Since taking over as CEO of Microsoft (NASDAQ:MSFT) in February, Satya Nadella has shifted the focus of Microsoft from selling software licenses to selling cloud subscriptions. In an interview with CNBC earlier this week, Nadella practically admitted that Microsoft's old business model is getting disrupted by companies like Google (NASDAQ:GOOGL) (NASDAQ:GOOG), which offer freemium services that compete directly with Microsoft's cloud services.
Microsoft, under Nadella's leadership, hasn't sat idly by while competitors attract its former customers with better prices (free), and good value. In the interview, Nadella said, "The thing that I don't want us as a company to shy away from is usage first." In other words, build up a user base first, then figure out how to monetize it -- the freemium model. That's a big change for Microsoft, which is used to getting paid upfront for its software, but the transition is already underway.
Office for the iPad
The release of Office for iPad came less than two months after Nadella took over as CEO, and it's emblematic of the transition from premium to freemium. Microsoft is offering the software for free to users -- but they're limited to reading documents. If the user wants to edit documents on his tablet, he'll have to pony up $99 per year for a subscription to Office 365 -- Microsoft's cloud version of Office.
Without the bastion of Windows PC sales, Microsoft can no longer depend on its operating system to spur sales of its productivity suite. Both Apple (NASDAQ:AAPL) and Google have their own products, which they give away free. Apple started offering its productivity apps (like Pages, Numbers, and Keynote) free with the purchase of any Apple device last year. Google has always offered free access to its online Google Docs service (recently rebranded Google Drive).
With the release of Office for iPad, Nadella said Microsoft's goal is to "drive Office 365 everywhere." The freemium model will be key to getting people using Office again as they gravitate away from Windows PCs.
Windows new pricing model
The next big initiative from Nadella was to offer device manufacturers a free license to Windows for devices with screens less than 9 inches.
That's a pretty big shift considering Microsoft made its billions by charging OEMs for its operating system. But Nadella thinks the move will improve adoption of its mobile OS, which, in turn, will increase the number of developers making apps for the platform.
The app store is Windows Phone's biggest downfall, as it lacks the breadth and quality of apps in the Android and iOS app stores. If Microsoft can improve the app store by bringing more users to Windows Phone, it will sell more apps, but also increase sales of premium versions of Windows.
The first round of devices with the free Windows license are just now being released. Notably, HTC adapted its flagship smartphone to run Windows Phone. Few other big-name manufacturers have released Windows Phones since Microsoft put its new licensing policy in place. Time will tell if this strategy will actually increase adoption.
The freemium model also applies to Microsoft's cloud business. Its OneDrive cloud storage service was Nadella's primary example of how his Microsoft does freemium. New users are offered 15GB of cloud storage for free. That's significantly more than small competitors like DropBox (2GB), and on par with Google's Drive service. It's also more than the 5GB Apple provides free for iCloud users.
The free tier is extremely important for Microsoft because it isn't price competitive on its paid tiers. For 200GB of storage, OneDrive users must pay $100 per year. Comparatively, iCloud users pay less than half -- $3.99 per month -- for the same amount of storage. That's not so terrible for Microsoft, though, because iCloud runs on Microsoft's Azure platform, so it's still getting paid.
What's more threatening is how aggressive Google is with its pricing. For just another $9.99 per month, Google Drive users can get 1TB -- five times Microsoft's highest consumer tier -- of cloud storage. Google also gives away 100GB of cloud storage for two years for Chromebook purchasers -- a model Microsoft could copy with its Surface tablets.
Nadella commented that Microsoft only has two real competitors in cloud computing -- Google and Amazon. On the enterprise side, it's doing very well, but on the consumer side, the freemium model will be key to increasing adoption of its paid services.
Hitting the restart button
When Nadella took over as CEO in February, Microsoft effectively hit the restart button. His mobile-first, cloud-first approach means adopting a new business model -- one that's effective on mobile and with the cloud.
During the last few years, the freemium model has been proven on several occasions. If Microsoft wants to succeed in the multi-device, multi-OS world we live in, it must do what works today -- not what worked in the '90s.
Adam Levy owns shares of Amazon.com and Apple. The Motley Fool recommends Amazon.com, Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Amazon.com, Apple, Google (A shares), 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.