Microsoft hatching online plans for Office

As more portal sites add free or low-cost business applications to their services, Microsoft finds itself in an awkward position: The software giant needs to launch a Web-hosting model for its Office desktop productivity software to counter competitors and maintain its huge customer base. It also needs to set prices that keep Office's enormous revenues--one-third to one-half of the company's total--rolling in.

In a sense, Microsoft finds itself in the same position Netscape Communications encountered a few years ago as it attempts to sell software that others are giving away. Netscape, which led the Web browser market by a huge margin with its for-fee Navigator software, eventually gave way to Microsoft's free Internet Explorer.

In the short term, analysts expect Microsoft to take a hit. "This [move to Web-hosted applications] represents both high risk and high opportunity for Microsoft," said Rob Enderle, an analyst with Giga Information Group. It "will require that they cannibalize their existing revenue and channels to get ahead of this emerging trend, and...it will likely have a short-term, adverse impact on earnings."

However, though many analysts expect Office revenues to sag, at least initially, few are betting against Microsoft for the long run. With a commanding lead in the applications market, and a history of beating all comers in the office suite area, Office has become a worldwide standard. For big companies the cost of switching to a new application is staggering, and for that reason, some analysts claim that even free Web-based applications will do little to dent Microsoft's lead.

So far, few details of Microsoft's Web-based application plans have come to light. Microsoft president Steve Ballmer told reporters earlier this month that the company is planning to offer Office--which generates between one-third and one-half of Microsoft's revenues--as a Web-based service.

"We certainly will have Web-based office productivity services, no doubt about it," Ballmer told the Financial Times, but he did not provide specifics of the plan.

Microsoft representatives would not comment on upcoming announcements. However, Office product manager George Meng said he doesn't expect Microsoft's lead being undermined by the new hosting craze. "Going forward we don't see any shift by customers from the traditional desktop model. We see a hybrid to complement the traditional desktop model."

Clues as to what Microsoft's Web application plan may look like are everywhere. Last week, Microsoft attempted to lay the groundwork for a move into the business of offering e-commerce tools or Web-based "megaservices." Microsoft sees megaservices as Web-based services that can be combined into new Web sites. Many speculated that the announcement last week was an admission that Microsoft sees its future in providing lucrative services over the Web, not just software.

One of the first megaservices Microsoft plans to offer is the Passport Internet identification and payment technology from its MSN portal site. Later this week, Microsoft is expected to announce future plans for MSN, and there has been widespread speculation that the company will shed light on its plans for Office. Yesterday the New York Times reported that one plan under consideration at Microsoft would make Office productivity software available as a $14.95-per-month service. Microsoft representatives declined to comment on the report.

Next week, Microsoft and outsourcing provider USWeb/CKS are scheduled to announce an alliance for Web hosting. Though details of the announcement have not been disclosed, one analyst said the deal may also be related to offering Office and Microsoft's BackOffice server as hosted services.

Earlier this year, Microsoft announced a new set of Web-collaboration services based on Office 2000 that will be hosted by Internet service providers Concentric Networks, Verio, InterLand, and AIS. The new service allows users who don't have a Web server on-site to collaborate on Office documents over an ISP-supported link, Microsoft said.

For software makers, Web-hosted applications could help stem software privacy, since applications are centrally hosted, provide better insight into customers' software usage patterns, and lighten customer support loads, since hosted software won't require as much installation assistance.

Nipping at Microsoft's heels?
Several competitors, including Sun Microsystems, Corel, and Lotus, along with Web portal-like start-ups such as Desktop.com, are way ahead of Microsoft in announcing plans for Web-based applications.

Sun, which acquired software maker Star Division earlier this month, plans to offer Star's desktop application suite in a hosted version called StarPortal. Due by the end of the year, StarPortal will be a free service of productivity applications accessible via gadgets including cell phones, TV set-top boxes, and laptops.

Both Corel and Lotus plan hosted applications. Corel teamed with Channelware in June to rent its software over the Web in a pilot program. Lotus representatives said the company currently has no plans to offer its SmartSuite via ASPs or ISPs, but it is still evaluating customer demand.

However, since Microsoft all but owns the PC desktop application market, with more than 90 percent share, there's no immediate threat to Microsoft's lead from either Corel or Lotus, which control a minuscule segment of the market, or from upstart Web-based productivity applications, said analysts.

"Microsoft has time before the personal productivity desktop market swings to the hosted model. Although it has to make sure its Office suite, which is a significant part of its revenues, is ready to respond to that shift, I don't believe there is a direct threat to its leadership in that space," said Eric Brown, an analyst with Forrester Research.

Buy or rent?
A Web delivery model lets software makers deliver their products through Application Service Providers (ASPs) or Internet Service Providers (ISPs) as rentable, or in some cases free, applications. The push into the rental market marks a radical change from the traditional pricing and implementation models for these bulky desktop application suites. Instead of installing hundreds of megabytes' worth of software on their hard drives, users could opt for a Web-hosting rental model that could save money and provide simpler software management.

Some analysts say that no matter how applications are delivered going forward, Office is not in danger.

According to a PaineWebber report, at an average price of less than $125 per Microsoft Office seat for a large corporation, it's "simply not worth the switching, training, and support costs to change from the global standard."

Bill Epifanio, an analyst at JP Morgan, doesn't see stampede of free Web services denting Microsoft's market share or revenues. He said that "until access to broadband [Internet access] becomes universal at a reasonable price, I don't believe enough people are ready to rely on an Internet connection to use something as common place as desktop productivity applications.

"I don't think the infrastructure is there for [hosted applications] to take off, so I don't think Microsoft revenues, or leadership in the desktop productivity applications market is threatened," said Epifanio.

But the slowing growth of the applications business may become a greater damper on the overall company's long-term revenue and earnings growth, according to Goldman Sachs.

Microsoft executives acknowledge the hosted application trend, and say they are planning for the future. According to investment firm Goldman Sachs, desktop applications currently account for about one-third of Microsoft's revenues, but as the market matures and the average sales price continues to decline, the growth rate of Office and related application revenues is slowing. In July, retail sales of business software overall decreased by 11 percent in dollars year-to-year, and 9 percent in units, according to PC Data, which tracks software sales trends.

One possible answer to slowing sales of shrink-wrapped software may be a Web-based strategy. Making Office available as a rentable Web application would let Microsoft reach the smaller companies and individual consumers that don't currently contribute to the company's bottom line by buying regular software upgrades, as corporate users do.

Analysts do not see Web-hosted applications as appealing to large companies, at least yet. Forrester's Brown said users, accustomed to sub-second response through locally installed applications, may balk at Web-based, centrally hosted software, mostly for performance reasons.

"Hosted desktop applications will serve a small percentage of the market that Microsoft isn't getting anyway," said Epifanio.

Still, Enderle sees the threat to Microsoft as real. "They are faced with the same problem they gave to Netscape, in the form of a free bundled office suite from Sun. It will be interesting to see if they do a better job of defending their market than Netscape, which wasn't being attacked by the federal government, did."