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Microsoft Can't Ignore Google Apps Forever

By Evan Niu, CFA - Dec 26, 2012 at 6:45PM

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Soon it'll be too late.

Instead of fully addressing the threat that Google (GOOGL -0.27%) poses, Microsoft (MSFT 1.47%) seems content to downplay the risk until it's too late. You'd think that the software giant would take it more seriously considering Google Apps is threatening Microsoft's biggest cash cow: its business division.

Last quarter, the business segment comprised 34% of revenue and 69% of operating income. So yeah, it's a pretty important division for Mr. Softy. Yet, in a recent New York Times article, Microsoft business exec Julia White said Google's isn't "truly serious" yet; "From the outside, [Google is] an advertising company." At the same time, Microsoft has launched its Office 365 cloud-based suite in direct response to Google Apps, and White said the service is set to become Microsoft's "fastest-growing business."

Dollars and sense
In fact, having productivity software as a side business is actually a strength for Google, since it can aggressively undercut Office without much risk to its overall bottom line. That's also why Google is such a disruptive threat to so many industries, as it likes to experiment for the sake of moat building and the going price for the vast majority of its services is $0. It's hard to compete with free.

In the case of Google Apps, it costs just $50 per person annually, dramatically less than the $400 per person annually that Microsoft demands, although many enterprise customers pay closer to $200 per person annually after volume pricing.

Office 365 starts at more competitive pricing around $72 per person annually, but in characteristic Microsoft pricing strategy, it offers a daunting number of packages at different price points, each with a different feature set. An Office 365 subscription with all the bells and whistles will set a business back by $240 per person annually.

Simplicity wins
In the report, one enterprise manager said one reason he went with Google was because it had a simpler pricing strategy. The exec would have had to sift through 11 different pricing models offered by Microsoft, each with different feature sets. Sometimes too much choice can be debilitating.

It reminds me of a Steve Jobs anecdote from Insanely Simple: The Obsession That Drives Apple's Success on Apple's (AAPL 1.30%) pricing strategy. Back in 2006, Apple acquired Silicon Color in order to include a color-grading tool in its Final Cut Studio software for video professionals. The tool, simply renamed "Color," had previously cost $25,000 per copy but Apple was going to bundle it in with the next version of Final Cut Studio.

The project manager wanted to have two editions with two prices: one with Color and one without Color. Eventually, Jobs had to sign off on the new software and he immediately shot down the idea of two editions: "Put Color in the Final Cut Studio box. We sell one product. Period."

Google recognizes the appeal of a simple pricing strategy and has maintained its $50 annual price point since the get-go.

The Feds are bailing
Even a slew of federal government agencies are making the switch. The General Services Administration said that the search giant scored 23 out of 42 government contracts this year for productivity software, with Microsoft garnering only 10.

The remaining nine went to VMWare's (VMW -1.08%) Zimbra subsidiary, which it acquired from Yahoo! (NASDAQ: YHOO) almost three years ago for an undisclosed amount. VMWare acquired Zimbra along with SlideRocket and Socialcast over the past few years to tap into the growing software-as-a-service market, a clear complement to its core virtualization business.

Moving mobile
The competition will inevitably turn toward mobile. Earlier this year, Google acquired QuickOffice, maker of a mobile productivity suite, for an unspecified amount. It seems entirely possible that Google could consider eventually bundling the package in for Google Apps subscribers to make it even more of a threat to Microsoft.

Rumors have persisted for years about Microsoft bringing Office to Apple's iOS platform, and that speculation may be about to come to fruition. Microsoft and Apple are reportedly at an impasse over the Mac maker's in-app subscription rules and 30% cut, but it still seems that Office for iOS is imminent.

Asymmetrical competition
Google is far more of a threat to Microsoft than the other way around. Microsoft has already proven that it hasn't fared well in trying to compete in online advertising (assuming that $6.2 billion goodwill impairments aren't a sign of success). Microsoft's business figures remain healthy for now, but Big G is chipping away.

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