May 7, 2001 5:20 PM PDT

Microsoft to keep software meter running?

Microsoft may be changing its licensing practices, potentially compelling large companies to pay up every three years to continue using a piece of software.

The Redmond, Wash.-based software company has been talking about selling software on a subscription basis for some time, but the change analysts see coming soon could force some of Microsoft's largest customers to rethink how they buy everything from operating systems to office productivity suites.

Under Microsoft's current licensing, large companies contract software purchases under three-year agreements, which they pay for on a one-time, annual basis. Under this type of license, known as an "enterprise agreement," they pay for software, such as Office 2000, on a per-user basis. In effect, companies are free to use the software for as long as they like.

Under the new plan, companies would continue to contract these agreements for three years, but at the end of the period they would either have to pay again or stop using the software. The change would move Microsoft software buyers from a "perpetual" license to one that is fixed for a period of time.

"If you buy a perpetual license, you own that copy of Office," Gartner analyst Neil MacDonald said. "You pay for it once, and that's it. Non-perpetual means that after three years, you're going to have to pay Microsoft again for that same functionality."

Analysts note that while these enterprise agreements affect Microsoft's largest customers, the open and select agreements for smaller customers are the most common. There are no reports of those licenses being changed.

Changing the enterprise agreement would mean a more even revenue stream for Microsoft, particularly as the company struggles to get companies to upgrade to the newest versions of its software. But for Microsoft's largest customers, the change could greatly increase how much they spend for software over time.

"What people don't realize is you're going to pay Microsoft a monthly bill, the same way you do electricity or water," MacDonald said.

In a Monday research note, UBS Warburg analyst Don Young said he believed Microsoft would soon announce a reduction in or elimination of perpetual licensing.

"We have confirmed with multiple global accounts that Microsoft is now proposing new enterprise agreements that provided a limited three-year software license, unlike the prior perpetual license proposal," he wrote. "In some cases, Microsoft is buying back existing perpetual licenses."

Microsoft spokesman Dan Leach said the company does not comment on rumor or speculation.

"As software has evolved more towards a service, we'll need new licenses, new support, and those things in the future that support those different kinds of models," he said. "Microsoft is always looking for ways to simplify and improve the flexibility of licensing and expand services and support programs."

But he emphasized, "We have no specific changes to announce."

Guernsey Research analyst Chris LeTocq noted that Microsoft already offers three-year subscription programs on a trial basis and for companies requesting it. But the extent of Microsoft's willingness to push companies to pay on a subscription basis is the issue here.

"Three years from now, I think you're going to have a pretty tough time buying a perpetual license from Microsoft for anything," he said.

MacDonald agreed. By taking the limited commitment from an optional to a mandated choice, "Microsoft essentially is forcing the move to subscriptions."

Sources close to Microsoft doubted the company would do away with perpetual licenses, even as it increases subscription revenue.

LeTocq balked at this. "Sure, they can offer perpetual licenses, but priced two, three or four times higher than now, so that no one would want them."

Microsoft's move away from perpetual licenses to a subscription model means the company can "further decouple its software revenue streams from the volatile PC shipment trends," Young wrote. The licensing change would "dramatically enhance the predictability and longevity of its mature businesses while reducing their volatility."

But LeTocq sees a larger problem at work, with Microsoft customers less willing to upgrade to new versions of its products.

"I don't think Microsoft would have been in this spot if the capabilities they offered encouraged people to consistently upgrade," he said. "If you can't get people to upgrade, you do a subscription basis. That essentially says, 'Whether you upgrade or not, you're going to pay me.'"

MacDonald agreed, warning that taking the upgrade choice away from customers "would be public relations disaster" for Microsoft.

Under the existing license programs, "You choose when you want to upgrade," MacDonald said. "A lot of people still use Office 97. Right now, companies choose when they want to make that move to the next version of Office."

By Microsoft's own estimation, about 60 percent of Office customers still run Office 95 or Office 97.

"Microsoft is finding it harder and harder to develop products that compel people to migrate," MacDonald said. "Microsoft built its market share because its products were good enough. But good enough isn't enough to get people to upgrade anymore."

How quickly Microsoft could move on pushing a license change is uncertain, but analysts expect the company will offer a carrot with the stick: pricing.

MacDonald said Microsoft could make the three-year commitments very attractive, "but in three years, what's going to be the cost? Microsoft could dictate what people pay because the switching cost would be so high. Can you imagine someone coming to your office saying, 'Pay me $100,000, or I'm going to pull out all your copies of Microsoft Office.'"

 

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