Microsoft's 'go-low' play puts Windows revenue on the line

Analysts were uncertain today whether the recent stretch of "go-low" moves by Microsoft means that the company has tweaked its strategy to emphasize services at the expense of devices.

"Occam's razor suggests that this is a response to Chromebooks more than anything," said Ben Thompson, an independent analyst who covers technology at his Stratechery website, of the report last week that Microsoft has cut Windows 8.1 licensing fees by 70% for devices that will cost less than $250. "There are very few people who will buy both a Chromebook and a Windows PC, whereas most people will buy both a PC and a tablet."

Chromebooks, powered by Google's browser-based Chrome OS, have made inroads into education and business, but their overall impact has been disputed. Still, Microsoft sees them as enough of a threat to attack them in its advertising.

Carolina Milanesi, on the other hand, was bullish on the idea that Microsoft is explicitly aiming for the lower-priced markets in smartphones, tablets and PCs -- even if that means diminished revenue for Windows -- in an effort to try to capitalize on its broad portfolio of services.

"From a Windows 8.1 perspective, it does seem that way, that Microsoft's going after the mass market, that it's no longer necessarily about the software but about the ecosystem," said Milanesi, strategic insight director of Kantar Worldpanel ComTech. "We're starting to see a place for that ecosystem [with lower-priced devices]."

The changes, Milanesi said, were right in line with new CEO Satya Nadella's first-day casting of the company's strategy as "mobile first, cloud-first."

Those moves have come in quick succession over the past few days.

Last Friday, Bloomberg reported that Microsoft had slashed the price of a Windows 8.1 license from $50 to $15 for OEMs (original equipment manufacturers) building tablets and PCs to be priced at under $250.

On Sunday, Windows Phone chief Joe Belfiore announced that Microsoft's mobile operating system would support cheaper chips from Qualcomm, that the company had partnered with a new set of device makers known for building inexpensive smartphones for emerging markets like China and India, and would relax some of the OS's requirements so ODMs (original device manufacturers) could cut corners. All, he said, were part of a "high-volume" focus by the company.

Yesterday, Nokia -- whose handset business is being bought by Microsoft for $7.4 billion -- announced a new line of smartphones powered by an offshoot of Google's Android. The Nokia X family, which will sell for as little as $29, will take on pure-Android rivals with a host of Microsoft services in place of those from Google.

Stephen Elop, still the head of Nokia's devices group but destined to take the same job at Microsoft when the acquisition closes this quarter, argued that cheap Nokia smartphones would provide a "feeder" system -- much like a Major League Baseball's farm team feeds players into the big time -- for pricier Windows Phone-powered handsets.

Sameer Singh, another independent analyst who covers mobile technology at Tech-Thougts, sided with Thompson on the "is this a new strategy or not?" question.

"I think this move is really a way to ensure that at least some Windows devices continue shipping at those price brackets," said Singh in an email reply to questions today. "The competition there, in both smartphones and tablets, is extremely intense [and] I think this is more of a concession to keep certain OEMs within the Windows fold. I don't think it suggests a change in the portfolio or positioning."

The questions Computerworld posed to the trio of analysts were sparked by Hal Berenson's piece of Monday. Berenson's frequent commentary on Microsoft is closely watched, since he was formerly a manager and engineer at the company, and often brings an insider's view of its strategy.

In his blog post, Berenson argued that with Microsoft's recent moves, "You start to get a picture of a strategy focused on winning at the low-end."

By going after low-priced, high-volume markets, said Berenson, Microsoft hopes to gain enough growth to attract more developer interest, which would feed into a virtuous cycle of more growth. And once within the Microsoft ecosystem, those customers would be fodder for higher-priced hardware in the future.

It's also a defensive ploy against additional Android -- and thus Google -- inroads into Microsoft's services turf, Berenson added.

Ben Bajarin, an analyst with Creative Strategies, echoed Berenson's point when he said Tuesday that the Nokia X line had the potential to bring in "hundreds of millions" of new customers into the Microsoft services ecosystem.

If Microsoft is giving up the very high margins that it's made selling software, it must plan on making it up on volume, or more likely, figure it can create a sustainable market for consumer-grade services, whether based on advertising, like Bing or Outlook.com, or on fees, such as Office 365, OneDrive and Skype.

But that begs the question of whether the company would take the Windows 8.1 licensing price cuts to their natural conclusion: Make Windows free to OEMs (original equipment manufacturers) that build PCs and tablets, and to ODMs that assemble smartphones.

"That would be a bitter pill to swallow," said Thompson, in an understatement. "But it would be a natural step in the move to being a pure services business." More likely, in his opinion, would be to make Windows free for tablets -- strictly tablets, not hybrids or 2-in-1s -- but he acknowledged that could be a long ways off. "They might not be ready to do that."

"I think they've already realized that the licensing revenue model is going away," agreed Singh. "The proposed 'devices and services' strategy certainly hints at that."

But realization of a far-future and making money in the present are two entirely different things. "I think their plan is to eventually monetize hardware and services, which means license costs will drop to zero," Singh added. "But that depends on how effectively or quickly they can monetize those two businesses. I don't see them getting rid of license costs, even in limited situations, unless they're confident in their devices and services businesses."

And even with low-priced tablets in its partners' portfolios, Microsoft could struggle to see any income. "In emerging markets, the low-end notebook market is rapidly being cannibalized by cheap tablets," Singh said. "In a lot of cases, these devices may never even be connected, so it's difficult to see [Microsoft's decision] as a direct services play."

The alternative, however, would be to let everything slip through its fingers, contended Thompson. "Anything running Google's software is a disaster for Microsoft," he said. "No OS money, and no Microsoft services. Something with very cheap Windows may limit the OS revenue, but at least they still have the inside route on offering services and Office."

Milanesi sounded as skeptical as the others that Microsoft would, or could, take Windows free in the foreseeable future, although the recent price cuts for cheap tablets and PCs made all the sense in the world. "If I'm looking to sign up with the 'white box' vendors," said Milanesi, referring to the lesser-known regional companies manufacturing smartphones and tablets, "the model just won't work if Microsoft charges much for a license. It's quite easy to see that a white box vendor just wouldn't be successful with Windows otherwise."

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, on Google+ or subscribe to Gregg's RSS feed. His email address is gkeizer@computerworld.com.

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