Microsoft Licensing history and challenges

With the end of the Microsoft fiscal year coming around I thought I would write a little about what my fellow co-workers make their living on – the licensing of Microsoft Software.  It actually is a rich and exciting history and  good insight to the future of Microsoft. In 1976 Bill Gates wrote a letter titled “Open Letter to Hobbyists” in the MIT Homebrew Computer Club newsletter which expressed his frustration that many were using Microsoft’s BASIC programming language and distributing it without having paid for the software.  This letter is probably one of the most important documents ever written, not only for Microsoft, but for the entire technology industry.  The Open Source community may decry my assessment of this as the most vile and evil thing ever written, but without this document they would have no enemy.  If you don’t have an enemy you really don’t have much of a cause.  The letter establishes what Microsoft was going to do to build a business model and lead to billions of dollars in revenue.  All in the name of the right to profit on intellectual property.

When I started in 1991 one thing that had been in place for a while and was generating a lot of revenue was the OEM model.  I wrote about this earlier but this was the simple process of licensing software (early on MS-DOS and later Windows) to hardware companies who manufactured PC’s.  It was a great model for a new industry that was still trying to find its footing.  All these new PC manufacturer’s needed an operating system and at the time MS-DOS was cheap and could be licensed.  Some of those names became big players in the industry like Dell, Compaq and Gateway.  It was cheap for Microsoft.  Once you had created the disc you just made some copies and shipped to eth OEM who installed on their hardware.  It was simple math.  My cost is $1 to duplicate the disc and I charged $75 (this is a rough estimation).  The margins in the intellectual property business are usually greater than 90 percent. It has become multi-billion empire within Microsoft.  Whenever you watch CNBC or read the  Wall St Journal and it says PC shipments are up, it means Microsoft is making hundreds of millions of dollars.

What was beginning when I started at Microsoft was the more structured process of licensing to businesses.  Like all things it started small, but it represented a real “green field” opportunity for Microsoft.  Remember at this time the idea of personal computing was still new to many companies and with it they received a whole host of benefits, but at eth same time they had new headaches they had not experienced before.  When a new operating system was released did the company have to go to the local reseller and buy new copies of the OS?  would they get a discount after they had purchased so many copies?  Why did they have to do this, why couldn’t Microsoft?  Bing (no pun intended), a new licensing model was created.  First there was Select Agreements, soon to be followed by Enterprise Agreements.  Stay with me on this one as I know licensing is about as much fun as watching paint dry, but it is super important to helping one understand how Microsoft makes money and the challenges they face in the not so distant future.

First lets tackle a Select agreement.  In simple terms this is just a negotiated price sheet.  Only two things occur here.  The customer and Microsoft negotiate what will be on the price sheet.  The second being what will the discount be.  They are always three-year agreements.  From a sales reps perspective it is pretty simple – when they sell additional software into a company they place an order through their reseller who provides the quote back to the customer and collects the purchase order.  Pretty simple stuff – there is one additional things – maintenance or the current term software assurance (SA).  I purchase this at the time of order and if I want all future releases of Office I pay for SA, when it ships I automatically receive as part of my contract.  Usually however a Select agreement is not alone. 

Now we hit the big agreement the Enterprise Agreement.  I will say my bias in this whole blog is towards these EA agreements as I spent over half my career at Microsoft calling on Fortune 1000 companies and working with our account teams to facilitate the growth of these large cash cows.  The EA in short is a commitment.  A three year commitment.  It is a large part of the Microsoft licensing machine.  For many sales reps it is their lifeblood (or death depending on how the deal goes).  So what exactly is it?  It is a list of products a customer commits to that includes a product (Windows) with Software Assurance and payments are spread out over three years.  If you do a $60 million deal then it..(I take it most of my readers are good at math).  So there you have it you are all now Microsoft Licensing Specialists.  There is a job title at MS for Licensing Specialist, so apply now you are qualified.

Early on in the early to mid 90’s this was all greenfield opportunities for Microsoft sales reps.  Most companies needed an agreement with Microsoft and the products were really not many – in fact the first ones would be dominated by Windows and Office.  It was a great time to be in the field.  It created an odd sales model as well as when reps made and exceeded quota they were not compensated with huge commission bonuses but stock options.  As we all know in those days the stock options were the road to riches. It also created a very Redmond centric environment where the Product groups were all-powerful and the field was simply a delivery vehicle.   I only say the sales model is odd because to a large degree that mindset remains today and though bonuses are available the Microsoft field rep is not compensated like other industries.  Redmond still holds the view that they are the kings of the company.  It always cracked me up and made me angry when product managers would say “the field does not know how to sell our product”.   This despite the fact that they spent so little time in front of customers. This is why so many senior leaders who have joined Microsoft say that Microsoft truly lacks a sales culture.

To follow-up on this some more the days of stock options are gone and the EA agreements that were originally Windows and Office have grown.  Early on that was a good thing as Microsoft added more and more value into the EA.  However starting even before the financial market meltdown the agreements had encompassed so many products from Windows to Office, development tools, Server products (SQL, Exchange, BizTalk, OCS, MOSS etc..) all with client licenses, it had become apparent companies were in many instances paying for stuff they did not use.  When the market meltdown hit companies really started taking a closer look at not just Microsoft agreements but all agreements.  The challenge the field is now facing at Microsoft is how do you grow a business when companies are trying to shrink what they buy from you?  The answer from current Microsoft COO Kevin Turner has been “you take share from your competitors”.  I always found this a bit simplistic since in my view you are always trying to take share from your competitors – in the good times and the bad.  When it comes right down to it the acct execs and other sales professionals at Microsoft get brought into a spreadsheet excercise and provided the account team has done their job the numbers either go up or go down. 

Moving forward and looking towards the horizon there are big changes in licensing under way as the industry starts to look at cloud computing and subscription based services and move away from the traditional licensing of software.  It is not entirely new.  I was there at the beginning when we introduced at Microsoft Service Provider Licensing Agreements (SPLA) in 1999.  It has just taken a while for the technology to catch up and the market to be ready to make this move.  For sales reps it represents an entirely new “green field” opportunity.  You can see based on the latest sales hiring activities at companies like VMWare and  For Microsoft it represents both an opportunity and a challenge as they have to transition from traditional licensing models to new licensing models.  It is the challenge of having a legacy, which many companies entering the cloud do not have.  I have no doubt Microsoft will overcome th technical challenges it faces but the ability to handle the financial transition from “old school” licensing of IP to the modern world, in my view, will play a huge part in determining the success or failure of Microsoft in the next five years. 

Good Night and Good Luck.

Hans Henrik Hoffmann July 1, 2010

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