• Illustration: Two Lending Models for MS Capital

Microsoft’s little-known MS Capital business unit supports Microsoft’s business priorities by tapping its cash reserve to help customers purchase the company’s software more easily. Although Microsoft has offered no-interest software financing for enterprises for some time, MS Capital’s focus is primarily on small and mid-size businesses. The financing strategy lets the company maintain prices in tough economic times and could convince smaller customers to make purchases that they might not otherwise have considered.

Easier Software Purchases

Microsoft has provided low-cost financing for enterprise customers for several years as an inducement to buy Microsoft products. For example, some of its volume licensing agreements allow customers to divide the cost of their software into two or three annual payments, rather than pay the full cost up front. No interest is charged for the unpaid balances. The company’s Select License and Enterprise Agreements have offered this option for some time, and next year the company will offer it for its Open License program, aimed at smaller businesses. Such plans allow a customer to begin using software immediately while having paid only one-half or one-third of the price in the first year.

During 2002, the company periodically offered special financing programs for Open License. For example, the Open License Credit Plan, in place until Jan. 2003, offers 0% financing over 24 months for purchases of software that include Software Assurance (which gives customers the right to upgrade to any new versions released during that time). In the past, Open License customers who purchased new software with upgrade rights had to pay the full price of the software, plus two years of Software Assurance (which costs an additional 58%), in a single lump sum. (For more information about Open License financing programs, see "Partner Compensation Introduced for Open License Sales" on page 21 of the Dec. 2002 Update.)

Beyond Installment Plans

Microsoft not only offers installment payment plans, but in some cases it actually lends money to partners for hardware and software purchases.

The idea of lending customers money to purchase software first emerged in the OEM division. Smaller computer system builders can open an OEM System Builder Instant Credit Line to purchase up to US$150,000 (recently increased from US$25,000) of hardware and software (including non-Microsoft products) from about a dozen participating distributors.

Nearly 4,000 system builders have taken advantage of this program, and Microsoft has lent them a total of about US$135 million.

A more ambitious plan for small business software purchases, Total Solution Financing, was announced in September. Backed by MS Capital and sponsored by Microsoft’s Business Solutions (MBS) division (which incorporates products from the Great Plains and Navision acquisitions and services from Microsoft’s bCentral Web site), the plan will lend customers money to purchase not only Microsoft software, but hardware and IT services as well. Entry to this program requires the purchase of at least US$10,000 worth of MBS software. David Kaminski, general manager of MS Capital, estimates that this program will become MS Capital’s largest lending program in 2003.

(For more details about MBS, see "Business Solutions Group Begins to Consolidate" on page 9 of the Nov. 2002 Update.)

Strategy: Promote Key Products

MS Capital is an effort by Microsoft to "prudently and profitably deploy a portion of the cash on its balance sheet" to facilitate software and technology purchases, says Amar Nehru, Microsoft’s general manager of financing strategies. The company will use its formidable cash holdings to increase sales of software, rather than lock all of its cash up in conservative investments that, in today’s investment climate, generate low returns. However, according to Kaminski, even rising interest rates would not prompt Microsoft to reduce MS Capital’s activities because the company is interested in using its cash holdings to encourage overall sales and improve customer satisfaction throughout the purchase process.

By helping customers purchase its software, Microsoft’s capital can increase sales without reducing prices or profit margins. Although this might delay the collection of some revenues, profits in the long run are not affected negatively by this type of inducement unless purchasers default on their payments.

Microsoft can also use its capital to promote particularly strategic products. For example, to take advantage of annual payments for software (rather than lump sums), customers must typically agree to purchase Software Assurance, an upgrade rights program that bumps the annual price of the software by up to 29%. Software Assurance has been controversial, and Microsoft believes that offering annuity payments with no interest will overcome some of the resistance to the program.

The system builders’ program attracts small companies with limited financial resources, many of whom might otherwise be invisible to Microsoft. Among other things, the program helps Microsoft track the activities of small system builders and gives the company a channel through which it can promote antipiracy messages, training, and new products.

SMBs the "Sweet Spot"

Vendor financing of software is not a new idea: not only has Microsoft done it in the past, but competitors such as Oracle and IBM also do it. Oracle has helped customers purchase some US$1 billion of its software over the last decade, and the giant IBM Global Financing has US$40 billion in assets on its books.

Most of this financing activity has been aimed at large corporations making big-ticket purchases (in IBM’s case, for example, financing is used for mainframe hardware and maintenance services, as well as software), but Kaminski says the small and mid-size business (SMB) segment is today’s "sweet spot" for financing. That’s because traditional lenders regard software as too risky—it’s an intangible that cannot be secured—and smaller companies have less clout with lenders. But Microsoft is willing to take the additional risk due to the revenue that software sales generate and the high gross margins on software, Kaminski says.

Moreover, it’s a huge market: AMI Partners, which specializes in marketing programs for SMBs, estimates that SMBs will spend more than US$130 billion on IT in 2002. This market is also far more likely to be using less-expensive Microsoft software than products from enterprise-oriented competitors.

Lender Relationships

Kaminski says MS Capital has access to as much of Microsoft’s cash that it can reasonably use; the amount committed so far is a tiny fraction of Microsoft’s available capital.

In general, the company prefers to lend its own capital, but it doesn’t want to run lending programs. Instead, it will rely on firms that specialize in lending, such as Household Bank (its partner for the system builders program), to review loan applications, approve loans, and handle payment and collection, following guidelines developed in concert with Microsoft. Lenders will receive a fee for each loan they process.

By limiting its role to providing capital and lending guidelines, Microsoft avoids the need to develop expertise in lending and a large staff to manage a loan portfolio. Thus, in spite of the fact that the company is likely to be lending several hundred million dollars to SMBs next year through existing and new programs, MS Capital will have fewer than 10 staff, Kaminski said.

In some cases, the company will attach its name to programs in which traditional lenders use their own capital. That’s more attractive to those lenders because they prefer to use their own capital and make the "spread" between borrowing and lending rates, rather than take a fee from Microsoft for managing the loan, which is the arrangement that Microsoft has with Household Bank. (For a graphical view of both types of arrangements, see "Two Lending Models for MS Capital".)

In certain instances, the company will have little choice but to let other vendors provide the capital. A recent program for SMBs in Brazil, for example, ran into so many complications involving regulatory requirements, currency exchange rates, and other issues that Microsoft eventually let a Brazilian bank provide the capital and run the program. Microsoft will provide additional funds so the bank can reduce the interest rate and make the program more attractive to the target SMB market.

Resources

The Open License Credit Plan is described at www.microsoft.com/licensing/programs/open/finance.

The System Builder Instant Credit Line is described at oem.microsoft.com/namerica/script/516832.asp. Access is limited to those who have registered as system builders.