Office 365 furnishes 4% of Microsoft's Office division revenue

Microsoft is bullish on rent-not-buy strategy's future as it touts $1 billion annual revenue pace for Office 365 subscriptions

Microsoft's Business division, which manages the company's Office cash cow, recorded a 5 percent revenue bump in the first quarter over the same period in 2012, an increase driven by a surge in enterprises signing long-term licensing agreements.

Office 365, Microsoft's expanded subscription program that it's promoted for both businesses and consumers -- and on which the company is pinning plans to drive future income -- will account for about 4 percent of the division's revenue for the fiscal year, Microsoft said.

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Revenue for the Microsoft Business Division (MBD) in the first quarter was $6.1 billion, 5 percent above 2012's first quarter when adjustments for a free Office upgrade program were excluded.

That contrasted with a flat quarter, year-over-year, for the Windows Division, which was harder hit by a serious slump in PC sales.

MBD's revenue boost stemmed from sales to businesses, which were up 10 percent compared to last year, said Chris Suh, general manager of investor relations, during an earning call last week. "[That was] driven by 16 percent growth in multi-year licensing," Suh said.

Microsoft has long relied on licensing deals struck with enterprises for the bulk of its Office revenue. Companies not only buy those licenses, but also sign up for, and pay extra for, Software Assurance, an annuity-like program that gives customers the right to future upgrades.

Recently, however, Microsoft has pitched Office 365 as an alternative, promoting the subscription plans' five-installs-per-user of Office 2103, and other benefits, to tempt customers into abandoning the traditional "perpetual" licenses -- those paid for once, then used as long as desired -- for the rent-not-buy programs.

Business customers pay between $12.50 and $20 per month per user -- or between $150 and $240 per year per user -- for Office 365. If a subscription expires, the locally-installed Office 2013 retreats to a reduced mode that won't let users create new documents or edit existing ones.

Last week, Peter Klein, Microsoft's outgoing CFO, stressed Office 365's importance to Microsoft's revenue strategy and touted its success.

"This quarter was our strongest ever [for Office 365], with net seat additions up five times over the prior year," Klein said. "One in four of our enterprise customers now has Office 365, and the business is on a $1 billion annual revenue run rate."

Those figures sounded impressive on the surface.

But Klein's comment that a quarter of Microsoft's enterprise customers had signed up for Office 365 does not mean that 25 percent of all Office licenses sold to businesses were, in fact, paid for by subscription.

As Wes Miller, an analyst with Directions on Microsoft, noted in an interview last week, few enterprises are wholly adopting Office 365's new payment structure. Instead, the bulk of companies are -- and will for some time -- rely on a hybrid approach where they purchase most Office licenses outright and subscribe to Office 365 for the remainder.

Nor does the $1 billion annual revenue from Office 365 account for a significant portion of MBD sales.

Over the last four quarters -- from April 1, 2012 to March 31, 2013 -- MBD revenue was $23.8 billion. Using that number, $1 billion from Office 365 would represent 4.2 percent of the total.

Still, Klein highlighted Microsoft's hopes for Office 365, even as he warned Wall Street analysts it would impact revenue in the short term.

"We expect to grow our customer base, increase customer satisfaction via continuous updates, and reduce piracy," said Klein, who added that as time goes on, Microsoft's costs for supporting the subscription services would decline. "We expect our transactional customers to increasingly transition to the cloud with Office 365."

However, that will affect the bottom line, at least in the short term, he acknowledged.

Rather than book the revenue when the subscription is sold -- as it currently does with perpetual licenses -- Microsoft will defer part of the revenue until successive quarters.

"In the short term, you'll be deferring revenues that were not in a subscription, and would have been recognized immediately," Klein told the analysts. "And as the subscription business is growing, you'll see that impact growing, but over time, what you'll get is what looks like an annuity revenue stream that's more predictable."

In other words, if perpetual-license customers switch to Office 365, per-quarter revenue will decline. Total revenue over the life of a subscription will increase, Klein said, driven by "higher customer satisfaction and probably higher retention rates going forward."

But MBD revenue is still tied to Windows, and in some cases, to PC sales.

Microsoft has thus far declined to offer Office for non-Windows tablets, which make up the vast bulk of the market. Some analysts have criticized the company for what they see as a short-sighted strategy to use Office to promote sales of Windows tablets, PC-to-tablet convertible devices and hybrids, such as the Surface Pro.

Microsoft did not mention any plan to bring Office to competing mobile operating systems such as Apple's iOS and Google's Android.

Office sales to consumers and small businesses, who purchase Office on a per-copy basis -- Microsoft calls that "transactional" -- were down last quarter, Microsoft said, because of the decline in PC sales. IDC pegged the contraction at 14 percent year-over-year, while rival research firm Gartner said it was a slightly-less-severe 11 percent drop.

For the first quarter, Office revenue derived from consumers was "roughly in line with the consumer PC market," said Suh, meaning that it was down by double digits from the year before.

The same is expected this quarter, Klein added. "Transactional revenue, which is the remaining 40 percent of the division total, should be in line with the x86 PC market," he said, referring to the quarter that ends June 30, also the end of Microsoft's fiscal year 2013.

MBD accounted for 31 percent of Microsoft's total revenue for the quarter, the most by any single division. Its operating income, or pre-tax profit, of $4.1 billion was also the most of any division, and was up 8 percent from the same period the year before.

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, on Google+ or subscribe to Gregg's RSS feed. His email address is gkeizer@computerworld.com.

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This story, "Office 365 furnishes 4% of Microsoft's Office division revenue" was originally published by Computerworld.

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