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| Understanding Windows Live |
| May 8, 2006 |
Windows Live is the most significant update to Microsoft's consumer online services since MSN was launched in 1995. The company is rapidly updating its services, hiring new staff, and building out its online infrastructure after years of letting them stagnate. Even so, Windows Live is not a fundamental change in how Microsoft does business—the company will continue to earn most of its revenue from selling software licenses, although more of that software might eventually be tied to online services. Moreover, while Microsoft hopes that online advertising becomes a significant source of revenue, it's simultaneously pursuing many other long-term opportunities. Build-Out Under Way Between approximately 2002 and 2005, consumer online services were a relatively low priority for Microsoft, and minor updates to most MSN services occurred once a year, if at all. Some services, such as Hotmail, have had the same user interface and few feature improvements since they launched in the 1990s. Since Microsoft announced Windows Live in fall 2005, online services have clearly become a high priority, as shown by the following: Service updates and launches. Under the Windows Live brand, Microsoft has updated nearly all MSN services and launched several new ones. (For a chart detailing all the announced Windows Live services, see "Windows Live Services".) Reorganization. In late 2005, Microsoft moved consumer online services into the same large division as the Windows client OS and the company's server software, its largest and fastest-growing businesses, respectively, and has put Windows Live leaders on the same organizational level as the leaders of these businesses. (For an overview of the organization, see "Windows Live Organization, Spring 2006".) Hiring. Since Sept. 2005, Microsoft has increased staffing for the MSN business unit (which includes Windows Live) 35%. In addition, the company is increasing research and development spending (most of which is salary and employee benefits) for MSN from US$500 million in fiscal year 2005 (which ended June 30, 2005) to a planned US$1.1 billion in fiscal year 2007 (which starts July 1, 2006). Infrastructure. Microsoft is increasing its investment in online infrastructure, with capital expenditures increasing from US$100 million in fiscal year 2005 to an estimated US$500 million in fiscal year 2007. For instance, in Jan. 2006, it purchased 75 acres in Quincy, WA (a rural area with inexpensive land, labor, and hydroelectric power, plus a fiber-optic network operated by the local utility) and plans to build a massive datacenter on the site. Google and Yahoo have made similar land purchases in other rural areas and are building datacenters as well. Acquisitions. Microsoft has begun to acquire companies with expertise or technologies that could improve its online services or revenue. Most recently, in May 2006, it announced plans to acquire Massive, Inc., which specializes in placing advertisements in online video games and will be used to deliver advertisements to Xbox games and the Xbox Live service, and Vexcel, which specializes in capturing data for mapping and will be used to improve the Windows Live Local service and underlying Virtual Earth platform. The Impetus for Windows Live The main purpose of Windows Live is to dramatically increase the amount of money Microsoft earns from online advertising. Windows Live is also a response to a threat from online services that substitute for core PC functions, such as communications and storage. If customers place less value on the PC itself, where Microsoft dominates, they will upgrade less frequently, causing a decline in the company's revenues. Missed Opportunity According to the Internet Advertising Bureau's 2005 statistics, businesses spent more than US$12.5 billion on online advertising in the United States, and the lion's share of this expenditure—US$5.1 billion—went to paid search, in which companies bid for placement in sponsored results on search engines. Despite Microsoft's 10-year presence on the Web, the company missed this opportunity. In the late 1990s, Microsoft considered building its own Internet search engine, but because it did not see an immediate revenue opportunity, it focused instead on building a Web portal to compete with Yahoo and other companies. Consequently, MSN decided to outsource Internet search to Inktomi (now part of Yahoo). Even as paid search grew into a viable business for other companies, Microsoft outsourced the sale of sponsored advertisements on the MSN Search site to paid search pioneer Overture (which Yahoo bought in 2003). Consequently, Microsoft left the paid search market largely to two players: Google and Yahoo. These two companies have since raced ahead of Microsoft in search market share and total revenue. Google, which handles nearly 50% of all Internet search queries and owes about half its revenue to paid search, has more than doubled its revenue every year for the past three, continues to grow about 80% per year, and is on track to clear US$8 billion in 2006. Yahoo handles about 25% of all Internet search queries; its revenue is increasing about 35% per year and will probably pass US$6 billion in 2006. In contrast, MSN's share of search queries is just over 10% (and has actually decreased in the last year), and the division has shown almost no revenue growth in the last three years. In Microsoft's 2006 fiscal year (FY'06, which ends June 30, 2006), MSN revenue is expected to remain nearly flat at less than US$2.4 billion. More generally, while total online advertising revenue grew about 30% in 2005, according to the Internet Advertising Bureau, MSN's rate of annual revenue growth from online advertising has consistently been less than 20%, with only 7% growth in the quarter ending Mar. 31, 2006. Microsoft believes there is still plenty of Internet advertising growth ahead: CEO Steve Ballmer has suggested that total online advertising expenditures will grow from US$16.8 billion in FY'05 to US$28.8 billion in FY'08. The main goal of Windows Live is to help Microsoft capture a large share of this growth. As part of its Windows Live initiative, Microsoft has also established new research facilities focusing on search, advertising, and general online services to ensure that it does not miss the next big online opportunity like it missed with paid search. Threat Response Networked services pose a potential threat to Microsoft's core software business. In the consumer space, the risk is that people will use a Web-based online service for functions such as data storage and document creation, reducing the need to buy Microsoft software or upgrade their PC and accompanying OS. This is not a new threat, but Google's rapid growth and demonstrated record of innovative online services—for instance, Gmail and Google Maps were quantum leaps ahead of MSN and other competitors when they were introduced—have created a renewed sense of urgency. Planned and rumored Google services such as G:Drive, which will reportedly offer unlimited online storage, and the possibility that it will branch into online productivity services, which could cut into consumer and small business sales of Office, have elevated the threat further. In part, Windows Live is Microsoft's attempt to draw users and advertisers away from Google, impacting Google's business before its services cut too deeply into Microsoft's main source of revenue. In the long run, if consumers prefer online services for certain functions, Microsoft will have up-to-date online offerings and a reasonable business model—online advertising—to support those offerings. Historically, Microsoft has been willing to invest heavily in new businesses to meet perceived threats. For example, since 2001 Microsoft has sustained losses of about US$4 billion in the game console business, largely to meet a perceived threat that Sony's PlayStation (or other game consoles) would reduce consumer PC upgrades and usurp the PC's place as the gateway to the Internet. Microsoft appears ready to invest in Windows Live on a similar scale in order to keep Google at bay: in the company's Mar. 2006 earnings call, it significantly raised its estimate of expenses for the next 15 months and said that the MSN business unit will sustain losses through June 2007—a notable shift after more than two years of profitability. The Scope of Windows Live When Windows Live was announced, executives such as Bill Gates and Ray Ozzie portrayed it as part of a broad, long-term response to disruptive changes in the IT market. Given this rhetoric, and the excitement surrounding Google and newer Web companies, it's easy to overstate the scope of Windows Live or to mistake Microsoft's renewed interest in online services as a repudiation of its traditional software business. To avoid costly misunderstandings, partners should understand the following about Windows Live: Not for enterprises. Although Microsoft is interested in hosted services for enterprises, Windows Live currently has no connection to these services. The company already offers hosted enterprise services such as Live Meeting, an online conferencing service, and Exchange Hosted Services (formerly FrontBridge, which Microsoft acquired in late 2005), which protects corporate e-mail systems against threats such as spam, viruses, and unplanned outages. In addition, Microsoft has a managed services contract with Energizer Holdings in which Microsoft hosts Energizer's Exchange and SharePoint servers (along with providing other services), and Microsoft is seeking other customers for similar contracts. However, these services are run by product groups different from Windows Live, have different business models, and respond to different threats and opportunities. Perhaps the most important difference: Microsoft's move into hosted enterprise services is currently more tentative and limited in scope than the Windows Live initiative. Different from Office Live. Office Live, a set of online services for small businesses, was announced at the same time as Windows Live. But apart from the word "Live" and a few shared infrastructure elements—such as Office Live's use of Windows Live Mail (the successor to Hotmail)—the services are very different. Office Live has a different business model (subscriptions instead of advertising, although the lowest tier of service is free and supported by advertising), is attempting to capture a different opportunity (small businesses that can benefit from shared applications but that don't want to buy and maintain server hardware), and has different competitors (Intuit QuickBase and Yahoo Small Business, among others). Perhaps most important: Office Live is seeking partners to resell these services to small businesses—an extension of the company's traditional software reseller model. Windows Live is seeking partners to drive traffic to its services, but is mainly focused on signing up advertisers. Not a content play. At the same time as building out Windows Live, Microsoft is increasing its investment in online content, including exclusive original video programming created in conjunction with partners (such as TV show producers Reveille Productions), user-generated content, and original content. Although these services might eventually leverage the same advertising platform as Windows Live, they will continue under the MSN brand name and will probably not receive as much investment as Windows Live services. (For details about the online content strategy, see "MSN Embracing Content Again".) Will augment, not replace core software businesses. Even if Windows Live meets Microsoft's most optimistic expectations, the company's traditional software businesses—the Windows client OS, Office and other Information Worker software, and server software—will continue to provide most of its revenue and profit for the foreseeable future. Given this financial reality, partners and customers should not expect Windows Live to change how Microsoft does business. Specifically:
Not the only new business. In the past decade, Microsoft has invested in many new business areas, including software for mobile devices, business management applications, console gaming, and home entertainment platforms and products. Any one of these, or some other new business, could become Microsoft's next US$10 billion revenue source (comparable with Windows and Office). Even though Microsoft will continue to spotlight Windows Live and online services in general, partners should not focus on them to the exclusion of other opportunities. Windows Live Strategy Microsoft's Windows Live strategy is to attract advertisers with a new advertising platform that can target their messages more effectively (including an in-house paid-search platform) and to increase the audience for those advertisements by building a comprehensive, well-integrated suite of online services. Microsoft is also using Windows Live services to bolster other companywide goals, such as Trustworthy Computing, but these are peripheral to the main goal of increasing online advertising revenue. New Advertising Platform Although advertising replaced subscriptions as MSN's main source of revenue in 2003, the vast majority of these advertisers are large companies engaging in brand advertising, such as banners and interstitial advertisements that fill the whole screen and are designed to enhance the companies' image and brands rather than to convey information about specific products. The core of Windows Live is the new adCenter platform, which is designed to let advertisers of all sizes reach Windows Live users with contextually relevant, text-based advertisements. Initially, adCenter is being rolled out as Microsoft's in-house paid search platform, replacing the company's deal with Overture (Yahoo). Microsoft is attempting to attract advertisers away from Overture and Google's AdWords paid-search programs with unique features such as more detailed demographic information about the users who click on particular advertisements, the ability to suggest additional keyword purchases based on query logs, and the ability to change keyword bids during different times of day to reach particular audiences. AdCenter is already being used for all paid search results on MSN Search in France, Singapore, and the United States and will replace Overture on all MSN Search sites by the end of 2006. In May 2006, Microsoft began extending adCenter beyond paid search with a new pilot program that allows businesses to place contextual text-based and image-based advertisements throughout Windows Live sites and services, particularly high-traffic sites such as Mail, Messenger, and Spaces. The service will eventually allow businesses to place advertisements in other Microsoft sites and services, such as Microsoft.com, Xbox.com, and the free tier of Office Live, as well as desktop client software, such as Windows Live Mail Desktop (a desktop e-mail client planned for late 2006). In addition, adCenter will eventually compete with Google's AdSense program, in which Google sells contextual advertisements on third-party sites, then splits the revenue with those sites. In the long run, the company says it will extend its advertising technology to other online products and services, such as Xbox Live and IPTV. Increase the Audience No matter how technically advanced, an advertising platform cannot be effective without an audience. For many years, Microsoft relied on the ubiquity of its software products to drive consumers to MSN services—for instance, MSN.com has long been the default home page in Internet Explorer (IE). However, that advantage has proven fleeting as consumers are spending less time at MSN and being drawn to more up-to-date online services from Google, Yahoo, and other companies. To recapture some of these users and keep them within Microsoft sites for a longer period of time, the company is taking numerous steps. Update existing services. Microsoft is updating nearly all of its existing consumer online services—in some cases, after years of stagnation—in hopes of increasing (or at least maintaining) their audience. Common improvements across Windows Live services include the following:
Launch new services. In addition to revamping existing MSN services, Microsoft is launching new services. In particular, the company seems committed to matching Google service for service, as well as matching third-party services that have high traffic but relatively low barriers to entry, such as Windows Live Expo (an online classified advertising service that resembles Craigslist) and Windows Live Shopping (for comparing prices from online vendors). The company is also launching several Windows Live services (Family Safety Settings, OneCare, and Safety Center) to help improve PC security, a major goal of the companywide Trustworthy Computing initiative. Unlike other Windows Live services, several of these services are not supported by advertising. In the future, Microsoft could use Windows Live to bolster other broad company goals—for example, an online storage service for digital media such as audio and video could help bolster Microsoft's home entertainment strategy. Integrate. By integrating Windows Live services, Microsoft hopes to drive traffic from more popular services (such as Mail and Messenger, both of which lead their markets) to less popular services (such as Search). More generally, integration among services makes them more useful and convenient—nobody wants to retype contact information into both an online mail service and an instant messaging service, for instance. Examples of this integration are already appearing in the Windows Live betas: users can view their Live Mail inboxes from the Live.com home page; users can limit viewership for an Expo advertisement or Spaces blog to a specific set of trusted contacts from their Messenger lists; and Search panes are beginning to appear throughout the services. Other services will become more prominent as Windows Live evolves—for instance, Windows Live Contacts, which lets users post contact information and automatically "push" updates to friends, will tie in to the address book in Mail and the contacts list in Messenger. Microsoft could also integrate Live services with its software, particularly Windows Vista or its successor (code-named Vienna). For example, Windows Live Search might be integrated into the Windows search interface being introduced with Vista, and Windows Live Mail Desktop could eventually replace Outlook Express (or Windows Mail, as it's called in Vista). Integrating online services with Microsoft software carries some risks for the company—in particular, online competitors may complain to regulators that Microsoft is using its desktop OS monopoly to try to dominate new markets. For instance, in spring 2006, Google complained to European and U.S. regulators that MSN Search provides the default Web search functionality in IE7. Similar complaints would almost certainly arise if Microsoft tried to integrate Search or other Windows Live services more directly into the Windows desktop. Despite the legal risks, and even though Windows integration was not sufficient to maintain MSN's audience in the past, integration—when combined with long-overdue improvements to online services—could give the company an edge that competitors will have a hard time matching. Pendulum Swinging Back Microsoft's latest effort to increase traffic to its consumer-oriented online services recalls earlier MSN strategies. In the 1990s, the company built a wide variety of MSN services and organized them around a portal, and it also invested heavily in editorial content, hiring editor Michael Kinsley to found an online magazine called Slate, co-creating a cable TV network and associated Web site with NBC (MSNBC), and launching a wide variety of interactive programs on MSN sites. The goal was to use highly desirable content to attract users, who would then either pay a subscription fee or view advertisements. The financial performance of MSN shows that these strategies did not pay off the last time. Microsoft believes there are some notable differences this time around: broadband access is more common, paving the way for high-bandwidth services and content; the increasing popularity of technologies such as AJAX has made it easier to build interactive online applications; users have become accustomed (thanks to Google and others) to performing more types of tasks online; much of the content will be provided by end users and will consequently cost little to produce; and the MSN division is clearly focused on online advertising as its main source of revenue, rather than Internet access or subscription-based services. Nonetheless, MSN's new leadership will have to overcome a long legacy of fair-to-poor performance to prove that online services are an area in which Microsoft can compete and grow with the leaders in the field. Availability and Resources Many Windows Live beta services are available from ideas.live.com. The Windows Live Contacts beta is at spaces.msn.com/profile.aspx?action=learnmore&mode=activecontacts. The Windows Live Custom Domains beta is at https://domains.live.com. The Windows Live Shopping beta is at shopping.live.com. LiveSide, a blog devoted to tracking Windows Live, is at www.liveside.net. AdCenter's progress was most recently covered in "Ad Programs Expanding" on page 24 of the May 2006 Update. For more background on adCenter, see "MSN Brings Paid Search In-House" on page 23 of the Apr. 2005 Update. Exchange Hosted Services is covered in "FrontBridge Becomes Exchange Hosted Services" on page 7 of the May 2006 Update. Microsoft's services deal with Energizer Holdings is covered in "Managed Services Beginning to Gel" on page 28 of the Apr. 2006 Update. |
