As the release of low-cost laptops based on Intel's upcoming Atom processor draws near, Microsoft is getting boxed into a corner. The software company plans to stop selling most Windows XP licenses after June 30, yet most of these low-cost laptops won't be powerful enough to run Vista when they arrive later this year.

That leaves Microsoft executives with a choice: Do they extend the availability of Windows XP for low-cost laptops (as they are rumoured to be doing), or possibly concede this nascent market to Linux?

The poster child for the low-cost laptop is Asustek's £200 Eee PC, which hit the market in October last year and runs the Xandros distribution of Linux. Consumers have embraced the laptop, which uses a version of Intel's Celeron M processor, for its small size and ability to perform basic tasks like Web surfing and e-mail. It became something of an overnight sensation, and that success caught the attention of other hardware makers, including top-tier PC vendors.

The Eee PC's success wasn't possible without Intel's support. The chip maker was initially hesitant to embrace Asustek's push into low-cost laptops for fear it would drive down margins for its mobile processors if users opted to buy low-cost laptops instead of more powerful - and more expensive - models. But Intel eventually decided that the opportunity to expand the size of the overall laptop market outweighed the risks of lower profit margins, and gave its backing to the little laptops.

Intel's support for low-cost laptops is ready to shift into overdrive. The company's upcoming line of Atom processors, relatively inexpensive chips that consume little power, will show up during the third quarter in small laptops - priced in the US from $250 to $300 - that will be aimed at users in developed markets and heavily promoted by the chip maker. Intel executives want these laptops to be cheap enough that US and European consumers don't think twice about buying them as a second computer. Most are planned to ship with either Linux or Windows XP, even though they will arrive after Microsoft's June 30 deadline has passed.

Windows Vista isn't a viable option in this product segment: It's too expensive and does not work on the stripped-down hardware configurations required to keep prices low.

"At the low end, Vista's hardware footprint is too large," said Tom Rampone, an Intel vice president and general manager of the company's Channel Platforms Group, noting that some low-cost laptops, such as Intel's Classmate PC, have just 2 Gbyte of solid-state storage instead of higher-capacity, more costly hard disks.

That small amount of storage rules out the use of Windows Vista on these machines - even Vista Starter, the stripped-down, low-cost version intended for sale only in developing countries.

In addition to its large footprint, Vista may not be a suitable option for low-cost laptops because of its price, according to Navin Shenoy, general manager of Intel's Asia-Pacific operations. "I don't think you'll see a lot of Vista in this space for cost reasons," he said in a recent interview, noting that 25 low-cost laptops based on Atom are being developed by various companies.

PC makers agree. Asustek has announced a Windows version of the Eee, but it's XP and not Vista. Executives have predicted that of the 5 million Eee PCs it expects to sell this year, laptops running Windows XP Home edition will outsell their Linux-based counterparts by a ratio of 3 to 2.

The Linux community takes the XP threat seriously. is providing developers with resources to develop mobile versions of Linux, including efforts to improve power management and develop a Mozilla-based browser that relies on a touch interface. Much of this work, including Canonical's Ubuntu Mobile Edition, will run on laptops and desktops, as well as mobile Internet devices (MIDs).

While Linux is generally the preferred OS for low-cost PC maker Everex, the company has sold low-cost laptops with Windows XP in developing countries. It agrees that Vista simply isn't an option, since Everex's Cloudbook laptop doesn't meet the minimum hardware requirements prescribed by Microsoft for Vista.

"Even 512M bytes of RAM with [Vista] Home Basic, it's a slow machine - underpowered and underperforming," said Paul Kim, director of marketing at Everex, adding that when it comes to low-cost computers, Windows XP "still seems to be a better path at this point."

Industry analyst Roger Kay, founder and president of Endpoint Technologies Associates, agreed that the cost of licensing Windows Vista will prevent Atom-based PCs from reaching Intel's target price of $199 to $250. "Given the cost of the Windows license, which hasn't decreased anything like the rate that hardware has ... that makes for a greater incentive for customers and [PC makers] to look for an alternative," he said, calling Linux the best option.

If Microsoft makes an exception to its plans and offers Windows XP licenses for low-cost computers in the US and other developed countries after June 30, the software maker may not have to worry about eroding sales of Vista. Intel is working hard to segment low-cost laptops and mainstream laptops to prevent any overlap in sales.

To do this, Intel has set guidelines for low-cost laptops based on Atom, restricting the features they offer. For example, Intel has told hardware makers they can only use the chips in laptops with smaller screens, preventing vendors from producing a 14-inch laptop based on the Atom. The goal is to protect the mainstream laptop segment for more powerful and costly processors, like the Core 2 Duo, while catering to consumer demand for smaller, inexpensive laptops that complement - but do not replace - their main computers.

Perhaps Microsoft will realize that if Intel is comfortable segmenting the market in this way, they can be comfortable, too. They may not have another choice.