March 20, 2003 12:51 PM PST

Microsoft plan raises software costs

Read more about software costs
A controversial licensing program from Microsoft has added up to higher costs for a number of the software maker's corporate customers.

Sixty percent of businesses that signed up for the Licensing 6 program have seen increases in the fees they pay for Microsoft's software, according to a recent survey. Yankee Group and Sunbelt Software conducted the survey among 1,000 technology managers worldwide.

The survey results are the latest pothole on the long road that Microsoft has taken toward the licensing system. The company has been catching flak for the plan for nearly two years. Microsoft announced Licensing 6 in May 2001, but stretched out the full implementation of the plan some 14 months in response to stiff customer resistance.

Microsoft fully enacted Licensing 6 on Aug. 1, 2002. Under two-year or three-year "Software Assurance" contracts, companies pay for discounted upgrades in advance of receiving the software. The new program also eliminated off-the-shelf upgrades that allowed businesses to purchase the software when they wanted.

But there is a bright spot in the latest findings. A similar survey conducted in October 2001 showed that 80 percent of technology managers expected an increase in their Microsoft software costs.

While the new program certainly hit many businesses hard, Yankee Group analyst Laura DiDio said that she was "encouraged" that only 60 percent of Licensing 6 adopters saw price increases.

DiDio attributed the lower percentage to two factors: Many larger businesses that upgrade every two to three years already "were in line for more favorable deals from Microsoft. Also, contrary to popular opinion, Microsoft did work closely with many customers and offer them additional incentives."

About 28 percent of those signing up for the plan saw their Microsoft licensing fees remain the same, according to the study. Twenty-two percent of Licensing 6 adopters saw their costs increase 5 percent to 20 percent, while 16.8 percent saw a 20 percent to 30 percent increase, 7.4 percent reported a 30 percent to 50 percent rise, and another 7.4 percent reported cost increases of more than 50 percent. Costs doubled for 6.3 percent of respondents. None reported costs tripling.

Analyst firm Gartner early on had estimated that the plan would raise licensing fees 33 percent to 107 percent.

Not all Licensing 6 adopters reported price hikes. The Yankee/Sunbelt study revealed that for 10.5 percent of participants, licensing costs decreased 5 percent to 20 percent. Only 1 percent of survey respondents reported savings of more than 20 percent.

As expected, a great many Microsoft customers simply skipped Licensing 6 altogether, the survey revealed. Nearly three-quarters of businesses--72 percent--refused to sign up for the program. But that figure is somewhat deceptive. About 42 percent of businesses signed up under the older and cheaper Licensing 5 plan, before Microsoft closed the door on the program at the end of July.

The number also fails to take into account the number of larger businesses that switched to a plan largely unaffected by the Licensing 6 changes. Microsoft offers three licensing plans: Open, Select and Enterprise Agreements. The first two are the ones affected by the Licensing


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6 changes and by the introduction of the subscriptionlike Software Assurance program. An Enterprise Agreement is already an annuity program, and one that has grown in popularity in part because of the higher cost of Software Assurance under Open and Select licensing plans.

Gartner analyst Alvin Park estimated that a full one-third of companies refused to sign new Open or Select agreements under Licensing 6. About another third renewed under Licensing 5, with the rest signing up for an Enterprise agreement. Based on analyst estimates, the percentage of businesses signing up for Enterprise agreements jumped to more than 30 percent, from less than 15 percent, of Microsoft licensing customers.

During Microsoft's analyst conference earlier this month, CEO Steve Ballmer revealed that 2,500 to 3,000 of the company's 4,000 largest customers had signed up for an Enterprise agreement, Park said. "That's much higher than I would have expected," he added.

The bigger the company, the better the deal
That larger companies were switching to Enterprise agreements or getting better Licensing 6 deals in general didn't surprise IDC analyst Al Gillen.

"What you didn't get from the bad press is a sense is who was complaining," he explained. "Very often it was the smaller organizations that were bent out of shape about licensing. That's because the larger organizations got a better deal."

Businesses skipping Licensing 6 cited many reasons, according to Yankee Group and Sunbelt Software. Twenty-five percent of technology managers said their businesses simply couldn't afford the new program. Another 28 percent said the Licensing 6 terms confused them, so they decided to pass on the plan. About 6 percent said they had significant problems with "non-complying software"--either packages the companies had paid for, but could not offer proof of having purchased, or packages for which there had been out-and-out piracy.

Microsoft would not disclose its licensing renewal information, which, as it uses actual sales data, conceivably would be more accurate than analysts' estimates. Because Microsoft doesn't publicly disclose those numbers to Wall Street, the information cannot be revealed elsewhere, said Harley Sitner, a Microsoft senior product manager. "That's a business decision we made, and once we made that decision we have to stay on that track," he explained.

Assessing the ultimate fallout of Licensing 6 could take years, say analysts. One reason: The first wave of Licensing 6 customers won't need to renew until the end of October.

"It's virtually impossible for a customer to calculate, when he pays his money in advance, what he's going to get in advance," said Paul DeGroot, an analyst with market researcher Directions on Microsoft. "He does not know when the product is going to be released, what he's going to get when it's released, and if it has anything he would like."

In two or three years, Microsoft will get the answer to that question, when customers decide to sign up for more Software Assurance or pass on renewing their contracts, DeGroot said.

In the short term, Microsoft reaped huge windfalls. Unearned revenue, mostly from licensing, accounted for 22 percent of overall revenue in Microsoft's second fiscal quarter, ended Dec. 31. Microsoft ended its second quarter with $8.83 billion in unearned revenue. During its first quarter, unearned revenue swelled to $9.13 billion, up from $5.85 billion a year earlier.

Still, Microsoft also recognizes Licensing 6 hurt customer relationships and is hoping to repair them. "A lot of customers are dissatisfied," conceded Rebecca LaBrunerie, Microsoft's product manager for worldwide licensing and pricing.

"We did make some mistakes," she said. "We didn't roll out (Licensing 6) properly and we didn't make the announcement and timing carefully, which is why we extended (the deadline) a few times, giving 14 months overall."

Gartner's Park said the damage has been significant. "Microsoft hurt the trust many customers placed in it, and that is going to take some time to fix," he explained.

Microsoft extends an olive branch
Damage repair in part explains a number of conciliatory changes Microsoft has made to its licensing changes over the last six months. For example, Microsoft last week changed the licensing for eight server software products. Starting April 1, customers will buy licenses for just the number of processors the software uses, rather than for every processor on a server.

In December, Microsoft changed client-access licenses (CALs) for accessing Windows Server 2003. Under the revision, companies could buy CALs for users as well as for computers accessing the server.

"When I look at Windows Server 2003 CALs, I just don't see any downside for customers," Park said. In fact, Microsoft may have learned from its mistakes, he concluded. The company could have eliminated per-seat, or per-machine CALs, in the process.

"There are lots of companies that have more users than they have computers," Park said. "Eliminating the older CALs would have made them mad at Microsoft."

In November, Microsoft launched a new licensing program aimed at bringing some benefits of Enterprise Agreements to smaller businesses--the group of customers most discontented with Licensing 6.

Microsoft's Sitner described these and other changes, such as the establishment of a customer licensing board, as a way of "recognizing the mistakes that we made" and a sign the company is "listening to our customers and making changes in response to that."

"Microsoft is clearly trying to offer olive branches," DiDio said. "Could more be done? Yes. I'm sure customers would like the status quo back. I'd like to pay 1965 prices for gas, too. But that's not going to happen."

Businesses will have to live with the peace offerings and be satisfied, she said. "Things aren't going back to what they were."

For now, the olive branches are having some impact. In the earlier survey of technology managers, 38 percent said they would wait on Windows XP as they explored other alternatives. But in the newer survey, 3.5 percent said they were in the process of switching to competing operating systems, such as Linux.

Mark Romanowski, a senior vice president with New York-based technology services company AMC, said that his customers have started accepting Licensing 6 and warming up to softening policies on other products.

"It has been relatively quiet," he said. "The major uproar that happened way back when--that's over now. We've been taking sort of an unscientific poll every time we meet with customers about any issues with their licensing. No one seems concerned."

Still, DiDio and Park both cautioned that there's more than goodwill at work on Microsoft's part. Park noted that the Open Value product greatly benefits Microsoft's push into the small business market. At the same time, changing Windows Server 2003 terms helps in a market where Microsoft faces competition from Linux and Unix.

More importantly, Microsoft is responding to the continuing decline in technology spending.

"They're getting the fact that the customers simply don't have the cash," DiDio said. "What good is picking the pocket if there's nothing there to pick?"

Microsoft's effort to take the sting out of Licensing 6 could be critical to moving the remaining three-quarters of the installed base to the plan, DiDio emphasized. "They are facing the worst and prolonged economic downturn in recent memory. Some customers simply lack the cash."

 

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