Why Office 365?

While Microsoft should be lauded for its smooth transition to the cloud, doing so comes with challenges that have yet to be resolved. That is, how can it convince consumers, especially, to pay for ongoing software subscriptions like Office 365 when free alternatives—including some of its own making—are so good?

You can see the impact of this transition from traditionally packaged software to subscription services in Microsoft’s bottom line. In the fourth quarter of 2014 alone, Office revenue from consumers dropped an alarming 25 percent year-over-year (compared to just an 11 percent drop for Windows). And Office revenue from businesses dropped 13 percent, again compared to an 11 percent drop from Windows business revenues.

In both cases, Office 365 was to blame. That is, on the consumer side, the transition to Office 365 subscriptions was be tied to a drop in full Office versions bundled on PCs, leading to lower revenues. And on the business side, where subscription licensing has in fact been in place for many years—that’s what volume licensing is, really—Microsoft also cited “the transition to Office 365.”

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But Office 365 can cost Microsoft in a number of ways.

First, the company is essentially offering Office 365 Personal to PC and device makers for free on many hardware types, with the goal of building a customer base that will later subscribe at full-cost. But that’s no guarantee. In fact, I expect the majority of these customers will not in fact re-up when their year is up.

Second, Office 365 generates less revenue than did previous Office bundling schemes. For each license that Microsoft does sell, it earns less than when it sold Office to consumers or businesses on a new PC, or even less than when it did so at retail.

Third, there is no evidence at all that consumers, especially, want to rent software. Most PC users today still believe that they own software and thus have perpetual rights to use that software. In the past, they would skip two or even three Office versions because what they had worked just fine. Asking them to pay $69 per year (for individuals) or $99.99 per year (for families) is an unproven strategy. So Microsoft must heap on extras—unlimited OneDrive storage, Skype minutes, and more—to attract the recalcitrant. But those extras also cost Microsoft, of course.

So why would Microsoft move to such a scheme?

Over time, Microsoft hopes to add more and more subscribers, closing the revenue gap between the old way and the new. And even if it can’t do so, it will also realize a more steady form of recurring revenue, essentially duplicating in the consumer market what it’s done with businesses.

From a technical perspective, Office 365 subscriptions are “better” in general because these users will always be up to date, both from a new feature perspective and for security purposes. In the past, those Office holdouts on years-old versions of the product weren’t just saving money, their PCs were exploitable time bombs too.

Looking a bit deeper, there is also a very real benefit to knowing that your customers are on the same set of server and client apps. In the past, there was no way to be sure that a user had certain Office applications, or access to all of the Office servers. Now that Office 365 combines all these things together, Microsoft can update its applications and cloud-based servers more holistically. So instead of new features for just, say, Exchange, they can add new features that work across the products.

I really like Office 365. And there is something intellectually and morally honest about Microsoft’s approach of charging users directly for the value they receive from applications (in the past) or services (today). But no matter. As good as Office 365 is—and I will make the case in a coming article that Office 365 subscriptions are indeed unique values for individuals, families and businesses—Microsoft is further constrained by the realities of today’s personal computing market. And thanks largely to Google, which subsidizes its once-terrible but steadily improving web productivity apps with online advertising, consumers now expect everything—online services, mobile apps—to be free.

And so here is Microsoft, trying to walk a line between giving enough away for free to both attract new customers and keep old ones, and directly billing customers for paid products like Office 365. Frankly, it’s free offerings—the Office apps for iPad, iPhone, Android and now Windows 10, an uncountable number of other Office and productivity-focused mobile apps, services like Office Online, which provide free web-based Office apps, Outlook.com, OneDrive and many others—all undercut its paid Office 365 subscriptions. It simply doesn’t have a choice.

As a consumer of these products and services, you do of course benefit from the competition in the marketplace, and you can opt to use free solutions, pay for Office 365 or other subscriptions, or mix and match. But for Microsoft, this is a perilous game. The firm wants to own productivity, and I can’t think of a company more deserving to do so. But owning productivity will come at a great cost. And I’m just not sure that its customers are willing to pay the bill.

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