July 31, 2001: Microsoft's New Licensing Model: The End of Shrinkwrap as We Know It?

In May, Microsoft announced what it calls "simplifications and improvements" to its volume software licensing programs. The major change includes a subscription option for enterprise customers; other changes involve upgrades, sales process, online licensing management, and eligibility for the Enterprise Agreement (EA) option. The licensing changes will be introduced Oct. 1 and will be available initially in the United States, Canada and Western Europe.

Most observers expect that these changes will eventually affect all of the company's software products and customers. Depending upon whom you talk to, these changes will be either the best thing to happen to software since the PC or a pox on businesses that will significantly increase the cost of purchasing and upgrading software licenses.

Simon Hughes, a Microsoft program manager, said the company isn't shifting away from offering licenses with perpetual usage rights, sometimes called the "packaged software" model, but is simply adding a new choice in licensing with a licensing program called "Enterprise Agreement (EA) Subscription." Microsoft currently sells various kinds of volume licenses that discount the retail prices of its products - Open License agreements are for small and midsized companies, Select Licenses for companies making decentralized buying decisions.

"Our new EA Subscription program provides a first step towards software-as-a-service, whereby software will be delivered in a more modular format, with more frequent updates," Hughes said. "We have had a favorable reaction to the subscription license pilot programs we have trialed for enterprise customers in certain parts of the world, and expect a growing interest following worldwide availability."

This doesn't come as any big surprise to many industry analysts. Dan Kusnetzky, Vice President-System Software Research for market research firm IDC, said Microsoft's business model has always been based on selling a relatively low-cost product and then coming back to customers every 15-18 months and asking them to purchase an upgrade. "As their products became 'feature-rich,' it became a harder sell for Microsoft," Kusnetzky said. "If a product has 450 features and a company's employees use only 30 of them, they are likely not be easily convinced that they need a product that has 550 features."

Kusnetzky added that financial analysts expect Microsoft to return quarter after quarter of increasing revenues and profits, compelling the company to consider a different approach. "Forcing people to change from a one-time purchase of packaged software to a subscription service (rent the software forever) is their answer to the analysts' expectations," he said. "While I expect the analysts will like this new business model, end-user organizations are likely to see this as a Microsoft tax on their business."

Microsoft's View

Microsoft insists this model offers numerous advantages. EA Subscription lets organizations license standard desktop software (Windows Professional Upgrade and Office Professional) for all PCs in their organization with non-perpetual usage rights that expire at the end of their agreement. Hughes likened it to a cable TV or cell phone subscription, where you pay for access to cable TV or the cell phone network for the duration of the agreement.

EA Subscription offers several key benefits, according to Microsoft:

• It's priced at 85 percent of a new traditional enterprise agreement,reducing upfront cash requirements.
• EA Subscription fees count as an operating expense, providing tax advantages in certain countries.
• A simple annual PC count for each year of the agreement lets customers upsize and downsize their agreement to match business needs.

Hughes said many Microsoft customers have stated they want to license the company's software. "Customers can match the license to their specific preferences - whether for per-license or enterprise-wide acquisition, perpetual rights through Open, Select or Enterprise Agreements, or subscription rights through EA Subscription, and a single enrollment option for Enterprise Agreement customers who want to acquire both licenses and Microsoft Premier Support at the same time," he said.

(Another) Truth

Skeptics abound. Although the licensing changes will initially affect enterprises, they will trickle down. Gartner Group analysts Alexa Bona and Alvin Park said that enterprises with four-year upgrade cycles for Microsoft Office will typically pay 68 percent to 107 percent more to upgrade. Those companies with three-year upgrade cycles will pay 35 to 77 percent more, depending on their volume discount level.

Jon Peddie, principal of market research firm Jon Peddie Associates, said Microsoft needs to find a way to justify their price/earnings ratios. "Since they've just about saturated all the markets they have entered, this is a logical next step, and if they are successful (and I wouldn't bet against them), they will in fact tax everyone who touches the Web just as they now control (if not directly tax) everyone who touches a computer," he said. "It will be devastating to smaller companies. Microsoft will drive down prices and make it up on volume (no joke). Small companies will never be able to reach crucial mass on subscribers and fail or be acquired."

Tim Landgrave, CEO of Vobix, an applications provider, said it's still too early to pass judgment. "The overall cost of ownership will be less, but the combination of the software and services to distribute it may be more than the cost of just the software licenses that companies buy today," he said.

Consequences

What does all this portend for the IT professional?

Microsoft's Hughes said subscriptions can be attractive to companies that prefer to spread their licensing costs over multiple years, and for those that see widespread fluctuations in computer usage across their company, lease PCs, or wish to treat software as an operating expense rather than an asset. "The subscription option is easy to administer because it only requires that companies do a simple year-over-year PC count," he said.

Tom Kieffer, president of Agiliti, a St. Paul, MN applications provider, added that the new licensing model should make it easier for IT departments to amortize the cost of their software. "When it comes to charge backs and what it costs to deliver services, most IT people don't have a clue as to what it costs, especially smaller firms," Kieffer said. "With a subscription model, everything is clearly identifiable."

"The number one problem of buying software is that it always get cheaper," Kieffer explained. "If you spend $200,000 for that next-level database and you're only using $10,000 of it and have to buy a huge server to run the software, it can take years to grow into it. With a subscription model, you buy the capacity you hope to use."

Vobix's Landgrave added that IT needs to "consider the total cost of ownership for software, not the cost of the license alone." Many larger companies spend money on consulting services to keep software upgraded and maintained. "When they roll all the charges together (including the reduction in downtime and support costs) I think they'll begin understanding the advantages," he said.

"It's easier and less expensive to support users who have the most current version of the software," he explained. "As everyone moves from sporadic connection to a full-time connection model, the dream of automatically updating software for individuals and users in corporations will become a reality. New pricing arrangements will be developed to reflect the value of an always connected, always updated, always available software model." He added that this shift wouldn't happen overnight but would take five to 10 years to unfold.

Kenneth Smiley, a senior industry analyst for Giga Information Group, said most customers will find costs to be about the same or a small percentage up or down once everything is calculated out over the years of their agreement.

"The tough portion is figuring out exactly where you are going to come in, when to buy, etc., and that depends on the specifics of your current agreement," Smiley said. "With Microsoft's assistance, we are attempting to do that for our clients."

The More Things Change...

However such software licensing programs are received, the business model is here to stay for the foreseeable future. Craig Mathias, a principal with Farpoint Group, an advisory firm specializing in wireless and mobile communications, said we're just entering into what he calls the "info-centric" era, where access to information comes from a variety of devices (including subscriber units like cell phones) over a variety of networks (including all forms of wireless).

"Microsoft needs to keep pace with this evolution; eventually operating systems and applications as we know them will disappear," he said. "Their entire business model must consequently evolve."

"It's like fashion - everything goes in cycles," said Agiliti's Kieffer. "We're going back to time-sharing and the service bureau model, the antithesis of the client/server model. In 10 years we'll get tired of this and probably shift the other way – at any rate, it'll keep us all employed!"