Microsoft (NASDAQ:MSFT) ended its free Windows 10 upgrade offer for Windows 7 and 8 users on July 29. The 12-month program converted some users, but the Windows market remains a deeply fragmented one, with Windows 10 powering just 21% of the PC market, according to Net Market Share. Microsoft recently claimed Windows 10 had been installed on about 350 million devices worldwide.
Windows 7 remains the most popular OS with 47% market share, Windows 8 and 8.1 account for about 10% of the market, and another 10% still use Windows XP. Last April, Microsoft boldly declared Windows 10 would run on a billion devices by mid-2018. But last month, Microsoft admitted it would miss that target. It pinned most of the blame on Windows 10 Mobile, but its PC adoption rate clearly remains tepid.
That's bad news for Microsoft, since it can't generate any Windows Store app revenue from Windows XP or 7 users. Those devices are also cut off from the "One Windows" ecosystem where phones, tablets, PCs, and consoles all share a common app store and cloud-based data. Therefore, I believe that Microsoft should have kept the consumer version of Windows 10 free forever, for three simple reasons.
1. Holdout users won't pay for upgrades
Consumers who missed the upgrade deadline now have to pay $119 to upgrade their systems. That decision is baffling, since consumers who weren't willing to upgrade their systems for free won't likely pay for the same upgrade. They probably also won't buy a new PC just to experience Windows 10.
Microsoft probably ended the free upgrade plan because it wanted to keep its word and show that it wouldn't offer its flagship OS for free forever. It also probably thought that PC makers and enterprise customers, which have been paying for Windows 10 licenses this whole time, might start demanding free copies as well.
2. Operating systems are mostly free
Unfortunately, Microsoft still doesn't seem to realize that its classic business model of selling operating systems has been turned upside down by Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google and Apple (NASDAQ:AAPL).
Google hands out Android for free, because the OS tethers more users to the data-mining ecosystem, which feeds its core targeted advertising business. iOS can't be installed on non-Apple devices, but Apple provides new versions for free via over-the-air updates. Both companies generate significant revenue by taking a 30% cut of app store sales.
Apple once sold OS X for Mac at prices similar to Windows', but the company made the OS free with Mac OS X 10.9 Mavericks in 2013. Apple can do that because it controls both the software and hardware. If Microsoft did that, it would lose its Windows revenue from OEMs, which account for most of the Windows business.
3. It's the only way to stay competitive
The only way for Microsoft to effectively compete against Google and Apple without a viable mobile platform is to mimic their business models with Windows 10. The only way to do that is to offer Windows 10 as a free download to all consumers until the user base is large enough to be tethered to its ecosystem of ads, apps, and cloud services.
Microsoft can likely continue charging PC OEMs, which don't have a viable alternative OS to Windows, and enterprise customers, which buy subscription-based plans with extra security features and rely heavily on older Windows-based software.
The Wall Street Journal estimated last year that direct sales of Windows licenses to consumers generate "roughly one-quarter to one-third" of Microsoft's overall Windows revenues, which would account for less than 3% of Microsoft's total revenue in 2016. Many consumers don't buy Windows licenses directly because they get Windows with new PCs -- in which case the OEM pays the fee.
Microsoft made the wrong play at the wrong time
Microsoft's decision to end free upgrades wasn't driven by revenue, since the consumer license business is small and holdout users are now less likely to upgrade. Instead, it was seemingly driven by a desire to cling to its classic business model of paid upgrades, even though Google and Apple rendered that strategy obsolete.
Therefore, ending upgrades now seems like the wrong play at the wrong time, and it would be wise for Microsoft to make the consumer version of Windows 10 permanently free to properly establish the foundations for its "One Windows" ecosystem.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool owns shares of Microsoft and has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. 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.