Falling PC Prices Pit Microsoft Against PC Makers

Plummeting prices of PCs are great news for consumers, but are a disaster for hardware makers. Microsoft isn't cutting them any slack with Windows pricing. Will PC price drops catch up with Microsoft in other ways?

Last week, research firm Gartner released a PC sales forecast that initially sounded like good news for Microsoft and its hardware partners, but likely indicates trouble ahead.

Why? Because even though more PCs are predicted to ship this year and in 2010, the PC prices will head downward, thanks to the continued popularity of inexpensive netbooks.

Gartner originally forecasted a 2 percent decline year-over-year in worldwide PC shipments for 2009, but after consumers purchased more computers than expected in the third quarter, Gartner flipped its forecast to a 2.8 percent increase in PC shipments, equating to 298.9 million PCs. For 2010, Gartner predicts PC shipments will grow 12.6 percent year-over-year to 336.6 million PCs.

[ For complete coverage on Microsoft's new Windows 7 operating system -- including hands-on reviews, video tutorials and advice on enterprise rollouts -- see CIO.com's Windows 7 Bible. ]

But here's the rub: the average selling prices for PCs in 2009 will experience a year-over-year decline of 10.7 percent, with only a slight increase of 2.6 percent predicted for 2010, according to Gartner.

Slideshow: Windows 7 in Pictures: The Coolest New Hardware

"We expect PC ASP [average selling price] declines to slow as the market recovers, but given the market's competitive dynamic, we don't see PC ASPs rising any time soon," said George Shiffler, research director at Gartner, in a release.

Microsoft Won't Budge on Windows Pricing

Industry analysts agree that falling PC prices hurt Windows hardware makers more than Microsoft. The price Microsoft charges PC makers for Windows 7 Professional is the same as what it charged for Vista's business version, though Microsoft actually cut what it charges PC makers for Windows 7 Home Premium as compared to Vista's home version.

Yet at the same time, PC price drops have exceeded expectations. In the past year the average selling price of all Windows portable PCs has fallen from $659 in Oct. 2008 to $519 in Oct. 2009, according to research firm NPD.

Another point of contention: Microsoft is charging PC makers $50 for entry-level Windows 7 Starter on netbooks, compared to the $15 the company had been charging for Windows XP on netbooks.

"As long as there is an uptick in demand for PCs, there's no incentive for Microsoft to lower the prices of Windows 7 licenses that it charges PC makers," says Tim Bajarin, president of tech consulting firm Creative Strategies.

As a result, PC makers such as Dell and Hewlett-Packard will have to pay Microsoft the same amount for Windows licenses, even as their Windows laptop prices dip into the $500 range and their profit margins shrink.

"Netbooks have been the catalyst for this," says Bajarin. "They reset expectations for what PCs should cost. It's a great time for consumers, but OEMs are getting killed."

This will increase the existing tension between OEMs and Microsoft, says Bajarin, and PC makers will be forced to look elsewhere to save money as Microsoft stands its ground on Windows pricing.

PC makers will look to trim costs on items such as keyboards and screens, adds Bajarin.

PC Makers Need to Get Creative

On the other hand, declining PC prices could also be an opportunity for hardware makers, says Richard Shim, PC analyst with research firm IDC.

"With ASPs coming down, PC makers can sell more units to consumers. They can create bundle deals, and maybe include Geek Squad-like tech support for a fee. There is a chance here for PC makers to be more creative."

Shim says that Microsoft is protected by rising PC demand, but is still not immune to falling prices. Even though the software giant is not going to risk revenue loss by lowering Windows license costs, it may be pressured into shelling out some marketing dollars, he says.

"Microsoft will have to deal with OEMs complaining, and one area it can appease them is by providing them with more marketing money to promote Windows 7."

Will Chrome Tame the Windows Bully?

Hardware makers could threaten to move to a more affordable operating system. But with only the option being the myriad flavors of the open-source Linux OS, this is not an approach many will take, says Bajarin.

"At least today, Microsoft has control of the operating system," he says.

This could change as Google's current Android mobile OS runs on more netbooks and its pending Linux-based Chrome OS comes to market in 2010 and matures.

But for the next few years, Bajarin says, the Windows ecosystem and compatibility will be too hard to compete with, especially at businesses that are built around Exchange servers and the Office productivity suite.

"Over time Chrome could become a richer OS and compete with Windows as Microsoft is forced from a user-based profit model to a Web-based model," he says.

Shane O'Neill is a senior writer at CIO.com. Follow him on Twitter at twitter.com/smoneill. Follow everything from CIO.com on Twitter at twitter.com/CIOonline.

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