Microsoft Reaps Licensing Policy Bounty

By Brian Morrissey

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Microsoft reported robust earnings Thursday, buoying the wobbly tech sector and giving a glimpse into the performance of its controversial volume-licensing software policy.

For the first quarter of the 2003 fiscal year, the Redmond, Wash., company reported growing revenue 26 percent to $7.75 billion, compared to the same period a year ago. Net income nearly doubled to $2.3 billion in the period.

Microsoft benefited from a big rush in July from procrastinating companies to sign on to Microsoft's Software Assurance (SA) program before the July 31 deadline.

The company has now built a sizeable amount of so-called unearned revenue, which includes the money earned over the life of the agreements in its volume-licensing programs. For the quarter, unearned revenue increased 56 percent to $9.13 billion.

"We saw broader customer adoption of our licensing programs than we anticipated, as customers recognized the value of entering into long-term licensing agreements for our products," Microsoft CFO John Connors said in a statement.

Introduced 15 months ago, the program scrapped Microsoft's hodgepodge licensing system, which included five different ways to buy upgrades, with a unified program that charges customers 25 percent of the license fee for server software and 29 percent for desktop software on an annual basis. It would allow customers to have guaranteed maintenance of their software, much like the system used for mainframes.

Customers quickly voiced displeasure with SA, despite Microsoft's soothing words that half of all enterprise customers would see no change in their costs, 30 percent would see a decrease, and 20 percent would pay slightly more.

Soon, Microsoft faced a brewing customer revolt, as many businesses saw the plan as confusing and designed to wring more money out of them. After delaying the program twice, Microsoft still faced customer discontent. In March, researcher Gartner Group estimated that 35 percent of businesses had joined the program.

While more companies signed up through the spring, Gartner analyst Alvin Park said many waited until July to make a decision. Park now estimates almost two-thirds of enterprises have signed up for SA, in some form. The added bonus, for Microsoft, was the impetus it gave companies to bump up to pricier licenses.

"Based on discussion we had with clients, our best guess is they significantly increased the number [of companies] that signed enterprise agreements," he said.

Park said between 10 and 15 percent of U.S. customers had enterprise agreements when Microsoft first announced Software Assurance in May 2001; now, he estimates 30 to 35 percent have them. Of the ones that did not purchase an enterprise agreement, Park said between 30 and 35 percent of them bought SA or another upgrade for at least some Microsoft products.

While Microsoft CEO Steve Ballmer sang the cost-saving praises of the policy, analysts said the main motivation behind the shift was to give the company a guaranteed annuity revenue stream to smooth out the peaks and valleys of its software business.

Microsoft's dominance mitigated some of these peaks and valleys. Still, as a software company, Microsoft has depended on blockbusters.

Microsoft's attention to this dilemma was on display this summer, when the SEC investigated it for hoarding revenues in some quarters to hold in a "rainy-day" fund to cover possible future revenue shortfalls. Microsoft settled the investigation without any admission of wrongdoing, but the company agreed to stop the practice.

Before the new policy, Microsoft had spread revenue through the life cycle of products -- over three years for Windows, for example. Yet many customers would end up running Windows for longer than three years, putting off upgrades for another day.

Under SA, enterprise customers are locked into upgrades as they come out. Microsoft's unearned revenue breakout for the quarter shows the advantages of this. Compared to the first quarter of fiscal year 2002, short-term unearned revenue increased almost 16 percent to $6.84 billion, while long-term unearned revenue rose 26 percent to $2.29 billion.

Even with some customers making noise about exploring Microsoft alternatives, such as the Linux operating system and Sun Microsystems' StarOffice suite of office software, most customers found switching from Microsoft too costly and too difficult, analysts said.

Park said it was still too early to pass final judgment on the policy.

"I think we won't know how successful it was until two years from this July," Park said. "We'll see how many people choose to continue signing up for Software Assurance when their current agreements expire."