James Kobielus: Creeping commoditization is Microsoft’s biggest foe

Above The Cloud

Microsoft Corp. CEO Steve Ballmer recently declared that the company will discount its software sharply rather than lose market share to open source alternatives such as Linux. Apparently, Microsoft is willing to sacrifice profit margins to prevent erosion of its substantial foothold in many market segments.

More than anyone else at Microsoft, Ballmer is keenly aware of the software Goliath’s vulnerabilities. As Ballmer noted in a recent presentation to industry analysts, Microsoft can no longer compete as the low-cost provider in many market segments. Server software commoditization – driven by open source initiatives and enterprise preferences for function-limited, best-of-breed products – is exerting continued pressure in many of Microsoft’s core markets.

Creeping commoditization – not Linux or open source – is Microsoft’s biggest foe and poses the most fundamental threat to the long-term profitability and revenue growth of traditional software vendors. Commodity-like offerings, many based on open source software, are starting to come on strong in many market niches, such as Web servers (Apache, for example) and mail servers (Sendmail, for example).

To the extent that whole countries migrate toward free-of-charge open source offerings, as seems to be happening in several European countries, Microsoft will find itself increasingly gasping for its precious oxygen supply: software license revenues.

Microsoft’s response to the commoditization challenge is more subtle and clever than simply slashing prices. In any market, companies compete on price or features (or both), and Ballmer has said Microsoft will step up research and development to distinguish its offerings from rival software products.

Microsoft also is increasingly stressing the benefits of its unified enterprise software architecture, based on features such as Kerberos, Active Directory and Enterprise Universal Description, Discovery and Integration (UDDI) Services.

But more fundamentally, Microsoft is fighting fire with fire by positioning its products as quasi-commodities (within a broad architectural framework) that are targeted at various market segments. Signs of this encroaching commoditization are popping up throughout Microsoft’s product road map. The company’s recent server software offerings are noticeably less monolithic and more function-limited in architecture than previous versions.

For example, the company has chosen to remove instant messaging, presence and other synchronous-collaboration features from its upcoming Exchange 2003 release, and instead has incorporated these features in a separate product, Real Time Communications Server 2003.

In addition, Microsoft has excluded a lot of promised new functionality from the latest major release of its server operating system: Windows Server 2003. Instead, the vendor says it will introduce many new server-based features later this year in layered (and separately licensed) add-ons to Win 2003.

Yet another sign of Microsoft’s foray into strategic commoditization is that it has created a Web edition of Win 2003. This is the first time Microsoft has “productized” a Windows server operating system edition to fit a particular deployment role: basic, stand-alone Web/application server. Befitting this narrow role, Win 2003 Web Edition lacks some features found in the complete release that aren’t relevant to this role, such as Active Directory, Enterprise UDDI Services and Windows Terminal Services.

Of course, Microsoft wants to sell its server software into all possible customer environments under all possible roles, and the Windows server operating systems are its primary platforms for addressing a broad range of markets. But the company knows that it hasn’t succeeded in being all things to all customers. The company knows it will need to venture deeper into commodity-like product positioning to fend off challenges from smaller, nimbler competitors.As a trend, server software commoditization is much larger than Microsoft or any other vendor. For corporations, this trend is encouraging. It promises to reduce software licensing costs, increase vendor competition and innovation, and encourage standards-based interoperability. Microsoft is smart and agile enough to know that it can only resist this inexorable trend at its own long-term peril.

Kobielus is a senior analyst with Burton Group, an IT advisory service. He can be reached at (703) 924-6224 or jkobielus@burtongroup.com.

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