The most controversial piece of Licensing 6 is Software Assurance, through which businesses pay 29 percent annually of the full price for two or three years. This entitles them to upgrade to new software versions released during the contract period. For the majority of businesses, which upgrade software every three to six years, Software Assurance works out to a hefty price increase, as there is no certainty that Microsoft will deliver a product during the contract period. Many businesses in this group have good reason not to sign up for the new licensing program, say analysts. "If you're on a three-year, four-year or five-year upgrade cycle, you're better off without Software Assurance," DiDio said. "The break-even point Microsoft has identified is about 42 months. After that, it costs you just as much as or less to buy a whole new licence." About 80 percent of technology managers in the second Sunbelt survey said they had a negative view of the new licensing plan. Thirty-seven percent of respondents said they would not sign up for the new licensing plan at all. Analysts note that in a competitive market, Microsoft would find it difficult to push customers into adopting a plan with uncertain benefits and a huge price increase. But Microsoft owns a huge share of the operating-system market. "It's not possible to quantify the benefits of Software Assurance, because you don't really know what you're buying," DeGroot said. "You don't know when the product is going to come out, so you can't say that, in early 2005, Longhorn -- the next version of Windows -- will be on our desktops. With Software Assurance, you simply cannot predict what you are going to get for that money." In that sense, Licensing 6 could backfire on Microsoft, because companies have more incentive to make sure the company's software ships on time. So far, Microsoft's record for on-time releases isn't good, DeGroot said. You're in trouble "if Microsoft doesn't meet the ship date, and as a consequence your Software Assurance expires", he continued. "The next time you buy this software, do you believe these guys? Are they credible? They've just taken a bunch of money, and they're not giving it back. But you got nothing for it. I think that's a terrible risk for Microsoft," said DeGroot. So if customer resistance is stiff now, it could be much worse in two or three years if products such as .Net Server -- already delayed by a year -- or Longhorn, ship late. In the past, customers accepted delays in expectation of getting a more stable product, but that, too, could change, DeGroot said. "Ironically, customers' attitude may change: Ship, ship, ship that sucker on time, and I don't care whether it works or not," he said. "I paid for you to hit that date." But some Microsoft customers said they'd survive the price increases because they retooled their budgets to absorb higher licensing fees. "I can understand how Microsoft's recent actions could have a heavy impact on business or government agencies that have not been as proactive as our chief information officer and agency leadership have been," said Elena Gellepis, a technology manager with the Florida Department of Transportation. Gellepis noted that her agency is the exception rather than the rule among Microsoft's customers. Other companies caught flatfooted by Licensing 6 should plan for future price increases. Gartner is recommending that its customers add 40 percent to their annual software budget with Microsoft to cushion against continued licensing changes. Microsoft's windfall
Even with the majority of customers refusing to sign on to Licensing 6, the company has seen an enormous windfall from the new program. Unearned revenue, the majority of which comes from software licensing agreements, rose more than $2bn during fiscal 2002 over the previous year, Microsoft reported. Analysts describe the increase in unearned revenue from the company's third quarter to fourth quarter as "staggering". "Growth in unearned revenue on the balance sheet was very strong, up 38 percent year over year, and $830m sequentially, reflecting the large number of annuity agreements signed during the quarter," Scott Boggs, Microsoft's corporate controller, told financial analysts during the company's fiscal-fourth-quarter conference call, about two weeks ago. In the fourth quarter, unearned revenue for desktop applications rose 59 percent year over year, and for server software, 102 percent. Also in that quarter, previously deferred licensing income accounted for 20 percent of revenue. Microsoft ended the fiscal year with $7.74bn in unearned revenue, the majority from licensing. Of that amount, the company expects to record $6bn as revenue during fiscal 2003, or about 20 percent of the projected $32bn in revenue. "The success we had in fiscal year '02 with our licensing business does give us an earned revenue in '03 that is a little bit unusual compared to years past," John Connors, Microsoft's chief financial officer, told financial analysts last week. Before introducing Licensing 6 in May 2001, Microsoft saw declines in its software revenue for key products, such as its Office application, as more customers extended their upgrade cycles to three years or more. By instituting an annuity program, which would be the precursor to a full subscription program, Microsoft could smooth out the hills and valleys in revenue. Even though only a third of its customers have agreed to the new program, "Microsoft should get a nice revenue bump as a result of people upgrading to Licensing 6.0," Yankee's DiDio said. "They needed to feed the revenue monster and feed the recurring revenue stream to make up for the shortfall for the upgrades they were getting from people buying new products. Without that 20 percent bump, where would Microsoft have been?" But Microsoft's enormous windfall could come with uncertain long-term cost. Sunbelt's March survey found 38 percent of respondents were considering switching to other products, a slight increase from the 36 percent in the October survey. "Lots of people say they are interested in Linux, but there are few actually doing it," said Sjouwerman. "Microsoft understands that Linux is a viable alternative, and there are people actually moving. But there aren't that many. Most people say, 'Listen, in two or three years if I really need an upgrade, I will think about it at the time.' So a lot of people simply have not taken any action." Another problem is lost revenue on existing software licences for the many companies that decided not to sign up for the new program. "That means that all those old licences are frozen in time and can never be upgraded, but must die a natural death," Gartner's Park said. "So for those people that don't sign for those licences, Microsoft can never recover that revenue again." Companies would not be prohibited from continuing to use those licences, just from purchasing upgrades for them. Still, unless a huge number of Microsoft customers switch to competitive products, the software titan is the ultimate winner, not customers, DeGroot said. For example, those people paying full price will be looking at a minimum of $700 for Office XP versus $440 under volume licensing. "Microsoft wins either way, whether you buy Software Assurance or not," DeGroot said. "Their revenues go up. You can pay more for your upgrade, but less than full price -- or you can pay full price later on. The fact that two-thirds of their customers are not purchasing Software Assurance is not necessarily bad news for Microsoft."
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