We mentioned in a previous post that Microsoft is in the grips of a pricing dilemma. Changing paradigms have weakened Microsoft’s dominant position in operating systems and office productivity programs. Businesses and affluent consumers no longer upgrade regularly. What they have now is good enough. Developing markets that don’t need to maintain backwards compatibility with Microsoft Office file formats are turning to free (!!!) software alternatives.

So what can Microsoft do? They can’t simply drop prices or give away software without further depressing their share price. Their efforts to gain online revenue through advertising have been disappointing. Vista, even more disappointing.

Microsoft’s efforts to offer a stripped down version of Windows for developing markets and netbooks is a step in the right direction. They are cannibalizing their own profits, but that’s better than having someone else cannibalize them.

But this is an incremental step. Microsoft “won” as much through clever pricing as through clever technology. They licensed their operating system cheaply (at the time) but made sure that computer makers paid them royalties regardless of whether they actually installed the system. They realized early on that they could create a whole new market for software if they could make it more affordable. Rather than charge $500 for a word processor, $500 for a spreadsheet, and $1000 for a database, they gave buyers the whole bundle for $500. How could you say no?

This helped them kill the competition and for a while, they added enough features to subsequent releases to get consumers and businesses to upgrade regularly.

The problem is that they were so good at killing the competition that they forgot how to innovate. The incremental value of each release got smaller, while even contemplating a switch let users think about using alternative applications like Google Docs, that suffice for many users. Using Windows and using Office hasn’t changed much in the past decade.

In addition to making desktop computing prettier, they need to make it faster. In theory, it should be. In reality, I stopped using Outlook when I realized that it faster to use the Google browser application directly, even with Xobni installed in Outlook. When is it faster to search the web than to search my own computer? Desktop computing should be instantaneous. It should provide a noticeably snappier experience than the web. (If this required a major rewrite that would break backwards compatibility, they could always run a virtual Windows XP or Vista instance. This works amazingly well on my Mac.)

Next, desktop computing and productivity work should look good. The templates in Office 2007 are actually a lot nicer than the ones in previous versions of Office, but they still look pretty lousy. (You can pick a template in Apple’s iWork, which has only been around for a few years, and get much better looking results.) Microsoft should spend the money to get or create some really nice looking templates. And everything on the desktop should be “HD”. PowerPoint should look nice, not grainy with clunky animations. Speaking of HD, desktop video editing is the killer app for operating systems– one of the few things it’s currently really hard to do in the Cloud. Windows Movie Maker is a joke. Build or buy a really good, easy video editing program. At this point, the DoJ won’t care if you bundle it with Windows. Make PowerPoint output to this HD format, but make it interactive, so you can give a really high quality presentation. And because the average business user won’t know how to create professional animations, have a huge gallery available for instant download. This is stuff that Linux can’t do well, and even Apple users need a fair bit of expertise (and possibly expensive extra software) to create.

Next, think about how users want to work with documents. For a software company that tries to reuse code, Microsoft makes it pretty inefficient to work with documents. Many business documents have various sections– headers, footers, standard terms and conditions, snippets copied and pasted from other documents, and some original content. But it’s hard to keep the snippets up to date. If the company changes a logo or a business address, you have to update all the documents individually. If standard legal terms change, you have to update them all individually. If a 10 page section of a proposal template changes, you have to copy and paste that into individual proposals. Office should allow users to “link” to other documents or snippets and update automatically when those links change. This would dramatically enhance productivity in many cases. (Office has made strides in this direction, but they’re clunky and they may require you to set up server software on your network, rather than allowing you to login to a virtual network.)

Finally, the internet has moved beyond the ability to insert hyperlinks and save as HTML. (Even that doesn’t always work well, as my recent attempts to view a PowerPoint presentation saved as web document demonstrated.) “Track Changes” is an awesome feature, but you still have to email around documents or set up a server. Apple beat Microsoft to the punch with its iWork.com concept, which allows users to collaborate online. Microsoft should provide a similar service, which would also include an easy way to manage the snippets I mentioned above. People with the appropriate permissions could update the snippets and apply the changes to sets of documents. This virtual space could support the automated backup of important files of any type, but with additional capabilities for Microsoft file formats or other file formats if their vendors created the right plugins. Make it easy for businesses and consumers to upload files to YouTube, Picassa, and other sites.

Now you have an operating system and a set of productivity applications that actually make people more productive. You can be better than Apple not just at the individual applications, but in the way they work together to help users perform tasks.

When it comes to pricing, you now have a lot more room, because you have created more value. For the people who don’t care about all the bells and whistles, offer the simple version of Windows with an online version of Office with basic capabilities. (Having a 3 application limit in the basic version isn’t as much of a restriction now that so many apps run in browsers– make sure users are at least running your apps.) The “standard” version should include HD authoring tools and should cost about what Windows Home costs now. The “advanced” version should encrypt users’ data, and come with a login to your company’s Windows Live intranet.

There’s a lot of talk that Microsoft should pursue subscription pricing. However, past efforts to do this raised customers’ ire when expected upgrades did not arrive during the subscription period. Until Microsoft demonstrates that it can release meaningful, compelling upgrades regularly, they should stick to licenses. (They can always offer financing to defray the upfront cost.)

What about all these extra goodies? What are they worth? They are worth spurring an upgrade cycle. They should be bundled into Windows and Office. Down the line, Microsoft can charge for them (think about moving SharePoint into the Cloud). More than falling behind the times in the pricing game, Microsoft has stood still while the value game has changed. Fixing the pricing problem and the sagging stock price start with fixing the value problem.

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