For 25 years, Microsoft (MSFT) held unquestioned dominance in the personal computer business. But last year the maker of the Windows operating system started to look like a weary, vulnerable champ. Fueled by iPhone-mania and the iconic "I'm a Mac" TV ads, Apple (AAPL) was nearing a double-digit share of the PC market. At the same time, a new generation of sub-$500 "netbooks" that ran on the free Linux operating system was taking off.
Now, Microsoft has launched a determined counteroffensive. Its uncharacteristically cool TV ads emphasize the affordability of PCs vs. Macs. And it has started offering PC makers a version of Windows, normally around $70, for as little as $15. Mac sales are sliding, and Linux is disappearing from most netbooks. Researcher NPD says 95% of PCs with a small screen and a sub-$500 price tag run Windows today, up from 10% in early 2008. "Microsoft has driven Linux off the lot in netbooks," says Roger Kay, founder of tech research firm Endpoint Technologies Associates.
Microsoft CEO Steve Ballmer and his top lieutenants say they're not done yet. They predict the introduction of the next Windows upgrade this fall will spark a renaissance in the company's flagship business. Named simply Windows 7, the program promises greater ease of use and reliability, rather than new bells and whistles. And while every major Windows overhaul in the past has required more powerful computers, Windows 7 can work with slower microprocessors and fit into less hard-drive space. That means it will run on a full range of PCs, including netbooks. "Although we make less per unit, we're making very decent money" on lower-price PCs, says Brad Brooks, Microsoft's corporate vice-president for consumer-product marketing.
Still, selling millions of copies of Windows 7 for $15 or so is hardly a positive trend. Microsoft investors are used to the massive profit margins that come with selling Windows for four times that amount. But Brooks says the company has found a way to attract new customers with cheap models, while minimizing price erosion. The secret is a new strategy behind its "Windows Anytime Upgrade."EASIER UPGRADE
Because of the smaller size of Windows 7, three versions of the program will come loaded even on lower-end machines. If a consumer on a cheaper PC running the "Standard" version tries to use a high-definition monitor or run more than three software programs at once, he'll discover that neither is possible. Then he'll be prompted to upgrade to the pricier "Home Premium" or "Ultimate" version.
Microsoft says the process will be simple. Customers enter their credit-card information, then a 25-character code, make a few keystrokes, then reboot. Brooks says pricing hasn't been determined, but upgrading "will cost less than a night out for four at a pizza restaurant."
Even at Pizza Hut prices, it's a risky proposition. Consumers may not appreciate having to fork over more money to accomplish routine tasks. "It could create a backlash from consumers," says analyst Toni Sacconaghi of Bernstein Research. "Such a move could be viewed as a bait and switch." The current version of Windows, called Vista, also has different tiers, but few customers upgrade because it means ordering a DVD and going through a clunky installation.
The strategy had better work if Microsoft is to maintain its Windows franchise's high level of profitability. The business pulled in $13 billion in operating profits for the past fiscal year, on revenues of $16.9 billion. While the Linux threat may have cooled for now, reports have leaked out that major PC makers including Acer, Dell, and Hewlett-Packard are interested in using Android, another Linux-based platform championed by Google.
The leaks may well be a tactic to influence discussions Microsoft is having with PC makers over the pricing for Windows 7. Nevertheless, "Microsoft is trying to freeze average selling prices when everyone else is trying to go the other way" and lower prices, says Endpoint's Kay.
That's where the new ad campaign comes in. A year ago, the company devised a three-year strategy to reestablish the Windows brand with consumers. The latest ads, which feature volunteers who hunt for a laptop using money from what they think is a market-research firm, resonate particularly well with the thrifty mood of today's shoppers. In the first, a part-time actress named Lauren chooses a $700 laptop over a $2,700 MacBook. "I'm not cool enough to be a Mac person," she says. In the second, a techie named Gianpaulo picks a $1,500 PC. The third will feature a mother and her 11-year-old son, who opt for a Sony after the boy dismisses a pink PC and Macs, which can't run the Blu-Ray DVDs on which many games are printed.
Lauren has become a YouTube sensation, but Microsoft recognizes it still has work to do. "We're not cool yet. Trust me, my daughter tells me that every day," says Brooks. "But we're having a lot of fun telling our story. It's been a long time coming."