Linux Nips at Microsoft's Heels

Microsoft's server and tools business accounted for 20.3% of overall revenue in the six-month period ending in December. The server and tools business is an important growth engine, posting 14.4% year-over-year growth in that six-month period. That surpasses the growth of Microsoft's two cash-cow businesses, Office and Windows on the desktop.

Linux is growing even faster, according to IDC (see chart). And while Microsoft still commands a significant market share lead, those figures downplay Linux's reach because IDC's tally includes only paid versions of Linux. (Linux is available for free online, but is also distributed by vendors such as Red Hat(RHAT Quote) under a service contract that includes certifications and updates.)

Servers at 20 Paces

Windows and Linux will continue to enjoy increases in shipment totals through 2007, but Microsoft will hold its lock on the No. 1 spot through then, IDC forecasts. Currently, Linux is primarily replacing Unix systems rather than facing Microsoft head-to-head, says Dan Kusnetzky, IDC's vice president of systems software research. He believes Microsoft will start to feel the heat from such head-to-head battles when Linux becomes mainstream in all markets, by the end of 2005.

Although Linux is most popular in areas like financial services, insurance, retail and academia -- which tend to be earlier tech adopters or have special needs -- others argue they're seeing enough skirmishes between Linux and Windows to declare Linux a clear and present danger.

Lundstrom, for one, reports seeing Microsoft giving large discounts to a number of companies taking an aggressive stance with Linux. That's bad news for investors because lower prices hurt margins.

Much of the price pressure comes overseas, another potential growth area for Microsoft. In fiscal year 2003, 23% of Microsoft's income before taxes came from outside the U.S.