Microsoft climbs aboard the new infrastructure economics

Cortana, Microsoft’s clone of Apple’s Siri, got a lot of the attention and ink during last week’s Build conference, but the real news was something more foundational, and economic. Microsoft showed that is the company is heading toward price of zero for Windows.

The future is not in operating system revenues, it is operating system relevance.

Last week’s announcement was limited to Windows on devices with screens under nine inches, which is effectively segregating laptops and desktops from tablets and smartphones. On paper, Microsoft is giving up a lot of income, but the reality boils down to a gamble the company needs to make.
The new economics of computer infrastructure is that operating systems are free. That’s what has become the norm for smartphones, tablets, and most recently, with Apple’s decision to make OS X Mavericks free (see What Apple’s zero pricing of iOS, Mac OS X, and iWork means), and Google’s approach with Android.
Microsoft is also in the position of having a very weak hand to play in the under nine inch device market, so Microsoft’s Nadella, the new CEO, is taking away the price barrier to any partners who want to make phones or tablets running Windows. Nokia was Microsoft’s biggest partner for Windows phones, and the merger of the two companies will be consummated next month.  So, whatever revenue the company might have received from an independent Nokia will soon be moot, anyway.
This is most obviously a play against Google’s Android — which which makes up over 75% of smartphones sold — and to a lesser extent, Apple, whose iOS captures the great majority of profits in the smartphone business. If Microsoft wants either share or profits it will have to be shipped on more platforms: hence, the new economics.
But I am betting that some time soon, Microsoft will drop the carefully drawn line of demarcation — the nine inch screen — and simply make Windows free everywhere.
The future is not in operating system revenues, it is operating system relevance. The new economics are trending toward zero not because operating systems are a commodity, but because the real decisions for buyers — both individuals and businesses — are what apps and services to use.

The place to make money in this new economy is not the apps and operating systems, but tools for connection.

Microsoft needs to make money from services like Office 365, for which they can charge people a monthly or annual fee. This is the same logic that drove the long-overdue releases of a free Microsoft Office for iPad recently (Office comes to the iPad, at last) and which led to an enormous surge of downloads as a result (see Office for iPad posts 12M downloads in first week). And which confirms the new economics, where the productivity apps that people use everyday in personal and business context will be free, as well.
The place to make money in this new economy is not the apps and operating systems, but tools for connection. Connection at the information level, where people will pay for services to sync their devices so that files and application data will flow quietly and invisibly from device to device, and at the social level, so that people can share information with others, for work or personal reasons. So Microsoft’s future is making money from Office 365, One Drive, Sharepoint and Yammer, and not from Word, Excel, Powerpoint or Windows.
The remaining question is how will Nokia fit into the new context? Nadella and Gates were opposed to the merger, and the rationale is still questionable at best. I predict that they will do more or less what Google did with Motorola, which is to pull out a small number of good ideas and technologies, and then to repackage Nokia and the devices business, and make suitable for a sale.
Why? At the very best, Microsoft can only hope to join the contest for a low-margin business — against Android cell phone manufacturers — which is now dominated by companies like Samsung and LG. Now that Windows licensing and Office sales on those devices are going away, what is the purpose of building hardware? And the same argument holds with tablets.
The fallback will involve a spin-out or sale of the Nokia business post merger, along with other Microsoft assets linked to Windows phones and tablets. It’s only a question of how long Nadella will wait before lopping off the dumb parts of Microsoft.