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Commentary: A quest for higher revenue

Meta Group sees Microsoft's licensing changes as an attempt to augment its revenue stream, which has suffered in the last year on slow upgrade rates to Office 2000 and Windows 2000.

On Thursday morning, Microsoft announced what it called "simplification and improvements" to its volume licensing programs for large enterprises--sweeping changes that will become effective Oct. 1, through the new Microsoft Licensing 6.0 programs.

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New Microsoft licenses may increase costs

Microsoft characterizes these changes as the latest in a series of improvements that it is making to its products, support, consulting services and business operations to better align with the needs of enterprise customers. However, we see this announcement primarily as an attempt by Microsoft to augment and even out its revenue stream, which has suffered in the last year as companies have been much slower than expected to upgrade to Office 2000 and Windows 2000.

Microsoft's business cycle has created a challenge that is more formidable than any threat posed by potential competitors or the Department of Justice, for that matter. The company's biggest hurdle has always been convincing large enterprises that it's a good idea to upgrade their existing software--such as Office or Windows--to the latest version.

Typically, corporate IT departments shun change, especially from software that is working well. This explains the relatively meager purchases of Upgrade Advantage (Microsoft's software maintenance program) and EA (Microsoft's subscription licensing program). Consequently, as desktop technology has matured, Microsoft has needed to perform increasingly Herculean feats of software engineering and product marketing to convince IT organizations to purchase costly one-time version upgrades to the latest software release. This process also leaves Microsoft captive to a costly "spike"-based revenue business model. Thursday's licensing changes have the effect of protecting Microsoft from this pattern of volatile and disappointing sales.

One of the primary features of the new plan is that it effectively compels all licensed customers to move to the latest version of software and keep that software current. The possibility of a company skipping intermediate versions with an uncompelling set of new features for a later version--for example, jumping from Office 97 to Office XP--is diminished.

The major changes
The major changes announced today include the following:

• All Version Upgrades, Product Upgrades, Competitive Upgrades and Upgrade Advantage will be eliminated and replaced with a perpetual License and a software maintenance deal called Software Assurance.

• The length of a Select Agreement will be changed from two years to three years to more closely resemble the Enterprise Agreement.

• Microsoft will offer a slightly lower-cost version of the Enterprise Agreement called EA Subscription that does not offer perpetual-use rights.

• The BackOffice license will be replaced with a newly branded license called the Core CAL (client access license, to a server product), which swaps SQL Server CAL for a SharePoint Server CAL.

• The indirect large account reseller (LAR) channel for Enterprise Agreements (EAs) will be replaced in the United States, Canada and some European nations with direct sales from Microsoft. Former resellers will now play the role of an Enterprise Software Advisor (ESA), providing guidance as well as license management, but will be paid on a fee basis by Microsoft.

Compulsory participation
As a result of these changes, most companies will be compelled to enroll in Microsoft's software maintenance program, now called Software Assurance (SA), paying 29 percent of the software license cost annually per user to keep their software licenses current. Previously, once an organization fully licensed its user base for a software application, it could purchase version upgrades (VUPs) every few years for that application at 50 percent to 70 percent of the cost of the full software license.

Microsoft says that for most companies the change will be revenue-neutral. This may be true for companies that always upgrade promptly to the latest version of Microsoft products. However, companies that are on a software upgrade life cycle of more than four years will find that the new programs increase costs.

Even with a life cycle of more than four years, Software Assurance membership will still be required for the entire installed base of desktop and server licenses to be eligible for Microsoft Premier Support starting in 2003. Furthermore, Microsoft mandates the purchase of Software Assurance for the Core CAL. Therefore, most enterprise users will have no choice but to accede to Microsoft's licensing demands.

Companies that are readily prepared to move to the Software Assurance program may also find it a more costly step than they might expect. A current version of a software application is required to be eligible for Software Assurance during the launch period (Oct. 1, 2001, through Jan. 31, 2002). People currently on Windows 98 and/or Office 97 must purchase upgrades to Windows 2000 and Office 2000 and then also pay for the SA program. Should worried customers procrastinate because of these costs, Microsoft has added another provision. If customers do not sign up by Jan. 31, they must purchase a completely new software license to be eligible for SA, thereby incurring even higher costs.

Customers must also be cautious about keeping Software Assurance up to date, as Microsoft requires the purchase of a full license for any Software Assurance membership that has been expired for more than 90 days.

Microsoft has already been piloting its new subscription, or software rental, program in Europe. This rental model, EA Subscription, will now be offered globally to enterprises with more than 250 desktops. Customers will pay an annual per-user fee, which will be approximately 15 percent lower than the per-user fee under a normal EA. However, the EA Subscription does not include perpetual-use rights. In other words, when the agreement expires, the organization does not have the right to use the software any longer.

A lower-cost option?
Normally, this would be a "show stopper" for any enterprise because the risk of not being legally licensed is too great. Microsoft does, however, offer a buyout option, which enables the organization to pay 1.5 times the third-year subscription fee to gain perpetual-use rights on the latest version of the application or applications covered by the agreement. Considering the other licensing changes Microsoft has made, many organizations that are willing to pay annual fees will find the EA subscription a lower-cost, acceptable alternative.

In general, customers will have no choice but to accept Microsoft's new licensing terms. This is especially true with regard to Microsoft operating systems and server software. Customers will need Premier Support, the ability to "ghost" client images onto new machines and other services that will be available only to those that are on an SA or EA agreement.

There is some potential for customers to ignore the SA/EA option with regard to Office. Customers aggressively pursuing enterprise portal strategies--particularly those that are built on Microsoft.Net and related technologies--will need to consider Office XP upgrades within the next few years. However, those with conservative approaches to portals and with a simpler set of office application needs can easily put off a move from the current Office versions for three to four years.

Meta Group analysts Kurt Schlegel, Mike Gotta, Steve Kleynhans, William Zachmann, David Cearley, Jack Gold and Dale Kutnick contributed to this article.

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