Easy Windows 7 upgrades could earn Microsoft billions a year extra

Easy Windows 7 upgrades could earn Microsoft billions a year extra

Summary: Most analysts who looked at Microsoft’s announcement earlier today of its new lineup of Windows 7 editions have focused on the number of SKUs and are busily debating whether the new selection will make choices more or less confusing for Windows customers. But there’s a more important story buried in the details. By making upgrades easy and cheap, Microsoft could finally convince its enormous user base to start paying extra to unlock features in higher-priced editions and pull in billions of dollars in additional revenue.

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Most analysts who looked at Microsoft's announcement earlier today of its new lineup of Windows 7 editions have focused on the number of SKUs and are busily debating whether the new selection will make choices more or less confusing for Windows customers. But there's a more important story buried in the details, one that will only become apparent when Microsoft fills in the rest of the picture by attaching price tags to the members of the Windows 7 family.

Two weeks ago, Microsoft delivered the shocking news that its Windows Client division reported declining revenue on a year-over-year basis, despite selling approximately as many licenses as it did in the previous year. It's easy to blame the shortfall primarily on netbooks, as Microsoft did. Indeed, those small, cheap PCs are part of the problem. The market figured out that the least expensive Home edition of Windows (XP or Vista) is an ideal choice for netbooks and in fact is perfectly adequate for many tasks on mainstream PCs. That's why Vista Home Basic is so popular on entry-level business PCs.

The big challenge for Microsoft in the Vista-to-7 transition is how to increase the average price of a Windows license without making users scream or quit in protest. By changing the upgrade game in Windows 7, they've created the conditions for a whole new revenue stream - and, paradoxically, have the chance to offer Windows customers an upgrade deal they'll actually want.

I've crunched the numbers, and my rough calculations suggest that this realignment could be worth hundreds of millions, and perhaps billions of dollars in new revenue for Microsoft, even if PC sales remain flat. Here's how I came to that conclusion.

On new PCs, which make up the overwhelming majority of the PC market, Microsoft's partners choose which Windows editions will be installed on a given PC at the time of purchase. Their goal is to keep costs as low as possible, which is terrible news for Microsoft's bottom line. In essence, OEMs make their OS choice based on the total price they want to sell a system for. If you buy a system sold at a retail outlet like Best Buy, customization is impossible: You get what's preinstalled. Companies that offer build-to-order PCs sometimes give the buyer a choice, but most customers accept the default configuration, which usually includes Vista Home Premium for a consumer PC, Vista Business for models designed for the corporate market, and Home Basic for entry-level systems for home and small business buyers.

OK, so you buy a new PC with Vista Home Premium and take it home, and then you discover that you can't use Remote Desktop to manage that system remotely, and it doesn't allow you to recover files saved by the Previous Versions feature, and you can't do image backups. If you want those features, you have to buy an upgrade copy of Ultimate edition at a typical cost of $150 or more. And if you decide to upgrade after the fact, you not only pay through the nose, you also sign up for several hours of downtime as the upgrade completely replaces your existing installation and then migrates your programs and data files.

Long story short, the current Windows upgrade model is completely irrational. As a result, almost nobody upgrades their copy of Windows Vista. You use what came with your PC and Microsoft sees almost nothing in upgrade dollars.

That means, in practical terms, that Microsoft's revenue from Windows client licenses is set by the mix of PCs in the marketplace and effectively determined by OEMs. To get a handle on how the mix works, I did some very rough back-of-the-envelope calculations. The following table assumes that Microsoft sells 200 million Windows licenses per year. I consulted with a few industry analysts to guess at approximate market shares and OEM costs for those licenses, and came up with the following total.

Vista SKU Share* OEM cost* Total**
Home Basic 12% $30 720
Home Premium 65% $60 7,800
Business 20% $90 3,600
Ultimate 3% $120 720
- Total - Avg: $64.20 $12.84B
* Estimate, for illustrative purposes only

** Based on 200 million licenses sold

The only way for Microsoft to adjust that number is to convince OEMS to build new PCs with higher-priced editions (and thus higher price tags) than they previously used. Good luck with that strategy.

So what's Plan B?

Crunching the Windows 7 numbers -->

< -- Continued from Page 1

With Microsoft's latest product mix in mind, let's look at the numbers for new PCs purchased with Windows 7 in the first full year after Windows 7 ships. All of those buyers in the U.S., Western Europe, and the rest of the developed world who would have purchased a PC with Vista Home Basic will have to choose the higher-price Home Premium edition when purchasing a Windows 7 PC. The only buyers left for Home Basic are in emerging markets, which cuts the percentage of Home Basic buyers down (but not to zero, because emerging markets are booming). At the high end, some buyers who previously would have chosen Ultimate (because they wanted Media Center and Remote Desktop capabilities, for instance) can now choose the less expensive Professional and still have the features they need. Figure that knocks a point off Ultimate's already low market share.

Here's what the Windows 7 numbers look like in that case:

Win7 SKU Share* OEM cost* Total**
Home Basic 7% $30 420
Home Premium 70% $60 8,400
Professional 21% $90 3,780
Ultimate 2% $120 480
- Total - Avg: $65.40 $13.08B
* Estimate, for illustrative purposes only

** Based on 200 million licenses sold

Assuming the number of license remains constant, the change in SKUs alone means a bump in the average selling price (and thus the total revenue, assuming flat growth in PC shipments) of 1.87%. Since this is back-of-the-envelope stuff , let's round it up to an even 2%.

But here's where it starts to get interesting. With Windows 7, Microsoft has made it technically easy to upgrade, and for the first time they also have the opportunity to price those upgrades reasonably. Imagine that an aggressively priced upgrade program is able to convince a mere 4% of the total Windows customer base to upgrade after the initial PC purchase, with the overwhelming majority going from the dominant Home Premium edition to Professional. Assuming 200 million new Windows-based PCs, that's 8 million buyers with cash in hand. If they can be convinced to pay an average of $50 each to unlock those Windows 7 Professional features, Microsoft pockets $400 million in extra revenue. No sales get cannibalized; these are buyers who would have never upgraded in the Vista world, because the cost and hassle factors were way too high.

Those assumptions might be too optimistic, but even a 1% upgrade rate translates into $100 million dollars in new revenue over the course of a year, something that Microsoft can't afford to sneeze at in these tough times. And if they can boost the upgrade rate into double-digit percentages at a higher price, the result could add up to billions in new revenue.

So who loses in this revised model? Entry-level buyers in the U.S. are the most obvious victims in this scenario. With no Home Basic edition, the price of a $400 budget Windows PC is going to rise by about $30, or 7.5%. Ouch.

Anyone trying to squeak by on a netbook with older, slower hardware is going to be stuck between a rock and a hard place, too. The low-priced XP Home is still available for those systems until June 30, 2010, but after that it's Windows 7 Home Premium (too expensive), or Windows 7 Starter Edition (too limited) or Linux (too not-Windows).

And that model doesn't factor in the bump in revenue coming from Windows Vista users who are enticed by Microsoft's "aggressive pricing" and special offers when Windows 7 launches.

All in all, it adds up to a potentially enormous bump in revenue for Microsoft from a seemingly small change.

Topics: Operating Systems, Hardware, Microsoft, Software, Windows

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59 comments
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  • That's assuming they use the same price structure

    for the "equivalent" SKU's. But of course if they do, I would expect there to be a lot of whining.

    I won't whine myself because I have no plans on buying the Basic edition anyway, but you can bet that there will be a lot of people who will complain about their inability to purchase at the $99/$199 level, even if they had no plans on actually buying that SKU.

    I can also see bundling accusations with regard to WMC, because now you have to buy it in the US and other developed countries if you buy Windows. I want it myself (in fact it's the primary reason I use Vista, though THAT'S only because of HD) but other third party media center makers would have a good case against them.
    Michael Kelly
  • I doubt netbooks with Starter will ever get delivered.

    [B]All of those buyers in the U.S., Western Europe, and the rest of the developed world who would have purchased a PC with Vista Home Basic will have to choose the higher-price Home Premium edition when purchasing a Windows 7 PC.[/B]

    Might it simply be that less people (in this economic climate) purchase a computer? Price is currently King. Now, Windows 7 starter edition will die instantly on netbooks, there really is no excuse for this OS version. MS will be forced to offer Basic on netbooks or completely lose to the slew of ultra slick Linux versions coming (Ubuntu remix, Android, Mandriva netbook, HP's MEI, etc). Or decide to give 7 Premium away like it does XP now. This might provide the leverage needed for OEMs to expand the definition of a "netbook".

    Now you are right, on paper, MS is assuming they can force Premium on customers (and again, starter on anything is a mistake, big mistake) but we are living in extreme economic downturns and nobody expects it to be getting better until well after launch.

    Also, could you, would you ever recommend 7 starter edition on a netbook? Would you use it with it being the choice? I am running 9 apps right now on my Aspire as I write this.

    FF
    Pidgen (IM)
    Amarok (docked and playing tunes)
    Thunderbird
    Skype is sitting there waiting
    OO is preloaded (is that classified as running?)
    I have a standalone RSS reader running
    Kontact manager and alarming is running
    Superkarumba is running (like Google's equivalent for windows.

    If I wanted to watch a movie, oh yeah, Kaffeine is docked right now, make that 10 apps, I would simply open them. Like KDEnLive, or whatever. Being forced to close on to open one is just too much.

    Hmmm, would be exactly similar to Windows so, let's play the mix and match game to see which three I need most any given time. :D

    TripleII
    TripleII-21189418044173169409978279405827
    • Good points

      My AAO is a surprisingly capable little unit. It's far more convenient to carry than my notebooks.

      I,m not happy that I had to buy the winXP version to get the better hardware.(160GB HDD, 1GB DDR2...upgraded to 1.5GB)

      Not all linux users want the minimalist hardware. Some of us want the superiority of Linux AND the better hardware. Normally a Debian/KDE user I found Linux Mint to be a great match for the AAO.

      That's right... I forgot that windows starter is artificially limited to 3 concurrent apps. Why would anyone not only tolerate such abuse but also pay for the privilege?
      Tim Patterson
    • Starter is a non-Starter

      I agree that few netbooks will ever ship with Starter. The manufacturers don't send to deal with the backlash from users who discover their OS is artificially crippled. Nor do they want to suggest to shoppers that their hardware isn't powerful enough to run "real Windows". Either Microsoft will back down and offer Home Basic for netbooks, or manufacturers will ship netbooks will Home Premium... alongside Linux models that are considerably more affordable.
      mistergoodman
      • Agree! Crippled software backlash is a real problem.

        Microsoft's entire pricing structure is a "pay now and pay again later" scam. They would make more money by selling ONLY Ultimate for the price of Starter. More would buy it. They would buy it sooner. They would buy at a faster pace. All the costs of multiple versions would be reduced. They would also piss off fewer customers. Desktop, laptop, and netbook manufacturers don't want to deal with 6 versions of Windows 7 any more than consumers do. Release one complete version for the price of the crippleware and you cover everyone's needs.
        BillDem
  • So you're predicting prices will stay static?

    Those figures are approximately the current prices for OEM Vista.
    Custard_over_2x_Pie
    • Yes

      I can't imagine Microsoft trying to raise prices on a nominal basis in this economy.
      Ed Bott
      • And lowering prices ?

        I think that he was wondering if you didn't think that Microsoft would lower their prices especially considering the current economic crisis ?
        I sure hope that they lower their price as i don't see myself advising people to buy Home Basic(i live in a developing country) to stay in the legality.
        For me Ultimate is the more likely option :)
        timiteh
        • I'd be happy with them staying the same.

          and definitely not up.

          Netbook edition seems like a dead weight that's going to cost them dearly. Kudos and OEM acceptance.
          Custard_over_2x_Pie
  • RE: Easy Windows 7 upgrades could earn Microsoft billions a year extra

    They will also get a lot of upgrades from those betas they let everyone download for free, when they expire.
    mrlinux
    • Those aren't upgrades

      Those are new sales.
      Ed Bott
      • Depends on how they count it...

        They may well call it an upgrade, we will have to see
        mrlinux
  • I think it's a bad thing

    All the different versions, doesn't sound like a wise thing to do. It didn't work for Vista and everybody is using XP Professional not Home.

    I hate encountering XP Home somewhere.
    TedKraan
    • You sound like Yogi Berra

      Yogi once said, "Nobody goes there anymore. It's too crowded."

      You wrote: "everybody is using XP Professional not Home."

      And then, immediately:

      "I hate encountering XP Home somewhere."


      But, but, but... If everyone is using XP Pro, how would you...?

      Oh, never mind.
      Ed Bott
  • Should Only Be Three Versions Of Windows 7

    Windows 7 Pro
    Windows 7 Home
    Windows 7 Media Center

    End of story...this 7 edition mess is ridiculous.
    itanalyst2@...
    • There pretty much are only 3 versions

      As far as you're concerned, you pretty much only have 3 real options.

      Windows 7 Home Premium (media center and normal user stuff)

      Windows 7 Business (Home Premium + full back up and remote desktop)

      Windows 7 Ultimate (Business + bit locker and VHD support aka enterprise for consumers)

      Home basic won't even be offered in developed markets. And enterprise is only for businesses that need volume licenses.

      No one in their right mind will get starter on a netbook. That has to be a joke. Why would they even offer that? You know by the time Windows 7 comes out, that's going to change. I'm sure that they only threw that out to gage reactions. They have to know better than that. But i don't necessarily want Home Premium on a netbook either. I'd want everything in home premium except media center on a netbook. What am i gonna use media center for on a netbook? I haven't tried out the removing windows components in the windows 7 beta yet, so i don't know if i could just get rid of it. Couldn't hurt though i guess...
      iceykola
      • That's maybe-

        But people with note-books will,are using them for video on the move ,were their portablity-battery life,comes to the fore.
        And by the time Win 7 appears,August on?,the lowly ones will have about 40Mb's of memory,pluss cheap availability of usb sticks,1Gh's of ram,on-board Aero graphic's-They should cleanly run Ultimate.
        Then when at home,connect to monitor and keyboard,so virtually replacing the lap-top,desktop,in one fell swoop?
        morrigen
  • RE: Easy Windows 7 upgrades could earn Microsoft billions a year extra

    hey, instead of ripping the consumer off, why doesnt Microsoft just come up with one version, that works. There R&D only goes into one version, then they cripple it down to the others. Remember when 95 and 98 was good? They should come out with one version, make it free for home use, and cheap for offices.. Admins can disable what they need too. If they do this...they will take over any gains made by Linux or Apple for that matter, and they can concentrate on making it a strong system.

    dclinks@...
  • Windows 7.....FORGET IT!!!!

    I have spent allot of time tweaking Vista 64 on my system and it's running fast and worry free. Plunking down more money for another OS, to tune and tweak to my taste?....NO WAY

    Does Windows 7 have a new improved file system? NO

    Does Windows 7 have a totally new interface/gui front end over Vista? NO

    What's the point? Windows 7 is a finely tuned Vista 64, which is what I already have.

    No upgrade for me.
    james_p
    • Don't say never! ;)

      "Does Windows 7 have a new improved file system?"
      Yes, the filesystem has been significantly improved. They've done A LOT of work to increase throughput and reduce locks, improve caching, etc. Net result is that the filesystem in Win7 is faster than in Vista.

      "Does Windows 7 have a totally new interface/gui front end over Vista?"
      Actually, there are a number of significant improvements in the Win7 UI. Not least of which is that DirectX11 now supports 2D rendering. Why is that important? Because Windows now offloads rendering of text and 2D elements to your GPU rather than rendering them on your CPU. This returns MUCH more performance to your apps and dramatically speeds up text-heavy apps like browsers etc.

      "What's the point? Windows 7 is a finely tuned Vista 64, which is what I already have."
      No you don't. You have a well tuned Vista. Good for you. But Win7 is not Vista. True, Win7 builds upon Vista and improved upon it significantly, but it includes a slew of new features that Vista doesn't ... and will never have.

      Oh ... and by the way ... just use Win7 for a week - it's hard not to love it!
      de-void-21165590650301806002836337787023