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Repricing Microsoft's future

February 29, 2008

For years now, we've seen a steady stream of would-be "Microsoft killers" - products that were going to break the hold of Windows and Office over the PC desktop. It's been assumed that a deterioration in Microsoft's fortunes and power would manifest itself in losses of market share. But that's been a faulty assumption, one based on a belief that future competition in personal computing would continue to be fought out on Microsoft's turf - the PC's hard drive.

The real threat to Microsoft has always been that the battle would shift away from its turf, that its traditional hegemony over the PC would begin to matter less. The threat, in other words, wasn't so much that Microsoft would lose its control over the operating system and the personal productivity application, control reflected in market share numbers, but that its control would simply fade in importance. And that phenomenon - the loss of importance - would be revealed through a loss of pricing power, not a loss of share.

That's what we're beginning to see today. At the edges of its vast and incredibly lucrative market, Microsoft is losing pricing power. As the center of personal computing moves from the PC hard drive to the web, people's reliance on Windows and Office begins, slowly, to fade, and as a result their motivation to buy or upgrade the programs weakens. To maintain its market share, Microsoft has no alternative but to cut prices.

Over the last couple of years, Microsoft has slashed the price to home users of retail copies of its Office suite. Last fall, it launched a special promotion aimed at college kids in which it cut the price of its high-end Office Ultimate 2007 edition by 90%, to just $60. In the end, as free alternatives continue to improve, it will probably have no choice but to give away a version of Office to students.

Now, Microsoft has also announced sharp discounts, effective later this month, for retail versions of Windows Vista. In the US, the price of Windows Vista Ultimate will be cut from $400 to $320, while the price for an upgrade version of Vista Home Premium will fall from $160 to $130. Such cuts, one analyst told Cnet, are "very unheard of." In explaining the reason for the discounts, Microsoft executive Brad Brooks was quite clear: there's been little demand among PC users for upgrading old versions of Windows to Vista. The PC operating system just doesn't matter the way it used to.

"Today," Brooks said, in a press release, "the vast majority of Windows licenses are sold with PCs; retail stand-alone sales, in contrast, have been primarily from customers who value being early adopters and those building their own machines." Microsoft has been testing price discounts for Vista in various markets, and, says Brooks, "one constant emerged – an increase in demand." Yep, it's true: if you cut prices, you increase sales.

It's true that retail sales of Windows and Office to consumers represent a relatively small portion of overall sales. But that's the way a loss of pricing power tends to work. It begins with the most price-sensitive customers and then works its way in toward the center of the market. To get a read on the long-term financial prospects of Microsoft's core businesses, don't focus on the market share report; look at the price tag.

UPDATE: Another point worth mentioning: Because the marginal cost of producing and selling a copy of a software program is so low, price discounts at the edge of the market are likely to provide an immediate boost to Microsoft's profits by bringing in high-margin revenues from a set of customers who otherwise would not have bought the programs. The financial danger to Microsoft lies further out, as the loss of pricing power expands to core customers. Given the relative price-insensitivity of a lot of those customers, the process could take a fairly long time.

Comments

Is it competition or a re-adjustment of monopoly pricing facing a reducing valuation of demand? This can be compared to a monopoly CPU maker that used to be offering the centrally differentiating piece of equipment, and was side-lined by the OS. Less marginal utility to the end-user means lower pricing -- without competition.

Posted by: Bertil [TypeKey Profile Page] at February 29, 2008 10:05 AM

Could it be that one of the real reason of Microsoft's motivation to buy Yahoo is so it can cut the price of its Windows and Office product, yet at the same time can still "protect" its shareholder-value through yahoo's "additional revenue & valuation"?

Posted by: Arvino [TypeKey Profile Page] at February 29, 2008 11:03 AM

One additional thought: If on desktop Mac OS is better than Windows, on server Linux/*nix is better than Windows, and on the web Google "OS" is better than Windows, then where is the place for Windows ??. I agree with you Nick, "of course" the price has to go down...

http://tinyurl.com/2px228

Posted by: Arvino [TypeKey Profile Page] at February 29, 2008 11:59 AM

What has struck me during the rollout of Vista and Leopard is the relative unimportance of the OS these days. In a comparison to Macs, Apple does have the benefit of being on both sides of the software/hardware coin, but it would be to see the upgrade rate of Mac users to Leopard.

Posted by: whatknows [TypeKey Profile Page] at February 29, 2008 12:07 PM

The biggest threat to Microsoft right now is people stoping buying computers and just buy mobile phones.

Since the playing field changed and they're not dominant on the new field, Microsoft can go under in these markets where mobile phones are growing more capable at each new generation.

We'll have to watch South Korea, Japan and get some recent statics on these markets.

Posted by: Emerson Seiti Takahashi [TypeKey Profile Page] at February 29, 2008 07:51 PM

An additional thought. A cheaper Windows Vista retail version might increase sales - but what about customer satisfaction?

I don't want to be the one upgrading my old machine from XP to Vista. Whatever the system requirements promise ...

Posted by: Harald Felgner [TypeKey Profile Page] at March 1, 2008 09:27 AM

whatknows: various Mac apps report the platform of the users of their software. One that's been going for a long time is Omnigroup's update statistics, which are currently showing around a third of their software's users running 10.5.

Annoyingly they don't have archived data from the 10.3 or 10.4 migrations, but I believe they were about as rapid.

Posted by: Paul Mison [TypeKey Profile Page] at March 1, 2008 10:34 AM

I made a similar posting here with one difference. I think Office is a bigger deal to MS than just the revenue it brings in. Redmond is integrating Office more and more with the OS and Windows Server infrastructures. The reason? To make the Office-Vista-Server 2008-Sharepoint-SQL ecosystem more compelling. It's not just Office Redmond's afraid of losing. It's the whole shebang. Each new version of Windows/Office is another shot in the arm of the terminal patient that is Microsoft's desktop monopoly. Look like Vista might have been the wrong medicine - the patient is looking weaker...

Posted by: Asad Quraishi [TypeKey Profile Page] at March 27, 2008 09:57 AM

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