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Commentary: Driven by licensing changes

Microsoft's recent maneuvers to strengthen its software revenue show how in many ways it is a victim of its own success.

Microsoft's recent maneuvers to strengthen its software revenue show how in many ways it is a victim of its own success.

With market share higher than 90 percent,

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Microsoft counting on Office XP cash surge
Office revenues are tied directly to new PC sales or product upgrades. With flattening PC sales, Microsoft is forced to focus even more attention on driving upgrade revenue.

However, consumers have been suffering from feature overload with Microsoft Office for at least the past three versions. They've found little relief in Microsoft's attempts to address this problem with the Office Assistant, variable menus that present the most frequently used commands and enhanced help systems. Most consumers need only a fraction of the capabilities offered by Office 95 and therefore see little reason to embrace Office 2000, much less Office XP.

Like other recent Office upgrades, the XP version offers no compelling features to drive a mass-market upgrade. Although XP does include an interesting collaboration tool called Team Services, this tool can be licensed and used separately.

Companies upgrading to Windows 95/98 largely drove upgrades to Office 95/97. Many organizations create a standard desktop that includes the operating system and basic personal productivity applications (such as Office). Businesses usually like to upgrade both of these systems at the same time to minimize total training and conversion costs--particularly if they have purchased maintenance as part of their Select or Enterprise Agreement.

As more companies move to Windows 2000, Office upgrades may result. However, insofar as these upgrades are covered under a maintenance program, there will be no additional revenue generated for Microsoft. In addition, the question for many consumers will likely be, "Should we move to Office 2000 or Office XP?" Office 2000 has had its "shakeout" period and is a stable platform; Office XP is an unknown quantity. Consumers should typically wait three to six months after release of a major product upgrade before committing to it.

The power of licensing
The uncertainties of a new version release and the lack of compelling functions would normally limit the uptake of a product. However, we expect Microsoft to drive the market for Office XP and its successors through its recent licensing changes for enterprises and future linkages between Office and other elements of its collaboration and .Net strategy.

On the licensing front, Microsoft recently announced a major shift in its programs for business consumers. Under the new scheme, which goes into effect Oct. 1, Microsoft is eliminating version upgrades. Consumers are forced to enroll in the Software Assurance maintenance program for a 29 percent annual fee or choose a software rental option. Starting in 2003, access to Premier Support, an important consideration for most large companies, will require companies to be on one of these programs. If consumers do not select either of these options, they must buy a completely new license when "upgrading" to a new version of Office.

While companies enrolled in Microsoft's Enterprise Agreement--which includes maintenance--will not be affected by the change (unless their EA expires before Oct. 1), many Select licensees are. Meta Group estimates that no more than 25 percent of Global 2000 organizations are under EA, with the remainder purchasing under the Select program. Moreover, our research indicates that most of these accounts do not purchase maintenance for Office.

Given the licensing changes, companies that plan on upgrading to a new version of Office within the next three to four years will find it financially compelling to commit to Office XP before October. We expect this to be the major driver for Office upgrade revenues in the near term and to establish a more regular revenue stream for Microsoft. However, while many companies will likely pay Microsoft for XP via this new licensing approach, we expect most to "downgrade" to Office 2000 in the near term for most system deployments.

Redefining the market
Microsoft is likely to redefine the market itself. We expect Microsoft to focus on group collaboration and ties to business applications, rather than personal productivity, to drive Office upgrades, and to attract new Office consumers. During the next three to four years, we expect Microsoft to slowly evolve Office from a personal productivity suite to a set of personal and group productivity services built on Microsoft's .Net foundation.

Although Microsoft would like to position Office XP as a first step in this direction, with features such as new "teamware" capabilities and links to IIS as a data store, the reality is that XP is still closely aligned with the traditional application model. In fact, XP seems to be the final gasp of the monolithic Office application suite. Even if Microsoft is successful in driving Office to a new Web services model, we believe it will take at least two more iterations--and at least 24 months to 36 months--for it to deliver compelling features that consumers will demand.

Companies that are happy with their current Office product and do not plan to upgrade for three to four years could ignore Office XP and save money. However, these consumers may find that other elements of the Microsoft strategy force an Office upgrade. Microsoft will likely integrate .Net services and its other business applications (for example, those from Great Plains) with future versions of Office XP. Although customers could buy the products separately and upgrade individually, the complete solution would likely require a Microsoft environment using all the latest applications.

This situation would harken back to much of the 1990s. Many consumers were "forced" to upgrade to newer versions of Office because of document incompatibilities between versions. Customers who did not keep current found it increasingly difficult to exchange documents. While the latest twist would be based on added features rather than document incompatibilities, the result would be much the same.

Consumers: Sit back and wait
Individual consumers will find few compelling features in Office XP. Moreover, they are not directly affected by Microsoft's current licensing changes or the evolving Office architecture. As a result, consumers should wait until Microsoft demonstrates a compelling set of features before considering an upgrade.

Businesses, however, have a more complex set of decisions to make, driven by financial considerations and planned upgrade cycles rather than product functionality. Companies that are satisfied with their present version of Office and do not expect to aggressively exploit Microsoft's future Web services capabilities can stay with their current Office 95/97/2000 mix. The danger of this approach, however, is that if they subsequently need to upgrade--for instance, to meet the needs of trading partners or to take advantage of new features in upcoming versions of Office--they will face steep licensing fees.

To minimize this risk, or if a company believes it will upgrade to a new version of Office within three years, it should exploit Microsoft's new licensing models to minimize costs. However, even these consumers may want to "downgrade" to Office 2000 on any systems deployed through the end of 2001 while Office XP proves its stability. Consumers interested in exploiting the Team Services capabilities with Office XP can license and use this tool without moving to Office XP.

Meta Group analysts David Cearley, Val Sribar, Matt Cain and Kurt Schlegel contributed to this report.

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