• Sidebar: What's New in MSN 8

MSN is updating the client software for MSN Internet Access, hoping to draw new users to the service and reduce churn rates. The new client, which adds features such as parental controls, spam filtering, and a new e-mail interface, will also be sold to users of other ISPs for a monthly fee. MSN will also cut costs, particularly by reducing expenditures on promotions. By increasing the number of paying MSN Internet Access subscribers, selling the MSN client software separately, reducing operational costs, and possibly increasing prices, Microsoft hopes to bring MSN into the black. This is particularly important as Microsoft subjects the unit to greater financial scrutiny by investors.

MSN 8: Updated Client, Business Strategy

As it traditionally does every fall, Microsoft will update MSN in fall 2002. However, while past updates focused on the MSN Web portal, this year's new features will be delivered exclusively in new client software called MSN 8 (which is essentially an updated version of the MSN Explorer client software introduced in fall 2000). The MSN 8 client will include a subset of features from existing Microsoft products, such as Outlook Express, Encarta, and Money, along with other features such as parental controls and better spam filtering. (For a detailed rundown of the new client, see the sidebar "What's New in MSN 8".)

MSN 8 will replace MSN Explorer as the default Web browsing and e-mail client for all MSN Internet Access subscribers, and for subscribers to certain ISPs that have partnered with MSN, such as Qwest and Verizon.

MSN 8 will also be sold to the broad consumer market as an alternate Web browser and e-mail client. Instead of giving the client away or charging a one-time fee, however, Microsoft hopes to charge users of other ISPs a monthly fee (probably about US$10) in addition to what they're already paying for Internet access. Distributing the client to these users could be tricky, as Microsoft will continue to bundle MSN Explorer—not MSN 8—with Windows XP. The MSN 8 client will be advertised and offered as a free download on the free MSN Web portal, and might also be distributed through marketing agreements with OEMs, ISPs, and other partners.

Revenue Crunch

MSN 8 is the latest effort by Microsoft to increase MSN's revenues and turn it into a profit center for the company.

Although Microsoft has never released financials for MSN Internet Access, the ISP is almost certainly not profitable. A recent New York Times article calculated that MSN Internet Access takes in an average of only about US$11 in Internet access revenues for each subscriber—not enough to break even, and far less than Earthlink (about US$21 per user) and AOL (about US$18 per user). That's because many of the reported 8.7 million MSN Internet Access subscribers are using the service for free as a result of promotions, and a large percentage of these users leave when their free trial is finished. According to a Forrester Research study of 16,000 Internet users released in June 2002, MSN Internet Access has the highest rate of customer defection of any major ISP: only 43% of the respondents who were using MSN Internet Access when the study began in 2001 were still signed up a year later. In contrast, AOL kept 79% and Earthlink 66% of its customers.

Meanwhile, online advertising and e-commerce are in an industry-wide slump, which has put additional revenue pressure on MSN. Although advertising and e-commerce revenues for the portal remained flat in most of 2001 and 2002 (which was enough to outpace some online competitors, such as Yahoo), Microsoft cannot rely on free Web sites for future revenue growth.

Previous Plans Highly Speculative

Understanding that it somehow needs to break out of this revenue crunch, MSN has been saying for about two years that it would roll out some type of online service, beyond basic Internet access, for which Internet users would pay a monthly fee.

These proposed premium services have been highly speculative from both a technological and business perspective. For example, the .NET My Services (HailStorm) were supposed to allow users to store personal information in an online repository at Microsoft, then make it available to a wide variety of applications, devices, and third parties. MSN hoped to roll out its own fee-based services based on the underlying .NET My Services technology, but lack of a clear revenue model for partners, as well as some technology holes, have delayed these plans. (See "New Strategy Devised for .NET My Services" on page 20 of the Apr. 2002 Update.)

Other proposed premium services have focused on entertainment, such as an integrated online music service that could let users download songs, check concert listings, and buy event tickets. But concerns about copy protection have made entertainment companies hesitant to offer digital content online, and AOL Time Warner owns so much content that MSN would be hard-pressed to create a competitive service.

Back to Basics: Selling Software

In contrast with these esoteric and untested services, MSN 8 is intended to increase MSN's revenues while sticking with a business Microsoft knows and understands: selling desktop software.

Specifically, MSN 8 is designed to increase MSN's revenues in three ways:

• By attracting new users to MSN Internet Access, thereby spreading the fixed cost of the ISP service over more users
• By reducing the defection rate of MSN Internet Access users so they stay on the service for long enough beyond their free trial period to become profitable
• By allowing MSN to charge a monthly fee to users of other ISPs.

Although Microsoft has not revealed any pricing information for MSN 8, it is also possible that the company will use the client to justify raising the price of MSN Internet Access.

Moreover, because many of the features of MSN 8 were already developed for other Microsoft consumer software, the client was relatively inexpensive to develop.

Cost-Cutting Measures

MSN is also trying to increase its profitability by cutting costs.

At Microsoft's annual meeting for financial analysts in July 2002, MSN Vice President Yusuf Mehdi said that reducing the cost of customer acquisition was MSN's "number one" area for improvement. To build subscriber numbers for MSN Internet Access, Microsoft used to work with partners (particularly OEMs) to give exceptionally generous rebates. For example, one deal offered a year of free MSN Internet Access for customers who bought certain new PCs; another offered a US$400 rebate on the price of a new PC if the customer signed up for MSN Internet Access. According to Mehdi, these "very rich deals" are being replaced by "more modest" incentive programs, such as offering 90 or 180 days of free access.

MSN will also cut costs by using a standard set of tools for managing MSN Web properties and content and by negotiating aggressively with partners to lower fixed costs, such as content licensing fees for the Web sites and the cost of MSN’s Internet backbone access.

Last, Microsoft will continue to add monthly charges to cover the costs of services on the MSN portal it currently offers for free, but which are expensive to operate. For example, the company now charges for some Hotmail services that were formerly free, such as the ability to collect messages from multiple e-mail accounts into one Hotmail account. Although these fees do generate monthly revenue, MSN views them as a cost-control measure, not a source of long-term revenue growth. As MSN Product Manager Lisa Gurry explains, MSN's long-term strategy "is not to take a bunch of services that are available for free and start charging for them," but rather, "to create a value-added suite of services" and offer them through the MSN client, as it is doing with MSN 8.

New Strategy Faces Closer Scrutiny

MSN's new software-driven strategy will play out under tighter scrutiny from investors and the rest of the company. Facing a flat stock price and a new economic climate in which investors are insisting on clear, detailed corporate financial statements, Microsoft will begin reporting MSN's revenues in the company's quarterly earnings calls and will reveal MSN's quarterly operating income or loss in filings with the U.S. Securities and Exchange Commission. (For background on this decision, see "Seven Core Businesses Explained".) As these numbers finally become visible, investors—and employees in more established Microsoft divisions, many of whom resent the resources allocated to MSN—are unlikely to tolerate continued losses.

MSN has undergone many transitions since its introduction in 1995, from an ISP to a collection of TV-like interactive Web programs to a portal, and now to a subscription-based software offering. Laying the unit's financial performance bare to critics could mean these years of experimentation are finally coming to an end.

Resources

For background on MSN Explorer, see "Latest MSN Launch Integrates Brand, Targets AOL" on page 22 of the Dec. 2000 Update.

For background on MSN's relationship with Qwest, see "Qwest Deal Brings DSL, Ads," on page 21 of the June 2001 Update.

For background on MSN's relationship with Verizon, see "Verizon, MSN Team Up on Broadband" on page 27 of the Aug. 2002 Update.

For background on Hotmail and what it charges for, see "Hotmail Adds New Charges" on page 19 of the July 2002 Update.