When is a Windows update not an update? When it's an upgrade

Microsoft labels Windows 8.1 an 'update,' not an 'upgrade,' to avoid deferring revenue

For Microsoft, there's a difference, a big difference, between a Windows upgrade and an update, even though both can be handed out free of charge to customers.

A free upgrade requires the company to set aside revenue at the time of sale, then recognize that revenue only when the upgrade is released. An update, on the other hand, lets the firm book all sales immediately.

The distinction may seem arcane or even meaningless to customers, but it has an impact: If Microsoft had called Windows 8.1, the overhaul slated to ship later this year, an upgrade, it would have had to either charge customers for the software or retroactively adjust Windows revenue to account for the deferrals, depressing that division's earnings over the last several quarters even further.

Microsoft spelled out the difference between upgrade and update in a regulatory filing this week with the U.S. Securities & Exchange Commission (SEC).

"Software updates are evaluated on a case-by-case basis to determine whether they meet the definition of an upgrade, which may require revenue to be deferred and recognized when the upgrade is delivered," Microsoft said in the Form 10-K.

"Windows 8.1 will enable new hardware, further the integration with other Microsoft services and address customer issues with Windows 8, and will be provided to Windows 8 customers when available at no additional charge," the company continued. "We evaluated Windows 8.1 and determined that it did not meet the definition of an upgrade and thus have not deferred revenue related to this planned release."

Microsoft can say Windows 8.1 is an update, not an upgrade, even though the list of new features, enhancements, improvements and changes has filled pages on the company's website and prompted much trumpeting by executives.

And those executives have been careful about what they call Windows 8.1, perhaps because of its accounting status, regularly labeling Windows 8.1 as an update and avoiding upgrade.

"It's a free update," said Tami Reller, then the CFO of the Windows group, at last month's Worldwide Partner's Conference (emphasis added). "I think it's safe to say that's a lot of functionality coming free in an update."

The casting of Windows 8.1 as an update reinforces the view by some analysts that Microsoft's oft-touted faster Windows development and release schedule is really its older practice of issuing irregular "service packs" with a new name.

Microsoft also gave away those service packs. It has discontinued them for Windows, but still issues them for other parts of its portfolio: A second service pack for Office 2010 shipped last week.

Windows 8.1 as an update also raises questions of how Microsoft will justify the eventual next upgrade of Windows.

The new faster tempo, most experts believe, will be composed of one or more interim updates -- Windows 8.1 is the first, Windows 8.2 next, and so on -- between each upgrade, the next of which could be called Windows 9. But if Windows 8.1 is packed with new features, software and hardware support, how much more will Microsoft have to deliver to, first of all, reasonably call Windows 9 an upgrade, and second, convince customers that the price tag is justified?

More importantly, how much more can Microsoft's engineers do for an every-few-years upgrade while they're also cranking out impressive interim updates?

Others have faced the same it's-an-upgrade-it's-an-update issues, but taken different tacks than Microsoft.

Apple, for instance, once charged iPod Touch owners as much as $20 for annual iOS upgrades rather than defer revenue. It later adopted the deferral tactic to make those upgrades free by setting aside a small portion of the proceeds from each iPod Touch sale. It has done the same with iPhone revenue to account for the free annual iOS upgrades, like this year's impending iOS 7.

The Cupertino, Calif. company also defers some revenue from Mac sales to account for any enhancements it provides to the computers' software and accompanying services, but solves the problem of annual OS X upgrades -- which by nature are evolutionary and rarely offer major improvements or enhancements -- by putting a low price on each upgrade.

In 2012, for example, Apple charged $20 for OS X Mountain Lion, a price sure to be retained for this year's OS X Mavericks. Prior to that, Apple priced OS X Lion at $30 and OS X Snow Leopard at $29.

Although Microsoft offered Windows 8 Pro upgrades for $40 for several months last year, it eventually raised the price to $200, essentially killing the upgrade market and forcing customers to make a choice: Either buy a new personal computer to get onto Windows 8 or let their existing machine age. According to the data on PC shipments from researchers like IDC and Gartner -- both which have tracked five straight quarters of shipment declines -- people are picking the second choice and opting for Android and Apple tablets, which come with free OS upgrades, instead.

Microsoft may face a pricing dilemma with Windows 9 (or whatever the next upgrade is called). It will have to choose between a low price, perhaps a permanent one rather than a temporary discount, and building an edition clearly superior to the interim updates. The latter may be difficult without an uptick in Windows development and engineering costs.

The company could solve the problem using the strategy it's pursuing with its Office franchise: Sell subscriptions. Office 365 subscriptions, Microsoft has boasted, provide customers continually-updated software and, as long as the subscription payments are made, no further charges for updates or even major upgrades.

But the chance that the Redmond, Wash. developer will extend the subscription concept to Windows is less than slim and none.

So, for Microsoft, an update is an update is an update. Until it's not. Then it's an upgrade.

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, or subscribe to Gregg's RSS feed . His email address is gkeizer@ix.netcom.com.

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Copyright © 2013 IDG Communications, Inc.

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