Microsoft software licensing: Seven deadly sins

First in a series. Ten years ago this month, Microsoft introduced the most controversial licensing program in its history: an upgrade rights and maintenance add-on called Software Assurance (SA). The experience was so traumatic that Microsoft has undertaken no comparable licensing initiatives since then. After five major revisions to volume licensing in the decade before 2001, Microsoft has been stuck at Licensing 6.0. That's too bad. The industry is different, Microsoft is different, and it's long past time for a new look at Software Assurance.

A Radical Change

Unlike consumers, which purchase retail software off the shelf, businesses typically enter into multi-year volume-licensing contracts. Until Software Assurance, upgrades followed the conventions of the time. When the company released a new software version, volume-licensing subscribers using previous versions or competitive products could purchase an upgrade version at a discount at any time, while customers who were new to the software category paid the full price. The discount varied, in part, based on when was the upgrade during the contract.

Software Assurance, announced on May 10, 2001, radically changed the rules: in order to get a discounted upgrade, volume-licensing customers had to pay Microsoft an annual fee, 29 percent of the full license price each year for desktop software and 25 percent for server software. Furthermore, they could not wait until the upgrade was released to start paying for it. They had to purchase upgrade rights at the time they acquired the original license, meaning they paid for upgrade rights before they needed them -- sometimes years in advance.

The program began with a transitional period, during which customers with existing products, such as Windows 2000 or Office 2000, could purchase Software Assurance on those products, thus gaining the right to future upgrades without having to pay for full licenses.

Why Software Assurance?

Microsoft had several major goals for Software Assurance:

1. Many of Microsoft's enterprise customers were signing on to Enterprise Agreements (EAs), in which they paid an annual fee for the right to deploy any version of desktop products like Windows and Office; Microsoft appreciated the long-term value of annual fees, so Licensing 6.0 added an Enterprise Agreement-like "annuity" program to other volume licensing plans, such as Select and Open programs.

2. Most other vendors dealing with enterprise customers charged an annual maintenance fee on top of the license price, typically 15 percent to 20 percent. Microsoft wanted part of that action.

3. Before Software Assurance, Microsoft's revenue was famously "spiky," jumping when a major new product released, then falling into a trough until the next version launched. Annual Software Assurance payments spread out the revenue, effectively funding product teams during the development of a new version, rather than after its release.

4. Annual payments make it easier for some customers to fit new software into their budgets. Organizations that use one year's budget as the basis for the next would no longer need to beg for substantial but temporary additions to their budgets for a major software upgrade.

5. By making customers pay in advance, Microsoft figured it could guarantee steady adoption of new software, since customers would be more likely to deploy something that they had already purchased. Presumably, these customers would be less likely to switch to competing products, such as Linux.

The plan was controversial, to say the least. Various analysts and industry associations calculated the effective price of Microsoft software would rise by as much as 200 percent as a result of the change. Customers also objected to the need to purchase upgrade rights long before they planned to actually deploy the software.

More Than a Marketing Error

Microsoft, characteristically, explained the fiasco as a failure to communicate. However, long after that failure, serious problems with Software Assurance persist and these are not just communications problems. The program has flaws so critical that they warrant ditching Software Assurance or changing it drastically. Customers do get it: I've spoken to dozens of Microsoft customers over the last decade who very clearly understand the technical and conceptual flaws of Software Assurance. These are smart people who ignore marketing smoke screens and cut through to examine critically what a vendor is really doing.

The original program's shortcomings were evident very early on, even to Microsoft's licensing staff. After the transitional period was over, and customers had hedged their purchase of near-term upgrades, such as Windows XP or Office XP, enthusiasm for Software Assurance was low.

Recognizing that problem, Microsoft's solution was to put more lipstick on the pig, throwing in a bunch of additional benefits -- subscriptions to TechNet and e-learning tools; software for home use; some tech support incidents; and more. The only constraint, one 'Softie said, was that Microsoft couldn't reduce the price of Software Assurance itself.

Another effort to put Software Assurance in a more favorable light involved a subtle change to the way renewals were counted -- a change that has had two major impacts:

• Confusing customers more about what Software Assurance is and how it works
• Concealing Software Assurance's failure from Microsoft executives

The change was to count Enterprise Agreement renewals as Software Assurance renewals, even though major SA characteristics, such as annual payments and automatic upgrade rights, had been built into EA before SA was developed. By counting renewals for the popular Enterprise Agreement program as renewals for the unpopular Software Assurance program, Microsoft could claim that SA renewals were running at 75 percent or better. However, since Enterprise renewals normally run at a 65 percent to 75 percent renewal rate, it seems clear that SA's incremental contribution outside of the EA, where customers have the option to renew or not, is very low.

Seven Deadly Sins

Ten years on, it is not clear that Software Assurance still has value. The program's flaws are more than skin deep -- Software Assurance penalizes not only Microsoft customers, but Microsoft itself, making the company's products more costly, discouraging upgrades and reducing enterprise customer flexibility.

Here's my list of SA's seven fatal flaws -- sins so serious that any one of them could justify total re-examination of how the company handles upgrades and maintenance benefits. Software Assurance:

1. Makes customers gamblers. Software Assurance is probably best compared to a Vegas casino. The odds of a big win are about the same, and the house always wins in the long run. Software Assurance customers pay upfront under two- or three-year agreements for upgrades, but Microsoft doesn't assure them new software will release.

2. Forces customers to make upgrade choices at the worst possible time. If you don't buy Software Assurance at the same time (in some cases, with 90 days grace) as you buy a new license, you can't ever add it to your new license, even if the payoff is years down the road and you risk losing all the money you put into Software Assurance.

3. Provides trivial discounts, while penalties for mistakes are large. On a desktop product, customers pay an extra 29 percent of the current license price per year. So, over three years, they pay three times that, or 87 percent of the license price. That leaves them with a 13 percent discount. If Microsoft releases no new software during the contract period, the customer actually loses money paid Microsoft, receiving little of value by the end of the agreement.

4. Makes Microsoft software more expensive. At 29 percent annually for desktop products, Software Assurance costs much more than typical corporate upgrade and maintenance fees. Oracle and IBM charge in the neigborhood of 20 percent a year for upgrades and maintenance, and that includes real tech support. The tech support benefits that Microsoft offers with Software Assurance are, in comparison, pitiable.

5. Discourages upgrades. The break-even point, where a full upgrade equals the cost of Software Assurance is about three-and-a-half years. At 29 percent a year on desktop products like Windows and Office, if customers hold out for four years or more, the non-Software Assurance customer will pay only 100 percent for the upgrade license, while the SA customer will pay 116 percent. In effect, the Software Assurance pays  a 16 percent premium to get a 13 percent discount.

6. Reduces Microsoft's competitiveness. Software Assurance creates constraints that limit Microsoft's ability to respond quickly to changing market events. This is particularly true for a company that is still stuck on three-year product cycles, while many of its competitors are far younger, more mobile, and rapidly modifying their offerings, sometimes on a monthly basis.

7. Benefits, if any, are too complicated. Software Assurance benefits are so complex that it takes a three-dimensional matrix to describe them. The PDF file that Microsoft gives customers has various benefits down the left column and various licensing programs along the top. Customers need to hover their mouse over the intersecting cells to view a pop-up that explains in more detail the amount of any given benefit each program offers.

Throughout the week of May 16, 2011, I will expand on each of these "deadly sins" in separate posts and end with a handful of suggestions for fixing Microsoft's software licensing problems.

Fixes won't be easy. Software Assurance upfront payments are a narcotic for Microsoft long-term revenue. The company records these payments as unearned revenue recognized over the life of the Software Assurance annuity contracts. Recognized unearned revenue accounts for 25 percent or more of any quarter's revenue. Imagine if Microsoft revenue dropped as much as a quarter during any quarter. Sadly, Microsoft is addicted to Software Assurance as it is, but it's time to kick the habit. In the long run, the current program could do more harm than good.

Paul DeGroot is one of the world's leading experts on Microsoft licensing policies, rules and volume licensing programs. Over a ten-year period, he developed and led the licensing practice at Directions on Microsoft, an independent analyst firm focused on understanding Microsoft policies and strategies. DeGroot formed Pica Communications, LLC, where he is principal consult, in 2010, to bring his licensing expertise to a broad range of customers worldwide. Please follow him on Twitter.