Pssst! Office 365 customers pay Microsoft up to 80% more over long haul

Moving a corporate customer from "transactional" purchases of Office to Office 365 rent-not-buy subscriptions results in almost a doubling of revenue for Microsoft.

Microsoft loves subscriptions.

Moving a corporate customer from "transactional" purchases of Office -- the once-traditional practice of purchasing one-time, perpetual licenses that let workers use the suite as long as their firms want -- to Office 365 rent-not-buy subscriptions results in almost a doubling of revenue for Microsoft.

"Over the lifetime, the increased reach, the increased frequency in this example, as well as some yield, adding some incremental services, results in a 1.8 times lifetime value of that user in the transition," said CFO Amy Hood in a meeting with Wall Street last week.

Transactional customers buy Office once every five to seven years, said Hood. But by convincing businesses to subscribe to Office 365, specifically the E3 plan, Microsoft can realize an 80% increase in revenue over the years-long relationship. Office 365 E3 includes the core Office application suite, as well as cloud-based Exchange, SharePoint and Skype for Business, shifting those services from on-premises systems to Microsoft's servers.

In other words, for every $100 Microsoft earned the old way, it reaps $180 under the newer subscription regime over the long haul.

Hood laid out other scenarios, too, including one where an existing customer paid for Office with an Enterprise Agreement (EA), which by necessity also included Software Assurance (SA), the annuity-like program that for a fee provides rights to upgrades for a multi-year stretch. Before Office 365, that was the closest Microsoft came to a subscription model.

"[That] example, which is pretty frequent, is moving an existing EA customer to the cloud, and that results in a 1.4 times increase in the lifetime value of that same customer," Hood asserted.

Even new customers, who licensed Office but after three years paid only the SA annuity, were worth more to Microsoft if the company nudged the businesses to the cloud: Hood said the revenue multiplier for that category was 1.2x.

One expert scoffed at Microsoft's multiplier, which he said was actually a low-ball estimate. "A 1.8x multiplier? How about a 6x or 20x multiplier?" said Paul DeGroot, principal at Pica Communications, a consulting firm that specializes in deciphering Microsoft's licensing practices.

DeGroot's point was that Microsoft rakes in much, much more than just an additional 20%, 40% or 80% by pulling customers to the cloud. "I think those numbers are conservative," DeGroot said in an email. "I always remind customers that Microsoft's internal rationale for the cloud is not superior technology or a better fit for customers, but that they can switch customers from purely transactional strategies -- where they wait for Microsoft to produce value before buying in -- or from standard EAs, where customers can stop purchasing SA but keep using the product -- to a subscription model where the customer owns nothing and must continually pay Microsoft."

DeGroot, like many licensing gurus, is often called in when a Microsoft customer grows weary of paying Redmond and wants ideas on cutting costs.

"We routinely reduce customers' payments to Microsoft by 40%, and the two most recent engagements were 75% lower," asserted DeGroot. The latter, he said, was accomplished by dropping the SA annuity when the customer had no plans to upgrade in the next three years, the length of SA contracts.

"Customers can drop SA but keep using the latest products in the full Microsoft stack for the next three years with very little downside," DeGroot added. "That's devastating for Microsoft's revenue stream. But if Microsoft can get them into [Office 365] E3, that can't happen. Microsoft will determine what features are available, when they upgrade to new versions, and how much they pay."

Wes Miller, an analyst at Directions on Microsoft who regularly conducts the research firm's licensing "boot camps," agreed that Hood's estimates of revenue increases are in the reasonable ball park, especially when Office 365 E3 is compared to transactional customers.

"They're like people who buy a car and run it until it rusts," said Miller, referring to companies that hold onto a version of Office for five or more years. "They're upgrading every other iteration, or even skipping two," he said. Naturally, getting those customers to pay annual subscription fees results in more money for Microsoft.

But Miller also argued that enterprises that shift to the cloud are saving money elsewhere, particularly in managing on-premises email, which Office 365 E3 assumes responsibility for. But that savings may not happen immediately. "Most don't go full cloud, at least not right away," he said. "They're not able to write off all their on-premises."

There are other benefits companies see in subscriptions, even though the cost may be higher. "We've been seeing more clients moving up to Office 365," Miller said. "They say, 'We're not great at keeping up to date, and we now regret that.'"

That's one of Microsoft's strongest pitches, that a subscription means the customer is always on the latest version, or has the choice of the latest.

In her presentation to Wall Street, Hood also talked about even greater revenue opportunities based on selling more cloud-based services to Office 365 customers. "There is additional 'yield opportunity,' in our language, to add lifetime value here, in addition to adding users," she said. For Hood, "yield" means, in her words, "selling more things on top of an installed unit."

Kevin Turner, the company's COO, hit that same button when talking about the lifetime value of a customer. "When we get a cloud customer completely deployed and get utilization and consumption, it opens up with the first service, it opens up the ability for me to get the other services in there," Turner said. "So it's really a tip of the spear as it relates to the momentum that we get from a customer."

DeGroot did not disagree. "Switching [customers] to the cloud will save Microsoft the potential for revenue declines and generate a steady, higher revenue stream, no question," he said.

But the increase in Microsoft's revenue from subscriptions like Office 365 comes from somewhere, and DeGroot argued that in most cases it comes from customers' pockets. "Any CIO who goes for this without thorough analysis should resign," DeGroot said. "He/she won't have much to do in the future anyway."

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