How the Global Economy and a Bi-modal Society Could Undo Microsoft

Itis impossible to ignore the effects of the global economy these days, and when I saw an article at Silicon Alley Insider about Netbooks cannibalizing the traditional PC market, I started wondering if perhaps, despite all the OS wars since the Mac shipped, perhaps something as simple and devastating as a bi-modal income distribution in the world could do far more damage to Microsoft.

During Appleis last earnings call on October 21, the following Q&A took place with Steve Jobs:

Analyst: "Steve, can you talk about the pricing of your Mac line right now and how you feel that is positioned going into this economy, and, in particular, as well, maybe, your thoughts? Thereis this new Netbook category thatis getting a lot of hype, and just where do you see that playing out in the market place and your position in the market there?"

Mr. Jobs: "Well, again, this particular down turn is not creating a market of cheaper computers. That market has existed for some time. And there are parts of that market that we choose not to play in. I think when people want a product of the class that we make, over and over again people have done the price comparisons, and weire actually quite competitive. So we choose to be in some segments of the market, and we choose not to be in certain segments of the market.

"And the question is, is the downturn going to drive some of our customers to those lower segments of the market place and get to buy lesser products. And I will be surprised in that happens in large numbers, and I actually think that there are still a tremendous number of customers that we donit have in the windows world or in the other 99% of the phone market we donit have, who would like to and can afford to buy Apple products. So, you know, weill see what the ratio of those two things are, but weire not tremendously worried.

"As we look at the Netbook category, thatis a category, as best as we can tell, not a lot of them getting sold. You know, one of our entrants into that category, if you will, is the iPhone, for browsing the Internet and doing e-mail and all of the other things that net book lets you do, and being connected via the cellular net wherever you are, an iPhone is a pretty good solution for that, and it fits in your pocket. But weill wait and see how that nascent category evolves, and have some pretty interesting ideas if it does evolve."

Thatis a fascinating outlook, but I want to focus on is the perception that the low end of the PC notebook market isnit doing so well. Anecdotal evidence combined with the report by Henry Blodget at SAI, which claimed that this could be the beginning of the end for Microsoft, pointed out:

"Despite healthy unit growth, OEM revenue declined 1% year-over-year as the average selling price declined. This was primarily the result of two factors. The mix shift in netbooks and continued mix shift to emerging markets, both of which have lower average selling prices than our historical average selling price.

At this stage it is too early to determine the extent to which the new netbooks segment is cannibalizing the traditional consumer PC market sales or simply capturing a new market opportunity, so we believe that there are likely aspects of both."

HP Mini 1000 MIE

The observation by Mr. Blodgett does appear to contradict what Mr. Jobs said about the economy not creating a market for cheaper computers. Itis a subject for continued study and discussion.

Amidst all this, I am mindful of the concept of whatis been called a bi-modal income distribution*, both in the U.S. and worldwide. That concept says that, like a two-hump camel, there are lots of people who donit make much money, a smaller hump of people who do make a lot of money, and a dip in the middle where a lot of middle-class people suffer. Politicians see it as a problem in the U.S. and vow to "restore the middle class."

If that economic effect tends to drive people towards a US$500 Netbook with Linux -- on which all they do is surf, read e-mail, and archive their camera photos, then there could be big trouble for Microsoft which is pushing an almost server-class OS, Vista, on middle-class people who really donit have $1,500 to spend on a PC. Moreover, companies like Hewlett-Packard are developing user shells that effectively hide the Linux OS from the average user.

On the other hand, Appleis recent decision about the pricing of the MacBooks suggests that Apple is going to stay on the high side of the bi-modal income distribution with classy, elegant, desirable computers that well off people can afford.

While that philosophy by Apple served them well when times were great and people were over extending their credit cards, it will also serve them well in tough times. Meanwhile, the average selling price of PCs could settle even lower and Linux (and XP) on a $500 notebook could become perceived as the "good enough" computer for many students, working families, and granddads.

I donit know if the trend will be sufficient to undermine Microsoft in a big way, but if the size and scope of Vista continues to be out of sync with the pocketbooks of Americans for PC hardware for the next 18 months, a subtle downward trend in standard PC sales, cannibalized by Linux Netbooks, by even a few percent, could have Mr. Ballmer throwing furniture once again.

* I didnit find a suitable chart for the U.S. as a whole, but here is one for attorneys.