Although no specific plans have been made, executives within Microsoft are examining whether it makes sense to release ad-supported versions of products such as Works, Money, or even the Windows operating system itself, according to internal documents seen by CNET News.com.
"As Web advertising grows and consumer revenues shrink, we need to consider creating ad-supported versions of our software," two Microsoft researchers and an MSN employee wrote in a paper presented to company executives earlier this year. The document was prepared for one of Microsoft's twice-yearly Thinkweek exercises, in which Chairman Bill Gates and other top executives gather to consider potential new avenues for the company to follow.
Microsoft officials confirmed the authenticity of the paper, dated Winter 2005, but declined to comment on its contents. However, a Microsoft source characterized the paper as an internal brainstorming exercise.
"It is simply an exploration of different models of delivering software to customers," the source said. "It is not policy, it is not a plan, and no decisions have been made--it's just some thoughts from our research and business units."
In recent weeks, Microsoft has identified a number of ways to increase its online advertising business as it seeks to fend off rivals such as Google. A move to bring ads into its desktop software, though risky, would offer the company an ability to move the battle on to its home turf.
The document also sheds light on Microsoft's concerns over the erosion of revenue from shrink-wrapped software, particularly in the consumer market.
Chief Technical Officer Ray Ozzie and Chairman Bill Gates outlined some of the opportunities and the challenges Microsoft faces in a series of October memos. In the more blunt of the two missives, Ozzie said Microsoft had an obligation to act on the shift to ad-supported software.
"It's clear that if we fail to do so, our business as we know it is at risk," Ozzie wrote. "We must respond quickly and decisively."
Already, the company has announced plans for Office Live and Windows Live, two products that are ad-supported complements to its existing desktop software. But in the internal documents, Microsoft workers maintain that the software maker may be forced to go further if rivals launch ad-supported versions of popular programs such as PowerPoint.
"If our competitors release free, advertising-supported versions of these programs, we may need to do the same," the two researchers and John Skovron, who works in MSN's Money unit, wrote in the winter 2005 paper.
Microsoft has been mulling a shift to ad-supported software for some time. A paper prepared for a summer 2004 Thinkweek gathering noted the decline in consumer software and suggested Microsoft's MSN online business might benefit from moving from a subscription model to one paid for through advertising.
The more recent paper outlines a number of factors for identifying which desktop software could be ripe for moving to an ad-based model. Such factors include whether the software is frequently used online, whether it contains good data for targeting ads and whether it is likely to face ad-supported competition. Among the products it identifies as meeting some of those criteria are Works, Money and OneNote.
But others both inside and outside Microsoft have called on the company to go beyond the types of services offered by MSN. An online version of Office is one of the products most often talked about. The company has in the past mulled such a move. But a commercial product never materialized, due to internal political battles and fears of cannibalizing revenue from Office, which is among the company's most profitable products.
Plan extends to Windows
The company's exploration of ad-supported software extends even to Windows, its most important product. An ad-supported version of the operating system could make some sense, the Microsoft researchers argue in their Thinkweek piece, noting that the product reportedly earns $9 per year per user.
"It seems possible that we could match that revenue via ads, but there are difficult UI (user interface) issues to solve, since the OS does not have a natural way to display ads that does not annoy users," the Microsoft workers said in the paper. One suggestion is a low-end version of the operating system that comes bundled with other ad-supported programs, such as Works, Outlook Express and Windows Media Player. However, the writers point out that "it's not clear how to prevent these elements from being replaced." The key is creating a robust enough advertising business to pay for more expensive content than what has been traditionally offered for free on the Internet. At the center of Microsoft's efforts here is a product called AdCenter. Its initial role is to offer the same kinds of text-based keyword ads as Google serves up though its AdWords, but Microsoft's ambitions for AdCenter go much further.
Executives see AdCenter, which has been known internally by the code name Moonshot, as a way to offer all manner of ads, text, display and video for use both online and offline on a PC, and on other devices, such as the Xbox gaming console or mobile phones.
"It's not just about (ads that run) in your PC with your browser open," Joanne Bradford, Microsoft chief media revenue officer, said in an interview last week. "Today, it's keyword...We believe in the future it will be about display (ads), video and all that is advertising."
Microsoft is clearly looking to forge new ground with AdCenter, said Matt Rosoff, an analyst at Directions on Microsoft. "It's pretty clear that AdCenter is going to be more than a traditional paid search platform," he said. "They are taking the idea of contextual advertising and applying it fairly broadly."
Rosoff said it makes sense for Microsoft to explore which types of products might be supported by ads.
"It doesn't surprise me at all that they are looking at all possibilities, especially given that a lot of people feel Google is going to go this direction," Rosoff said. He notes that Money, for example, is already a hybrid product that has both a desktop software and an online component.
However, he is not convinced that consumers will accept a vast quantity of ads rather than pay for software.
"Are people willing to pay $100 every three or four years not to get bombarded with ads?" Rosoff said. "I think a lot of people will."
He also notes that however promising the ad market, it is a finite one that can only support so many products. Today, online advertising is growing as businesses shift from things like yellow pages, print and TV ads, but, Rosoff said: "Eventually that tops out."
Microsoft faces other challenges as well. One problem with inserting ads served over an Internet connection into desktop software is that while broadband access has grown, many computers spend a significant amount of time offline. Also, to pay off, such advertising must be targeted and relevant enough to both generate higher revenue and avoid annoying users.
"It's definitely an idea to pursue, but it's fraught with perils," said Forrester Research analyst Charlene Li.
Li said the move could open up new markets for Microsoft, but notes that it is also a move into largely uncharted waters. "The challenge becomes users aren't necessarily used to having ads on desktop applications."
These concerns could explain why Microsoft held discussions to buy controversial adware maker Claria this summer, though ultimately no deal was announced.
Privacy is another major issue Microsoft expects to face. The paper suggests some options such as offering paid, ad-free upgrades; allowing users to turn off some of the personalization options in favor of more generic ads; and choosing applications to be ad-based in which users are already sharing private data. Even those moves may not be enough, the paper suggests. "Unfortunately, even where consumers are willing to make this trade, privacy advocate and perhaps European regulators are not," the authors wrote.
Li notes that some users might feel comfortable, say, writing a letter about their trip to Costa Rica in a free, ad-sponsored word-processing program and seeing ads for Costa Rica travel, while others may find that crosses a line.
"Everyone has different thresholds for how much their privacy is worth," Li said.Despite the concerns, though, the researchers argue that Microsoft needs to act.
"As online advertising increases our competitors will enter many markets with free, ad-supported products," they wrote. "We must have free, ad-supported entries in these same areas."