Microsoft fleshes out 'Windows as a service' revenue strategy

Microsoft CFO Amy Hood

Microsoft CFO Amy Hood takes questions at an annual shareholders' meeting in December 2014. 

Credit: REUTERS/Jason Redmond

Lower licensing revenue from consumers will be offset by increases in search, games and apps, company's CFO says

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Microsoft executives last week further fleshed out the firm's "Windows as a service" strategy, an effort to shift money-making from the traditional practice of licensing the OS to one more reliant on revenue from search, games and apps.

"When we talk about why we're upgrading the Windows 10 install base, why is that upgrade free?" Amy Hood, chief financial officer asked during a meeting with Wall Street analysts. "Why is it important to get to a modern environment? And why, when you look at the Windows interface this morning, did you see search built into the experience? You saw gaming built into the experience. You saw a unified store. These are all new monetization opportunities once a PC is sold."

Hood then showed the analysts a chart that displayed revenues from the sale of Windows licenses for consumer devices -- Microsoft dubs these "non-Pro" licenses to separate them from licenses from more advanced versions that are sold for business PCs -- to illustrate the declining income.

Windows 8.1 is the non-Pro edition of that operating system, while Windows 8.1 Pro is the business version.

"You can see when PC consumer shipments got weak, we adjusted our approach. We adjusted our approach in terms of SKU [stock-keeping unit] strategy, making sub 9-in. devices free," said Hood. "We added new pricing strategy for opening price point devices. And we had programs to drive genuine Windows attach in high-piracy markets."

Hood was referring to the multiple moves Microsoft has made over the last year to fuel device sales, including a free license to any device with a screen under 9-in. -- smartphones and smaller tablets -- and the subsidy to OEMs (original equipment manufacturers) via Windows 8.1 with Bing. That move made the license free or very inexpensive to makers of larger cut-rate systems, like entry-level notebooks.

"It clearly had an impact on our revenue per license, but also had an important impact in driving unit growth," Hood said.

MSFT Revenue per license Microsoft

Revenue per consumer Windows license took a dive last year after Microsoft began giving away licenses to smartphone makers and subsidizing OEMs that built and sold cheap notebooks.

Microsoft's strategy is to go low on consumer Windows licenses, hoping that that will boost device sales, which will in turn add to the pool of potential customers for advertising, services and apps. In other words, what Microsoft gives up in selling each Windows license it figures to make up in volume elsewhere.

Satya Nadella Reuters

Microsoft CEO Satya Nadella.

CEO Satya Nadella has referred to the customer revenue potential as "lifetime value" in the past -- and did so again last week during the same meeting with Wall Street -- hinting at Microsoft's strategy to make more on the back end of the PC acquisition process. The more customers, the more money those customers will bring in as they view ads, pay for services, play games and buy apps.

Hood outlined how other revenue streams were almost balancing the decline in consumer Windows licenses, using another chart that showed increasing advertising income from the Bing search engine and a much smaller contribution from PC games. Over the last two years, Hood claimed, Windows' CAGR (compound annual growth rate) was -16%; when Bing and games were added in the CAGR climbed to -1%.

Her point? Bing advertising, which has increased as a percentage of the accounting whole, and to a lesser extent games, have largely made up for the declining revenue of Windows licenses.

MSFT Consumer opportunity Microsoft

Microsoft made the point that increased search revenue was a core part of its 'Windows as a service' strategy, its plan to make up for declining licensing income with money made in other ways from consumers.

"What this chart does is take the revenue from those key franchises and adds them together to show that the mix of our consumer monetization has already pivoted, and has the opportunity to pivot and grow further," said Hood while describing the chart.

Hood did not include revenue from the Windows app store -- perhaps because it would have been minuscule at this point -- but Microsoft clearly expects it to be significant after the debut of Windows 10's new unified market, which will include traditional desktop applications as well as apps for mobile devices.

Hood's illustration was in part an accounting magic show -- moving revenue from one place to another for demonstration purposes -- but it also showed Microsoft's thinking about its consumer Windows revenue plans in the most detail so far. In particular, it revealed why Microsoft has embedded Bing and the Cortana assistant so deeply into Windows 10.

"Windows as a service" has at times been interpreted as a strategy that would ultimately make the operating system a subscription of some sort; Hood said nothing about that last week, instead pointing to add-on revenue as the plan.

But at another point in the meeting, Kevin Turner, Microsoft's chief operations officer, made a comment that hinted a subscription was, if not in the immediate future, something the company may covet. "With Windows as a service, you can only dream about what the capability might be over the long term there as we develop that and it matures," Turner said, talking about the shift from a focus on licenses to one on "annuity conversion."

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