Years ago, Microsoft created a multi-tier pricing structure for Windows that emphasized pre-installing its software on new PCs. The result was, by one measure, an outrageous success. So much so, in fact, that it led to an antitrust trial that declared the company a monopoly subject to governmental restrictions on its behavior.
Ultimately, Microsoft's confusing business strategy has led to a problem that threatens the success of its next version, Windows Vista. My instinct says consumers can't value an operating system at more than 10% of the value of the physical hardware.Historically, 9 out of 10 copies of Windows are sold preinstalled on new computers. The business model that Microsoft created has been so successful that the average consumer has no idea what Windows is worth. The notion that different purchasing channels have different Windows license restrictions is completely inscrutable. (How many questions can you get right in this quiz?) In fact, based on prevailing PC prices in the retail channel, I wouldn't be surprised if most consumers think Windows is essentially free.
Over the past two weekends, I researched prices of new PCs and retail copies of Windows. The results revealed a startling gap between what a pre-installed copy of Windows appears to be worth and what Microsoft charges when it puts the same software in a retail box.
Windows XP Home Edition: $30? Zero?
This weekend, I went unscientifically through the back-to-school ad supplements in my Sunday paper. Hewlett-Packard is selling a full computer system, with CRT monitor, keyboard, mouse, and printer, for $299? Yes, it's a loss leader, but it's the first product offered in the four-page HP supplement, and it sets the baseline for consumers. Office Depot has a Compaq system, also with a CRT monitor, at $299. At Best Buy, the entry-level system is $350. Dell's back-page ad shows an "amazing offer" on a back-to-school system for $279 with a free printer. You have to look carefully to see that the flat-panel display in the picture costs an extra $130, although that still only drives the price to a little over $400.
Every one of those systems includes an impressive amount of hardware, along with a copy of Windows XP Home Edition. So. what sort of value perception does that create for Windows? I'm sure someone has done the research, but my instinct says that consumers can't possibly value an intangible product like an operating system at more than 10% of the value of the physical hardware. Which means that the perception is that XP Home Edition is "worth" about $30, at most, to a consumer. And I'll bet many people assign no value to it. They just think Windows comes with the computer and don't even think of it as a valuable commodity.
Big-name OEMs reinforce this impression with their online build-to-order web interfaces.
At Dell, Windows XP Home Edition is worth $30. That's the discount you get if you purchase a Dimension 1100n with no preinstalled operating system ( a copy of FreeDOS is included in the box) for $269; the identical system with XP Home is $299; the same $30 price tag attaches to the Dimension 3100n ($429 with FreeDOS or $459 with XP Home) and the Dimension 5150n ($619 with no OS, $649 with XP Home).
Windows XP Media Center: $70?
For a few hundred dollars more, you can upgrade those crappy entry-level systems with higher-end hardware - LCD monitors, DVD burners, dual-core CPUs, a gig of RAM, and 200GB+ hard drives. Total cost is still ridiculously low, even with a premium version of Windows. The Best Buy circular offered a tricked-out $700 dual-core desktop PC with Windows XP Media Center Edition. Likewise, every vendor offers reasonably full-featured notebook computers in the $500-750 range, all with Media Center preinstalled. As with XP Home, I'm guessing that the perceived value of this premium Windows version for consumers can't be more than about 10% of the total system cost, or about $70.
Here, too, the big-name PC builders reinforce the impression. How much of a premium Is Windows XP Media Center Edition 2005 worth? If you upgrade an entry-level Dell PC like the Dimension E310 at the time of purchase, you'll pay $24. For higher-end systems, Gateway and Dell offer Media Center as the default choice, with no discount for a downgrade to Home Edition. In big box stores like Best Buy, Media Center is now the default OS on everything except entry-level systems.
Windows XP Professional: $149?
Given the back-to-school them, I was surprised to see OfficeMax selling a nicely outfitted small-form-factor system with Windows XP Professional for $650. For the most part, I found XP Professional offered as standard only on high-end PCs with high-end prices in the $1000 and up range.
The business version of Windows XP also costs significantly more as an upgrade with a new PC. In fact, prices from build-to-order shops were all over the map, in my research. To upgrade from XP Home Edition to XP Professional with a new PC, Dell charges $159 with a Dimension B110, $149 from XPS 700 or Dimension 1100/3100/5150, and a mere $124 from Dimension E310. Gateway wants $100 to replace Home with Pro on its DX310 or FX510. By contrast, Sony will only ding you for an extra $79 to add XP Professional on its Vaio VGN-SZ240. Toshiba charges the same $79 upgrade fee for its build-to-order Satellite U200. Lenovo's ThinkCentre A52 is the best bargain of all, at $70 for the XP Pro upgrade.
Dell's pricing really makes buyers of its n Series PCs feel like they're getting a bargain. The total cost of Windows XP Professional is $179 over the FreeDOS-equipped barebones Dimension 1100n, 3100n, and 5150n systems.
Shrink-wrap sticker shock
Want to build your own PC or buy from someone other than a big-name builder? Be prepared for sticker shock. You can shop around for slightly better prices, but this is what a reasonably savvy shopper will buy from well-established, legitimate resellers, give or take a few bucks.
XP Home: $81-199 A full retail edition of Windows XP Home Edition typically costs $199, regardless of whether you buy from a mail-order reseller like Newegg or direct from Microsoft. That's two-thirds of the cost of those entry-level systems, which include the exact same operating system, with different license terms.
The upgrade edition of XP Home costs $99 from the same channels and can only be legally installed if you have a full version of Windows 98 or Windows Me.
A single OEM copy of Windows XP Home Edition, which you can legally use to build your own PC, typically costs around $90 with shipping (last weekend Newegg was offering single OEM System Builder CDs for $89.99 and Mwave had the same package for $81). Most system builders will preinstall an OEM copy of XP Home for about $20 more than the cost of the software.
Media Center Edition 2005 isn't available as a retail product. But you can purchase a single OEM System Builder copy from a reseller, typically for about $20-30 more than the equivalent XP Home package. It's no accident that that number matches so neatly with the $24 premium Dell charges for the Media Center upgrade.
XP Pro: $131-299 The full retail edition of Windows XP Professional will set you back roughly $279 plus shipping if you buy from a reseller like Newegg, or $299 with free shipping direct from Microsoft. The retail upgrade is a rarely discounted $199, regardless of channel.
By comparison, OEM editions of XP Pro are a bargain. I found perfectly legal OEM System Builder copies for $131 (Mwave) and $137.99 (Newegg). As with XP Home, most small system builders tack on a surcharge of $20-30 to preinstall this version on a built-to-order PC (Newegg $109.99; Mwave, $119).
Microsoft's high prices
Avoiding channel conflict has always been a goal of Microsoft's Windows sales strategy, so it's not surprising that their direct-to-consumer prices are hard to find and hardly a bargain.
I already noted the direct prices Microsoft charges for upgrade and full copies of Windows XP (Home Edition costs $99 and $199, respectively; Pro is $199 or $299).
If you already own a retail copy of Windows, you can buy up to three extra licenses direct from Microsoft. (Sorry, OEM licenses aren't eligible.) The deal, such as it is, represents a $15 discount over the shrink-wrapped version. Each additional Windows XP Home Edition license costs $84 if you already own a full retail version or $184 if you own an upgrade version. An additional license for Windows XP Professional costs $184 if you own a full retail version or $269 if you own a version upgrade.
And then there's the Windows Genuine Advantage Kit, available direct from Microsoft and soon through resellers. If you have a pirated copy of Windows XP installed, you can "get Genuine" by paying $99 (XP Home) or $149 (XP Pro). The offer you get depends on what's installed on your PC. Most pirates use cracked or stolen volume license keys, which work only with Windows XP Professional, so few people are likely to see the less expensive XP Home offer.
What it all means
When I look at the Windows market, I see three fundamental implications for this disconnect between what people think Windows is worth and the much higher price tags Microsoft puts on the retail product:
Artificially high retail prices encourage consumers to unwittingly buy counterfeit software. I found it difficult to find discounts on retail copies of Windows XP. Most online resellers charge close to the same price as Microsoft does, which seems unrealistically high. Consumers are used to finding bargains through web-based comparison shopping services. The discounts they see match the values they perceive when they look through the Sunday PC ads. The trouble is, many of those copies are pirated or otherwise less than legal, which means they're more likely to fail the Windows Genuine Advantage validation sometime in the not-so-distant future and have to pay even more.
High retail prices discourage upgrades. If you've spent $2000 on a high-end gaming PC, you might be willing to pony up another $200 when Windows Vista rolls around, so you can get some of the new media and gaming features it includes. But will the average consumer with a $500-800 PC be willing to spend $200 for an upgrade? I don't think so. The magic number is more likely to be around $99, especially if there's a compelling new feature that isn't available with the old version.
There's no family value. Apple has an excellent idea, with a fixed $129 upgrade price and $199 family packs that can be used to legally upgrade up to five Macs. Of course, Apple has it easier than Microsoft, because they sell a copy of the base OS with every new computer (no resellers) and then have a captive audience for upgrades. But still, the price is right and the value of a five-pack license is unmistakable.
Back in my college days, I took Econ 101, and I've never forgotten the classic price-demand curve. Lowering the price usually makes customers happier. Sometimes, it makes companies more money too. Maybe someone in Redmond needs to crack those old textbooks and start slashing prices.