Disruptive Innovation and the Walmart Linux PC

The Everex TC2502 is being sold by Walmart for $200 (no monitor included), assuming it hasn't sold out a second time. Part of the reason its so cheap is that it runs Linux and OpenOffice.org instead of Windows and MS Office. The first run sold out within days, which is a strong clue that it was a lot more popular than expected. This doesn't mean popular in an absolute sense, just more than Walmart and Everex expected when they decided how many to get in stock. But its the relative popularity that counts: Walmart and Everex produced this box because they calculated they would turn a profit on whatever number they expected to sell. So the fact that they sold out fast means two things:

1. A bigger profit than expected, which is nice for Walmart and Everex.
   
2. Cheap Linux-based PCs have a market niche big enough to make them worth-while. Other manufacturers will have taken note. Expect imitators.

Anyone who has read The Innovator's Dilemma will recognise this pattern: a market incumbent listens to its best (i.e. richest and most profitable) customers, and in consequence makes its products bigger, better and progressively more expensive. The incumbent also finds it unprofitable to compete with narrow niche offerings at the bottom, because they are low quality and aimed at poor customers that can't afford the market leader. So it forgoes the bottom end of the market and concentrates on its nice profitable high-end models. However over time the bottom-end offerings improve, and so become a cost-effective choice for more and more customers. Eventually this starts to make serious inroads into the sales of the incumbent. But by then its too late. The incumbent must choose between cutting prices to compete with the newcomer or else continue to see its market share erode. Neither option will bring back the glory days, and historically many such companies went out of business surprisingly fast.

I'm quite sure that Bill Gates and Steve Ballmer have read The Innovator's Dilemma and seen this coming. There is a bit of MBA strategy theory that sums up their position nicely. Plot their product lines on a chart with two axes; market share and growth potential. The high-share-low-growth lines are "cash cows": they should be milked, and the profits put into high-growth lines. Eventually all cash-cows turn into dogs (low-share-low-growth) and these should be killed off. You just have to hope that by then you have some new cash cows to replace them.

Microsoft has two cash-cows (Windows and Office), and Microsoft has indeed been milking them for all they are worth. The money has been ploughed into a bunch of ventures over the years, but none of them look like becoming future cash cows.

Now we may be entering the final act. People have talked about Linux as a disruptive technology for the last decade, and for server operating systems it definitely has been. Its effectively killed off proprietary Unix, and put a serious dent in Windows. Microsoft continues to fight a rearguard action in this market, but its reliance on big corporate customers is becoming more and more obvious as it tries to separate its premium products (which rich big companies will still reliably pay for) from its lower end offerings. But on the desktop Windows and Office have continued to reign supreme.

Now for the first time in a decade a competing office suite is starting to nibble at the toes of the incumbent. Its not going to make a dent in Microsoft's quarterly numbers just yet, but the future can only go one way. Microsoft sells Windows and Office to PC builders for less than the retail prices, but it cannot let Windows and Office go onto a PC that sells for $200 because they would be giving it away: it would actually be cheaper to buy the PC with the software than to buy the software alone at retail prices. But as more people find that bottom-end hardware with Linux and OpenOffice.org makes a perfectly useful home PC at a fraction of the cost of the Microsoft alternative, so the market will grow. Microsoft may try to segment the market by offering a cut-down version of MS Office (maybe Word with a 20 page limit), but they are competing with a fully featured product. No matter what they do to Windows and Office, Linux and OpenOffice.org are going to look like better value to anyone who is on a tight budget.

Initially it will just be cash-strapped consumers who buy these boxes (students in particular are going to love them). But this is a one-way street. Every consumer who buys one of these boxes is a consumer who is never going to buy a Microsoft box again, even when they get rich. Why pay more to learn a different set of software? And they'll tell their friends about how well it works too. The flow of money into multiple vendors coffers will stimulate investment and competition. All the vendors will want a slicker, more fully featured Linux offering with a bigger repository of instantly downloadable free (in both senses) software. The resulting competition will be downright Darwinian, and the offerings are going to get very good very fast. Everybody is going to race up-market as fast as possible because thats where the real money is. At the moment that money is being taken by Microsoft, but not for long.

Add to this the famous network effects. Part of the reason MS Office dominates is that you need it to exchange documents with everyone else. But if that stops being true then another good reason to pay for MS Office disappears as well.

So I predict that Microsoft is going to be in serious trouble, probably within the next few years. Their existing cost base is tuned to making and selling ever bigger and better versions of their cash cows, and there is no way that they can cut this back to compete with Linux and OpenOffice.org on a cost basis. But if they can't compete then their cash cows are going to turn into dogs before they can be replaced. So Microsoft will be left with two dogs, a bunch of ventures that require investment, and no cash flow. Sure they have big cash reserves they can burn through, but thats not going to be enough even if their investors let them do it.