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| Emerging Markets Present New Challenges |
| Feb. 6, 2006 |
Emerging markets play a prominent role in Microsoft's growth forecasts, but most emerging economies are only a fraction of the size of those in developed countries, and even their rapid growth will generate only modest increases in Microsoft revenue in the near future. More important, while Windows plays a major role in computing worldwide, other critical Microsoft products such as Office and server software are less dominant and face stiff competition from less costly alternatives. Microsoft will need to refine its current strategies and possibly make major changes to product lines and pricing to tap into these emerging markets effectively. Emerging Markets Defined Definitions of emerging markets differ, but they are generally countries with low-to-middle per capita income, developing capital markets and economies, and stable governments. Morgan Stanley Capital International lists some 25 countries in this category. (For a list of these countries, see the illustration "Emerging Markets", and the chart "Emerging Market Statistics".) The so-called BRIC quartet of Brazil, Russia, India, and China are of particular interest because they have very large populations, growing economies, and regional or international political clout. Microsoft's emerging markets taxonomy is influenced by IT adoption, the total size of the economy, Internet connectivity, language, and other issues. Microsoft is focused primarily on the BRIC countries and about 30 other countries deemed to have sufficient growth or strategic importance, although the company has 55 subsidiaries worldwide and sells its products in 130 countries and territories. IT markets in the developed countries are relatively mature, and growth in revenues there generally tracks overall economic growth. Microsoft (and most of its competitors) see emerging markets, which are moving up a steep part of the economic development curve, as an opportunity to accelerate revenues. According to the World Bank, the aggregate gross domestic product of developing countries grew 6.6% in 2004, compared with growth in high-income nations of 3.1%. Those rates are expected to decline slightly through 2007, but developing nations will continue to grow twice as fast as developed nations. IT Growth In some specific industries, such as IT, emerging economies are an attractive target because the potential upside is so large. For example, while the U.S. PC market is relatively saturated (with about 75 PCs for every 100 residents) the highest PC ownership rate in a BRIC country is 12.5% in Russia. In the lowest, India, the number of computers is about 1% of the population. (Numbers for both countries are as of 2004.) But in both cases, the installed base is expected to at least quadruple by 2010. Microsoft's business may not benefit much from emerging markets in the near term. Software accounts for only about 5% of IT spending worldwide (external services and telecommunications account for the lion's share of the market), and although growth in emerging markets is faster than that in developed markets, those markets are still small. Forecasts from the Gartner Group, for example, say software spending will grow about 35% in the Asia Pacific region (excluding Japan) from 2006 to 2009, but that growth still amounts to barely US$2 billion, from US$6.9 billion to US$9.2 billion. The North American market for software in 2009, in contrast, will be about US$60 billion, up about 20% from 2006. However, Microsoft crunches the numbers differently. According to Will Poole, vice president of the Windows Client division, about 400 million people in emerging markets will buy their first PC between 2005 and 2008. Given that Microsoft gets an average of US$50 in Windows client revenue for every PC shipped in the world, this represents potentially US$20 billion in additional revenue over three years, clearly a target worth pursuing. And the opportunity will persist for much longer than three years: only about 10% of the world's population interacts directly with Windows today. That leaves plenty of upside. Current Strategies Microsoft's strategies in emerging markets focus not only on revenue growth but also on improving the company's image, attacking piracy, customizing its products, and stalling the growth of competitors, particularly open-source software. Improving the corporate image. Microsoft makes many donations of money, hardware, and software to schools and community facilities in emerging markets through programs such as Partners in Learning and Unlimited Potential. In Jan. 2006, for example, Chairman Bill Gates announced at a government leaders' forum in Europe that Microsoft would put another US$25 million into Unlimited Potential projects for community technology centers. Some 36,000 centers have been founded worldwide, most by nonprofit organizations. The company also sponsors about 90 Microsoft Innovation Centers (MICs) worldwide. MICs provide training, as well as testing and development laboratories, and help make up for the lack of good facilities for computer education in many emerging economies. As these MICs tend to provide much of their training on Microsoft products and technologies, such as the .NET development framework, they nurture local expertise and support for Microsoft-centric solutions. Attacking piracy. Because software piracy rates are high in many developing economies, even among governments, Microsoft realizes far less revenue from use of its products in these countries than it does elsewhere. The company plays a visible role in encouraging legal use of software, crackdowns on piracy, more stringent policies and laws regarding piracy and protection of intellectual property, and vigorous enforcement of those laws. Customizing products. Although Microsoft's preferred approach is high-volume production of software that can be used worldwide with little modification, it has begun to offer specially customized versions of its products in some markets. Best known is Windows XP Starter Edition, an OEM-only product with a lower purchase price and certain limitations, such as no local networking and a cap of three applications that can run at once. The company also came up with special, steeply discounted versions of Windows and Office for Thailand in order to meet a government initiative for inexpensive computers. Microsoft has also created a Local Language Program that promotes development of Language Interface Packs (LIPs) that can be used to create language-specific versions of Windows XP and Office independently from Microsoft's own localization efforts. Only a small fraction of the world's 6,000 languages are used in commerce and are therefore attractive to Microsoft's business-oriented software model, but many other languages are nevertheless spoken by millions of people (e.g., Amharic is spoken by 60 million Ethiopians). Without local assistance, Microsoft and its products would be invisible to these groups as they develop economically. LIPs also provide an alternative to open-source projects that can easily create local versions because they have access to the software's source code. Beating back the competition. The high price of Microsoft products relative to local incomes in many countries makes free and open-source software much more attractive. The company lobbies governments to ensure that local laws and regulations do not place it at a disadvantage (e.g., by procurement rules that dictate the use of open-source products where available), and conducts extensive campaigns to demonstrate that its products are competitive with open-source offerings when long-term costs are considered. While license acquisition costs for most open-source products are lower than for Microsoft products, the company often sweetens the pot with funds for proof-of-concept development, training, deployment, integration with existing systems, and other services that vendors of open-source solutions cannot match. Focus on Government, Education Unlike developed markets, which typically have a large middle-class consumer market and robust enterprise and mid-size business sectors, emerging economies tend to have small elites with access to technology and a few large enterprises that are often owned or controlled by government. As a result, Microsoft's marketing efforts in emerging economies tend to be pitched at influential elites, notably government officials and the education market. The company offers a number of special benefits for the government and education sectors, including software licensing for home use by government employees and steeply discounted software for students in universities. (A program called Microsoft Student Select in India offers full versions of Office for as low as US$30.) Government Cooperation Agreements lock in broad government support for Microsoft products (e.g., in most or all government departments) in exchange for lower prices. The company also monitors government technology investments, lobbying against RFPs that appear to be biased against Microsoft solutions and aiding partners that want to bid on government projects. Strategic Gaps The current policies are unlikely to maximize Microsoft's presence in emerging markets because they don't address the largest barrier to adoption—a worldwide pricing policy that puts Microsoft products out of reach for middle-class consumers and small businesses in many emerging markets. An estimated 86% of the world's population live in countries with annual GNP per capita below US$10,000 (the U.S. number: about US$40,000), and about 50% of the world's population live on less than US$2 a day. Microsoft, like many IT companies, is also struggling to address a technology adoption curve that doesn't match that of mature markets. Cellular telephones are much more common than computers in most emerging economies—in Hungary, for example, 93% of the population now have cell phones, about five times the rate of computer ownership. This situation is likely to persist for many years in countries with low literacy (although Hungary's literacy rate is 99%). In the United States, in contrast, computer ownership still exceeds cell phone ownership. Microsoft's product roadmaps also work against emerging market adoption. Hardware requirements rise with each new version of Windows and Office, making it impossible for users in emerging economies, many of whom are using hand-me-down PCs from developed countries, to keep up. Most of the computers now in use even in developed countries will be unable to tap the full feature set of Vista. By the time Vista appears in any quantity in emerging markets, Microsoft will have moved on to yet another hardware plateau and will be encouraging users in developed countries to get off that "legacy" OS. Microsoft's efforts to reduce piracy by emphasizing legal purchases, and to connect privileges such as World Trade Organization membership to commitments to respect intellectual property rights, can also work against the company. The fastest and cheapest route to getting legal is to use free open-source solutions, and every one of the BRIC countries has government-funded programs aimed at promoting Linux and other open-source solutions. Brazil, for example, has a goal of moving 80% of computers used by state departments and organizations to Linux. Addressing the Gaps In order to address these gaps, Microsoft will probably be forced to make some significant changes in the way it does business worldwide. Potential changes include the following:
Organizing for Emerging Markets Microsoft's current organization works well in developed economies with competitive markets and a lively mixture of multinational, regional, and midmarket commercial enterprises. But in many emerging economies the players are different: governments and large monopolies may be the only institutions with modern computer systems, infrastructures of all kinds are poor, sales channels and distribution are weak or nonexistent, and language and cultural variety complicates delivery of inexpensive, high-volume software. Moreover, ISV partners are likely to be small and undercapitalized. Responding effectively to such challenges from Redmond, WA, will be difficult, and Microsoft is likely to increase its presence in emerging markets and give staff in those regions more power to act independently. Stronger local teams will be essential for developing fruitful relationships with governments and major IT players, such as telecommunications companies. Today, pricing and licensing policies are controlled by Microsoft's headquarters, and local sales teams have limited discretion to change them. To compete with open-source alternatives, Microsoft's regional offices must be able to respond quickly with complex offerings that combine attractive pricing on software licenses with services, financing, training, and other benefits that outweigh lower license acquisition costs for open source products. More effective regional offices, backed by Microsoft's resources, can also help local governments and nongovernmental organizations tap international financial resources on behalf of local projects that will improve living standards and provide indirect benefits for Microsoft. This is an important tactic: stable governments can attract billions of dollars in foreign aid and favorable loans from agencies such as the World Bank, and nothing is likely to raise Microsoft's fortunes faster in emerging economies than national programs and policies that improve infrastructures, raise overall standards of living, and consequently create more demand for technology as well as the means to pay for it. Partners and Sales Channels Microsoft relies heavily on partners to sell, deploy, and maintain its products, but the value added resellers and integrators that play a crucial role in developed nations are only beginning to appear in emerging economies. To compensate, Microsoft is working with the limited channels that do exist. The company has worked with governments to promote Windows Starter Edition, and with telecommunications companies (e.g., in Mexico) to promote hardware and software bundles combined with Internet access. However, these solutions often require the company to dramatically cut its margins, as it has in Thailand, demonstrating the dangers of trying to compete with free software on price. Windows Starter Edition has also had a lukewarm reception. It is unlikely to provide much protection against competition such as the US$100 Linux-based PC championed by Nicholas Negroponte of the MIT Media Lab. As an alternative to the US$100 PC, Microsoft is promoting the concept of more powerful cell phones that, attached to a common television monitor and an inexpensive keyboard, could provide basic computing resources. This approach could be attractive in emerging markets, but it could cost Microsoft sales in other respects. For example, it will be some time before cell phones that are affordable in emerging markets (and even developed markets, for that matter) will have the capacity to run Microsoft applications such as Office. The company can improve its sales channels through ongoing partner development programs and training centers; these tactics may pay long-term dividends in the form of IT professionals trained in Microsoft products. Currently, Microsoft's partners receive little compensation from Microsoft for promoting and selling the company's software; most sell the products near cost and make their money from selling related services and training. Microsoft may be forced to sweeten the pot for partners in some areas to create more direct incentives, such as commissions or financing, in areas where services revenue from complex installation is likely to be scarce and where credit systems are in their infancy. By financing sales, the company can maintain higher price points while making its products more accessible to small businesses, for example. The company may also need to go direct to consumers (through retail outlets) in some areas, a tactic that it has not generally employed in developed markets, but is currently testing in India. This can better leverage the smaller number of qualified salespeople in emerging economies and will also give the company more opportunities to provide direct financing for purchases. Pricing, Volume Sales, and Licensing Microsoft has generally tried to maintain similar prices worldwide for its products. Software is inexpensive to ship, and selling the same product at different prices in different markets encourages a gray market as brokers purchase the product at low prices in one region and sell it at higher prices in another. But creating different binaries to prevent this gray market complicates inventory management, localization efforts, patching, and licensing for global customers. Nevertheless, current pricing policies are a major deterrent to adoption of Microsoft products in many emerging markets. The product most vulnerable is Office, which is not only far more expensive than Windows but also faces a free competitor, OpenOffice, that is highly compatible, nearly Office's equal in functionality, and can run on the older hardware found in most emerging markets. Microsoft is promoting lower-cost alternatives, such as Works, in many emerging markets, but Microsoft could give this product away and still lose: OpenOffice is also free, but more capable than Works and more compatible with Office itself. Volume licensing programs can provide some cover for Microsoft in emerging markets: by restricting low-priced versions of its products to volume customers, the company can appeal to government and educational elites and fend off competition from free software. However, that still leaves more than 90% of the market served only by free software in most emerging economies. In addition to price reductions, Microsoft will need to reassess some of its licensing rules. Shared computers, kiosks, application portals, and thin clients that act as terminals are popular ways to spread scarce resources across a large population, but Microsoft's licensing rules, such as the rules involving its Terminal Services client, are intended to prevent pooling of many users on a few licenses. Costly External Connectors and Client Access Licenses are required when large numbers of public clients access many Microsoft server resources. Such rules are designed to ensure that large corporations don't replace thousands of Windows desktops with a small number of servers, but set a threshold for use of Microsoft products that users in many emerging countries cannot meet. Product Changes Given these difficulties, pricing flexibility might be achieved only with product inflexibility—that is, by creating specially priced versions of products that are only usable in particular regions. Software could be locked to a particular language pack, for example, or licensed for use in only a particular country. The latter option is not an absolute protection against a gray market, but it could make it easier to spot noncompliant uses outside of the intended market. Hosted applications, such as those envisioned in Windows Live and Office Live, offer another solution in emerging economies, reducing the need for powerful PCs. However, this solution will require reliable networks, which are unavailable in most parts of the world and beyond Microsoft's ability to provide. The company is also likely to reexamine its strategies for Office in light of competitive threats. Much of the focus in developing and marketing Office 2003 was on server-based collaboration features, such as better integration with Windows SharePoint Services and Exchange, but such systems, which rely on servers running the latest versions of many Microsoft products, have even less traction in emerging economies than they do in developed countries. Furthermore, recent versions of Office do not run on the downlevel OS versions, such as Windows 98 or even Windows 3.1, that can still be found in emerging economies. The dilemma that Microsoft faces is that its new products and technologies, intended to capture the imaginations of early adopters in developed countries, often put the company far ahead of the adoption curve in emerging markets, which are thus unable to make a meaningful contribution to the company's current goals. To compete in emerging markets, Microsoft may need to create parallel, but far simpler and cheaper, OS and desktop productivity products. Such an approach is not attractive financially: it represents a substantial increase in investment with the promise of lower returns. At the end of the day, the company may try merely to do what it can with its current products and hope that as these economies develop they will join the ranks of the developed markets where the company has enjoyed its success. Resources Unlimited Potential is described at www.microsoft.com/citizenship/giving/programs/up. The Partners in Learning Web site is www.microsoft.com/education/PartnersinLearning.mspx. Windows XP Starter Edition is described in "Windows Starter Edition Launched in Asia" on page 5 of the Sept. 2004 Update. The Local Language Program is described in "Language Localization Accelerated" on page 31 of the May 2004 Update. |
