Microsoft Can't Sell Windows 8, So It's Giving It Away

Will users bite on a free Windows 8 upgrade? And if they do, can Microsoft make money by advertising to them?

Mar 5, 2014 at 1:00PM

Microsoft (NASDAQ:MSFT) is pulling a 180. After lambasting Google (NASDAQ:GOOGL) for collecting data on its users to sell ads, Microsoft is prepared to do the exact same thing. With weak sales of Windows 8, Microsoft is preparing to offer a free upgrade to Windows 8.1 for Windows 7 users. "Windows 8.1 with Bing," as the name implies, will feed users into Bing search and other Bing services as well as Microsoft's cloud-based services.

Free OS upgrades are something new to Microsoft, but not to the industry. Apple (NASDAQ:AAPL) offered free upgrades to its newest Mac OS X last year, and Google offers free upgrades for Chromebooks and Android devices that support the update. The move is questionable for Microsoft, however, which has typically received $50 per device from OEMs to license Windows.

Nobody is upgrading?
Windows 8 is a strong departure from its predecessors, focusing more on touch devices than traditional mouse and keyboard inputs. So far, the new user interface has been a flop. Only 10.7% of PC users have Windows 8 or 8.1 installed, according to Net Applications. More telling is that fewer than half of Windows 8 users have installed the 8.1 update.

Comparatively, Windows 7 commands a 47.3% share of the market, and 12-year-old Windows XP still has 29.5% of the market. Even though Microsoft has scheduled April 8 as the final day of support for XP, about one-third of Windows users are still on the operating system. The anticipated rush to upgrade has yet to materialize, and it might never happen.

Will a sizable chunk of those XP users who are left without virus protection and Windows 7 users, offered a free upgrade, make the jump to Windows 8? If they haven't in a year and a half, there's not much reason to think they ever will.

Windows Vista, an equally poor-performing Windows iteration, currently has just 3.1% market share. At 16 months, the point Windows 8 is in its life cycle, Vista had a similar 10.2% market share. It peaked at just 23.3% market share. It was quickly supplanted by Windows 7. Windows 8 may face a similar fate.

But let's say they do
Let's say Microsoft's strategy proves successful, and people start upgrading to Windows 8. Instead of charging $50 or even $15 per device sold, Microsoft expects to make up revenue in its advertisements and cloud services. But Microsoft is no Google, and its average revenue per user is nowhere near the Internet search giant's.

Last quarter, Microsoft successfully captured 18.2% of the U.S. search market. The company generated approximately $759 million in search advertising and $1.04 billion in total online advertising. Comparatively, Google took 67.3% of the search market, and generated $10.55 billion from Google sites during the quarter. Using some back-of-the-envelope math, Google is monetizing its users about 2.75 times better than Microsoft.

Granted, Microsoft isn't completely reliant on advertising. It hopes to improve sales of Office as users upgrade their operating systems. On the company's second-quarter conference call in January, CFO Amy Hood noted: "As people refresh a PC, and if they're buying Pro, those people often are Office customers, and so if they tend to buy on a transactional basis, we also see some impact through Office."

Windows, Mac, or Chrome?
Microsoft faces another problem: Mac OS is seeing increased adoption, even as PC sales fade. With Windows XP support expiring, most users will need to upgrade their hardware in order to upgrade their software. This leaves them with a choice of what hardware to purchase, and more often, that choice leans toward Apple.

With its latest iteration of iPads and Mac OS X, Apple is including its productivity suite along with new hardware purchases, which eases the cost burden of more expensive Apple hardware. Moreover, Apple's computers have a notably longer lifespan than most Windows PCs, adding value to the purchase price.

Additionally, Chromebooks are gobbling up a small chunk of new laptop purchases, and Microsoft is, of course, not too happy. This is the basis behind a recent decision to decrease the cost to license Windows 8 for manufacturers selling a PC for less than $250.

If you can't beat 'em, join 'em
Microsoft's new CEO, Satya Nadella, is certainly shaking things up at the company. In fact, this strategy is probably better than standing still, but it's only staving off an even bigger decline in revenue as Apple and Google eat into its market share and the PC market continues to decline. The company has a dud on its hands with Windows 8. Windows 9 can't get here soon enough.

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Adam Levy owns shares of Apple. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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