Google Has Forced Microsoft to Change Its Business Forever

Last week, Microsoft (NASDAQ: MSFT  ) made a radical change to its business model, effectively doing away with the strategy that helped it dominate personal computing: Going forward, it will only charge OEMs for Windows licenses if the device in question has a screen size 9 inches or larger. In other words, Microsoft is now giving away Windows 8.1 and Windows Phone to tablet and phone manufacturers. It will still, however, charge for copies of the operating system installed on traditional PCs and laptops.

At least for now.

It's become abundantly clear that the days of charging for an operating system are rapidly coming to a close: By giving away Android, and to some extent Chrome OS, Google (NASDAQ: GOOG  ) has forced Microsoft's hand and has slowly destroyed its long-standing business model.

With Android and Windows, history repeats itself
Before the announcement, there had been widespread chatter that Microsoft had made (or was considering making) cuts to its Windows licensing fees. Although Android OEMs have to pay Microsoft royalties, Google doesn't charge for the mobile operating system, giving handset and tablet manufacturers a financial incentive to use it. The same is true for Chrome OS.

That puts Microsoft in a tough spot, as Google's operating systems have risen to dominate the globe. Gartner projects that Android will power more than 1 billion devices shipped this year. In contrast, IDC expects Windows PC shipments to come in at fewer than 300 million.

The whole episode is reminiscent of the browser wars in the mid 1990s, when Microsoft, by giving away Internet Explorer for free with a paid copy of Windows, more or less ran Netscape out of business. Before the introduction of Internet Explorer, Netscape had been charging $49 for a copy of its popular Navigator -- it found it quite difficult to compete with Microsoft's free alternative.

How much longer until Microsoft completely gives Windows away?
Microsoft doesn't plan to give Windows away for traditional PC and laptops users, but it seems inevitable that it will be forced to, at least eventually. There are 8-inch tablets on the market right now that sport full versions of Microsoft's Windows. While a bit less powerful, they could eventually cannibalize sales of competing low-end, Windows-powered laptops and desktops.

By cutting the Windows licensing fee to zero, Microsoft is giving manufacturers more room to price these devices aggressively, which could make them more attractive to consumers who had otherwise planned to buy a traditional laptop or desktop. Lenovo's ThinkPad 8, for example, is an 8-inch tablet with an HDMI-out port and docking capability -- attached to an external monitor, mouse, and keyboard, it could easily replace a traditional PC.

Putting aside potential intra-Windows cannibalization, Google is encroaching on Microsoft's PC dominance in other ways. Chromebooks, for instance, remain a small minority of global PC shipments (less than 1%), but have experienced rapid growth in the last year, particularly among educational institutions who turn to them in place of traditional laptops. Google's Chrome OS powered almost one-fifth of the laptops sold to K-12 schools in 2013, and its growth has been enough to solicit attack ads from Microsoft. At the same time, Android has made the jump from tablets and phones to a few desktop PCs, although this trend remains nascent.

A growing number of users are making smartphones and tablets their primary computing devices, eschewing traditional PCs altogether. With that trend in mind, last year analysts at Gartner predicted that, by 2017, Microsoft's Windows would be virtually irrelevant, replaced almost entirely by Android.

Microsoft without Windows
A free Windows could help to prevent that, but at what cost? Last year, Microsoft reorganized its divisions, obscuring Windows' performance by grouping it with other segments. Microsoft's devices and consumer licensing division includes Windows sales to OEMs, but also includes consumer Office sales and Android royalties. The enterprise licensing division includes Windows licenses sold to businesses, but also includes Windows Server and Office.

The last time Microsoft broke out Windows' performance was the fourth quarter of fiscal year 2013. Back then, Windows was generating about about one-fifth of Microsoft's revenue and one-sixth of its operating income. Presumably, both these figures will decline to zero in the coming years -- that's probably why Microsoft reorganized its divisions in the first place. Microsoft's without a for-profit Windows isn't necessarily a bad thing. If giving away Windows results in more market share, Microsoft can make up the difference by selling other software and services. Bing could finally turn a profit, as it's become more heavily integrated with the Windows operating system.

One thing is for certain: The days of charging for an operating are effectively at an end. With Android, and some to extent Chrome OS, Google has forced Microsoft to fundamentally alter its business model. For most of its history, Microsoft's business was built around selling Windows licenses -- those days are over.

Microsoft is spending hundreds of millions trying to beat Google to the punch
The tech world is changing. Microsoft may have missed out on the mobile revolution, but is betting big in an attempt to beat Google and Apple in the next big growth market. But if you thought the iPod, the iPhone, and the iPad were amazing, just wait until you see this. One hundred of Apple's top engineers are busy building one in a secret lab. And an ABI Research report predicts 485 million of them could be sold over the next decade. But you can invest in it right now... for just a fraction of the price of AAPL stock. Click here to get the full story in this eye-opening new report.

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  • Report this Comment On April 08, 2014, at 1:27 PM, emilykulish wrote:

    Again, Sam, you are helpless, you will be miserable for years to watch Microsoft crushing Google. By offering Windows free on WP and small tablets, almost everybody agrees it's a right move for Microsoft, and Microsoft's stock is up far more than Google this year.

    Google is in a losing battle as now WP is totally free, whereas Android OEMs have to pay Microsoft $5-10 per unit. Moreover, there are numerous lawsuits filed against Android OEMs, a result of Google's stealing patented technologies from other companies.

    At this time, Google is a boring company with no growth. Its market has saturated. Google won't be able to find more users like you. In fact, from all research, Microsoft's WP and tablets will gain market share from Google's. Google probably will still make a lot of money, but the fast growth is gone.

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Sam Mattera

Sam has a love of all things finance. He writes about tech stocks and consumer goods.

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