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Does Microsoft need consumers? Yes.

February 09, 2008

Henry Blodget offers an interesting analysis of Microsoft's future business prospects today. He argues that the company is making a colossal mistake in trying to compete for the online consumer applications market, an error in judgment that, he says, dooms its proposed acquisition of Yahoo to be "a disaster." Microsoft should not be worried about competing with Google and others for free, ad-supported consumer software served up from the cloud, he argues, because the consumer software market is trivial to its business:

In short, the threat to Microsoft from Google et al is not "free software." Consumer software is going free, but Microsoft doesn't make much money from consumers.

Rather, argues Blodget, Microsoft should focus wholly on the business market, in particular on shifting to supplying web apps to corporations for a subscription fee as Salesforce.com does and as Google does with its premium edition of Google Apps. For Microsoft, cloud computing is all about "paid desktop licenses giving way to paid web-based licenses." In the future, "today's stark differentiation between the 'Corporate' and 'Consumer' markets doesn't change. 'Advertising,' moreover, has nothing to do with it - except on the Consumer side, which is far less important a market to Microsoft than it is to Google and Yahoo."

Blodget is right to point out the big differences between supplying consumer applications and supplying business apps. But he's very much mistaken in dismissing the importance of the consumer market to Microsoft.

For one thing, Blodget is wrong to say that Microsoft "doesn't make much money from consumers." The company makes a whole lot of money from consumers. Microsoft's largest single business unit, in terms of sales, is what it calls, somewhat misleadingly, "Microsoft Business Division," which is essentially the Microsoft Office business. MBD took in $16.4 billion in sales in fiscal 2007, compared with $14.8 billion for the Windows PC business and $11.2 billion for the "server and tools" business, the other two largest units. Fully 25% of the MBD revenues - about $4 billion - came from sales of Office to consumers. That means that consumer sales of Office alone represent about 8% of the company's overall revenues (and that doesn't include the significant revenues from consumer sales of Windows or other consumer software.)

The revenues from consumer sales of Office are not only substantial; they also help provide stability to the division's, and the company's, income and earnings. In the past, cyclical weaknesses in the business market have been tempered by strength in the consumer market.

But the importance of the consumer market to Microsoft goes well beyond money. There is no bright line between the use of Office in businesses and the use of Office in homes and schools. People's use of Office in their personal lives reinforces their use of Office in their professional lives, and vice versa. If people move away from using the Office programs at home and, particularly, at school, and instead adopt free alternatives like Google Apps or Zoho or Adobe's Buzzword, they also become less likely to require Office when at work. Lose the student, and eventually you may lose the professional worker that the student becomes.

In an article on the rise of web apps in today's New York Times (in which I'm quoted), Matt Richtel tells a story that is sure to send at least a small chill down Microsoft's spine:

Kevin Twohy, 20, a mathematics student at U.C.L.A., uses a free service on Facebook to store and share photos, a program called Picnik to edit the images, and Gmail.

For his English class last semester, he wrote a term paper about William Blake using Google’s free word processing software, even though Microsoft Office had come loaded on his personal computer.

The advantage of the Google program, he said, was that it allowed him to keep his information on Google’s servers so that it was accessible at any computer, whether he was working at his fraternity, a coffee shop, a campus computer bank or the library. The experience, he said, has persuaded him not to pay money for software.

“I don’t ever see myself buying a copy of Office,” he said.

Blodget is correct in saying that "cloud computing appears to be a classic disruptive technology." What he misses is that such disruptions start at the low end of the market - in this case with the individuals, sole proprietors, colleges, and small businesses that find free web apps an attractive alternative to Office and aren't averse to the ads that go along with those apps.

As Richtel points out, Microsoft has been slashing the price that it charges home users and, in particular, students for Office. Companies don't cut prices for no reason, and the Office cuts are driven at least in part by Microsoft's recognition that individuals have new, free options when it comes to word processing, spreadsheets, calendars, and other such popular programs. Microsoft knows it has to keep a grip on the consumer market even as it builds up its capacity to serve business apps from the cloud. To take Blodget's advice and ignore the consumer market would be, well, a disaster.

Comments

Separating the consumer from the business user seems a little rash - it's rather assuming they are two different entities.
I'm often asked for IT advice from my rather large extended family (large in the sense that they are numerous, and in a few cases, in terms of sheer poundage) concerning software/hardware purchasing.
They are pretty intelligent people on the whole, but I'm surprised at how often when, on receipt of a new computer, they ask me where all the office applications are. They seem somewhat peeved that after buying a new computer they then have to fork out again for a familiar office suite.
For most non IT people who work with computers, Microsoft Office is the main application suite - if Microsoft ignores consumers it ignores a massive market share.
People will pay extra for a familiar product, and if in future that product is available only online, they will still probably choose the familiar option over a competitor's product.
Personally I like things to be innovative and ground-breaking. The 'average user' however, just wants something that will work - something that they aren't going to have to think about (and fair play to them).
Familiarity may well breed contempt, but people would rather be contemptuous of the familiar than fearful of the unusual.
Microsoft may or may not need consumers, but for a while at least there are a large amount of consumers who think they need Microsoft.

Posted by: Pondlife [TypeKey Profile Page] at February 9, 2008 01:45 PM

I think you are spot on, Nick. In my experience, the Office tax is in somewhat significant danger of becoming unacceptable to a large number of people. While the so-called Windows tax is still hidden in the cost of the computer, buying Office is a real pain point that most people accept because they assume it is necessary. If that assumption is proved invalid by the ascendancy of a free option, then I think many would embrace that change, and quickly change their home usage patterns solely to save money. That potential adaptation would make a subsequent change in the business environment infinitely more likely, not only due to worker familiarity with other applications, but perhaps even to the benefits of online productivity applications over Microsoft's standard desktop fare. Microsoft certainly does not want to have many consumers actively preferring the free alternatives at home.

Posted by: Anthony Cowley [TypeKey Profile Page] at February 9, 2008 02:51 PM

I agree that the consumer is important to Microsoft, but I don't agree with your analysis of the psychology of Office adoption, Nick, or in fact that it is the Office consumer market that is the important one.

First, while I understand that neither position can be adequately proven, I believe that you have the causation exactly backward when it comes to business/personal office suite adoption... in my own anecdotal experience, what decides a consumer on the type of office suite he or she will pick up for the home computer is what the business is using, not the reverse. Office prevails on home computers today because people needed it to work from home, not because it's what they picked and the business also adopted it for their convenience. While the "capture the student, own the professional" argument seems good in theory, it was exactly the approach that Apple attempted in the early days of PC marketing, offering steep educational discounts to ensure market penetration in schools... placing millions of Apple IIs and Macs in front of future professionals.

Apple remains strong in the education market, but that groundswell of adoption never drove businesses to Apple products, despite millions of future business users having been introduced to them first, and in many cases continuing to prefer them for personal use. There were a lot of other factors which doomed Apple's stabs at penetrating the business market, but it seems clear that personal adoption never helped them significantly in that endeavour.

Where I do think the consumer is still important to Microsoft is a few line items down the profit report: the Entertainment division, at $3.1B in revenues. While considerably less than the MBD revenues, it's worth considering that MBD is selling to a market it already owns nearly 100% of, while the console and device markets still represent significant room for expansion.

So Blodget is correct in asserting the company is wasting time and resources pursuing home users in the Office market; those users will continue to use Office as long as Microsoft continues to win in the business market. But neglecting the consumer entirely forfeits tremendous room for expansion in the entirely unrelated entertainment sector.

Posted by: Scott Wilson [TypeKey Profile Page] at February 9, 2008 07:04 PM

So Blodget is correct in asserting the company is wasting time and resources pursuing home users in the Office market; those users will continue to use Office as long as Microsoft continues to win in the business market.

That's an assumption that could prove fatal. When Google Docs and Zoho can read/write in Word and Excel file formats, why would the consumer continue to buy Office?

Let's not forget that the home user is pretty much pure profit for Microsoft. Losing that marketshare could prove to be very painful to their bottom line, regardless of the impact on business users.

But neglecting the consumer entirely forfeits tremendous room for expansion in the entirely unrelated entertainment sector.

Where they lose money on every sale but make it up in volume? Microsoft has yet to prove that they can succeed in the entertainment sector, and I certainly wouldn't want to wager on them succeeding there in the future.

Posted by: Timothy Swan [TypeKey Profile Page] at February 9, 2008 09:40 PM

With local software, Office is basically the same for Business & Home: you are assuming that this would still be the same for Cloud computing. I agree that Calendaring, Text & Voice messages benefit from similar format — but what would more sophisticated, subtle ERP do in the Family? Couldn't VoD for Entertainment & Training be on very different format? Finally, can't the “average” user become savvy enough to improve his understanding and use different apps?

Posted by: Bertil [TypeKey Profile Page] at February 10, 2008 07:39 AM

When Google Docs and Zoho can read/write in Word and Excel file formats, why would the consumer continue to buy Office?

Truly, I don't understand it myself, but it's already clear that the simple fact that cheap or free Office alternatives which read/write those file types won't displace Office... such programs have existed for years and years without making any appreciable dent. I suppose it's that the translations are not yet adequate; I move back and forth between Docs and Word and still see even simple formatting hashed in the process.

Where they lose money on every sale but make it up in volume?

So I have often heard, but that has been true for a time in most markets where Microsoft has had to play catch-up, and it doesn't seem to hurt their profit margins much after they've finished squeezing out the competition and consolidate the market.

As for their current standing in the entertainment market, it may not be spectacular, but it's significantly stronger and has a brighter future than do their positions in the web services and advertising markets... so if you're looking to make a bet, that seems the better one at the moment.

Posted by: Scott Wilson [TypeKey Profile Page] at February 10, 2008 03:51 PM

Timely topic, again, Nick.

Henry is right for the wrong reasons. Notwithstanding brand, execution & integration impossibilities, Yahoo! is a weak second place in the branded web -- and not great at search. This would consign Microsoft to an even weaker second place (also due to culture conflicts) in the game of clipping a vig off of Web traffic.

Therefore I don't see a Yahoo! acquisition as a) likely; or b) attractive as a positive move for MS.

People disregard 2 things about this: i) acquiring Yahoo! is driven in part by a take-out of Zimbra, Yahoo!'s interesting open source e-mail platform (the only one existing that's represents a serious online|offline threat to Exchange|Outlook); and ii) Google is unique in its search technology and in the way it harvests innovation; it has only mastered 5-10 percent of what's possible with search, so Microsoft will never compete effectively enough there.

It's not like Henry says, though. Microsoft has NO WAY out: they will not be able to change the wings on the airplane fast enough to cope with the commoditization of Office by the cloud. Not even the enterprise markets can support the business completely during this transition.

Microsoft should prepare itself to be a smaller consumer|enterprise player in a few higher-quality niches where good enough isn't quite good enough. Trouble is, the cultural transition even to this middle ground is too much to imagine with no existential crisis brought about by a revenue decline which for a while will seem difficult to stem.

Posted by: Sam [TypeKey Profile Page] at February 10, 2008 05:45 PM

>> Microsoft's largest single business unit....
>> which is essentially the Microsoft Office
>> business.

M$ office products are also JSAs (Job Security Applications). High paying IT management jobs in big corporations and government departments are tied to the M$ office product lines, per seat licensing schemes and maintenance for PCs. When PCs and local office apps disappear in favor of subscription services on thin clients through the cloud, these jobs will go away. That’s the only thing that has delayed their deployment. Hey, Mr. IT manager. Cheer up! McDonalds is hiring.

Posted by: Linuxguru1968 [TypeKey Profile Page] at February 11, 2008 01:17 AM

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