May 10, 2002 4:00 AM PDT

Microsoft program meets some resistance

With a summer deadline looming, about two-thirds of Microsoft's largest customers have not signed up for a new software licensing program that represents an important source of revenue for the company.

According to surveys by two research groups, Gartner and Giga Information Group, one-third of businesses contacted said they do not intend to sign up for the subscriptionlike software program, and another one-third of businesses said they are undecided. Most in this latter group are expected to go with the program, the market researchers concluded.

Customers still have two months to sign up, leaving plenty of time for hesitant businesses to get with the program. Still, the sign-up rate does not reflect overwhelming support.

Julie Giera, an analyst with Giga, described the number of businesses saying they refuse to join the program as "no small number" and noted that the undecided camp also is sizable.

One year ago this week, Redmond, Wash.-based Microsoft announced a radical change in the way that businesses buy its software: Rather than simply being able to upgrade their software when they wanted to--and when their budgets allowed--companies would need to commit to buying operating-system and application upgrades ahead of time through an annual fee.

Microsoft customers can decline the plan, but they will lose out on discounts.

With this "Software Assurance" program, Microsoft intended to make its revenue more predictable by signing corporate customers up for what amounts to a subscription to Microsoft software upgrades. But many customers howled in protest, citing estimates that their costs could more than double at a time when the sputtering economy was cutting into their own revenue.


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"We will not be involved in the new licensing program," said one technology manager from a midsized Midwestern company, who asked not to be identified. "We cannot see the value in it. Our business evaluation is that Microsoft is not giving us value for the return on our investment."

The manager added that he will upgrade his software only if absolutely necessary and is exploring alternatives.

Companies have until July 31 to sign up for the program; some of those on the fence are using the remaining time to consider alternatives, such as the Linux operating system and Sun Microsystems' StarOffice software, said analysts familiar with the contract negotiations between Microsoft and its customers.

Sun, in fact, plans to rev up interest in StarOffice. On May 22, the company is releasing a new version of StarOffice with pricing changes. Sun Chief Operating Officer Ed Zander has said that some large companies will demonstrate how they have deployed StarOffice in select departments this quarter.

Pay now or pay later
Those that choose to remain with Microsoft but not to sign up for a renewal plan may save some money in the short term, but Microsoft will eventually get its share, and then some.

The reason: After July 31, companies lose the opportunity to renew their contracts with Microsoft at a discount. For companies that don't upgrade often, that may not be a problem, but they could run into problems complying with license restrictions, and they will eventually need to upgrade their software.

"If Microsoft doesn't get (its) money now, it will later," said Michael Silver, an analyst with Gartner. Still, the more than 30 percent of companies that said they will pass on the new licensing program "is a fairly high number, considering that the (holdout) companies had used one of the older options," he added.

Still, Microsoft has reported that licensing revenue has jumped by about $1 billion since the plan was introduced. And there's a bonus: Customers locked into two- or three-year commitments won't have much incentive for looking at Linux, StarOffice or other Microsoft alternatives.

But the program has not been without risk.

From the outset, many customers resisted the Software Assurance program, which Microsoft announced about a third of the way through many companies' fiscal years. The program initially included a requirement that meant virtually all Microsoft volume licensees had to upgrade to Office XP just to qualify. In the United Kingdom and New Zealand, irate technology managers filed complaints with regulators over the licensing changes.

In addition, on two occasions, Microsoft pushed back deadlines for fully implementing the program.

"The financial impact on some of these companies could have been done a whole lot smarter than Microsoft did it," Giga's Giera said. "You announce it in May and say it goes into effect in October--80 percent of your customers don't have the budget for it."

Rebecca LaBrunerie, Microsoft's product manager for worldwide licensing and pricing, defended eliminating the most popular means of buying upgrades in favor of an annuity maintenance contract where companies pay for the right to upgrade. Under the old model, they also had the option of paying for an upgrade when they wanted to rather than only choosing an annualized fee.

"This is really a paradigm shift," LaBrunerie said. "This is the biggest licensing change we (have) ever had. Moving customers from one-time upgrades to an annuity model was critical for us."

By the numbers
The cash bonanza for Microsoft due to the licensing change is sizable. For instance, Microsoft pulled in an extra $1 billion during the first three quarters of its 2002 fiscal year for Office, just one of several products affected by the change. The change, according to Gartner, raised licensing fees paid by customers between 33 percent and 107 percent. More Software Assurance subscribers, fees from other software subscription programs, and other sales relating to the change in licensing could account for another $1 billion increase in the future.

"If you look at the year-over-year deferred revenue for desktop applications, which is mostly Office, it's grown by 48 percent," said Silver, who attributed the increase to the change in licensing.

The increase even surprised Microsoft, which Chief Financial Officer John Connors noted in the 2002 fiscal second-quarter conference call.

"During the quarter, we also saw strong adoption of our volume licensing programs," he said. "In fact, there was a shift in the product mix--much greater than anticipated--in favor of these license types, primarily in the Office and server businesses."

The program also has a smoothing effect on the balance sheet. Microsoft accounts for the licensing programs as deferred revenue, which is realized as earned revenue on a monthly basis over the life of the contract. The licensing contract periods are typically two or three years.

"What Microsoft has done with this new licensing program is move to a recurring revenue stream," Giga's Giera said. "They're trying to smooth out the revenue bumps, the peaks and valleys associated with each time they introduce a new product. Wall Street doesn't like to see peaks and valleys."

Before instituting the licensing changes, Microsoft was subjected to the uncertainty of customer buying habits and the pressure to release a new product version to reinvigorate sales. In this regard, the licensing changes have affected Office, Microsoft's longtime revenue cash cow, more than any other product. But Office sales are slumping. Desktop applications, which include Office, accounted for 33.6 percent of Microsoft's revenue during its fiscal third quarter, ended March 31. That's a decline from 37.6 percent for the same period a year earlier and 40 percent in 2000.

While Microsoft adds new features to every version of Office, customers have stretched out their upgrades. Microsoft's new licensing plan is cheaper for those companies upgrading every two years or less.

"But increasingly people are waiting three and often four years or more to upgrade," Silver said. Businesses upgrading to Office every three years will pay 33 percent to 77 percent more under the new plan than they did with the old plan, according to Gartner. Four-year upgrades would cost 68 percent to 107 percent more. "You change the way people buy the products, so you make more money on them," he added.

Resistance is futile
The unexpected increase in costs is the major reason businesses are either resisting the new licensing program or are noncommittal about making the move. A survey conducted last autumn by Giga and Sunbelt Software found that 80 percent of the 4,550 technology managers polled said they expected to pay more under the new program.

Customers opting out of the new licensing plan have two main options: pay full price for Microsoft software later on or switch to a competing product.

"Software Assurance versus doing a one-time license fee, the break-even point is three and a half years," said Microsoft's LaBrunerie. Companies upgrading less frequently than that should continue paying full price when they upgrade rather than signing on to the new program, she said.

Of the more than 30 percent of companies passing up the new licensing program, about "80 percent of them are installing Linux somewhere in their company," Giera said. "There's no question that the licensing change brought more attention to Linux."

Gartner's Silver sees more serious interest in Sun's StarOffice, which on a licensing basis costs companies considerably less than Microsoft Office. But other factors "make switching prohibitive for most companies," he said.

Gartner estimates that companies switching to StarOffice will pay around $1,200 per user--and possibly higher for employees who exchange a lot of files with outsiders. Almost $800 would go to labor costs in making the change and potentially $400 more for lost productivity.

Over time, StarOffice costs less than Office to maintain, but it would still take eight years to break even on the initial conversion costs, Gartner concluded. Whether upgrading in two years or four years, the cost for StarOffice would be around $350 per user. Once again, labor would account for the bulk of the total. Licensing Microsoft Office, by contrast, is considerably more expensive. Companies upgrading every two years would pay on average $550 per user or $700 if upgrading every four years.

"Microsoft was really good at getting people locked in to their products through file formats, user interface, learning, macros and all that stuff," Silver said. "It's just really hard for enterprises to move to another product, but it's great for Microsoft."

The conclusion: The majority of companies looking at alternatives will stick with Microsoft and pay full price for upgrades later on.

Those undecided companies have until July 31 to sign up for Software Assurance or an older licensing program, Upgrade Advantage, to make sure they have a valid contract beyond the deadline. Companies with older Office or Windows versions must either make sure Upgrade Advantage covers them beyond July 31 or move to Office XP and Windows XP. After that date, older programs will not be eligible for Software Assurance. Because Microsoft issues perpetual licenses to most customers, their right to use the software doesn't change, only their right to discounted upgrades if they don't sign up for Software Assurance.

With the deadline so close and with so many companies uncommitted, the pressure is building, Giera said.

 

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