Microsoft has a tough challenge: Sell a Windows 7 upgrade as a way to save money.

The company's fourth quarter Windows revenue declined 8 percent, as PC buyers opted for lower-priced netbooks that run either Windows XP or Linux, rather than the higher-priced Windows Vista operating system, which does not run on netbook hardware.

Now Microsoft is building netbook-compatible versions of its next operating system, Windows 7. The plan is to restore lost Windows revenue - its most profitable business - by convincing netbook buyers to opt for the premium versions of Windows 7. "The challenge for us is clearly to get the average selling price up," Microsoft CFO Chris Liddell said last week.

For users, this will mean sacrificing functionality for cost. Windows 7 for netbooks will ship with the premium versions of the software ready for installation on the hard drive. The stripped-down Starter Edition will only run three applications at a time. Customers will be able to buy an upgrade, which will reconfigure the operating system to the more powerful version.

But Intel CEO Paul Otellini told investors at a conference in San Francisco last week, "That upgrade's going to be tough." The reason is simple: Netbook shoppers are buying on price. Spending less of their cash is top priority, as consumers worry about losing their jobs or their investments in the current economy.

Microsoft's pricing plans also clash with Intel's own netbook strategy. The chip giant has positioned its Atom processor at the heart of netbooks, and create a deliberately downsized, underpowered laptop that can be sold for under $500 (£350). Asus's Eee PC 900HA sells for just under $300 online.

For many buyers, a full-sized laptop with a more powerful Intel or other processor just isn't worth the money. If netbook buyers won't spend more money on a CPU, why would they spend more on an operating system?

It'll be interesting to see what ad campaign Microsoft whips up to try to convince penny-pinching netbook buyers that an operating system upgrade will cost them less in the long run.