted (too early) for a decade, but is finally starting to happen. For someone who accesses eMail from more than one device (an increasing portion of the population), there is only one low cost, simple method currently available: Gmail with IMAP enabled (I personally just made the switch from MS Outlook to Gmail w/IMAP).

Hardware requirements for Windows Vista much larger than Linux hardware requirements.

Ultra cheap computers are proliferating - ASUS EEE, Everex, Zonbu and many more are coming in 2008. Most will run Linux as that is the only way to be ultra cheap and/or take advantage of fast but more expensive flash-based memory. They work much better than ultra cheapies that have failed in the past, thanks to improvements in Linux, Firefox, openoffice.org, connectivity, web based aps, etc. And some of them will be much easier to use out of box than a Vista machine (i.e. Asus EEE) and less hassle to maintain.

Software piracy in developing countries.

And on top of all of this - many are now proclaiming VISTA to be one of the worst operating system releases by Microsoft and are wanting to hang on to their XP systems as long as possible. Complaints range from the high hardware requirements, excessive security dialog boxes, confusing array of versions of VISTA, but above all no real compelling reasons to change from XP, which was "good enough." This is causing both consumers and corporations to consider switching to other operating system platforms.


Many of these trends come together in the Linux-based Asus EEE PC. This flash-based $400 device is already selling faster than Asus can produce them (various component issues which should be resolved within a few months) - and it will get substantially better in June of 2008 when Intel's new low voltage chip comes out (The next version of the Asus EEE PC will run without a fan and have a longer battery life than all other laptops - around 7-8 hours). It includes what many people need in a computer - email, web access, an office package that can deal with simple excel/word files. Compared to Windows-based UMPCs, it`s easier to use/maintain, faster, more stable, and much cheaper. It`s also cheaper than most full-powered laptops but there are enough tradeoffs such that most will not soon abandon their full-powered laptops. MS has lowered the price on Windows XP to $40 for this device and it remains to be seen if XP version will be as popular as the less expensive, faster, linux version. For sure it won`t boot in less than 20 seconds and shutdown in less than 5 like the Linux version. The price continues to plunge on flash memory so perhaps 12-18 months from now the machine will be able to ship with plenty of memory to run XP or even Vista faster and better - but by then Asus (and other competition that will already have sprung up) will have sold many millions of machines and given the final push to getting Linux established as a desktop O/S - and that will lead many major software developers to start making versions of their software for Linux.

Another example of many of these trends coming together: iPhone is first smartphone with a usable browser - so is rapidly becoming smartphone of choice for those who want to use their phones to browse. Over 20m smartphones have shipped with MS mobile - yet were used less for browsing than the 1.4m iPhones shipped just 4 months after launch. iPhones will become more popular by the end of 2008 due to various software and hardware enhancements and will be the preferred phone browser for at least a couple years.

I am believing that Microsoft will eventually have to lower prices on both Windows Vista and Office if they want to keep consumers and small businesses from defecting - but they will of course delay as long as possible until they feel they have to. They are already lowering prices as a response to specific threats - China piracy, XP for the EEE PC, etc. I'm not counting the recent VISTA price cut as that was only retail which doesn't sell much.

But with mobile and other limited purpose devices causing operating system builds to rapidly fragment, it will be impossible for MS to keep up with all these developments, while open source code can be much more rapidly customized and deployed for any specific purpose.

So - just curious - what reasons do the bulls have for Microsoft being able to keep up its market share and prices? I know the balance sheet is very strong and that Microsoft has proved adept in the past at responding to market challenges - but what can they possibly do about people abandoning their thick clients for thin clients?