Mobile Tech: What $199 Windows Laptops Mean for Microsoft

This holiday season, Microsoft's (MSFT -0.66%) hardware partners launched several $199 Windows laptops to curb the rise of Google (GOOG -0.58%) (GOOGL -0.67%) Chromebooks. Notable devices include Hewlett-Packard's (HPQ 0.92%) HP Stream 11, Acer's Aspire E-11, and Asus' EeeBook x205.

The arrival of these low-end laptops, along with $99 Windows 8.1 tablets, is a stark contrast to the high-end Ultrabook strategy championed by Intel (INTC -1.13%) over the past three years. Will these new devices help Microsoft and its partners widen their defensive moats against Google and Apple?

HP Stream 11. Source: HP.

Why Microsoft needs $199 laptops
The Ultrabook strategy, which focused on premium laptops priced above $1,000, targeted Apple's high-end devices (which only account for 5.5% of the PC market) while leaving the low end Windows laptop market undefended.

In 2011, the year that the first Ultrabooks arrived, Google partnered with Samsung and Acer to launch the first Chromebooks. Instead of encouraging companies to sell expensive devices that required additional purchases of productivity software, Google gave away an OS for cheap devices dependent on free cloud-based apps.

Google's low-end strategy proved popular among students and young professionals. Gartner estimates that Chromebook shipments will rise 79% year over year to 5.2 million this year, and then nearly triple to 14.2 million units by 2017 -- making them green shoots in a stagnant PC market. Gartner expects global PC (desktops and laptops) shipments to decline 6.7% to 276 million units this year.

Google Chromebooks. Source: Google.

Realizing that Chromebooks were helping Google expand from mobile devices into PCs, Microsoft launched Windows 8.1 with Bing, a lower-cost version of Windows 8.1 with Bing set as its default search engine. That shift helped OEMs manufacture Windows laptops which matched Chromebook prices. To counter Google's free apps, Microsoft bundled a free year of Office 365 and One Drive (a $70 value) with many of these cheap laptops.

Microsoft hopes that when a Windows laptop and Chromebook are sold at the same price, consumers will prefer backwards-compatible Windows devices over cloud-dependent Chromebooks.

User growth over margins
Under CEO Satya Nadella, Microsoft now prioritizes user growth over short-term profitability.

That's why Microsoft introduced Windows 8.1 with Bing, made Windows free for devices under 9 inches, and made Office free on iOS and Android devices. Windows 10 is also expected to be a free upgrade for many Windows 8.1 users. In hardware, Microsoft slashed the price of the Xbox One repeatedly to gain ground against Sony's PS4 and is selling low-end Windows Phones which for under $100.

Those strategies took a toll on Microsoft's bottom line. Last quarter, Microsoft's net income fell 13% year over year to $4.54 billion, because of higher operating expenses and restructuring costs related to Nokia's handset division. This pressure will continue as long as Microsoft subsidizes sales of its partners' $99 tablets and $199 laptops with free and cheap software.

But by tethering more users to its cloud-based ecosystem, Microsoft paves the way for the arrival of Windows 10, which will be a single unified operating system for its phones, tablets, and PCs. This development could help Microsoft leverage its dominant market share in PCs to further expand into mobile devices, where Apple and Google have marginalized it.

The consumer wins ...
As a result of this proxy pricing war" between Microsoft and Google, laptops have never been cheaper. Windows laptops that sell for $199 aren't powerhouses by any means, but they are certainly adequate workhorses for productivity and media consumption needs.

Source: Company and industry websites.

Five years ago, entry-level "netbooks" cost around $350 to $400. They were usually equipped with a low-end Intel Atom CPU and 1GB of RAM and lasted around five hours on a single charge. Today, consumers can buy superior devices at around half that price.

Google's Chromebook partners are expected to respond to this new wave of Windows laptops with even lower prices. According to Digitimes, Asus and Lenovo could launch $150 Chromebooks in 2015.

... but Microsoft investors might lose
The key takeaway is that the battle between cheap Windows laptops and Chromebooks is asymmetrical.

Microsoft is dramatically slashing prices for paid software to defend its turf against Google's free software. Yet Google can afford to keep giving away software, because it's merely a tool to tether more users to its revenue engines of search and display ads. The majority of Microsoft's revenue comes from software sales, not search and display advertising.

Microsoft's strategy won't be sustainable if Windows 10 fails to unify the fragmented universe of Windows versions. But if Windows 10 eventually achieves Microsoft's "One Windows" vision, the defensive sacrifices Microsoft is making with cheap laptops and tablets today could be worthwhile.