May 5, 2001 11:15 AM PDT

Microsoft shelves Office XP subscription plan

Microsoft has temporarily nixed a controversial plan to sell Office XP on a subscription basis to some U.S. customers.

The surprising turn in positioning comes less than a month before Office XP's official May 31 launch and days after Dell Computer started offering the productivity suite on new PCs.

In an e-mail late Friday, a Microsoft spokeswoman explained the strategy.

"(The) Office XP subscription offering will not be offered in the U.S. this year," she wrote. "It will be available in a few select locations when Office XP becomes available in those locations. Those countries plan to make their subscription offering announcements at a later date."

Analysts have viewed selling Office as an important test of Microsoft's ability to sell software via subscription as well as for a flat fee. The Redmond, Wash.-based company is preparing to launch its .Net software-as-a-service strategy sometime next year. Office subscriptions would have been a good gauge of Microsoft's subscription mettle, said Guernsey Research analyst Chris LeTocq.

But Microsoft also faces challenges getting customers to pay for straight Office upgrades, something the subscription program could have hurt, analysts say.

While desktop-software sales rose 7 percent during Microsoft's 2001 third fiscal quarter, the category fell to 37 percent of the company's revenue from about 40 percent a quarter earlier. During fiscal year 2000, desktop applications accounted for about 46 percent of Microsoft's revenue and more than half its income.

"The thing about subscriptions is you build long-term users, but in the short term you take a hit," LeTocq said. "Microsoft has a need to pump up that 37 percent Office revenue and may not be willing to invest in the long term when the short term is so important."

While Office has traditionally been Microsoft's most important product, a successful launch during difficult economic times could make a big difference as the company closes its 2001 fiscal year on June 30 and moves into fiscal 2002, say analysts. Office XP is also the first of several new products coming out of Microsoft this year, with Windows XP expected Oct. 29 and the Xbox gaming console late fourth quarter.

"Microsoft cannot afford to miss any cues with Office," LeTocq said.

In a Friday research note, Merrill Lynch analyst Henry Blodget revised his revenue projections upward for Office XP in the short term, but remained somewhat cautious about fiscal year 2002.

Blodget raised his desktop-application revenue-growth projections to between 7 percent and 9 percent, and possibly as high as 11 percent. He also predicted 6 percent desktop-application growth in fiscal year 2002, "with possible upside growth of 8 percent," Blodget wrote.

"However, we doubt that Office XP can drive double-digit revenue growth," he emphasized. "The product is viewed as a discretionary IT expenditure, and therefore is easily deferrable in uncertain economic times. Moreover, Office depends partly on business PC unit sales, which could decline in (fiscal year 2002)."

In fact, Merrill Lynch sees little uptake in PC sales during the second half, projecting about 5 percent growth. Dataquest expects 10 percent worldwide PC growth for the entire year but flat sales in the United States. But those projections are based on a seasonally strong fourth quarter, something that didn't happen in 2000.

LeTocq said the conclusion is clear: "Either Microsoft needs initial-term revenue, or the subscription trials aren't going very well. I'd put my money on the revenue issue."

By temporarily suspending subscriptions, Microsoft removes any risk of lost upgrade revenue or sales confusion, he added. But the company also sacrifices potential subscription renewals from subscribers, particularly consumers, about the time of the projected .Net rollout next year.

"Subscriptions would have been a vehicle to sell into .Net a year from now, but for now there is no real impact," LeTocq said.

Currently about 60 percent of Office users work on either version 95 or 97, not the more recent Office 2000. In a strange move, the company has opted not to offer Office XP upgrades to version 95 licensees, who make up about 10 percent of Office users. They will have to pay full price.

The Microsoft spokeswoman emphasized that the company remains "committed to the subscription model and definitely plan(s) to continue with plans to deliver subscription offerings worldwide." She described Microsoft's new strategy as a "more metered approach," with the company "rolling out subscription offerings on a country-by-country basis."

Interestingly, this might have as much to do with fighting software piracy as anything else. Already, in advance of the official Office XP launch, pirated copies are selling on the streets of Malaysia for as little as $2.60.

By switching to subscriptions and using a new authentication system that forces users to register each copy of Office that is locked to the computer hardware, Microsoft hopes to combat overseas piracy.

In this context, a country-by-country introduction makes sense, LeTocq said.

"Particularly, if you look at a country-by-country basis where they don't have as many users, trying subscriptions there makes a lot of sense," he said.

 

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