Commentary: Why XP Won't Swell Microsoft's Coffers

By Jay Greene

Just hours after Microsoft Corp. (MSFT ) engineers completed the new Windows XP operating system on Aug. 24, the marketing team went into overdrive. Usually, the gearheads quietly hand off the software code to computer makers, who begin the month-long process of testing and installing the software. Not this time. Microsoft invited the media to watch Chairman William H. Gates III personally hand the code to execs from the six biggest computer makers on gold disks, nicely packaged in custom-labeled silver attaché cases. Then the execs boarded two helicopters that whisked them to the airport so they could begin building computers to run Windows XP. "With Windows, it's hard not to use superlatives," Gates gushed.

Gates calls the new operating system, set to launch on Oct. 25, Microsoft's most important product since Windows 95. One reason is new features, such as digital photography and instant messaging. Those additions have sparked fear among rivals and trustbusters that XP will again allow Microsoft to ratchet up its power using its Windows monopoly. A new judge in the antitrust case has scheduled a Sept. 21 hearing at which questions about Windows XP will likely surface.

But strip away the hype and legal maneuvering, and it becomes clear that XP just isn't going to provide the sort of performance blast that Windows 95 did. That launch spurred a 62% surge in overall sales and a 27% gain in operating income during the quarter it was released. "If you listen to Microsoft, you get the impression that this is Windows 95 all over again," says Al Gillen, an analyst at market researcher IDC. "But market conditions are just too different."

The sour economy will keep consumers out of stores and corporations on the sidelines. That's why IDC thinks Windows XP sales growth will hover around 5% in its first year vs. Windows sales in the previous year. Contrast that with 1995, when Microsoft's platform-product group sales, which consist largely of Windows revenue, spiked by 104% in the quarter Win95 launched. Even Win98, little more than a tweaked version of Win95, triggered a 38% jump in platform-product group sales in the first full quarter after its release.

It isn't just the lousy economy that could hold XP back. The market is saturated, and consumers are largely content. In 1995, there were only 150 million PCs worldwide, with huge software innovations on deck. Then Win98 came out just as the Internet boom turbocharged PC demand. And Windows 2000 has gradually taken over the corporate PC market. But today, nearly 500 million PCs have been sold, and many of the features XP will offer already exist, such as instant messaging. "It's going to be harder and harder to find a new buyer," says Drew Brosseau, an analyst at SG Cowen Securities Corp.

That's true for the upgrade market, too. Six years ago, consumers lined up outside computer retailers in the dead of night to buy Win95. Not this time. The memory, disk space, and processor speed required for XP limits customers to those who've bought high-end PCs in the past two years. And even they aren't likely to shell out the $99 to $199 it would cost to upgrade to XP, since their machines already perform at a high level.

The challenges have set Microsoft's hype apparatus in gear. It plans to shell out $200 million on a marketing campaign in the four months after the launch. And it expects chipmakers, PC makers, and electronics retailers to kick in $800 million more. XP will be an improvement: It will be less likely to crash than earlier versions of Windows, and it will give users quick access to music and pictures.

Still, despite the marketing blitz, the sorry state of the economy and the PC market could dim Microsoft's prospects. Chances are Gates won't need superlatives to describe Windows XP's results.

Greene covers Microsoft from Seattle.

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