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A Subscription for Microsoft Windows?

By Timothy Green - May 27, 2014 at 1:15PM

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A leaked screenshot suggests that Microsoft will soon offer a subscription version of Windows, Windows 365. Here's what it means for Microsoft.

A Chinese leaker recently posted a screenshot which points to the existence of various upcoming products from Microsoft (MSFT -0.74%), including Windows 9, Office 2015, and a touch-friendly version of Office codenamed Gemini. The most interesting piece of information, however, is the mention of Windows 365, presumably a subscription version of Microsoft's operating system in the same vein as Office 365. While the average consumer would likely balk at the notion of paying a monthly fee to use Windows, enterprise customers are a different story.

Eliminating the upgrade cycle
Office 365, Microsoft's subscription version of its dominant productivity suite, has been growing rapidly since it was first released. The enterprise version had a $2.5 billion annual run rate at the end of the most recent quarter, representing 100% year-over-year growth. It's clear that the subscription model is appealing to enterprise customers. Instead of buying licenses for new versions of Office every few years, a subscription spreads these costs out and allows customers to always have the most recent version of the software.

The argument for Windows 365 is much the same, and the recent hoopla surrounding the end of support for Windows XP demonstrates why both enterprise customers and Microsoft would benefit from a subscription version of Windows. When Microsoft officially ended support for Windows XP in April, an estimated 30% of Windows users were still using the outdated OS. Organizations like J.P. Morgan and the Internal Revenue Service were forced to pay Microsoft millions of dollars in support while they upgraded thousands of PCs, and anyone still using Windows XP is subject to serious security issues.

A subscription version of Windows would prevent something similar from happening in the future. Enterprise customers are typically slow to upgrade software, especially operating systems, so for Microsoft a subscription-based Windows would avoid the trouble of having to sell new versions of Windows to its customers. Instead, customers would always have the latest version, eliminating the upgrade cycle altogether, and Microsoft would be relieved of the problem of reluctant upgraders.

For enterprise customers, the cost of Windows could be spread out over time instead of making large, discrete payments at every upgrade. The success of Office 365 shows that this payment model is appealing to a significant number of enterprise customers, so it's really no surprise that Microsoft plans on offering a subscription version of Windows as well.

What about consumers?
While a subscription version of Windows seems like a good idea on the enterprise side, the consumer side is a different story. With alternatives like Google's (GOOG -0.69%) (GOOGL -0.72%) Android tablets and Chromebooks, Windows PCs have more competition than ever before. The changes made in Windows 8 compared to Windows 7 certainly didn't help the perception of the Windows operating system in the minds of consumers, but being forced to pay a subscription fee would do far more damage.

While we have no details at all about how Windows 365 will work or even a confirmation that it exists for that matter, I suspect that Microsoft is slowly moving toward offering a free version of Windows for consumers. This is purely speculation, of course, but Microsoft could offer a basic version of Windows 9 (or whatever the next version of Windows is called) either for free or for a very low cost. It could then charge a subscription fee for the more advanced features that are typically found in the professional versions.

Since Microsoft derives most of its profit from enterprise customers, the hit from giving away basic Windows to consumers wouldn't be all that dramatic. In the most recent quarter, the commercial segments generated $9.9 billion in gross profit, growing by 6% year-over-year. The consumer segments, in contrast, generated just $4.7 billion in gross profit, down slightly year-over-year. While the consumer side of things certainly isn't irrelevant, the bulk of both Microsoft's profits and growth are coming from the enterprise.

Part of the problem is competition from tablets and Google's Chromebooks. A free version of Windows would make low-end Windows devices more competitive. A Windows laptop can already be bought for $300, but a free version of Windows could drive this price down into Chromebook territory. Chromebooks priced as low as $200 are routinely among the top-selling laptops on Amazon, so while they may not quite be mainstream devices, they are picking up at least some market share at the low-end. Chromebooks are inherently limited devices, though, and with no price advantage preference becomes the only reason to not buy a Windows device instead.

The bottom line
On the enterprise side, a subscription version of Windows makes a lot of sense. The success of Office 365 is a testament to the value that enterprise customers see in the subscription model. On the consumer side, Windows 365 could end up being a way for Microsoft to give a basic version of Windows away for free while charging for more advanced features, crushing Chromebooks in the process. While everything is speculation at this point, a subscription version of Windows seems inevitable.

Timothy Green owns shares of Microsoft. The Motley Fool recommends Google (C shares). The Motley Fool owns shares of Google (C shares) 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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