New York TImes article

http://www.nytimes.com/2009/01/26/technology/26spend.html?_r=1

$200 Laptops Break a Business Model

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By BRAD STONE and ASHLEE VANCE
Published: January 25, 2009

SAN FRANCISCO — The global credit crisis may have caused the decline in consumer and business spending that is assaulting the giants of high tech. But as the dominant technology companies try to emerge from this slump, they may find themselves blaming

Mr. Title, a 35-year-old new-media manager at a film production company in New York, has dropped his cable subscription and moved to watching most of his television online — free. While shopping for a new laptop for his girlfriend recently, he sidestepped more expensive full-featured computers and picked a bare-bones, $200 Asus EeePC laptop, also known as a netbook.

“We’ve reached one of those moments in tech history when there are low-priced and free alternatives that are both user-friendly and reliable enough to make the switch,” Mr. Title said. “Then there’s the extra bonus of saving some cash.”

Silicon Valley has been gripped by a growing sense that the economic retreat might do more than depress earnings. There is too much ingrained optimism here to think that the tech sector will not bounce back, stronger than before.

But the fear now is that consumers like Mr. Title, and businesses operating with the same cost-cutting mind-set, will erode the high-margin businesses of the information technology industry — slowing some technologies and companies but giving new momentum to others.

A normally confident Steven A. Ballmer, chief executive of Microsoft, expressed this very fear last week after announcing the company’s first big reduction of its work force. “Our model is not for a quick rebound,” he said. “Our model is things go down, and then they reset. The economy shrinks.”

This has happened before. The dot-com bust earlier in the decade dragged down high-fliers like Sun Microsystems and America Online but set the stage for a new generation of Web powerhouses like Google and other innovative Internet software companies like Salesforce.com, founded on disrupting the status quo.

The recession of the early 1990s sent I.B.M., then the dominant force in technology, into a five-year tailspin. But it also propelled Microsoft and Compaq, later acquired by Hewlett-Packard, and Dell to the forefront of computing.

Indeed, Silicon Valley may be one of the few places where businesses are still aware of the ideas of Joseph Schumpeter, an Austrian economist who wrote about business cycles during the first half of the last century. He said the lifeblood of capitalism was “creative destruction.” Companies rising and falling would unleash innovation and in the end make the economy stronger.

Recessions “can cause people to think more about the effective use of their assets,” said Craig R. Barrett, the retiring chairman of Intel, who has seen 10 such downturns in his long career. “In the good times, you can get a bit careless or not focused as much on efficiency. In bad times, you’re forced to see if there is a technology” that will help.

So who’s up, who’s down and who’s out this time around? Microsoft’s valuable Windows franchise appears vulnerable after two decades of dominance. Revenue for the company’s Windows operating system fell for the first time in history in the last quarter of 2008. The popularity of Linux, a free operating system installed on many netbooks instead of Windows, forced Microsoft to lower the prices on its operating system to compete.

Intel’s high-power processors are also under assault: revenue tumbled by 23 percent last quarter, marking the steepest decline since 1985.

Meanwhile, more experimental but lower-cost technologies like netbooks, Internet-based software services (called cloud computing) and virtualization, which lets companies run more software on each physical server, are on the rise.

Penny-pinching shoppers like Mr. Title could have the most immediate effect on the tech industry, particularly if more people consider canceling their cable subscriptions to watch video online, or drop their landline telephones to depend on their cellphones or on Internet calling services like Skype.

Many consumers appear ready to abandon the costly desktop computer altogether. Analysts expect PC sales to fall in 2009 for just the second time in the last two decades, with desktops falling even faster than they did in 2007 or 2008.

The only bright spot in the PC industry is netbooks. Analysts at the Gartner research company said shipments rose to 4.4 million devices in the third quarter of 2008, from 500,000 units in the first quarter of last year. Analysts say sales could double this year despite a deep worldwide recession.

Two lumbering giants, Hewlett-Packard and Dell, missed the first wave of these tiny, stripped-down machines, allowing Acer of Taiwan to grab market share. Acer pushed Apple out of the No. 3 spot behind H.P. and Dell as sales soared 55 percent. Dell and H.P. are making the devices now.

Even the mighty Apple, whose iPod and iPhone revenue had helped insulate it from the first phase of this recession, reported last week that revenue from its desktop line fell 31 percent from the same period a year ago.

“The day of the Rolls-Royce laptop and the high-end computer may not be totally over,” said Charles King, an independent technology industry analyst in Hayward. Calif. “But certainly the audience for that type of product is getting smaller and smaller.”

Companies have also started to examine what they can do without and what they can do differently, and their choices may alter the competitive and lucrative landscape of business computing.

Hoping to save money, Arista Networks, a start-up based in Menlo Park, Calif., has much of its internal technology processes online, or “in the cloud.” Instead of buying its own hardware and software systems from the likes of Microsoft and Oracle, it opted for e-mail and online document services from Google and online sales and manufacturing software from Netsuite, based in San Mateo, Calif.

It is spending a fifth of what it would be for traditional technology, said Jayshree Ullal, Arista’s chief executive.

She smells a trend. “I think 80 percent of the new high-tech and small to mid-size companies are doing what we’re doing,” she said.

A spate of start-ups have seized on cloud computing. Companies like Intacct offer online accounting software as an inexpensive alternative to Microsoft’s products, and giants like Amazon.com sell access to data centers for business operations. Amazon has outpaced the traditional hardware makers with such services.

The number of virtualized new servers has doubled over the last three years, which has driven the revenue of VMware, one of the leaders in this cost-saving technology, to an estimated $1.88 billion last year from $387 million in 2005.

The makers of open-source software also continue to benefit from the growing appeal of their often cheap, if not free, products. Sun Microsystems distributes 65,000 downloads a day of its MySQL database, which has turned into the favored business software of new companies. The job search engine Indeed.com shows a thriving job market for MySQL and Linux developers.

Linux has proved popular as well on a new crop of smarter devices — be they phones, TVs or set-top boxes — that have captured software developers’ imaginations. The new products they build will undoubtedly challenge the status quo.

“Companies like Intel, Qualcomm and Texas Instruments that make chips for these devices are hiring Linux talent as quick as they can,” said Jim Zemlin, executive director of the nonprofit Linux Foundation. “They know the future is netbooks and mobile Internet devices.”