Microsoft ( MSFT -1.79% ) has long been dependent on selling software -- its business centered around charging licensing fees for the Windows operating system and the Office software suite. But thanks to Google ( GOOGL -2.50% ), those days are coming to an end.
By offering its operating systems and software for free, Google has slowly eroded Microsoft's ability to charge for its products. To stay relevant, Microsoft may be forced to completely change its business model.
Windows: Cheap or free?
While the ongoing decline of traditional Windows-based PCs has largely been characterized as a byproduct of Apple's meteoric rise, in truth, the real culprit has been Google's Android. Shipping on the vast majority of both smartphones and tablets, Google's mobile operating system has slowly eaten away at the demand for Microsoft's Windows.
Earlier this week, research firm IDC revised its PC shipment estimates down, predicting that sales of Windows-powered PCs would continue to decline in the coming years. Previously, IDC had expected more demand from emerging markets, leading to a stabilization in Microsoft's core market.
But that demand doesn't appear to be there. Instead, emerging market buyers are turning to mobile devices powered by Google's Android. Eventually, Google's mobile dominance could spill over into the traditional PC market as well, as major PC manufacturers, including Lenovo, have unveiled Android-powered desktops.
Unlike Microsoft with Windows, Google doesn't charge for Android, which makes the operating system far more appealing to device manufacturers and ultimately end consumers. The same is true for Chrome OS, the web-dependent operating system that Microsoft's traditional hardware partners are increasingly embracing.
To bolster its market share, Microsoft may be forced to follow Google's lead, slashing its licensing fees, perhaps to zero. According to PC Mag, Microsoft is considering cutting the cost of a Windows Phone license fee by as much as 70%. The same is true for some versions of Windows 8. According to Bloomberg, Microsoft plans to cut Windows 8 licensing fees for copies of the operating system installed on certain low-cost models.
Microsoft is even considering giving away a version of Windows 8, according to The Verge. This edition, dubbed "Windows 8.1 with Bing," could be a free or low-cost update for owners of PCs running older versions of Microsoft's Windows.
Office Web Apps reborn
Google has also put some pressure on Microsoft's Office with its competing web apps. Free for consumers, and cheap for business users, Google's management has argued that it could eventually capture 90% of the market for Microsoft's Office.
Nothing close to that has happened yet, and given corporate America's addiction to Microsoft Office, it might never happen. Still, Microsoft appears to be mindful of Google's expansion into the Office market, and has responded with its own free version of Office.
Office Web Apps, originally launched in 2010, was a stripped-down version of Office available for free online. Last month, Microsoft made some significant changes to the product, renaming it "Office Online" and introducing a number of improvements.
It's still free, but is now deeply integrated with Microsoft's other web services and allows for real-time collaboration, making it a true alternative to Google Apps.
Is Bing the future of Microsoft?
Investors have long been critical of Microsoft's online efforts: Hedge fund manager David Einhorn argued in 2011 that Microsoft should get out of its money-losing online businesses, most notably Bing.
But Microsoft's management has remained protective. Now former CEO Steve Ballmer, responding to the criticism of Bing, said late in 2012 that he was "glad" Microsoft invested in Bing, and that he was "more excited about [it] than people would think." In his final speech to Microsoft's shareholders as CEO late last year, Ballmer again defended Bing, arguing that it was integral to the company's future.
That could ultimately be the case. If Microsoft has to follow Google in offering its software for free, it will have to monetize it in other ways: Making money from its web services could be one way to accomplish that.
In the 1990s, Microsoft was able to destroy the once-dominant Netscape Navigator and conquer the browser market by giving Internet Explorer away for free. Since every Windows PC came with a free copy of Internet Explorer, there was no reason to shell out $49 for a Navigator license.
Slowly but surely, Google seems to be doing the same to Microsoft. With Gartner analysts expecting Google's Android to subsume the market for Microsoft's Windows by 2017, Microsoft will have to transition to a business model that doesn't depend on selling software.