Microsoft: It Is Time To Take Chrome OS Seriously

| About: Microsoft Corporation (MSFT)

Since Google (NASDAQ:GOOG) first unveiled Chrome OS in 2009, it has been met with significant skepticism. Why buy a system that runs only one browser when you can buy a Microsoft (NASDAQ:MSFT) Windows computer that runs that same browser and more?

Still, Chrome OS has carved out a nice niche market for those that want an inexpensive, simple machine that is free from viruses and gets faster over time. The highlights so far are:

  • According to NPD Group, Chromebooks have captured 20-25% of the sub-$300 laptop market in the first half of 2013 and 3% of total back-to-school PC sales this Fall.
  • Around 22% of all school districts in the US are using Chromebooks, and the number is increasing.
  • OEM partners now include HP, Acer, Samsung, Toshiba, Lenovo and LG.

The New Generation of Chromebooks

OEMs have now announced new models for the fall season, including several that are powered by Intel Haswell chips, each with price tags under $300. As these become available, early indications are that they are grabbing more market share. On Amazon (NASDAQ:AMZN), for example, four of the top five best selling laptops are Chromebooks. That is not a misprint. Now Amazon is obviously not the only distribution channel out there, but that is simply incredible.

What's more incredible is that this is despite the fact that the current crop of Chromebooks are all flawed in some way or another. The new HP Chromebook has innovative hardware, including micro-USB charging, and a great casing and screen, but is powered by the aging 2012 Exynos ARM processor and only 2GB of RAM. Similarly, the Acer Chromebook has a more powerful Haswell processor and 4GB of RAM but comes in a cheap casing with a cheap screen. What happens when one of these OEMs puts out a model with good performance and solid hardware?

Looking Ahead

I expect Chromebooks to start making a more significant push for market share next year when the existing models are upgraded with new components while maintaining their sub-$300 price tag. A strong driver over the medium term will be advancements in ARM processors. Chrome OS is better positioned to power inexpensive, ARM-powered laptops than Microsoft's Windows RT, which has been dismissed by OEMs, confuses consumers that expect Windows machines to run legacy software and is less efficient than Chrome OS on the same hardware. Although the ARM threat is the reason Microsoft created Windows RT in the first place, the platform is unfortunately on life support right now after being abandoned by all major OEMs.

The reality is that we are still at the beginning stages of Moore's law when it comes to ARM processors. ARM A57 processors promise significant increases in performance next year. Rumors point to Samsung (OTC:SSNLF) releasing a 14nm Exynos 6 processor in 2014. This will likely power an updated version of the $250 Samsung Chromebook that has ranked as the top selling laptop on Amazon for all of 2013 notwithstanding the fact that its current Exynos 5 processor is barely up to the task of powering a laptop.

The Ball is Now in Microsoft's Court

The biggest threat to Microsoft's utility position in the PC market obviously comes from iOS and Android. But Microsoft has a history of dismissing new products to their detriment, and the story is no different with Chrome OS.

When the original Linux-powered wave of netbooks threatened to gain share in the low-end market a decade ago, Microsoft took decisive action by giving OEMs inexpensive licenses for starter editions of Windows. That strategy worked to eliminate the Linux netbook threat because Windows was clearly preferred by consumers as long as the price differential was small enough.

Microsoft is taking a similar strategy to drive sales of Windows on small laptops against competition from tablets and inexpensive Chrome OS laptops. Although Microsoft does not disclose OEM Windows licensing fees, reports are that Microsoft has discounted Windows 8 licensing fees for small laptops, with some reports from earlier this year that licensing fees for small laptops were discounted from $120 per copy to $30.

Unfortunately for Microsoft, that strategy is not the slam dunk it was when Microsoft was trying to knock Linux out of the netbook market years ago. For one, a $30 licensing fee on a sub-$300 machine is still 10% or more of the total cost of the machine, a not insubstantial number. More importantly, Windows 8 is a polarizing operating system and there are a significant number of people that simply do not want to deal with Metro. Although it's possible now with Windows 8.1 to minimize your interaction with Metro, it's still a significant part of the OS. With Chrome OS, you boot straight into the browser without any distractions, and that's perfect for many people. Chrome OS is also a light-weight OS that can be more efficient and faster than Windows on the same hardware.

As a result, Chrome OS is threatening to become a beachhead in the laptop market even in the face of aggressive pricing tactics from Microsoft on small laptops. And the trend promises to become more significant next year and beyond as the Chrome OS platform matures and ARM processors become faster. OEMs like Samsung will continue to push Chromebooks as an outlet for their in-house ARM processors. With the ability to leverage ARM processors, smaller hard drives than Windows machines, and a free OS, Chromebooks should maintain a significant price advantage over Windows machines going forward. Google's vision of fast, incredibly inexpensive laptops is becoming the reality, and Chrome OS and Android will continue to push prices down. The $100 laptop is not that far off.

An Inevitable Long-term Decline in Windows Consumer Licensing Revenue

For Microsoft, the Windows franchise is not going away anytime soon, particularly in the business world where Microsoft can basically charge whatever it wants given the reliance on Windows. Even in the consumer PC market, Windows will maintain 80%-plus market share for the foreseeable future. But small market share from alternative operating systems can have effects on profitability that are much larger than their share through pricing pressure on the consumer OEM Windows license fees. When Microsoft lowers its Windows OEM license fees from $120 to $30 per unit, that represents a 75% decrease in license revenue from each unit. The fact is that in the consumer market at least, with competition from Android and iOS smartphones and tablets, and price pressure from sub-$300 Chrome OS laptops, the days of $120 OEM consumer licenses for Windows are coming to an end.

Microsoft should embrace this reality now. One solution would be to offer Windows RT to OEMs for free, which would serve the dual purpose of stealing some of Chrome OS's thunder and igniting OEM interest in Windows RT. I am not expecting that to happen, which is why I am looking for Chrome OS to take double digit consumer laptop market share and Windows consumer licensing revenues to decline over the next several years faster than the overall PC market.

The technology world has changed and the consumer OEM licensing model for Windows (and Office) is coming under pressure. I am avoiding Microsoft stock until Microsoft can demonstrate that its devices and services strategy can generate sufficient profits from the consumer market to offset expected declines in the consumer OEM licensing model.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Tagged: , Application Software
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here