If Microsoft (NASDAQ: MSFT) isn’t careful, a few of its software cash cows could be headed straight for the slaughterhouse. If you’ve ever flipped through Microsoft’s financial statements, you know the company simply mints money licensing its Windows and Office franchises to PC makers and corporations. These two units combined generated more than US$25 billion in operating income for Microsoft over the last year alone. However, the future of these valuable franchises is increasingly under threat, as Google’s (NASDAQ: GOOG) Android mobile software becomes the global de facto standard in smartphone and tablet operating systems; it most recently controlled 79% and 62% of these respective growth…
If Microsoft (NASDAQ: MSFT) isn’t careful, a few of its software cash cows could be headed straight for the slaughterhouse.
If you’ve ever flipped through Microsoft’s financial statements, you know the company simply mints money licensing its Windows and Office franchises to PC makers and corporations. These two units combined generated more than US$25 billion in operating income for Microsoft over the last year alone. However, the future of these valuable franchises is increasingly under threat, as Google‘s (NASDAQ: GOOG) Android mobile software becomes the global de facto standard in smartphone and tablet operating systems; it most recently controlled 79% and 62% of these respective growth markets, according to IDC.
Taking the fight to Google
Google effectively broke Microsoft’s uber-profitable software sales and licensing model by making Android free to smartphone and tablet original equipment manufacturers (OEMs). These manufacturers have been faced with paying Microsoft a licensing fee for a mobile version of Windows, or simply adopting Android for free. This has been a powerful economic incentive that’s been the driving force of Android’s market share.
Microsoft has tried — and thus far sadly failed — to counter Google’s growing dominance in smartphone software through a number of strategies. These include its first ever OS that’s compatible with desktop and mobile Windows 8 (and its recent update), the launch of its own line of tablets, and the purchase of its largest smartphone supporter. And while these strategic moves certainly make plenty of sense, they’ve fallen well short of driving the kind of mass adoption Microsoft has hoped for.
Waving the white flag?
Microsoft’s OEM partners have been dropping like flies. Nokia, whose handset business Microsoft is acquiring outright, is set to remain the platform’s only significant supporter, at present. The next largest hardware partner Microsoft has is HTC. However, HTC has been steadily ramping down its WP products, as well, over the last year. According to Windows tracking site AdDuplex, HTC’s share of Windows Phone’s OEMs has decreased from 17% last November, to only 7% this month.
And if not Microsoft, what company would HTC use as a software partner? You guessed it, folks — Google’s Android.
The solution is clear, although somewhat unpalatable for Microsoft investors. In order to save its fatted calves, Microsoft needs to take the fight to Google in mobile. And if a recent rumor is any indication, Microsoft might be ready to do just that, and finally challenge Google in the way that matters most to smartphone makers — price.
According to multiple reports, Microsoft pitched the idea of eliminating the licensing fee it charges altogether, in recent discussions with HTC. Microsoft doesn’t disclose how much it charges its OEM partners, but this would be the first time that Microsoft has seemed willing to take such drastic steps in order to gain some kind of adoption with OEMs other than Nokia.
Broader implications for Microsoft
To me, this is a mixed bag for Microsoft and its investors. I’ve been predicting for some time now that Microsoft would need to slash prices drastically if it ever wanted to break into Google’s mobile empire, and this report certainly supports this idea.
Microsoft needs to come up with a new strategy and fast — otherwise, this presents a significant threat to one of Microsoft’s massive profit drivers. Unlike Google, which can afford to give its mobile software away for free and more than make up the difference with its massively profitable services on the back end, Microsoft’s services division has been nothing but a money pit. Giving away Windows Phone licenses for free could be the beginning of a trend that, over the long term, could be hugely erosive to Microsoft’s margins, especially within its Windows division.
However, making such a move could also be the hard decision Microsoft needs to make in order to essentially buy its seat at the mobile table. If free licenses actually spur adoption en masse, Microsoft still stands to gain by opening up its Office products to a massive new installed based of devices.
This might not be ideal, but it might be just what the doctor ordered if Microsoft wants to stay relevant in our increasingly mobile future. It sure beats the heck out of the alternative.
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A version of this article, written by Andrew Tonner, originally appeared on fool.com.