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My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price. This blog includes commentary on market conditions as well as fundamental analysis of specific companies. Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing. Currently working on obtaining the CFA designation. Previously worked in Mortgage Trading for a major bank. Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Monday, May 12, 2008

Advantages to Controlling Hardware Selection and OS Development

PC Magazine contributor Sascha Segan shares his insight on Microsoft’s recent missteps with Vista and Mobile OS in this month’s edition (June ’08). His primary thesis is that there is a disconnect between Microsoft’s OS and the capabilities of hardware components. Microsoft develops software on the assumption that the hardware installed-base would contain the latest, most powerful processors and graphic cards. This became problematic for MSFT when chip and device makers chose to keep costs down by utilizing lower powered circuitry. In short, Microsoft OS is built for the hardware of tomorrow as opposed to that of today.

Firms such as Apple (AAPL) and Research In Motion (RIMM) control the OS and hardware for their products. In my opinion, this gives them an advantage over Microsoft who must tailor its OS to the hardware of multiple manufacturers.

According to Segan, Intel needed to contain its costs, thus it opted for motherboards that included non-Vista-friendly integrated graphics as opposed to a dedicated chip set. Even though Vista operated poorly integrated graphics designed PCs, Microsoft approved its operability. This hardware-software gap caused significant performance issues for consumers.

Eventually, PCs become more powerful thus performance catches up to the needs of the Microsoft’s OS. In past years, this wasn’t a significant issue. However, today, consumers have a more viable alternative as evidenced with the populatity of Apple’s Macintosh. Consumers may not wait for performance to catch up, rather they may be inclined to purchase a Mac instead.

Segan also claims that MSFT has made the same mistake with Windows Mobile OS. It’s designed for processor speeds not found in the majority of mobile handsets. Segan adds “given a choice of making it faster or making it cheaper, most manufacturers will pick cheaper”

We have seen that Vista has had a rocky introduction, and Microsoft recently announced that a “downgrade” to XP would be available for less powerful machines. Mobile OS has been less than stellar as well, albeit improving. My experience with Mobile OS was horrible. I finally ditched the device after becoming fed up with the “spinning hourglass” popping up when trying to answer a call.

I believe Segan’s article illustrates the advantage Apple obtains from controlling both software and hardware functions. This gives Apple total control over the user experience as well as making it very difficult for competitors to duplicate.

I was dismayed when PALM decided to go with Windows Mobile OS for its Treo handsets. This creates several problems. First, MSFT Mobile OS places constraints on PALM’s innovation of its mobile devices. The user experience is dependant on MSFT not necessarily on PALM. Second, it limits PALM’s ability to differentiate its handsets. There isn’t much difference between PALM devices and others running Windows Mobile OS, given that the hardware is the easiest component to replicate. Even if competitors are able to replicate Apple’s or RIM’s devices, the software is still different and protects from “knock-off” models.

Apple has a distinct advantage; it’s devices run seamlessly. Vista’s troubles may partially be responsible for the surge in adoption of Mac computers. The simplicity of Apple’s iPhone OS may prove to be a huge weapon against Windows Mobile OS devices, especially when the iPhone become more price competitive.

Apple recently agreed to purchase PA Semi, a private boutique microprocessor design company known for robust, low-power designs. The true nature of Apple’s plans for the acquisition is unknown; however, PA Semi would aid in creating chips that are optimal for Apple’s OS. In addition, instead of licensing CPU architecture, Apple's proprietary, in-house chip design differentiates itself from competitors who use "off the shelf" chip architecture. With unique OS and CPUs, both aspects can be designed around each other, optimizing performance.

Apple and RIM will continue to outshine other mobile handset device makers using Windows Mobile OS. Even if Mobile OS drastically improves, these manufacturers lack differentiation and will have to compete on price. This increases pressure to utilize less powerful components, which will affect performance. RIM and Apple select the hardware needed to support the OS and do not have to make sacrifices detrimental to performance. MSFT, on the other hand, must design its OS according to the specs of the available hardware. However, since MSFT doesn’t control which hardware will be actually used by manufacturers, it faces a more challenging task.

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