Microsoft Corp. may in the future be forced to lower its software prices as a result of the growth of open source, the company cautioned in its latest filing with the Securities and Exchange Commission.
In its latest 10-Q quarterly filing, Microsoft said that the popularization of the open-source movement continues to pose a significant challenge to its business model.
This threat includes “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.
“To the extent the open source model gains increasing market acceptance, sales of the companys products may decline, the company may have to reduce the prices it charges for its products, and revenues and operating margins may consequently decline,” it said.
At the root of the problem for Microsoft is the challenge open-source software presents to its traditional business model—which is based on customers paying to license its software. Under this commercial software development model, software developers bear the costs of creating the software but receive license payments for its use.
But the open-source movement has turned that model on its head. Now, software is produced by global communities of programmers, with the resulting software and intellectual property licensed to end users at little or no cost, the filing said.
Microsoft also alienated many of its largest customers with its controversial new Licensing 6 and Software Assurance program, which took effect last year.
The company has since tried to address some of the issues it faces resulting from the growing popularity of open source, by looking at new ways to make Licensing 6 more beneficial to small- and medium-size businesses, as well as by creating a new global initiative to provide governments around the world with access to Windows source code.
This new security initiative, known as the Government Security Program, is designed to “address the unique security requirements of governments and international organizations throughout the world,” Microsoft said.
The governments of both the United Kingdom and Russia have signed up so far, as has NATO, and Microsoft is talking to more than 20 other countries about their interest in the program. Microsoft has been increasingly concerned by moves such as that of the German government, which announced last June that it was moving to standardize on Linux and an open-source IT model at the federal, state and communal levels.
The German governments move followed more than 75 other government customers. The U.S. Department of Agriculture, the Federal Aviation Administration, the U.S. Department of Energy, the U.S. Air Force and Pinellas County, Fla., are all using Linux, as are agencies in the governments of China, Singapore and Australia.
But the greatest open-source threat Microsoft faces is to its server business. In fact, research and consulting firm Meta Group predicted that Microsoft would begin moving some of its current proprietary application enablers, such as the components of its software-as-a-service .Net strategy, to the Linux environment in late 2004.
: Microsoft Warns of Open-Source Threat”>
And in a controversial client advisory released last month in which Meta gave its current analysis and five-year forecast for Linux and its impact on the IT landscape, the firm said its research indicated that Linux currently commanded between 15 percent and 20 percent of new server operating system shipments, but that by 2006 or 2007, Linux on Intel, or Lintel, would be on 45 percent of new servers.
Microsofts latest 10-Q filing shows that its financial fortunes continue to lie squarely with its Windows client, Office desktop productivity and server platforms—all of which are being aggressively targeted by the open-source development community.
Microsoft is also bringing new server and Office offerings to market this year, which it hopes will help drive sales momentum. Windows Server 2003, the upgrade to Windows 2000 server, will be released on April 24, while Office 11 is slated for release by the end of June.
The latest 10-Q filing shows that in the quarter, ended December 2002, those three business units generated some $4.346 billion in operating income.
But that was offset by $1.087 billion in operating losses from Microsofts Business Solutions, MSN, CE/Mobility and Home and Entertainment businesses, as well as reconciling amounts—which includes state revenue and operating income adjustments and corporate level expenses not attributed to any one segment.
On the positive side, Microsofts Windows-based client business generated $1.965 billion in operating profit on the back of $2.435 billion sales revenue for the quarter. The Information Worker segment of its business, which includes Office, Project, Visio and SharePoint Portal Server, generated $1.883 billion in operating income on revenue of $2.411 billion; while its server platforms business garnered $498 million in operating income on revenue of $1.665 billion.
In contrast, its Home and Entertainment unit, which includes the Xbox video game system, its other PC games, consumer software and hardware and TV platform, turned in an operating loss of $348 million in the December quarter, with the MSN subscription and network services unit reporting an operating loss of $157 million and reconciling amounts coming in at a $450 million operating loss.
Microsoft also cautioned in the SEC filing that while it had made significant investments in research, development and marketing for new products services and technologies, including Microsoft .Net, Xbox, MSN and wireless and mobile technologies, “significant revenue from these investments may not be achieved for a number of years, if at all.
“Moreover, these products and services may never be profitable, and even if they are profitable, operating margins for these businesses are not expected to be as high as the margins historically experienced by Microsoft,” it said.
That sobering outlook follows the bleak picture of the global economy painted by Microsofts chief financial officer John Connors, in presenting the companys second-quarter financial results last month.
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