I'm skeptical that the hardware couldn't handle full Windows (because Starter also provided an Anytime Upgrade option), so it seems likely this was an intentional decision to reduce the features of netbooks at the software level, in order to avoid cannibalizing larger PC's and laptops.
EDIT: link to feature limitations for W7 Starter: http://answers.microsoft.com/en-us/windows/forum/windows_7-w...
They didn't want to install a full copy of Windows 7 because they would have had to pay the full price for it (after the usual discounts etc).
After much argument, they came up with a compromise that had acceptable functionality (to Microsoft) at an acceptable price (to the OEMs).
So Microsoft was helping, rather than "not helping".
But you're right: the aim was to sell netbooks without having too big an impact on more profitable sales of laptops.
If the specs could have been a bit higher and increased in a timely manner, netbooks would have been perfect for a lot of the market. They were limited in speed just below the edge of what most people would consider to be capable.
If Ubuntu netbook edition was more user friendly and more windows-like I'm sure a lot of people would've been very happy with a low specs machine that ran smooth enough for the kind of tasks you'd want to do on a <= 10'' screen.
I agree, and that's the tragedy of the situation.
The first netbooks shipped with Linux, and Microsoft saw that as a threat, so they started licensing Windows at very low rates for netbooks. When the cost difference was minimal to ship Windows on netbooks, that's what vendors did, and the Windows netbooks dominated the market.
Once they'd conquered the market, Microsoft pulled the bottom out by seriously limiting the capabilities of netbooks. Netbooks then developed a reputation of being slow because most of the netbooks on the market were running Windows and were slow. The "netbook" name was already tarnished, making it difficult for the original Linux netbook idea to succeed.
> The first netbooks shipped with Linux
The first netbook shipped with Linux but the launch announcement for the Asus included both Windows XP and Linux. Windows sold better and was more profitable.
> Once they'd conquered the market, Microsoft pulled the bottom out by seriously limiting the capabilities of netbooks.
No, the capabilities of netbooks were always limited. The netbook spec was upgraded twice to allow larger hard drives and screens etc.
You could certainly argue that it wasn't upgraded enough, but then, it was limited to protect sales of laptops that were more profitable for Intel, Microsoft and the netbook OEMs.
Netbooks had two main points: (1) provide a portable PC solution suitable for schools -- see Intel Classmate and, indeed, OLPC; (2) to provide a companion PC for existing PC users.
It was nobody's idea to provide cut-price netbooks that would damage laptop sales.
You might think it's a tragedy but it's just business.