Why falling Flash prices threaten Microsoft

The surprise success of the Asus Eee could mark a change in how people view open source — and cause problems for Windows

It seems that the £200 ultraportable Asus Eee PC can do no wrong. The size of a paperback, weighing less than a kilogram, with built-in Wi-Fi and using Flash memory instead of a hard drive for storage, the Eee PC has been winning positive comments not just from hyperventilating hardware reviewers, but also from ordinary people who have actually bought it.

According to an (admittedly biased, because it was self-selecting) online survey of 1,000 users on the independent Eee PC site eeeuser.com, around 4% were dissatisfied with their purchase, 33% found the system pretty much what they expected and 62% thought it was even better than they had hoped.

Looking through the thousands of postings in eeeuser.com's user forums, the same comments keep coming up: it's so small, the build quality is high, it boots up quickly, it just works. In fact, it's hard to find many negative points. Most are about the placing of the right-hand shift key, the small size of the keyboard, the limited battery life and the slightly awkward mousepad. One thing that is almost never mentioned as a problem is the fact that the Eee PC is running not Windows, but a variant of GNU/Linux.

Better in store

Until now, the received wisdom has been that GNU/Linux will never take off with general users because it's too complicated. One of the signal achievements of the Asus Eee PC is that it has come up with a front end that hides the richness of the underlying GNU/Linux. It divides programs up into a few basic categories - Internet, Work, Learn, Play - and then provides large, self-explanatory icons for the main programs within each group. The result is that anyone can use the system without training or even handholding.

This combination of good functionality and out-of-the box ease of use with a price so low that it's almost at the impulse-buy level could prove problematic for Microsoft. Until now, there has been no obvious advantage for the average user in choosing GNU/Linux over Windows on the desktop, and plenty of disadvantages.

The price differential has been slight, and there has always been the problem of learning new ways of working. The Asus Eee PC changes all that. Because the form factor is so different, people don't seem to make direct comparisons with the desktop PC, and therefore don't expect the user experience to be identical.

The price differential between the basic Eee PC running GNU/Linux and one running Windows XP is now significant as a proportion of the total cost. One of the main suppliers of the Asus Eee PC, RM, sells the GNU/Linux version with 4Gb of storage and 512Mb of RAM for £199. The cheapest machine running Windows XP costs £259, 30% more, not least because Microsoft's operating system needs more storage and memory - 8GB and 1GB respectively. It is that difference, far more than any cost of licensing Windows, which means that Linux-based machines can remain consistently cheaper.

That disparity seems likely to increase when Microsoft phases out Windows XP at the end of June. Vista costs more than Windows XP and it requires a minimum of 15GB of storage for installation of even the most basic version. In order to run Vista on the Eee PC, users will need to buy models - currently non-existent - with much more Flash memory.

At least Moore's Law should mean that the price of memory chips will continue to plummet. For example, in 2001 $8 (£4)would have bought you around 8MB of Flash memory, whereas in 2011 it will buy you 8GB, according to projections by Gartner. As a result, Alan Brown, Gartner's research director for semiconductors, says the price of ultraportables like the Eee PC "could decline about 15% within three years to between £160 and £170".

The UK company Elonex has already set an even lower price point: it has just announced its own ultraportable, called The One, which offers most of the features of the Eee PC for £100. Other companies that have launched, or announced, similar machines running GNU/Linux include Acer, Everex, and the Australian company Pioneer Computers; even HP seems to have one on the way. At least one manufacturer of traditional portables is worried by the downward trend in prices. According to Cnet, Sony's Mike Abrams commented: "If [the Eee PC from] Asus starts to do well, we are all in trouble. That's just a race to the bottom."

This makes the relative cost of systems running Microsoft's products greater. The argument that its software is "worth more" because it has more features is unlikely to cut much ice as users discover that functionality of the kind offered by Firefox and OpenOffice.org is fine for most everyday uses - the target market for these new small devices. Moreover, the rise of free browser-based online services such as Gmail and the Google Docs office suite means you can get by with just Firefox.

The situation in developing countries is even worse. Not only must Microsoft and its partners compete with new low-cost portable GNU/Linux systems specifically designed for these markets, like the XO-1 from the One Laptop Per Child (OLPC) project or Intel's Classmate PC, but they must also sell against unauthorised copies of Microsoft's products, which are routinely available on the streets for a few dollars. To combat this, Microsoft has started selling copies of Windows for around $3 in these markets.

Size does matter

Although this kind of bargain basement pricing helps make its products competitive with low-cost alternatives like open source or unauthorised copies, Microsoft's profit margin is cut close to zero. That's not necessarily a disaster for a company with huge cash reserves, but it could be dire for one planning to take on billions of dollars of debt - as Microsoft has said it will need to do in order to finance the acquisition of Yahoo. What if it is forced to extend this kind of pricing to western markets in order to match the cheap GNU/Linux systems in this "race to the bottom"?

The first effects may already be being felt. Notably, last week Microsoft cut the cost of retail copies of Vista, apparently because people don't see it as a necessary upgrade at the prices charged. While the vast majority of Windows "upgrades" will still come through people buying new PCs, as corporate customers hold back, the erosion of Microsoft's ability to set prices for its operating system - and perhaps more importantly its hugely profitable Office suite - could spread deep into its product suite.

And if people don't think that the extra features of Vista are worth the price, at least at retail, it makes the argument that Windows is "worth more" than Linux harder to sustain. It's an interesting - and, for Microsoft, critical - question just how low the price of these "basic but good enough" portables can go.

The original target price of the OLPC machine was around $100, but its designer, Mary-Lou Jepsen, already thinks she can do better. She says that a $75 system is "within reach," and she set up a new company, Pixel Qi, to help realise that vision.

In the process, she hopes to spawn an entirely new generation of computers. "We'll have decent, highly portable, rugged, multi-use computers everywhere. That poses constraints on the circumstances of use - the input aspects and the screens, the networking and the software, all will have to evolve." If they're to be cheap enough for many people in developing countries to buy, these systems will almost certainly be using open source, but Jepsen doesn't see the zero price tag as its main advantage: "The true and large value of free [software] is the ability to change and customise it."

In other words, Microsoft could give away its software, and it still couldn't compete with the truly open, customisable nature of free code. It seems that the only way Microsoft can hope to get people using its software on this new class of low-cost, ultraportable machines is by going fully open source itself.