Bill “Linux Pundit” Weinberg explains:
Business Model and Execution: Many MontaVista watchers have argued that the company’s business model was essentially flawed. […] Such a model based on building with and for open source can devolve into less attractive high-overhead packaged service business in the face of a rising value line.
[…] The model did not fail the company, but rather the company failed to execute on that model.
Failure to execute belies key assumptions about serving device OEMs with embedded Linux platforms and toolkits:
- OEMs look to suppliers like MontaVista for productization of the latest Linux kernel technology, libaries, middleware and tools
- OEMs expect frequent releases and deep expertise at many levels of the platform and tools
- OEMs anticipate something “in the box†other than bits and bytes they can increasingly source directly from OSS project trees
While MontaVista made a strong start in all these areas, over time they reduced the investments needed to meet these (not unreasonable) expectations
To me, MontaVista made a number of serious errors, but also faced a fundamentally 
difficult situation caused by the massive underpricing of “board support” and the hostile nature of the business models of the semiconductor and device manufacturers on which it depended. The embedded industry is jam-packed with no-value added differentiators at the hardware level. Or to use English, the companies that make embedded devices choose to use a very large number of different hardware platforms that are very similar in terms of capability and cost, on the reasonable theory that a small difference in the sum of component costs – the bill of materials (BOM) - can lead to huge cost differences at large volumes. The result, however, is that these companies need a large amount of work performed to make their development and production boards run application software. They don’t start from working boards and software, they start from something new, although generally only new in being incompatible, not new in the sense of being better. Making a board support package, the low level software is not easy and it is often very laborious. But if you are committed to thinking in terms of saving $0.05 on a processor as a big deal, paying hundreds of thousands of dollars for software development – on invisible, low level, enabling software seems outrageous, particularly if it is “free” software. So Montavista’s business was doing something hard and time consuming for a customer base that insisted (with some justification ) that this was a low value product. And they entered the industry by selling the proposition that paying royalties for software was a terrible idea and that everyone else was overcharging.
So you sell something that (a) takes a lot of work to do and traditionally needs a lot of engineering time, (b) meets customer resistence on price (c) is sold upfront – that is before the customer gets any revenue from selling devices, and (d) that you deliberately produce in a way that leaves you with zero leverage in terms of intellectual property limits. How could anyone make money from such a plan?
It’s not widely appreciated that software and hardware companies are competitors. Well, it’s appreciated by Google, Microsoft, Intel, Oracle, and other companies that have made a lot of money, but not by many other companies that continually are surprised by low profits. End users of computer based devices, especially embedded but increasingly in enterprise as well, pay for applications, not for bill of materials. It’s not like a cell phone user is willing to pay more for a nicer capacitor, a prettier battery, a better device driver, or a cleaned up browser. They pay for the working telephone. So if the market price is $X for a phone, the big question is how those $X get shared among integrators, capacitor makers, battery producers, chip vendors, and application, middle-ware, and OS level software developers – there is a competition for who gets what share. And if you find yourself as the junior partner in the BOM scrum, one who is there primarily because you are advertised as undercutting your fellow vendors, you can expect to get squeezed hard. I bet that this is what MV experienced.
I should also note that MV had no happy allies either. It was not easy to collaborate with them and the idea that “if we do this together both of us will prosper” was not one that their management was enormously receptive to. The result was that their ability to act as an integrator was limited.