——The details around Windows 9---code named "Threshold"---are beginning to emerge, but the real action will go well beyond features and whether Microsoft can put Windows 8 in the rear view mirror. Microsoft's real challenge with Windows will be navigating a classic innovator's dilemma and how it can thread a needle between preserving a cash cow and ultimately give Windows away to hardware makers.
Give Windows away for free?!? What?!? How?!?
That place is where Microsoft is going to have to go if it wants to preserve its Windows ecosystem and market share. And how Microsoft navigate that business model change is going to be telling. The folks in Redmond may laugh off the idea of giving Windows away for free to original equipment manufacturers, but the writing is on the wall. Consider:
Windows 8 was a black eye for Microsoft and it's going to be a challenge to come back from a Vista-ish flop twice.
The PC market is being splintered into multiple operating systems.
When I consider those moving parts, it's not that surprising that Microsoft is having trouble naming a new CEO. It's going to suck to be the new CEO. For starters, Microsoft isn't that screwed up so a new leader can't be a hero. Think John Chen at BlackBerry. Chen has little downside. If he turns around BlackBerry he's a legend. If BlackBerry fails Chen carries none of the blame.
Microsoft's new CEO will have to preserve two cash cows---Windows and Office---be saddled with low-margin Nokia and most likely keep the company together when a breakup may make more sense. With Microsoft more can go wrong on the new CEO's watch than go right.
In Clay Christensen's books on innovation there's a theme that plays out repeatedly. A leader in an industry is threatened from below by rivals. Those rivals use price as a weapon and gain share. The leaders move upstream to preserve margins. The upstarts move upmarket and the leader has no space to maneuver. An example of this scenario was the U.S. auto industry as Toyota and Honda entered the market. The PC and server markets are also examples as contract equipment players ultimately become brands.
"If you're worried about what may kill you, look down."
Down to Microsoft's Windows is Android and Google's Chromebook franchise. Chromebooks have become more popular and functional. Android is emerging as a PC option. Both of Google's computing operating systems are free to hardware makers. Microsoft can pitch Windows as a premium OS, but the margins will be increasingly difficult to defend.
The move for Microsoft will be to off Windows free to hardware makers and profit from the ecosystem---subscriptions, apps and other revenue streams. Here's the problem: Windows is a huge business. Microsoft will have to preserve and navigate a move to free with precision timing.
In a research note a week ago, Stifel Nicolaus analyst Brad Reback made the case the Windows will eventually be free.
Today, when looking at the aggregate OS market (phone/tablet/PC), Microsoft is the only vendor that explicitly charges for the OS software. We believe this could prove untenable in coming years, forcing Microsoft to give away the OS and attempt to monetize Windows usage/support via various methods depending on the end-customer. We believe this is the single biggest challenge Microsoft's new CEO will face in coming years.
At the very least, Windows average selling prices will tank. There's no other outcome. To fend off Chromebooks and now Android, Microsoft will have to give concessions to hardware makers so they can offer sub $300 devices. Reback argued that Microsoft's OS license fees will fall to $10 to $30 for each device down from $40 today. Those concessions, however, are just the beginning.
Over the medium to longer term, we believe Microsoft will be forced to follow Apple and Google and give away the OS, especially in the consumer market, and use services like Bing, Skype, Office 365, etc. as its primary monetization engine. That said, we expect Enterprises to continue to pay for support via various enterprise agreements.
The good news for Microsoft is that it'll be able to milk Windows on the enterprise side for the foreseeable future.
Frankly, I don't see many holes in Reback's case. The only debatable point about Windows going free for the consumer market is timing. This chart tells the tale: