Microsoft reaps profits from revamped Office 2007 pricing

The keys: Opening the student edition to all, shifting Outlook to the pricier standard edition

For Daniel Duffy, president of Valley Network Solutions Inc., a leading Fresno, Calif.-based systems integrator, the strong demand by his customers for Office 2007 instead of Microsoft Corp.'s other big release this year -- Windows Vista -- was unexpected.

"There are a lot of five-to-50-seat companies getting new installations of Office for the first time," he said. "We figured there'd be more demand for Vista. Actually, I'm a little surprised with the [slow] uptake."

So perhaps are a lot of people. Although Vista has gotten the lion's share of Microsoft's marketing dollars, its sales performance so far remains mixed. Use of the new operating system may be steadily increasing, but many users are clinging to Windows XP, forcing Microsoft to trim its fiscal 2008 projections of Vista's adoption by users.

Though on an upswing in recent years, Office, meanwhile has seemed vulnerable. Open-source rivals such as the OpenOffice.org suite, and online upstarts such as Google Docs and ThinkFree, have gained buzz -- and fans. And Office 2007's radically overhauled Ribbon interface, designed to expose more of the software's thousands of features to users, has many grumbling about the inconvenience and likely retraining.

But Office continues to prove itself as Microsoft's quiet profit machine. During the company's fourth-quarter earnings conference call last week, Microsoft officials said that revenue in its business division -- driven largely by enterprise sales of Office -- was up 19% year over year to $4.6 billion. Sales in that same division for the current quarter are expected to increase 14% to 15% from the same period a year ago.

And at its annual meeting with financial analysts yesterday, Microsoft said the renewal rate for Office is running at 90%. Jeff Raikes, president of Microsoft's business division, attributed that to "the strength of our road map and the future [that customers] see in what we are investing in for the Office system."

Moreover, data from market researcher NPD Group Inc. shows that at the retail stores and e-commerce sites where most consumers and small businesses buy software, revenue from all versions of Office was up 60% in the first six months of this year compared with the same period in 2006.

"Microsoft Office has been breaking all kinds of land speed records, but there doesn't seem to be many spectators in the racetrack stands," said Chris Swenson, an analyst at Port Washington, N.Y.-based NPD. "It's a phenomenally successful product."

Swenson credits Office's success in the retail channel -- where it has seen double-digit revenue growth year over year for the past three years -- to changes in Office's pricing and feature sets. Although the standard edition of Office may list at $399, the vast majority of consumers and small businesses either buy less expensive upgrades or, in most cases, lower-priced versions of Office once aimed solely at students.

The $149 Student and Teacher Edition for Office 2003 and the Macintosh-based Office 2004 accounted for fully 86% of the copies of the software suite sold in the U.S. last year, according to NPD. Microsoft aggressively used rebates during the back-to-school buying season to juice sales, said Swenson. "You could get Office for the unheard price of $100 last year," he said. "By effectively dropping the price a bit, they saw Office shipments and revenues explode."

With Office 2007, Microsoft has maintained the low price of the Student and Teacher Edition and some of the same rebates, while making two key changes. Realizing that many buyers of that version were neither students nor teachers, and that policing whether they were was impossible, Microsoft renamed the product the Home and Student Edition and gave a stamp of approval to all buyers.

The company also removed its Outlook e-mail program from the Home and Student Edition, replacing it with the OneNote note-taking software. And Microsoft essentially bet that it could upsell a small slice of customers -- those who want home access to corporate e-mail, especially if it's hosted on Exchange servers -- to the $399 Office Standard, Swenson said.

Both gambles appear to have paid off. According to NPD, Office 2007 Home and Student was the third best-selling title at U.S. retail and e-commerce stores in the first half of the year, behind only Intuit Inc.'s TurboTax and H&R Block Inc.'s TaxCut.

In addition, the percentage of retail sales accounted for by the Home and Student Edition so far this year is 78%, down 8% from last year's level. That, combined with strong demand resulting from the Office 2007 launch, is why overall Office revenues from U.S. retail store sales are up sharply, Swenson said.

Although it's possible that Office 2007's strength is based on pent-up demand from a minority of eager customers that will peter out soon, Swenson thinks Microsoft has found the "sweet spot" in its Office pricing strategy.

He also points to the effectiveness of Microsoft's try-before-you-buy program. The number of people buying Office online after using it on a trial basis has doubled each year for the past two years, according to NPD. Swenson said he expects that trend to continue.

Another factor is Apple Inc. Although the Mac's resurgence -- one in seven laptops sold in U.S. stores is a Macintosh -- cuts into Vista PC sales, it boosts sales of Office 2004. It should also help Office 2008, the Macintosh counterpart to Office 2007 that's due next year.

For all the attention they garner in the tech press, rivals to Office have made few real inroads among users, Swenson said. Those $39 boxed copies of OpenOffice and Sun Microsystems Inc.'s StarOffice available on retail shelves "didn't sell at all," he noted. And Swenson said that although he has "no doubt that people use Google Docs, I think it's mostly as a supplement" to Office.

Anecdotal evidence from Microsoft partners selling Office in the field reinforces that. "Everyone sees Office 2007 as a natural migration," said Larry Hunt, chief engineer at Integrated Digital Systems Inc., a maker of enterprise document management software that runs on top of Office and SharePoint. "The jury is still out on Vista."

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