Despite all the new businesses it’s entered, nearly half of its revenue and a majority of its profit comes from sales of Windows and the desktop Office suite. And most of those sales come when businesses and consumers buy a new PC.
Both reports blamed sluggish consumer demand in the United States, and Gartner specifically blamed the iPad, noting that consumers who buy an iPad are less likely to buy a new PC. This should be obvious by now, but it still bears repeating since Microsoft CEO Steve Ballmer seems to change the subject every time it comes up: the iPad is a real and immediate threat to Microsoft’s core business.
There’s no short term answer. But looking out two to three years, Microsoft’s effort to push business customers to the cloud might just save the company’s bacon.
The reason: business customers who subscribe to Microsoft’s online services, such as Exchange Online for e-mail, will over the long run pay Microsoft far more than they would if they simply bought the company’s software once. In theory, many customers should agree to this equation because the extra amount they pay Microsoft is more than offset by the IT savings of not having to run Exchange on-premises.Here’s a very simple test case. Assume a company with 1,000 employees, interested in core e-mail and calendaring functions, but not interested in advanced Exchange functions like journaling, legal holds, and so on.
Running Exchange Server on-premises requires the company to buy software licenses costing $72,666 at the time of purchase, plus an optional extra $18,279 per year for a guaranteed upgrade program called Software Assurance. Depending on the company’s needs, it might upgrade to a new version of Exchange in five or six years, which could start the revenue cycle over again.
Subscribing to Exchange Online requires the company to pay Microsoft a subscription fee of $60,000 per year.
There are lots of caveats and assumptions in this test case. (If you’re interested, you can read them below.*) But the basic takeaway is that after the first year, Microsoft collects far more revenue per customer from online services than it does from software licenses.
There’s also an added benefit: lock-in. Unlike the case with on-premises software, Microsoft doesn’t have to return to its customers every two or three years to try and push the latest upgrade to start the revenue cycle again. Online customers need to keep paying the subscription, year in and year out, just to keep getting e-mail. The upgrades are delivered automatically.
Profit margins are much harder to evaluate–online services have ongoing operational costs, but supporting mid-size businesses as they try to roll out and update and patch Exchange Servers is probably a cost centre for Microsoft (they charge for support, but not enough to make a profit). And as you get to huge scale, operational costs don’t look so bad. It’s not software, where every sale past the cost of development is 100% profit, but it’s pretty nice.
This is why Microsoft is pushing business online services so hard this year.
Next Tuesday, we’re expecting to hear an announcement about the next version of Exchange Online and its brethren. (Collectively referred to by the memorable acronym BPOS, which stands for Business Productivity Online Suite. Hopefully they’ll come up with a new name.) After that, Microsoft’s sales teams and partners are going to hit the ground running, trying to spur businesses of all sizes to move to the cloud. Their success or failure could determine Microsoft’s growth prospects for the next decade.
*Now for the caveats:
1. All software licence prices are Open Business or Select A, which is a standard discount level for a mid size company doing a one-time purchase. Large enterprises will get discounts but will probably need higher-priced versions of the products so it kind of washes out in the end. Large enterprises will also probably buy Software Assurance as part of an Enterprise Agreement, so annual payments are almost guaranteed.
2. Licensing costs don’t include the Microsoft software (Windows, Outlook) that is generally required or recommended on the client PCs.
3. Other costs, such as hardware and IT staff, make up the majority of IT-related costs. They’re not measured here.
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