For Microsoft, new Windows revenue may mean 'subscriptions'

Company ponders how to make money on its OS when 'old-world' business models no longer function

After Microsoft's chief operating officer last week said the company was going to change the Windows business model, analysts tried to figure out exactly what he meant.

Those business model modifications, said Microsoft's Kevin Turner, would be revealed early next year when the company will outline how it plans to make money on Windows as it gives away an increasing number of licenses that once generated revenue.

"We've got to monetize [Windows] differently," Turner told an audience at a technology conference sponsored by Credit Suisse (transcript in Microsoft Word format). "There are additional opportunities for us to bring additional services to the product and do it in a creative way" [emphasis added].

Although Turner did not share details of what Microsoft might do, he reminisced about the good old days. "The first 39 years of our company, we had one of the greatest business models of all time built around ... the Windows client operating system," Turner said. "The beautiful thing about the old-world business model was that, hey, as a customer bought our software, we got paid 100% of it up front and we got paid regardless of whether they used it or not."

Cynical as that sounds, it made billions for Microsoft. But it's not how things work today, Turner acknowledged. "The ability to transition from that business model, candidly, is where we are today," he said.

So what monetization moves might Microsoft make that it hasn't already unveiled or at least tipped? Turner rejected the idea of giving away Windows across the board, a move that would destroy Microsoft's third-biggest business overnight. Instead, he ticked off some of the usual suspects -- services and what he cryptically called "add-ons" -- when he talked about changing the business model.

What else could Microsoft have up its sleeve? Analysts interpreted Turner's hints several ways.

"I think we'll continue to see increased prices in the enterprises," said Wes Miller, an analyst at Directions on Microsoft who was, coincidentally, calling from one of the boot camps his research firm runs to help businesses untangle Microsoft's Byzantine licensing. "Prices have risen in the enterprise to counter the decline [in consumer revenue for Windows]. They'll continue to add value to those enterprise agreements to justify the higher costs."

Historically, most of Microsoft's Windows revenue has come from corporations, either indirectly via the licenses purchased by computer makers whose PCs businesses buy, or directly through annuity-style agreements that give enterprises a variety of rights, including free upgrades to the newest OS. That gap between consumer and corporate revenue widened this year as Microsoft began handing out free licenses to Windows Phone vendors, to OEMs (original equipment manufacturers) of tablets with 9-in. screens and smaller, and to those building inexpensive notebooks.

Microsoft is making a volume play, a tactic it's not shy to admit. "We want to be able to make sure that we compete on all price points and overall grow the volume [of Windows devices]," CEO Satya Nadella said during an October call with Wall Street.

Miller, then, expects Microsoft to pull more money from its enterprise side to subsidize its efforts in the consumer market, essentially a continuation of its current strategy. Because that's conservative by nature, one must wonder if it would be worthy of Turner's use of "creative."

There is some recent evidence of Microsoft's creativity: It's begun to dabble in pre-user licensing, the bedrock of Office 365's model in the enterprise, for Windows as well. Licensing experts have examined the new licensing model and concluded that its appeal will be limited, but that could change.

Like Miller, Jan Dawson of Jackdaw Research said Microsoft could continue to subsidize its growing give-away habit by squeezing more revenue from enterprises. But he also saw other opportunities.

Dawson started out by noting that Microsoft's "old-world" model, which relied on expensive operating systems and software designed for expensive hardware made by others, is increasingly obsolete.

"In both Windows and Office, the mainstays of Microsoft's revenue, it's trying to sell something in an environment where others offer those things for free," Dawson said. As examples, he cited Apple and its iOS and OS X, Google and its Android and Chrome OS; their productivity suites, iWork and Google Docs; and with the exception of Macs that run on OS X, all of that inside a universe of historically cheap smartphones, tablets and Chromebooks.

"One of the challenges for Microsoft is that it keeps charging for what others give away," Dawson continued.

Microsoft has approached that hurdle with Office already, and has changed the consumer business model to, if not make the suite free, to make more of it free. A month ago, the company changed the rules for Office for iPad, giving customers editing tools that could be used free of charge in non-commercial settings.

Dawson wondered if that was a taste of what Microsoft plans for Windows, at least on the consumer side. "Much of their innovation lately has been giving away stuff for free."

Microsoft could replicate the Office for iPad model -- which presumably will be how it handles the upcoming Office on Android tablets, perhaps even some of the future desktop editions -- by giving away an entry-level, non-commercial version of Windows to OEMs, then trying to entice users into paying, most likely through a subscription, for a more capable, feature-rich edition.

While Dawson didn't go into the specifics, his concept has precedents: Microsoft has used mechanisms in the past, including in-place upgrades to premium editions from within Windows 7 (called "Anytime Upgrade" at the time), and withholding enterprise-necessary features, particularly domain joining, from consumer-grade Windows, to differentiate versions and segregate first-class customers (commercial) from those in coach (consumers).

The task would not be easy. "Microsoft has always had a harder time monetizing on the consumer side than it has on the enterprise side," Dawson said.

But a free Windows baseline could be Microsoft's solution to what Dawson saw as its most-pressing problem for 2015: Shifting the huge legacy installed base to its newest Windows 10, which will be the flagship for years and years to come, and hopefully will reinvigorate the PC market along the way.

"Windows 8 did not work out, and there's a massive base on older versions," Dawson said. "Windows 10 is intended to solve that strategic problem, so Microsoft will want to get as many people onto [Windows 10] as possible.

"But can they create a compelling product? And when it's compelling, can they charge for it?" Dawson asked. "They'll have to adopt more flexible business models, perhaps the freemium and premium models, or they face a much more fragmented future for Windows."

A Windows subscription, whether for services or for Turner's vague "add-ons" -- which may simply be code for beyond-the-basic features -- might keep the revenue stream flowing. As with Office 365, canceling a subscription would have dire consequences for those used to more than the elementals: The device would revert to a rock-bottom OS.

That didn't escape Miller. "With a subscription, you can't ever stop," he said.

Now that's creative.

Copyright © 2014 IDG Communications, Inc.

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