• Sidebar: SA Rules
• Sidebar: Product Futures by Pool
• Chart: Winning the SA Bet

Microsoft’s annuity licensing plans face a major test in 2005, when many licensing agreements are up for renewal. Customers are taking longer to make renewal decisions, and changes to Microsoft product roadmaps have altered the value and timing of future updates, making it more difficult for customers to determine the value of paying for them on an annuity basis. With future releases uncertain, other benefits of volume licensing (of which annuity licensing is just one part) will assume greater importance. Customers need to consider all the options, including full renewal, renewal for one year, or nonrenewal.

Annuity Licensing Plans

Microsoft’s main annuity payment offering, Software Assurance (SA), covers software updates for volume licensing customers.

It is automatically included (and mandatory) for licenses purchased through Enterprise Agreements (EAs), for customers with more than 250 PCs, and through the Open Value volume licensing program, for customers with fewer than 250 PCs. These programs focus primarily on desktop software, although servers can be added to them, and customers use them to pay for licenses and SA over three years.

In other volume licensing programs—Select, used by larger firms, and Open Volume and Open Business, for smaller companies—SA is optional. Customers in these programs are generally billed immediately for license purchases, although if they attach SA to a software license they can in some cases amortize both license and SA payments over the remaining term of their agreement.

When SA is attached to a license, it gives an organization the right to upgrade to any new versions of covered software that become available during the term of the agreement, typically a period of three years. (For the rules that govern the purchase and use of SA, see the sidebar "SA Rules". For a comprehensive review of Microsoft’s volume licensing plans and SA, see the Dec. 2003 Research Report, "Understanding Microsoft Licensing.")

The initial focus of SA was on upgrades, but Microsoft added other benefits to SA in 2003 to compensate for the fact that if no upgrades were released during a customer’s SA coverage, the customer would get nothing for its SA payments. After adding learning resources, technical support benefits, employee purchase benefits, and deployment tools to SA, Microsoft began calling the program a "software maintenance" offering because of its resemblance to competitors' offerings that combine technical support and upgrade rights. (For a description of these additional benefits, see "Software Assurance Improved" on page 24 of the July 2003 Update.)

As welcome as these benefits are, their value depends on factors such as the type of volume licensing agreement, the type of software purchased, and the customer’s actual requirements. Customers will derive varying results, depending on their licenses and their willingness to study and implement a complex matrix of SA benefits.

The 2005 Deadline

The year 2005 plays a prominent role in the SA story because of the program’s history. The program was announced as part of Licensing 6.0 in 2001, but Microsoft implemented a 10-month transition period, ending July 31, 2002, to give customers an opportunity to purchase upgrade rights for licenses they had purchased earlier. (During the transition period, a rule limiting SA to newly purchased licenses was waived.) The bulk of the initial Licensing 6.0 agreements were signed toward the end of that transition period in 2002, and these agreements will all expire by Aug. 2005. Thus, during 2005, customers who have had three years of experience with SA will for the first time face decisions about whether to renew it.

Such decisions are of significant consequence to Microsoft. Annuity billings—including both SA and the license component of agreements such as EAs—accounted for 26% of Microsoft’s billings in calendar year 2003, according to Chief Financial Officer John Connors. Broken down by key product segments, annuity billings accounted for about US$4 billion of the company’s Information Worker business, primarily for Office; about US$3.8 billion of its server and Client Access License (CAL) business; and about US$1.6 billion for Windows Client, mostly for upgrade rights for the Windows desktop OS.

Reservations About Renewal

Although customers will certainly continue to sign volume license agreements with Microsoft in 2005 and beyond, they are likely to pay close attention to their renewal options for EAs and other agreements that include SA. The main reasons for this close consideration are an uneven track record for product upgrades in the past, ownership of products that many customers consider "good enough," and uncertain roadmaps for many products.

Past upgrades. In looking forward, many customers will be reviewing their experience with SA in the past, and in particular, whether they got a product upgrade. For example, none of the customers who paid for upgrade rights on Windows XP since 2002 will receive an upgrade, because no new version of the Windows desktop client will ship before 2006. By that time, all of the upgrade rights purchased with the first round of Licensing 6.0 agreements will have expired.

Another upgrade at risk concerns SQL Server. Many customers who owned SQL Server 2000 purchased SA for it during the transition period, assuming that would gain them an upgrade to the next version, code-named Yukon, which was slated for release in 2004. However, Yukon is now scheduled for release in "summer" 2005—between late June and late September. If it slips past July, customers who purchased SA on SQL 2000 will not get the upgrade they expected.

Good enough. Even when customers do get an upgrade, not all deploy it. Numbers for so-called shelfware’—licensed but undeployed software—are sketchy, because while license purchases are easy to track, actual deployment of those licenses is more difficult to determine. In the past, about 40% of EA customers have not exercised all of their rights to the latest version of their software, in many cases because the cost of deploying new desktop software is high, and their current desktop image is adequate for their needs.

Microsoft executives have begun to emphasize the danger of customers who find older software "good enough," and the company has added sales staff whose role it is to demonstrate to customers the value of upgrading to the latest version of Office. The company is also investing heavily in Solution Accelerators designed to reduce deployment costs for desktop products.

However, even if customers do upgrade to the latest software, the "good enough" problem is likely to remain. Most firms with EAs are already licensed for Windows XP, Office 2003, and Windows Server 2003, products that Microsoft will continue to support (through both free and paid support) until at least 2009. These customers may not view further upgrade rights as a priority and might balk at renewal when confronted with a hefty bill for rights that they might not exercise in the next three years.

Future products. The roadmaps for future releases of many major products are not concrete. Customers may conclude that products like SharePoint Portal Server, last upgraded in 2003 and with no further upgrades on the horizon, will be good enough for several more years, and that the rationale is weak for spending money on an upgrade that not even Microsoft can describe. (For a review of how roadmaps for specific products affect annuity renewals, see the sidebar "Product Futures by Pool".)

The Case for SA

However, updates are not the only benefit of SA. Customers considering renewal need to factor in the additional benefits available in the program, special upgrade pathways available only to SA customers, and price increases that, though rarely predictable far in advance, nevertheless affect the net value of SA.

Additional benefits. As noted above, Microsoft added various benefits to SA in 2003 in an effort to make the program more attractive. The actual benefits for which a customer is eligible depend on the type of volume licensing program they are in, the product licensed (benefits for servers are different from those for desktops), and the product edition purchased (server Enterprise Editions have better benefits than Standard Editions).

Special upgrade paths. Microsoft frequently changes the architecture of a product or creates additional editions in a new version. For example, Office 2003 featured a new Professional Enterprise Edition, and Project 2002 added an entire server back-end to a product that had previously been primarily a desktop application. In such cases, Microsoft often offers SA customers the right to automatically upgrade to the new higher-end version of the product.

Price changes. Microsoft sometimes changes prices between versions of a product, and SA customers are typically entitled to upgrade to a higher-priced product at no additional charge. For example, when Commerce Server 2002 introduced an Enterprise Edition the price was triple that of the previous version, but SA customers were nevertheless entitled to the more expensive version of the product at no additional cost (although the cost of renewing SA also tripled, since it is based on the price of the customer’s currently licensed product).

Deciding Factors in Renewal

The value of SA for any given customer cannot be nailed down to a precise value, with the result that an SA purchase will in most cases be a gamble. (For a simplified analysis of this gamble, see the chart "Winning the SA Bet".)

Making the wrong choices can be very costly: an organization that makes little use of the support benefits (for example, if they already have a Premier Support contract) and that doesn’t get or doesn’t deploy upgrades could spend a substantial portion of its software budget for naught.

Because of this, most organizations will want to make their best judgment on the costs and benefits of SA. The following steps should be part of any analysis of the merits of SA or EA renewal in 2005:

Review current versions and use. Organizations should determine what Microsoft software is currently in use, and the current versions of applications that are actually deployed. (This information should be readily available as part of a routine internal licensing-compliance audit.)

Determine future needs. The organization should realistically project what its software requirements are likely to be for at least the next three, and ideally, the next five years. (Five years is the approximate lifetime of a business PC, and any new PCs the organization purchases today should be selected and configured with their lifetime software requirements in mind.)

Match future needs against Microsoft roadmaps. The organization should look for gaps between its current license rights (including undeployed licenses) and its future requirements. Those future requirements should include realistic deplo ment dates.

Renew SA on any products that are likely to be upgraded and deployed in the next three years. Actual deployment dates are more critical than release dates because the organization will require upgrade licenses only when it actually deploys future upgrades, and very few organizations deploy software on its release date. Evaluation, testing, and training can be done with evaluation software, available from many sources, such as the Microsoft Web site, or a TechNet Plus subscription.

Determine additional SA benefits. In the case of any products that the organization is likely to deploy in three years or more, the calculation becomes more complicated. Is the product likely to undergo a substantial price increase in that time? If so, SA may be a useful hedge against significant price increases or product consolidations. (In general, mature products that face a lot of competition in the market, such as Windows Server, are less likely to see significant price increases than relatively new products in new market segments.)

Another SA benefit is technical and training support. In general, the support benefits for desktop products covered by SA are limited to training material that, though useful, can be purchased separately at lower cost than SA. SA on desktop software also entitles customers to low-cost copies of Microsoft software for employees’ home use. Technical support benefits on server products are more valuable and could be used to reduce other support expenses, such as the cost of a Premier Support agreement. Note that customers do not receive technical support benefits through SA on server licenses unless they also purchase SA on all CALs associated with the server.

Support benefits alone generally do not warrant purchasing SA. Most large organizations will want to maintain a Premier Support agreement with Microsoft to provide technical support for all their software, including that not covered by SA support. In that case, support through SA will in many cases duplicate support already purchased through Premier.

Other issues that should be considered include the following:

Licensing compliance benefits. EAs cover all of an organization’s desktop PCs and reduce the requirement to maintain accurate records of the Microsoft software installed on each machine. An organization whose IT requirements change frequently can have trouble allocating its software assets efficiently, and an EA provides more assurance that all PCs will be properly licensed. On the other hand, an organization whose requirements are relatively static, or that only needs to upgrade a well-defined portion of its employees, may find that ad hoc purchases provide greater flexibility and lower overall cost.

Payment stability. Microsoft offers better payment terms for much software purchased with SA. In many cases, payment for both the software license and SA can be amortized over the remaining length of the customer’s volume agreement. That may be valuable for organizations that have budgeting processes that work best with predictable and level annual payments.

SA Options for 2005

After reviewing how well Microsoft’s annuity approach matches their needs, organizations will be better equipped to make renewal choices. Such choices are not necessarily all-or-nothing decisions. With Select and Open agreements, organizations can renew SA on some products and not on others. However, customers who value the additional support and training benefits of SA should keep in mind that they may need to purchase SA on all new licenses in a product pool to get these benefits. Thus, organizations should review their renewal options by pool as well as by product.

The main customer options include not renewing SA, extending the current agreement and associated SA for just one year (in Select and EA), or renewing such agreements for three years and purchasing three years of SA.

Nonrenewal is a choice with significant consequences. Organizations should make this choice only if they're certain that their software requirements will not change significantly over the next two to four years.

Nonrenewal is particularly significant in the case of an EA, because it is not a short-term decision. Customers whose EAs expire in 2005 will have fully paid for their existing software licenses, and in a renewal will need to pay for only the SA portion of their licenses, which typically reduces the annual cost of their EA by about 30%. However, if an organization drops an EA and renews it later, Microsoft will charge for the product licenses again, possibly forcing the customer to pay twice for the same licenses.

As a result, customers who do not renew an EA should be willing to stay with their current desktop software licenses (currently Windows XP and Office 2003) for at least four years, when Mainstream support for both Windows XP and Office 2003 will end. They could then do a corporatewide desktop upgrade by purchasing a new EA. That would entitle them to all new licenses, such as post-"Longhorn" versions of Office and the Windows desktop OS, and their net cost would probably be lower than if they had been making annuity payments for four years.

One-year extension will be attractive to organizations that have SA on specific products that are likely to be upgraded in late 2005 or early 2006. For example, if SQL Server 2005 has not shipped by July 2005, a customer could extend SA for one year with a one-year Select renewal. Similarly, if Microsoft announces a version of Office that will be released by mid-2006, a one-year extension of an EA could earn that upgrade without committing the customer to a much longer contract.

A one-year extension is also a useful hedging strategy: an organization unwilling to completely cancel its EA in 2005 can extend it for one year and then look at the upgrade landscape from a 2006 vantage point. However, EA and Select agreements can be extended only once. In 2006, organizations that complete their one-year extension can only continue the agreement by renewing it for three years. This has little impact for Select agreements, which require a relatively low purchase commitment, but it is a more significant factor for EAs: an organization coming off a one-year EA extension in 2006 must commit to annual EA payments into 2009.

A three-year renewal reflects the organization’s desire to have access to the latest Microsoft software, particularly in the case of an EA. Although software licensing may be more costly with this approach, it has other compensations: an organization can more easily maintain a common desktop image, reduce the effort required to ensure licensing compliance, and make predictable annual payments. Organizations that want to maximize their opportunities to use a wide variety of Microsoft software and to upgrade that software with a minimum of hassle, and that have procedures in place to utilize the additional benefits available in SA, such as training and technical support, should consider a three-year renewal.

Resources

Information about Microsoft’s volume licensing plans is at www.microsoft.com/licensing.

A comprehensive report on Microsoft licensing can be found in the Dec. 2003 Research Report, "Understanding Microsoft Licensing."

The learning and technical support benefits available through SA are described in "Software Assurance Improved" on page 24 of the July 2003 Update.

Roadmaps for a wide variety of server and desktop applications can be found in the June 2004 Directions on Microsoft Enterprise Software Roadmap.