For years now, we’ve seen a steady stream of would-be “Microsoft killers” – products that were going to break the hold of Windows and Office over the PC desktop. It’s been assumed that a deterioration in Microsoft’s fortunes and power would manifest itself in losses of market share. But that’s been a faulty assumption, one based on a belief that future competition in personal computing would continue to be fought out on Microsoft’s turf – the PC’s hard drive.

The real threat to Microsoft has always been that the battle would shift away from its turf, that its traditional hegemony over the PC would begin to matter less. The threat, in other words, wasn’t so much that Microsoft would lose its control over the operating system and the personal productivity application, control reflected in market share numbers, but that its control would simply fade in importance. And that phenomenon – the loss of importance – would be revealed through a loss of pricing power, not a loss of share.

That’s what we’re beginning to see today. At the edges of its vast and incredibly lucrative market, Microsoft is losing pricing power. As the center of personal computing moves from the PC hard drive to the web, people’s reliance on Windows and Office begins, slowly, to fade, and as a result their motivation to buy or upgrade the programs weakens. To maintain its market share, Microsoft has no alternative but to cut prices.

Over the last couple of years, Microsoft has slashed the price to home users of retail copies of its Office suite. Last fall, it launched a special promotion aimed at college kids in which it cut the price of its high-end Office Ultimate 2007 edition by 90%, to just $60. In the end, as free alternatives continue to improve, it will probably have no choice but to give away a version of Office to students.

Now, Microsoft has also announced sharp discounts, effective later this month, for retail versions of Windows Vista. In the US, the price of Windows Vista Ultimate will be cut from $400 to $320, while the price for an upgrade version of Vista Home Premium will fall from $160 to $130. Such cuts, one analyst told Cnet, are “very unheard of.” In explaining the reason for the discounts, Microsoft executive Brad Brooks was quite clear: there’s been little demand among PC users for upgrading old versions of Windows to Vista. The PC operating system just doesn’t matter the way it used to.

“Today,” Brooks said, in a press release, “the vast majority of Windows licenses are sold with PCs; retail stand-alone sales, in contrast, have been primarily from customers who value being early adopters and those building their own machines.” Microsoft has been testing price discounts for Vista in various markets, and, says Brooks, “one constant emerged – an increase in demand.” Yep, it’s true: if you cut prices, you increase sales.

It’s true that retail sales of Windows and Office to consumers represent a relatively small portion of overall sales. But that’s the way a loss of pricing power tends to work. It begins with the most price-sensitive customers and then works its way in toward the center of the market. To get a read on the long-term financial prospects of Microsoft’s core businesses, don’t focus on the market share report; look at the price tag.

UPDATE: Another point worth mentioning: Because the marginal cost of producing and selling a copy of a software program is so low, price discounts at the edge of the market are likely to provide an immediate boost to Microsoft’s profits by bringing in high-margin revenues from a set of customers who otherwise would not have bought the programs. The financial danger to Microsoft lies further out, as the loss of pricing power expands to core customers. Given the relative price-insensitivity of a lot of those customers, the process could take a fairly long time.