Microsoft loves, hates netbooks, says analyst

Wants OEMs to toe spec line for netbook-only Windows 7 to limit revenue damage

Microsoft loves netbooks, the ultra-small, ultra-cheap laptops that accounted for about one in every 10 notebooks sold in the last eight months, but only up to a point, a retail analyst said today.

"They love [a] netbook, as long as it's a low-powered companion, accessory PC," said Stephen Baker, an analyst with NPD Group, a market research firm that specializes in watching retail sales. "But they don't want to sell too many of them."

Microsoft's quandary is that while the jump in netbook sales means more copies of Windows are sold to computer makers, the versions suitable for the smaller systems -- primarily the ancient Windows XP Home -- are its lowest-priced. Every netbook, then, is a lost sale of a so-called "premium" edition of Windows.

"It has a vested interest in minimizing cannibalization as much as possible," said Baker, referring to netbook sales eating into those of more powerful, and higher-priced, notebooks that run, for instance, Vista Home Premium, or in the future, Windows 7 Professional.

One move Microsoft has made to keep the netbook in its place is to limit sales of some editions of Windows 7 to computers with small screens and low-powered single-core processors. The Malaysian Web site TechARP.com, which leaked the specifications last week, said Microsoft will sell Windows 7 Starter, Windows 7 Starter for Small Notebook PC and Windows 7 Basic for Small Notebook PC only to OEMs planning to install those editions on netbooks with 10.2-in. or smaller screens that use a power-miser processor running no faster than 2GHz.

"They can make the format stick with OEMs," said Baker. "But can they minimize the price declines that are pushing PCs under $400? I don't know if they can do that."

What Microsoft can do -- and will -- said Baker, is use those Windows 7 specs to minimize the potential damage netbooks pose to its revenue, and, if possible, coax users into moving up to editions with a larger profit margin.

"What they can do by forcing specs is [force] that netbook to remain an extra PC," Baker said, pointing to the low-powered processor requirement in particular. "They'd like to take people off the idea [of netbooks] and move them back to something that answers some pieces of what people want in a netbook -- small and light -- but more powerful. Then they have a win."

A more powerful, more traditional laptop, of course, would more likely run Windows 7 Home Premium, Professional or Enterprise, all of which Microsoft considers part of a premium line that makes more money per unit when sold to OEMs.

Microsoft is eager to boost client revenues after turning in another disappointing quarter. Last month, the company acknowledged that first-quarter revenues in the Windows client group had plunged 16% over the same period the year before, and that the "premium mix" -- the percentage of Windows sales attributed to the higher-priced and higher-margin editions -- fell by 14 percentage points year-over-year. The latter was the second quarter in a row that Microsoft reported a drop in its premium mix rate.

Executives blamed netbook sales for the poor numbers.

But even as one Microsoft manager denigrates netbooks, another brags how much of that market the company controls. "Less than a year ago we had zero attach rate with netbooks, now it's 97%," Tami Reller, the chief financial officer for the Windows client group, said yesterday during a question-and-answer at the Cowen and Company Technology Media and Telecom Conference ( Listen to audio.) "That's an amazing consumer-driven demand."

Microsoft regularly touts its netbook "attach rate," the percentage of the systems that run Windows, to demonstrate how it stole the category from Linux, which had been the early operating system of choice for OEMs because Windows Vista wouldn't run on the small machines. More than a year ago, Microsoft backtracked on plans to kill Windows XP Home, saying it would continue to sell it to computer makers for installation on so-called "ultra-low-cost PCs," the company's jargon at the time for netbooks.

Baker doesn't see that attach rate falling, even if Microsoft ups the price of the entry-level Windows 7 editions to OEMs. That's true, too, even if Windows 7 Starter will let users run only three applications simultaneously. In fact, Baker expects the attach rate to go up.

"It's going to be even more so as netbooks become more and more mainstream," Baker argued, adding that Linux, no matter how slick a distribution's graphical interface, just doesn't cut it for the vast majority of users.

"As long as this [netbook] needs to be integrated into a greater whole, people will want Windows," he said.

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