Microsoft gets outside the box with software

A decade ago, Bill Gates and other executives at Microsoft decided that traditional packaged software was dead--all software would eventually be delivered via the Internet.

Microsoft's thinking was premature, but not necessarily incorrect, Gates told CNET News.com last week.

"Like many things around the Internet that were predicted to happen quickly, they're not wrong, they're simply things that take more time," Gates said in a recent interview.

Now, Microsoft is quietly working on the technological innards that will one day let the company offer corporate customers what is known in the industry as "software as a service." Some of Microsoft's competitors in the business software market, such as Salesforce.com and NetSuite, have been offering software as a service products for years.

For Microsoft, the transformation is substantial, and will involve two key changes: subscription pricing, and software that's stored remotely, or "hosted," rather than installed directly on a business' own servers.

"You'll see us do more hosted things with our business and professional offerings," Gates said, adding that Microsoft is already in the game on the consumer side with Hotmail and other MSN services.

Although the company is not talking in detail about its plans, one definite area of interest is the Microsoft Business Solutions unit, which specializes in business management applications for small and medium-size business.

Gates said Microsoft definitely considers Salesforce a rival and looks "intensely" at where that company is seeing success.

The head of Microsoft Business Solutions, Doug Burgum, said last week that his unit is planning for a day when it delivers its software as a hosted service, but the division doesn't plan to create the infrastructure for that itself. Rather than try to develop something unique to his unit, Burgum said, he intends to work off of a broader Microsoft-developed platform.

Without offering specifics, Gates confirmed that plan.

"You'll see us do more things like hosted SharePoint (portals) and hosted environments that the MBS applications can then sit on top of," Gates said.

An unsmooth transition?
The problem is that many of Microsoft's applications, particularly the MBS products, are not very well suited to the changeover, Summit Strategies analyst Paul Wainewright said. Microsoft is making some moves through Project Green--an effort to modernize and unify several different business applications--but that project is taking longer than planned. "The delay of Green shows just how difficult it is," Wainewright said.

Indeed, Microsoft still releases and updates most of its products in the traditional way. Software is developed in cycles, with enhancements delivered in large measure by way of paid upgrades and, to a lesser extent, via smaller patches.

In recent months, though, Microsoft has shown that it's willing to experiment.

In January, for example, it debuted Microsoft Office Outlook Live, which takes the company's Outlook software and offers it to consumers along with storage space as part of a monthly or annual subscription.

Sheryl Kingstone, an industry analyst with the Yankee Group, points out that just because Microsoft hasn't offered many products this way doesn't mean the company is opposed to the idea. In fact, she gives Microsoft credit for spotting back in the mid-1990s that the Internet could be used as a mechanism to deliver games and other software.

As for the business side, she says, it's "just not something that they have put a stake in the ground yet and said that they want to go after."

Ultimately, though, analysts say, the trend is headed toward a greater use of hosted software, particularly for small and midsize businesses that are looking to avoid the complexities and upgrade hassles that come with running their own software. What such customers really want is software that's functional, easy to use and has a low total cost--needs, Kingstone said, that the hosted software approach is well-suited to meet.

Such a move, though, presents more than technical hurdles for the world's largest software seller. One of the key issues is how Microsoft will price such offerings.

Gates agreed that pricing remains a big challenge. It's relatively straightforward for truly generic applications, but it quickly grows thorny as companies want to run their own unique business processes. Meeting the business needs of one customer could ultimately interrupt or slow work for another company.

"It's very hard to do service-level agreements and resource pricing when things get arbitrary," Gates said.

For Microsoft and other traditional software vendors, though, service-based pricing requires a broader shift in economics. Such companies are used to getting paid up front for licensing and then again for either consulting or ongoing support services. In a service-based model, all of those costs must be factored in to the monthly fee.

In addition, there's a shift in expectations, Wainewright said. With traditional software, companies like Microsoft are offering a set of capabilities that customers must either work into their businesses themselves or pay consultants to do. With a service, customers expect the product to work immediately and contain enough connectors to hook up with other business applications.

Another key question is how Microsoft might deliver future software-as-a-service products. Although Office Live and some other Microsoft products are delivered directly, the company has traditionally relied heavily on partners to sell and tailor its software.

But Gates and the analysts agreed that as there are definitely challenges, so too are there benefits.

One of the benefits for companies such as Microsoft is a consistent revenue stream. Since the late 1990s, Microsoft has been trying to get more of its sales to come from subscriptionlike contracts rather than through one-time licenses.

"I don't think there is any question that Microsoft would love to get there," said Paul DeGroot, an analyst with market researcher Directions on Microsoft. "It's quite evident, particularly as product release cycles get longer."

DeGroot said Microsoft's historical method of getting paid for a one-time license worked pretty well when major releases came every two to three years and customers moved comparatively quickly to update their software.

However, he said, many products are now getting updated more slowly, such as the company's SQL Server database and Windows operating system, which will have gone five years between major paid updates by the time the next versions are released.

"You may have a long dry spell there," DeGroot said. Microsoft has tried to fill that gap with various types of annuity pricing, such as its Software Assurance program. In such programs, Microsoft charges a portion of its original license fee each year in exchange for enhanced support and the right to receive any upgrades that are released.

In a sense, Microsoft has been moving to servicelike pricing even though it's been delivering its software in pretty much the same old way.

The response, analysts say, has been lukewarm. DeGroot said many companies have been less than enthusiastic about renewing such support pacts when they find there's not been a significant upgrade during the term of the contract.

Though Wainewright said Internet-based software services are a challenge for parts of Microsoft's business, such as MBS, he sees a potentially expanded role coming for the company's mainstay Office program.

"Office has an opportunity to be a rich client for these applications," he said. Because Office is so widely employed, companies can use it as a familiar interface to connect to these online applications. Wainewright pointed specifically to one way Microsoft is already doing that internally. In the company's Project Elixir, Microsoft is using Outlook as a means to view data from its third-party customer relationship management software.

Perhaps equally important, Microsoft is reshaping the overall Windows environment to better work in a world in which software resides both on a company's PCs and at remote servers hosted by another company. In particular, Wainewright points to the Indigo communications system that Microsoft plans to debut next year, alongside the Longhorn upgrade to Windows. Indigo will be a layer within Windows that makes it easier for separate programs to exchange data using Web services protocols.

Such efforts are particularly important to counter the growing threat of browser-based applications, Wainewright said, highlighting Google's Gmail as an example of "quite a powerful browser-based interface."

In the end, Gates sees a world in which there is a mix of both hosted software and that which is run from company-owned PCs and servers.

"Clearly we want to accommodate both models and give people even the flexibility if they want to switch from one approach to the other approach," he said. "But we'll have more to say about that."