Microsoft (NASDAQ:MSFT) just unveiled what could either be its craziest or cleverest plan ever: offering free Windows 10 upgrades for pirated versions of Windows 7 and Windows 8.
The unorthodox decision is aimed at growing Microsoft's legitimate user base in China, where three-quarters of PC software isn't properly licensed. Microsoft doesn't disclose how much revenue comes from China, but former CEO Steve Ballmer claimed in 2011 that Microsoft's Chinese revenue was only equivalent to 5% of U.S. revenue, although both countries had roughly the same number of PC users.
Will giving pirates a free pass improve Microsoft's situation in China? Or will it backfire and gut Microsoft's Windows cash cow?
Why Microsoft's plan is clever
Upgrading pirated versions to legitimate versions of Windows 10 makes sense for two simple reasons.
First, it instantly increases Microsoft's legitimate user base, which will allow Microsoft to expand its ecosystem with Cortana, Spartan, Office 365, Azure, and Xbox One connectivity. Instead of charging an upfront fee for the OS, Microsoft could generate revenue in more passive ways, such as Bing search, ad revenue, and subscriptions to Office 365 and OneDrive. Tethering more users to that ecosystem will let Microsoft secure the Chinese market against Google (NASDAQ:GOOG) (NASDAQ:GOOGL), which remains crippled by various bans across China.
Microsoft is also partnered with Internet titan Tencent, security company Qihoo 360, and PC giant Lenovo to launch Windows 10, which should accelerate its adoption rate across China.
Second, it's a way for Microsoft to curry favor with the Chinese government. Last year, the Chinese government banned Windows 8 on its PCs for vague reasons, then raided Microsoft's offices on equally vague antitrust charges.
In my opinion, the reason China cracked down on Microsoft was its decision to end support for XP, which ran on most government computers. That decision highlighted the Chinese government's dependence on Microsoft, which it is trying to eliminate with its own Linux-based OS, Ubuntu Kylin.
Therefore, offering Windows 10 for free, with no strings attached, might convince the Chinese government to reinstall Windows. Microsoft previously stated that it won't upgrade enterprise versions for free, but it might make an exception for the Chinese government.
Why Microsoft's plan is crazy
The obvious flaw with Microsoft's plan is that it encourages everyone in the world to install pirated versions of Windows to wait for a free Windows 10 upgrade. Meanwhile, it alienates consumers who purchased legitimate copies of Windows.
It's also highly unlikely that ecosystem (Bing, Office 365, Azure) revenue will offset lost Windows license revenue after Windows 10 arrives. That's why the future of Windows 10 beyond its first year of "free upgrades" remains nebulous. Microsoft will likely have to pivot Windows 10 toward a subscription-based model, but the company has said little on the issue. Microsoft quietly trademarked the "Windows 365" brand earlier this year, fueling speculation that the company would pull the ultimate bait-and-switch after it consolidated the PC market under a single free OS.
If that happens, those former pirates will likely revert back to their old ways, and crack the OS to gain lifetime subscriptions to Windows. On the bright side, those pirates might remain tethered to Microsoft services like Bing, so it could be considered a partial victory for Microsoft.
Crazy or not, it's necessary ...
Microsoft investors probably saw this decision coming from a mile away. Last year, the company eliminated Windows license fees for phones and small tablets, and slashed fees for large tablets and cheap laptops.
Those decisions were intended to help OEMs launch cheaper mobile devices and laptops to counter Android devices and Chromebooks. To challenge Google Drive's free services, Microsoft encouraged OEMs to bundle free Office 365 and OneDrive memberships with Windows devices.
Offering Windows 10 as a free upgrade for a year was the culmination of that strategy, and extending that offer to pirates lets Google know that Microsoft is ready to fight fire with fire.
Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Google (A shares) and Google (C shares). The Motley Fool owns shares of Google (A shares) and Google (C shares). 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.