Update:  Microsoft says 'Open source threatens our business'

CAIRNS, AUSTRALIA -- Microsoft has confirmed it sees the open-source software movement as a threat to its commercial business model, in a quarterly report filed with the U.S. Securities and Exchange Commission (SEC).

The statement, which first appeared in Microsoft's annual report on its 2002 fiscal-year operations, amplifies comments by Microsoft Chief Financial Officer John Connors recently about the threat of Linux to Microsoft's server business.

"The popularization of the open source movement continues to pose a significant challenge to the company's business model," Microsoft wrote in its recent filing. "[This is] including recent efforts by proponents of the Open Source model to convince governments worldwide to mandate the use of Open Source software in their purchase and deployment of software products."

Microsoft said it may have to reduce the prices it charges for its products, and revenue and operating margins may consequently decline if the open-source movement continues to gain market acceptance.

But an analyst who closely follows Microsoft said that while Microsoft genuinely perceives the open-source software movement as a threat, it is unlikely to adjust its pricing any time soon in response.

"Microsoft's response up until now (to the open-source movement) has been nonmonetary," said Directions on Microsoft Inc. Research Director Rob Helm, in Kirkland, Washington . "It's loosened up access to source code, made more efforts to support the government market, and created online communities that mimic those that support open-source development projects."

With Microsoft's desktop operating-system market share at more than 90 percent and still growing, any threat to Windows from a system like Linux remains a distant one, Helm said. Where Microsoft faces near-term pressure is in the market for server software, where Microsoft hopes to expand its Windows NT/2000 market share but finds itself fighting the growing open-source groundswell, he said.

It also faces growth challenges in the acutely price-sensitive government and educational markets, he said.

"Sometimes, Windows may be overkill for (those markets), and outside the U.S. , there's political pressure to not be too dependent on Microsoft for government functions," Helm said. "There's a long-term threat there."

In the SEC filing, Microsoft contrasted its commercial software development (CSD) model with the open source movement. The financial investment in software inherent in the CSD model benefits end users, according to Microsoft.

"The company believes that the CSD model has had substantial benefits for users of software, allowing them to rely on the expertise of the company and other software developers that have powerful incentives to develop innovative software that is useful, reliable and compatible with other software and hardware," Microsoft wrote.

If Microsoft is to vanquish this threat and overcome challenges posed by a weak global economy, it will have to offer users compelling reasons to buy its software, the company said in its filing.

"The company's revenues would be unfavorably impacted if customers reduce their purchases of new software products or upgrades to existing products because new product offerings are not perceived as adding significant new functionality or other value to prospective purchasers," Microsoft wrote in its filing.

Microsoft began adding the open-source risk disclosure to its quarterly SEC filings because "it just seemed like an appropriate place to list it, along with other uncertainties," according to a spokeswoman. "Microsoft had been publicly acknowledging those concerns for quite a while."