Microsoft and the future of software pricing–when free isn’t quite free

The excellent, but paywalled, Lex column in the FT has an interesting article today which speculates on how Microsoft will price its forthcoming releases of Windows 8 (tablet edition) and Microsoft Office. Software prices are dropping and the importance of local operating systems and having locally installed productivity software is declining which makes the future for Microsoft’s consumers software a challenging one. The interesting question is how challenging.

The biggest competitor in mobile, Google’s Android is free, and Google docs is getting better every year (although in my opinion still not up to the standards of Office for anything complicated or difficult). To keep their burn low many startups I know eschew Microsoft entirely and run on Google’s free software. For these reasons I’ve long thought that Microsoft will lose their monopoly positions in OS and productivity software and is in for a tough time.

I still think that is true but they may be able to hold pricing better than I had previously assumed.

The interesting new news, as reported in the FT, is that Bernstein Research have analysed the hidden costs of working with Android (software integration, support costs and royalties for the parts of Android that are based on Microsoft’s intellectual property) and estimate that if Windows 8 is priced at $40 per tablet it could actually be cheaper for tablet makers who ship fewer than 9m units a year, rising to $50 if Office is bundled in. Apparently that is broadly comparable with what Microsoft charges PC makers now.

If Microsoft can maintain profitability whilst their market share declines then they still have an interesting paid for software business.

The centrepiece of the ‘free’ argument is that the price of everything drops to its marginal cost of distribution. In theory software delivered over or downloaded from the web has a marginal cost that is very close to $0 and a lot of people believe that software companies of the future will derive their revenues more from support, services and hosting than licenses.

The Microsoft analysis highlights that in practice their are other costs (software integration, royalties) which can keep the marginal cost significantly above $0 hence allows for successful license based business models – this is a rehash of the total cost of ownership argument that software companies like Oracle and Microsoft have been making against open source for some time now. $40-50 isn’t that much though, and software companies with license business models will need to keep their costs low and find efficient routes to market if they are to make good profits and become very valuable.