Thursday, October 22, 2009

Microsoft's New Operating System Costlier to OEMs

News shows use of Microsoft's operating system is more expensive to PC OEMs than the mere cost of the operating system licenses. Paying Microsoft for the OS doesn't apparently absolve OEMs from additional OS-related engineering overhead. Toshiba's Redmond-based engineers labored harder than ever before to make sure Microsoft's newest operating system sucked less than prior versions on Toshiba's hardware. Dell also spent engineering resources to reduce the MS-Windows suckage, and Windows 7 will reportedly cost OEMs more than prior versions.

The increased OEM investment in MSFT's OS development doubtless will aid MSFT in its primary objective, which is to launch an OS capable of pulling customers off the 8-year-old XP operating system to which they've clung to avoid Microsoft Vista. The fact that OEMs have to pay more for the privilege of pre-installing a Microsoft operating system while also contributing to its development will likely go unnoticed by customers, unless in the form of higher retail prices. On the other hand, can commodity PC OEMs price their products to recapture their increased expenses and retain share against non-MSFT competition?

What does this mean for PC hardware? Apple's ability to make a profit on comparable hardware is ensured well into the foreseeable future. Competitors pay increased operating system overhead, face undiminished supply constraints, suffer ongoing limitation in selecting alternative hardware, and increasingly end up like Dell -- commodity vendors without a durable competitive advantage or distinguishing feature. While Windows 7 might be a victory for Microsoft (offering upgrade revenue and increased per-installation fees), it's doubtless a disaster for hardware OEMs whose margins are already in trouble. (Sure, there'll be a surge of hardware demand based on waiting-until-the-new-OS-is-pre-installed, but this is neither a competitive advantage for any given OEM nor a situation that will endure. It's a blip. If people shop on pure price, it'll be a blip that leads people into low-margin products whose sale offers scant value to their manfacturers.)

Meanwhile, Apple's top-notch supply chain management, freedom to renew products with radically different underlying hardware without disrupting consumers' experience, self-produced operating system, and high rate of new operating system adoption mean that Apple enjoys competitive advantages that increase with its improving fortunes in the marketplace. Simply copying Apple's retail outlets' aesthetics (an NPR piece on Microsoft's imitation of Apple's stores can be heard here) will do little to address the underlying economics of Apple's profitability relative to commodity vendors'.

(Interestingly, Microsoft's investment in direct relationships with customers runs contrary to its prior model of relying on OEMs to market hardware to and solve the technical problems of customers; Microsoft undermines part of its old high-margin model by accepting the overhead of building customer relations and supporting their issues. Apparently, Microsoft has reaslised that being hated as a distant ogre is worse for its long-term image than the short-term pain of increased expense; in short, the whole effort to engage customers is marketing expense. We will have to look at MSFT's sales and margins over time to understand the degree to which it succeeds in this effort.)

UPDATE: Daring Fireball offers this piece on how PC makers are doomed to commodity product competition, and pointing out that HP's answer to a new iMac line with quad core CPUs and an integrated 109dpi monitor was to offer, for the same money, a desktop and two notebooks with Windows 7. HP -- the owner of the once-awesome Alpha chips and vendor of one of the planet's major Unix versions -- is arguably transforming into a commodity vendor.

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