So Microsoft's put out a crippled 'Starter Edition' of Windows 7 that can only run three apps at a time, intended for 'netbooks'. Cost to the netbook OEM: $15. While some think this is not too big a deal from the user's point of view, a look at the market dynamics behind this announcement reveals serious problems for Microsoft. Consider the issues from the viewpoints of Microsoft, the netbook OEM, and the end user:
Microsoft
Microsoft gets $15 for a copy of the crippled Windows 7. We don't know what pricing it negotiates with big OEMs for full versions, but we can make an informed guess. Here's some 2007 pricing for the so-called 'OEM bundles' of Vista that leak out of the manufacturer channel and into the end user market. Take the 'Home Basic' version then at $99 and cut it in half to reflect markup along the way from leaky OEM to final buyer. That suggests that MSFT might be getting a little less than $50 per copy of the most limited Vista from its OEMs. Call it $45 to make the math come out neat.
So Microsoft is taking a 3x haircut when moving from Vista on a full laptop to 7 on a netbook. It may have no choice - see below - but Redmond simply can't afford to let the netbook price point erode what it can extract from the makers of full laptop and desktop PCs. There must be some sort of functionality differentiator between them. Limiting the number of launches is simple and doesn't involve the compatibility and regression testing issues of limiting the APIs or other gross functionality.
The OEM
While I've not seen the BOM cost analysis on a netbook, I have to imagine it's brutal. Every netbook product manager is fighting a deflating market on one side, and tough parts supplier negotiations on the other. Given the current economy, you know which is winning, but there is a hard limit to what you can squeeze out of a supplier. Each has a real cost of goods (COGS) because it produces a physical product. They might be willing to price below cost at the start of a big contract in the expectation of cost reductions due to volume and experience. But if the parts manufacturer finds itself running at no or negative margins, the OEM will find its supply channel drying up unexpectedly.
On the other hand, Microsoft is known to have essentially zero COGS in its product. After development costs are sunk, each incremental copy of Windows is essentially free. Under heavy market pressure, the product manager will turn to Microsoft and try to take advantage of this essential difference between virtual and real goods, knowing that MSFT will not go upside-down on its costs.
Whereupon the differing market expectation for netbooks cuts against Microsoft. By its very definition, the device is to provide portable access to the net, not necessarily a full Windows capability or 'experience'. The "it's not a real PC without Windows" boogieman already has one foot out the door. Linux or another embedded platform is a realistic option for a netbook. Given the open source option, and the presence of its own legacy XP product, Microsoft is likely having to accept close to a real market price for its OS. As this astute observer notes: "Windows only commands a $15 premium over free software on low end PCs." That's the market price for device-based compatibility with the conventional PC world.
The User
It's user expectations that are driving this situation, and where Microsoft's dilemma is most clearly exposed. In the past I've discounted the aspirations of 'almost PC' products to knock the Wintel world off its perch. See my trashing of the ludicrous OLPC for an example.
One of the heads from that old post is appropriate here: "Cheap Means Vanilla". Cheap is obvious - netbooks are nothing if not cheap compared to a conventional design. 'Vanilla' represents the default choice, the low-cost perennial volume leader at the ice cream parlor. Vanilla has heretofore meant Wintel.
The evolution of the word 'netbook' from a product name to a generic term shows that there's a new vanilla in town. We have a rough market consensus around a medium-size portable device whose function is primarily access to Internet based services, as opposed to local functionality.
In the new ice cream parlor, the price uplift for chocolate chips - device based Windows compatibility - is $15. The old ice cream stand - Wintel - is still in town, but what it can charge is now going to be limited by the competitor. Microsoft is fighting a rear guard action against that change, with all it implies for revenues and margins. Fire-walling against erosion by crippling netbook Windows functionality makes sense in this context, the first horn of the dilemma.
Reducing functionality, however, has the side effect of making the new ice cream flavor even more distinct. If it's a PITA to run extra apps on the client device, then it will be a natural tendency to push that functionality into the network as well. One of the ambitions of platform providers has always been to control the 'user experience' or, if you want it to put it more charitably, to be seen to deliver the most value on the device. The mere existence of netbooks shows that Microsoft is in retreat on this front. Crippling Win7 on netbooks represents Microsoft deliberately reducing its share of value and user experience even further.
This obviously leaves room for Google and others to provide the functionality that would have come from the 4th app and onwards via the browser - making the new vanilla even more tasty. And it further shifts the model for interaction with the Wintel world from device compatibility to data compatibility implemented on the net, weakening the total Windows and Office franchise.
This is the second horn of the dilemma, the one that will now gore Microsoft: Hastening the further differentiation of netbooks from the Wintel world.
(Update: See also this nice analysis, which arrives at similar conclusions for the Windows franchise through different but consistent reasoning.)