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New Microsoft licenses may increase costs

The company revamps its software licensing program for most business customers, effectively raising the cost of upgrades by as much as 107 percent, according to analysts.

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Microsoft on Thursday revamped its software licensing program for most business customers, effectively raising the cost of upgrades by as much as 107 percent, analysts said.
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Under the new licensing agreements, Microsoft will encourage customers to enter "software assurance" contracts that will effectively commit them to buying operating system and application upgrades for an annual fee. Additionally, Microsoft will also lease software through annual subscription contracts, rather than sell software outright. The Redmond, Wash.-based giant will also sell more of its software directly to customers rather than through computer dealers or consultants.

Although Microsoft will continue to sell software the old-fashioned way, an increasing pool of customers will likely sign these lease-like agreements. While some of these programs will make it easier and cheaper for some customers to acquire software, it will also place many on a more rapid upgrade cycle.

The change is so dramatic that "for people that upgrade every four years, it would be cheaper to go out and just buy the full version of the product," said Guernsey Research analyst Chris LeTocq.

Microsoft's problem has been a slowing cycle of upgrades, which could hurt the company's revenue. The licensing revamp helps keep the revenue flow steady but also essentially penalizes companies that don't upgrade every two years, analysts said.

"Looking forward, Microsoft saw many customers deferring upgrades, which would be a loss of revenue," LeTocq said. "So what Microsoft is doing is putting a pricing structure in place to protect those upgrades."

Bill Henningsgaard, Microsoft's vice president of worldwide licensing and pricing, attributed the changes to meeting customer needs. But he acknowledged the revenue advantage for Microsoft. "It does tend to smooth things out," he said.

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

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"Many customers tell me the way we license software today is too complicated and requires too much administration," Henningsgaard said. The new program is simpler to manage and is more "a maintenance model, where you spread the cost of upgrades over a couple of years."

"Microsoft says they're simplifying software contracts," said Gartner analyst Neil MacDonald. "We believe they're confusing simplifying with removing options."

Forced upgrades
The changes affect the most popular type of Microsoft's licensing programs, Select Agreements. Under the old terms, most companies could purchase upgrades one of two ways: through a two-year maintenance contract called a Upgrade Advantage, or by buying one of four common version upgrades--the most popular option. Microsoft eliminated both plans and replaced them with a new program called Software Assurance.

"They've eliminated the most popular way that midsize organizations upgrade their software and raised the upgrade price in the process," MacDonald said.

Gartner estimates that medium-sized businesses upgrading software every three years will pay anywhere from 33 percent to 77 percent more under the new plan than they did with the old. Four-year upgrades would cost 68 percent to 107 percent more.

"We went through a typical organization with 5,000 desktops that runs Microsoft Office and uses version upgrades," MacDonald said. "The increase in cost with the elimination of version upgrades ranges from $900,000 to $1.6 million."

Companies that upgrade software every two years, however, would see an annual decrease of between 2 percent and 19 percent, according to Guernsey Research.

"The message here is if you're a good Microsoft customer, you will be rewarded, but anyone pushing off upgrades will pay more," LeTocq said.

Companies upgrading every three years would pay 22 percent to 47 percent more, with the increase jumping to 40 percent to 68 percent for four-year upgrades, Guernsey Research concluded.

Because small businesses "upgrade the least frequently of all, they end up paying 70 percent more per year," LeTocq said.

"I would agree that with someone who upgrades less frequently than, say, the four-year time frame, Software Assurance would result in a higher price than it is today," Henningsgaard said.

But he disagreed that this would affect the majority of Microsoft customers, arguing that most companies upgrade every 2 1/2 to 3 years. That works out to no change or a decrease for 80 percent of Microsoft customers.

"Even for the 20 percent, they have a software asset management model that is actually practical and usable compared to the current model," Henningsgaard said.

MacDonald disagreed. "Most people don't upgrade for at least every three years," he said. "For Microsoft Office, it's every four years."

Out with the old
Because the Software Assurance program costs somewhat less than the Upgrade Advantage option, Microsoft is positioning it as a better value.

"But it's all a matter of perspective," MacDonald said.

Version upgrades cost anywhere from about 59 percent to 72 percent of the full purchase price. Because of the lower fees and flexibility to upgrade when needed, these were the most common means of upgrading Microsoft software, analysts say.

Under Software Assurance, companies pay 29 percent of the licensing cost for desktop products and 25 percent for server software per year. If Microsoft's full price for Office upgrades was $100 per copy, customers would pay $29 a year for the right to upgrade. Over the two years of the contract, that works out to as much as 58 percent of the full price vs. as much as 80 percent under Upgrade Advantage.

But over three years, the company would pay 72 percent of the full purchase price for the right to upgrade. The majority of companies, though, wouldn't upgrade for four years, both MacDonald and LeTocq said. For four years, the cost would be 116 percent of the full purchase price, making it cheaper to skip the upgrade program altogether.

MacDonald slammed the changes as a "forced upgrade program." He also noted that even on its merits, the Software Assurance program is no deal.

"The typical industry standard is 17 to 22 percent of the license cost for this kind of thing," he said. "Microsoft is still way high and doesn't offer technical support the same way as the majority of the other software vendors."

Henningsgaard disagreed that Microsoft's Software Assurance program costs more than competing programs. "Lotus, their rates are on the order of 25 percent," he said. "Computer Associates is between 25 and 30 percent. Oracle is actually lower than us--between 15 and 20 percent. So there's a range, and we're in that range.

For subscribers only
Microsoft introduced one other significant change to licensing with the introduction of an optional subscription program for its largest customers. Speculation earlier in the week had the software maker forcing companies using the Enterprise Agreement program to abandon perpetual licenses for three-year subscriptions.

Enterprise Agreement licensees, like anyone else, pay once for software with the right to use it indefinitely. But those opting for the subscription plan would have to repay every three years.

MacDonald praised Microsoft's decision not to force a switch to subscriptions. "Making them mandatory would have been a huge tactical error on the part of Microsoft."

Microsoft also introduced a buyout option that would allow companies to return to a perpetual license by paying 1.5 times the third-year subscription fee.

"This is like leasing a car," MacDonald said. "Microsoft is saying you can buy out the lease in the end."

The company also put a 5 percent to 8 percent increase cap on the next three-year contract.

Still, MacDonald remained cautious, seeing subscriptions as the future of Microsoft licensing.

Henningsgaard said that while most customers want to own software as an asset, the subscription model works for "customers who view software as an expense to them." He estimated those interested in subscriptions "is about 15 to 20 percent today and moving toward the majority in a couple of years."