• Chart: Office Retail Pricing Changes

Retail prices of Office XP have been reduced by about 15%, and prices of individual Office components, such as Word and Excel, have been reduced by more than 30%. The move suggests that Microsoft sees more opportunity in the consumer market for Office, which has traditionally been a business product, if it brings the price closer to those of lower-cost application suites from itself and competitors. However, volume prices have not been reduced, and the new retail pricing reduces the appeal of volume purchases for small customers.

New Pricing

The estimated retail price (ERP; Microsoft does not set final retail prices) for Office XP Professional will drop from US$579 to US$499 and for Office XP Standard from US$479 to US$399. The ERP of individual applications in the Office Standard Suite (Word, Excel, PowerPoint, and Access) will drop from US$339 to US$229. The prices were effective May 28, 2003.

Although prices for Office have not changed much recently (Office XP Professional and Standard were US$20 less than Office 2000, but also included fewer components), Microsoft has reduced its price over the years. The ERP of Office 1.0 for Windows, for example, released in 1990, was US$995.

New Opportunities

Microsoft has several reasons for reducing Office and Office component prices, including the following:

Generate more revenue. Although Microsoft does not release results by sales channel, the retail channel probably does not generate substantial sales of Office XP Professional and Standard—rather, the vast majority of Office sales are believed to be to corporate customers buying volume licenses. Sales of Office by OEMs, which frequently offer attractive prices on Office when purchased with a new PC, are probably the second-most popular channel.

But the Office XP Professional and Standard bundles are too expensive for casual home use, particularly when compared with Microsoft Works or other inexpensive bundles that consumers might get free with a new computer. Since 2001, the US$149 Student and Teacher Edition of Office, identical to Office XP Standard, has also become very popular with consumers (who aren’t asked to prove their status as educational consumers when they buy the product).

Given that the full business applications suites currently generate little revenue in retail channels, Microsoft has good reason to lower prices in an effort to make them more attractive. If lower prices spark additional unit sales—to small office/home office customers, for example—they could quickly make up for the lost revenue on each unit sold. This may also reduce the temptation for small business customers to use the Student and Teacher Edition in spite of prohibitions against business use in the end-user license agreement.

Competition. High Office prices have left a vacuum in the consumer market that competitors have begun to fill. StarOffice from Sun Microsystems, for example, offers much of the functionality of Office Professional at a retail price of US$76, and Sun's volume customers can buy it for less than US$50. A related product, OpenOffice.org is a free, open-source application suite comparable to Office Standard. Although it is unlikely that open-source products represent a serious challenge to Microsoft in business markets at the moment (one estimate puts the 2004 market share of StarOffice and OpenOffice.org at about 10%), these products have the potential to put a ceiling on revenue growth in Microsoft’s Office business. The price changes could thus be seen as a preemptive action.

Get ready for Office 2003. With Office 2003 expected to arrive in fall 2003, the price cut can help clear out retail inventories of Office XP.

However, when Microsoft has offered similar reductions in the past, it has not applied price reductions to their successors as well. For instance, retail customers who purchased Office 4.0 close to the release of Office 95 were given technology guarantees that entitled them to upgrade to Office 95 at a lower price. This prevented Office sales from drying up before the release of Office 95, but had little long-term effect on the net price of Office.

In contrast, the recent price reductions, which Microsoft says will apply to Office 2003, represent a more permanent move whose effects will last well beyond the transition to Office 2003.

Volume Customer Impact

The retail price reductions will not apply to volume customers, which could cause some of these customers to question the value of their volume license agreement.

Retail products will now be available for nearly the same price that customers pay in some volume licensing programs. For instance, the ERP for Office Standard, at US$399, is only about US$20 higher than the estimated price in Microsoft’s Open Business volume licensing program.

Although retail products require product activation, this is not generally a big problem in a small office, and purchasing retail versions gives customers one benefit that volume programs lack: the ability to purchase discounted upgrades any time they like.

The only upgrade program for volume customers is Software Assurance (SA), which will cost a small business about US$220 for two years of upgrade rights on Office Standard, and which must be bought at the same time they purchase Office itself. Retail customers, on the other hand, will pay a bit more—US$239 for an upgrade—but they need not purchase the upgrade until they actually are ready to perform the upgrade. Moreover, retail customers can skip a version or two of Office without paying upgrade prices, while SA customers must renew their SA agreements every two or three years to be eligible for upgrades in future years. In some scenarios, SA may be more costly than simply purchasing new licenses.

The price reduction points out another anomaly in Microsoft’s embattled SA program: SA protects customers against future price increases, but it has no provisions for refunds if Microsoft reduces prices. If customers' paid-in-advance upgrades cost more than purchasing a full product at retail, this would make many volume customers who are already unhappy with the program even less inclined to renew or purchase SA.

Testing the Market?

Although it has announced how Office applications will be bundled, Microsoft has not announced the pricing of those bundles, and it might still reduce volume prices for Office. (In the past, bundles and bundle pricing were generally announced at the same time.) That leaves the door ajar for volume price reductions.

Such reductions could have several advantages:

Prompting upgrades. The last time that Microsoft got a major revenue boost from an Office upgrade was in 1999, with the release of Office 2000. Office XP only had a minor impact on business application revenues, and Office 2003 might not fare better, partly because it will not be boosted by the nearly simultaneous release of a new Windows client. This stagnation is largely because the company so dominates the business application market that it has few new customers to win, and most current Microsoft customers appear to be happy with earlier versions. About 30% of Office users are estimated to still be on the seven-year-old Office 97, and the largest portion of the remainder are using Office 2000. A price reduction that convinces a significant number of these customers to upgrade could generate more Office revenues than maintaining prices and suffering static sales.

Selling servers. Most of the new capabilities of Office 2003 are dependent on new Microsoft server products, which deliver new collaboration and digital rights management services for Office users. Any boost for Office 2003 sales is likely to improve the prospects for new Microsoft server products as well, including Windows Server 2003, Exchange 2003, SharePoint Portal Server, Real-Time Communications Server, and Rights Management Server. If Office 2003 sales are flat, however, many customers will not have Office clients that can take advantage of these new server offerings.

The retail price reduction then can be seen as a test of the elasticity of Office pricing. If Office Professional and Standard get a boost in retail channels, Microsoft could extend similar price reductions to volume customers as well.

Resources

A review of Microsoft’s consumer strategy can be found in "Three Imperatives Drive Consumer Strategy" on page 25 of the May 2003 Update.

For more information about Microsoft Office suites and pricing, see www.microsoft.com/office.

Volume licensing information is at www.microsoft.com/licensing.