Microsoft's big decision: Who gets a free upgrade to Windows 10?

One of Microsoft's biggest decisions this year will be whom to charge for Windows 10, and the dollar figure on the price sticker.

Hints of that decision could come as early as Jan. 21, when Microsoft executives will not only unveil the next iteration in Windows 10's string of previews, but also further explain Windows' part in the company's overall strategy. CEO Satya Nadella has alternately portrayed that strategy as "cloud-first, mobile first" and "productivity and platforms."

In December, Microsoft COO Kevin Turner said that the firm would reveal its Windows business model plans in early 2015. Details of that model have not been disclosed, but would certainly include how Microsoft figures to make money off Windows after it's begun giving away licenses to makers of phones, smaller-sized tablets and inexpensive personal computers.

As part of an explanation of monetization -- which Turner acknowledged requires "creative ways" -- Microsoft might also use the January event to discuss Windows 10's upgrade pricing.

Or not.

Wes Miller, an analyst with Directions on Microsoft, was skeptical in a recent interview. "[Upgrade pricing] isn't the most important thing right now," he said, pointing out that Microsoft typically discloses that information just a few months before shipping, or early-to-mid summer when it releases a new operating system in the fall.

Make or break time for Microsoft

Instead, Miller believed that Microsoft would discuss Windows in more general terms in January, perhaps focus on its creation, or as he put it, "Talk about how the sausage gets made."

Still, Windows 10 will be "the real make-or-break" test for whether Microsoft can reinvigorate the consumer part of its PC customer base, Miller said. But he was painting in broader strokes, not focusing on upgrade pricing only.

Jan Dawson, principal analyst at Jackdaw Research, saw it differently. Although he had no predictions for what Microsoft would reveal in two weeks, he has called the upgrade pricing question one of the most important facing the company this year. "The single greatest test may be whether Microsoft can successfully charge large amounts of money for a new operating system to consumers and still see significant uptake," said Dawson in a piece published last month on Tech.pinions (subscription required).

There is increasing evidence that Microsoft believes it will not be able to pass Dawson's test with Windows 10, and so will, through necessity, choose a strategy very different from decades-long pricing practices.

Strategy options

First on the witness list is Microsoft's stunning decision earlier this year to give away Windows licenses to OEMs (original equipment manufacturers) building devices with screens 9-in. or smaller -- in other words, smartphones and larger tablets. That was quickly followed by a free or nearly-free (it depends on whom you ask) version of Windows for traditional PCs, dubbed "Windows 8.1 with Bing", that now powers a line of ultra-inexpensive notebooks. Those are best exemplified by HP's Stream, which compete on price with the many flavors of Chromebook, the Chrome OS-based laptops that put a fright into Redmond.

While there's nothing to stop Microsoft from charging historical prices for Windows 10 upgrades -- roughly $100 for a consumer edition, $200 for one aimed at businesses -- in light of giving corporations like HP a free ride, the backlash would almost certainly be fast and furious. With Windows free elsewhere, even the aggressive discount prior to the release of Windows 8 three years ago, when Microsoft charged customers $40 per license, would come across as squeezing coin from the villagers while leaving the aristocracy untaxed. The last thing Microsoft needs is another "I-hate-Windows" groundswell, this one triggered by customer class warfare.

Secondly, Turner made clear that everything is up for grabs. His words must be taken seriously, as Microsoft rarely if ever reveals anything it doesn't want to reveal.

In early December, Turner said "We've got to monetize it differently," referring to Windows, and then stressed that the new business models would "allow us to monetize the lifetime of that customer through services and different add-ons (emphasis added)." If that doesn't sound like a freemium strategy, analogous to in-app purchases on a smartphone, we don't know what does.

And finally, there's Windows 10 itself.

When the company's top operating system executive Terry Myerson unveiled Windows 10 in September, he said, "We're not building an incremental product," to stress that 10 is a big break from the past. (Skipping "9" was another clue.) Although his assertion could reflect any number of things, including the merging code base of Windows, much about the new OS will be radically different than the Windows of the past. WIndows 10 will have a much faster update cadence -- which some believe will make it impossible for Microsoft to charge for updates, even major ones that previously would have been labeled "upgrades" -- and retain the moniker for many more years than the usual three.

 It's all about the price

That last means Microsoft must get the pricing right at the start or face more backtracking, something it should be loath to do, what with the backpedaling from Windows 8 in the last two years.

Altogether, the evidence points to a rethinking of Windows 10, including its pricing. But what are Microsoft's options?

Dawson laid out three.

Option A: Free upgrade from Windows 8.1 seems like a lock. "This would be mostly about pacifying those users," said Dawson, referring to the complaints lodged about Windows 8 and even Windows 8.1, like the lack of a Start menu, and a reluctance to try "Modern," née "Metro," apps.

Option B: Free upgrade from older versions of Windows may be a stretch, but a free deal for Windows 7 would almost instantly boost the user share of Windows 10, where customers could be monetized through app and service purchases.

Option C: Free upgrades to all consumers, and possibly free licenses to all consumer PC OEMs, too, while continuing to charge for enterprise-grade licenses, would be the most radical move.

The options could be combined, so that Microsoft, for example, selects B but also applies C, giving a free Windows 7-to-Windows 10 upgrade to consumers only.

Not surprisingly, these options come with trade-offs and long-term implications.

Under any of its free upgrade options, Microsoft will surrender varying amounts of revenue, with the smallest hit from A, much more from B and the largest, by far, from C. With between hundreds of millions and billions of dollars at stake, revenue drop-off certainly has to have been at the fore of the firm's deliberations.

Turner denied that Windows would be a "loss leader," implying that Microsoft would not make the OS free across the board. Even under the biggest break with the past, Option C, Microsoft would still charge some customers -- those in the enterprise -- for upgrades or new licenses. That leaves the company lots of maneuvering room.

Windows class warfare?

Creating customer classes -- consumer on one hand, commercial on the other -- by giving the former free upgrades but making the latter continue to pay, also could be risky: As with the OEM-customer pricing disparity, enterprises might balk, especially if they're asked to pay even more for their Software Assurance annuity plans, as some experts believe will happen.

On Microsoft's side, however, is the fact that businesses have little alternative to Windows for their PCs, and although they might grumble at paying for upgrades when consumers get them for free, they will have to bite the bullet and pony up.

If Microsoft does choose Option C, or one of the others but limit the free deal to consumers, it would probably proffer a less-capable version of Windows 10 as the upgrade, one that omitted domain joining and other enterprise-grade features found only in Windows' Enterprise, Pro and Professional editions. That would let it continue to charge Windows 10 customers who need those business tools, much like it now does for Office on the iPad.

Also on the decision scale are Microsoft's relationships with its OEMs. Traditionally, computer makers have used each new edition of Windows to shill systems, knowing that most customers do not upgrade, but instead buy a new PC after Microsoft rolls out a new OS. By giving away upgrades to Windows 10, especially if the eligible include Windows 7 users, Microsoft would essentially dump that sales tool.

OEMs would rightfully see any broad-based free upgrade as a threat, something doubly difficult for them to swallow during the current tough times for personal computers.

Free upgrades would also set a precedent, Dawson observed, that might be difficult to later reverse. That alone makes Microsoft's Windows 10 decision important: It could be stuck with what it chooses in 2015. In some ways, however, that hesitation to break with precedent would be minimized. Most analysts expect that Windows 10 will be the last major upgrade, if not for forever, then for many more years than the usual three-year cycle, with constant updates replacing occasional upgrades.

Perhaps Microsoft believes the benefit of a widespread free upgrade -- anything more than Option A -- outweighs the revenue and OEM relationship problems. If so, one reason has to be its app issue.

Before the launch of Windows 8, then-CEO Steve Ballmer boasted that Modern app developers would have hundreds of millions of customers, basing that on the number of PCs sold annually, plus anticipated upgraders. "It's going to create a heck of a lot of opportunity for folks in this room to make millions," Ballmer claimed in October 2012.

That opportunity did not materialize. But a free Windows 7-to-Windows 10 upgrade has the potential to add millions more to the pool of app purchasers, and millions of buyers of what Turner called "services and different add-ons."

Microsoft may not strike out with just one whiff at the app plate, but it's hard to see how it could convince developers that Modern is worth their time if it swung and missed again with Windows 10. This might be its last chance.

"In some ways, Windows 10 may be seen as symbolic of all the challenges facing Microsoft," said Dawson.

Exactly.