INDUSTRY ANALYSIS
Linux vs. Apple: An Uncomfortable Battle

The Linux threat to Microsoft has, despite all of the hype, failed to make much of a dent in Microsoft's financial performance . But while we were watching for that impact, Sun was all but gutted. Think back that, with all of the rhetoric surrounding the death of Microsoft, even Sun was focusing on Microsoft and actually helping create a future in which Sun would not exist. The company even went so far as to fund OpenOffice, which further supported the belief that Linux is the future and that proprietary companies like Sun are the extinct past.

The reason Linux took Sun out so easily is that it attacked Sun where it was the most vulnerable: in the hardware. Linux has the advantage that Microsoft enjoys in that it uses low-cost commodity hardware. Sun enjoys one huge disadvantage that Microsoft does not enjoy: Linux is a Unix derivative and, as such, it is an easy migration from Unix for administrators. It also uses the same tools, which makes it attractive to Unix administrators and technicians. And, lastly, Linux is trendy, where Unix has been seen as a dull legacy system for some time.

Sun has been undergoing dramatic changes, but while the threat to the Unix servers is now clear, there is no threat to the desktop other than Microsoft. Right? It's not like there is a desktop Unix, is there? Of course there is: The Mac OS is now based on FreeBSD Unix, as was Solaris, which makes Apple (Nasdaq: AAPL) a natural target.

The Risk to Apple

The recent and highly visible Windows migrations are at risk: Munich's IT department is badly stalled and running overbudget due to compatibility issues; the Thailand Linux win apparently has simply resulted in a large number of students removing Linux and loading pirated copies of Windows; and Home Depot (NYSE: HD) failed its Linux migration due to cost overruns. Windows migrations to Linux still look ill-advised and way too risky.

Both Red Hat (NYSE: RHT) and Novell are sending messages that they are designing new user interfaces based on the Mac OS. While their stated target is Microsoft, the collateral damage from the developments, much like it was with Sun, will probably be Apple. Apple has been subsidizing its relatively expensive hardware with software, so the cost disadvantage that Sun enjoyed would seem to be dramatically less for Apple. But that might not be the case. While much is said about the success of the Mac OS X, the speculation remains that the majority of Apple's installed base has stayed with its older hardware and has not migrated to the new operating system.

In addition, the feedback is that most of Apple's servers -- which also are subsidized by software -- are running Linux today. While many of the buyers indicate publicly that they plan to run the Mac OS at some future time, currently they are not, which showcases the problem of software subsidies if there is another platform that will run on that hardware. People will buy the hardware but not buy the software that supports it, a phenomenon that could do incredibly ugly things to Apple's margins even if it does result in a dramatic increase in sales for Apple hardware.

That's right. This trend could actually result in more Apple hardware sold. But because the corporate buyers are loading something else after buying Apple hardware, Apple's margins will collapse. In a way, we will get a chance to see what would have happened had Apple tried to compete head-to-head with Dell (Nasdaq: DELL) , but Apple simply is not structured for this competition yet. And with the most expensive CEO in tech, the outcome would not be pretty for Apple or Steve Jobs.

Now the Novell (Nasdaq: NOVL) and Red Hat user interfaces aren't done yet, and even when they are finished, it will take some months before Apple is adversely impacted, forcing a response. But the company's choices are ugly.

Apple's Defenses

The most common response I get from Apple advocates when I mention this threat is that Apple will sue the Linux providers. Given that the user interfaces could fall under the GPL , a lawsuit strategy will be problematic. We have only to look at SCO to see just how problematic this will become.

Unlike SCO, Apple has a well-funded marketing organization and could be far more effective at painting Linux advocates as communists and thieves. But this could get incredibly ugly. Apple is seeking patents to protect its interface better, but its litigation against Microsoft a decade ago didn't go well, and Microsoft will clearly dispute these patent attempts and make it difficult even if Linux supporters don't initially dispute these patents.

Apple could abandon the hardware and shift to software-only strategy but, unlike Microsoft, Apple doesn't have deep penetration into the corporate market. And consumers are far less loyal. While this trend could protect the hardware margins, without branded PC hardware partners Apple would still fail. Of course Apple does have a new relationship with HP (NYSE: HPQ) that could be expanded, and this relationship is becoming increasingly interesting as a result.

Apple could abandon the OS and focus on hardware -- plus their own unique user interface for Linux. The problem is that Linux buyers don't want to pay a lot for software . Adobe (Nasdaq: ADBE) and Corel (Nasdaq: CORL) have tried this and both have found that the retail price of software on Linux is too low for them to fund this platform fully. Apple would probably find the same thing to be true, collapsing its margins and creating the same outcome.

Threat and Opportunity

Of course, Apple could do nothing. This was the strategy it employed to fight Windows 95. The success of this strategy is hard to dispute, but Apple's recent reorganization that shifts its A players to the iPod might represent its move to becoming a cross-platform multimedia and accessories vendor, which shows that it is doing something. Logitech and Adobe continue to do very well and both survived the recession more effectively than Apple did. This would appear to be the best path for Apple. And it does look like Apple, at the very least, is setting up to use this strategy as a contingency plan even if the company hasn't yet fully shifted to this model.

In the end, Linux represents a threat and an opportunity for every software and hardware company. Apple is once again at the crossroads. While it will take a couple of years before we know whether the company will make the right choice, one thing is clear: Apple's path is about to become vastly more interesting.