By Paul DeGroot [bio]
Posted: Mar. 24, 2008

• Illustration: Microsoft Online Services Roadmap

The following is the full text of an article published by Directions on Microsoft, an independent research firm focused exclusively on Microsoft strategy & technology. More samples of our content, as well as a list of upcoming articles and reports are also available.

Microsoft-hosted versions of Exchange, SharePoint, Communications Server, and other servers will be made available to customers of all sizes through partners and through Microsoft's volume channel later in 2008. The offering amends an earlier announcement in which Microsoft offered hosted servers only to customers with more than 5,000 seats. The services will help Microsoft compete with online applications and services offered by competitors, and could help Microsoft tap a much higher share of the largest single component of corporate IT spending, the cost of managing and maintaining software. However, current hosting partners could find themselves in stiff competition with Microsoft.

What's on Offer?

Microsoft has offered hosted services through partners since the mid-1990s, but has been experimenting with offering hosted services directly since 2005, when it revealed that it was hosting Exchange, SharePoint, and Live Communications servers, as well as managing desktops, for Energizer Holdings.

In Oct. 2007, Microsoft announced Microsoft Online for enterprises with more than 5,000 seats, which included server application hosting but not desktop management.

In Feb. 2008 it announced the Business Productivity Online Suite (BPOS), a similar set of services aimed at business customers of any size, with two tiers of service. The Dedicated tier is provided on dedicated servers, allowing scope for greater customization, while the Standard tier will be provided on servers set up for multitenant operations, in which a single server can by used by multiple customers.

The Standard tier includes the following:

• Exchange 2007 e-mail, including hosted antispam and antivirus
• SharePoint site hosting, which provides Web-based document and data sharing with site search and basic content management
• Communications Server instant messaging and presence, as well as peer-to-peer Internet voice and video chat between two parties with the Communicator 2007 client.
• An administrative console, which lets organizations create users, manage their privileges, and change their passwords.

Also included in the offering is Live Meeting, Microsoft's hosted Web-conferencing service, for conferencing and application sharing. Customers who purchase Live Meeting through BPOS don't get anything new, but, depending on the as-yet unannounced pricing, they may find it more convenient to pay for it as part of a larger subscription service than as a separately licensed product.

The Standard tier uses secure HTTP to communication between clients and servers, while the Dedicated tier uses a virtual private network connection, which enables Active Directory federation and single sign-on. The Dedicated tier provides Exchange, SharePoint, and Communications Server hosting with all the features of the Standard tier, plus a variety of additional features, including the following:

• Mail archiving, such as that required for regulatory compliance (and currently available to customers as part of a separate Exchange Hosted Archive service)
• Hosted SharePoint Server 2007, including Web-based distribution and processing of InfoPath forms and Excel spreadsheets; enterprise-wide search indexing; and the Business Data Catalog, for integration of SharePoint with enterprise resource planning systems, such as SAP.

The Dedicated tier will be available to customers in the first half of 2008, while hosted Exchange and SharePoint services for the Standard tier will be available in fall 2008, and the Standard tier of hosted Communications Server will be available in 2009.

(For a roadmap showing the evolution and delivery dates of these products, see the illustration "Microsoft Online Services Roadmap".)

In general, Business Online Services do not provide the full feature set of their on-premise counterparts. For example, unified messaging, which combines voice mail, fax, and e-mail in a user's Exchange mailbox, is not available in the hosted version of the server. One service provided in the original Energizer contract but missing from the BPOS: desktop management, such as maintenance, security, and change management.

Delivery Organization

The BPOS comes from the Business Online Services group, which has consolidated many Microsoft teams engaged in hosted and subscription services under the technical leadership of Dave Thompson.

Thompson's team includes the following engineering groups:

• Microsoft Managed Solutions, which developed the Energizer offering
• Exchange Hosted Services, which built an online service (based on the acquisition of Frontbridge) that supplements on-premise Exchange servers with virus and spam filtering, mail archiving, and other services
• Hosted Messaging and Collaboration (HMC), which has created provisioning systems for partners who provide hosted Microsoft servers and applications for customers
• Live Meeting, used for online Web conferencing
• The BPOS team, which has focused on multitenant solutions using Microsoft servers.

In addition to defining some of the licensing and pricing models for online services delivery, the Business Online Services group is working with Microsoft product teams so that the next versions of Exchange, SharePoint, and other products will work better in a multitenant environment.

"Right now, we don't have feature parity between the on-premise editions and the online services, but the goal is to have feature parity so that the customer doesn't need to choose on the basis of the features they need but on the basis of the delivery model they prefer, whether it's on-premise, hosted by a partner, or a subscription from Microsoft," says John Betz, director of product management for Business Online Services.

The team uses Microsoft's HMC platform itself to deliver the BPOS, and will continue to enhance the HMC, updating it for its hosting providers as new features are stabilized and tested.

Per-User Subscription Licensing

Each person who accesses BPOS will require a User Subscription License (USL) rather than a Client Access License (CAL), which is required for on-premise versions of Exchange, SharePoint, and Communications Servers.

Microsoft will offer an upgrade path from CALs to USLs, and a USL will qualify as a CAL as well. This means an organization that has both on-premise and hosted servers—for example, it might use hosted Communications Server for instant messaging and presence but an on-premise version of server for Voice over Internet Protocol calling—will not need to buy multiple licenses; only a single USL is required.

Strategic Issues

Online Services, part of Microsoft's broader "software plus services" initiative for consumer and business customers, is driven by three imperatives—competition, customer demand, and revenue potential.

Competition. Online applications and services from Google, Salesforce.com, Yahoo, and others offer a long-term threat to Microsoft's lucrative Office and servers businesses. Customers who want to avoid the licensing, management, and maintenance costs of on-premise software can duplicate many of its features with online services for document creation, calendaring, e-mail, customer relationship management (CRM), and lightweight databases, among others. Though usually not as sophisticated as their on-premise counterparts, such applications are often free or relatively inexpensive, can be accessed from Web-enabled mobile devices, and offer built-in collaboration capabilities. For example, free online text editors from Google and Zoho allow multiple users to edit the same document at the same time, something that Microsoft does not offer in either its on-premise or hosted offerings.

A secondary risk for Microsoft is that the more people depend on Web-based productivity applications, the more likely they are to encounter advertising placed by or through Google, giving that company an even greater edge over Microsoft in Internet advertising. Microsoft's offering keeps the on-premise client intact, while moving servers to the Internet and providing centralized management and efficiency.

Customer demand. One of the driving forces behind the Energizer engagement was Energizer's unhappiness with the time its IT staff spent on routine management tasks, such as managing Exchange. Most IT departments spend at least 50% of their budget on salaries, and up to 70% of IT staff time is spent on maintenance, according to the Gartner Group. In-house IT specialists might cost companies US$100 per month per employee for IT management. A hosted service, on the other hand, may charge only half that for a suite of managed file and print services, e-mail, and a document portal, including 24x7 monitoring and higher uptime than many companies can achieve with on-premise staff and systems.

The demand for hosted services has spawned a growing industry of partners who offer hosted Exchange, SharePoint, and other applications. Organizations that use such services can focus more directly on revenue-generating activities and reduce their IT staff or redeploy staff to projects that provide clear advantages in efficiency or competitive value.

Revenue. Although customers who switch from on-premise and self-managed services to hosted services may only be substituting one Microsoft offering for a different one, the shift to hosted services offers Microsoft substantial opportunity for additional revenue. Microsoft's share of overall IT spending is small—typically no more than 5%, even in all-Microsoft shops. Through economies of scale—huge datacenters, advanced monitoring and management software, and use of standardized configurations—Microsoft can substantially reduce per-server management and troubleshooting costs and can capture some of the money that customers save on such activities when they move to hosted servers. In effect, rather than limiting itself to capturing 5% of customers' IT spending, Microsoft can grab at least some of the 50% that most companies spend on staff who maintain static systems. For example, Microsoft could theoretically position its hosted services so they not only replace the license revenue formerly allocated to these server products but also replace 20% of a customer's IT management costs at one-half the price. In this case, not only would the customer save money, but Microsoft would substantially increase its share of the customer's IT spending and generate more revenue than it could from license sales alone.

The Partner Picture

The Energizer type of engagement for customers with more than 5,000 seats, will continue to be available from Microsoft, but the company still considers it a pilot project, sold directly by Microsoft. The Standard and Dedicated tiers of the BPOS, however, will be sold through a variety of sales channels, including current hosters, volume resellers, integrators, and telecommunications firms.

These companies will be able to brand the service with their own logos and perform simple management tasks, such as creating new users, on behalf of customers, or delegate such tasks to customers.

The services will be sold via Microsoft's volume channels, providing some compensation to resellers who are likely to lose on-premise license sales if customers switch to subscription services.

Some current hosters may opt to build a sales and services organization on top of Microsoft's services rather than continuing to run their own server farms; some new providers may build a new kind of business, acting as agents who resell Microsoft services directly to customers.

Compensation and Partner Uncertainty

How current reseller models will adapt or new ones will emerge remains uncertain because the company has not outlined BPOS pricing or the compensation structure for partners.

Resellers. Volume resellers typically receive margins of about 18% for conventional Microsoft licenses. Subscription services generate less revenue initially, but may generate the same or more over a three- to five-year period.

Microsoft seemed to have set a precedent at its worldwide partner conference in July 2007 when it announced that partners who sold its CRM Live service would get 10% of the subscription revenues for the life of the customer's contract. However, subsequent announcements for hosted services have not included any compensation information, and the offer made to CRM partners may have been driven by the need to generate momentum against Salesforce.com, the current leader in hosted CRM services, which has grown at 85% a year for the last five years and is on the verge of US$1 billion in annual revenues.

According to Michael van Dijken, marketing manager for Microsoft's communications sector sales and partner organization, "Our intent is to go to market only through partners, so if there are not interesting margins for partners that model is not going to work." He expects that Microsoft will tell partners more about the share they will get from BPOS sales at the company's worldwide partner conference in July.

Hosting partners. Microsoft may also need to resolve a disconnect between BPOS and the Service Provider Licensing Agreement (SPLA), used by partners who currently host Microsoft products, including products that are part of BPOS.

SPLA hosters do not purchase software licenses upfront, but instead pay Microsoft on a monthly basis for the number of customers using their hosted Microsoft applications. SPLA pricing is already coming under fire from Microsoft hosting partners because they receive an effective price only about 20% lower than retail pricing, even though many of them serve thousands of customers and would like to get the greater volume discounts available to larger Microsoft licensees.

If BPOS are priced at or below what SPLA hosters must charge their customers, hundreds of Microsoft's hosting partners will be in trouble. They may be able to survive by offering more advanced services (such as dedicated servers and advanced customization) for which they can charge more, but Microsoft may challenge them at the low end of the market, where costs are lower and more predictable. This could make SPLA hosters' overall business unprofitable. On the other hand, Microsoft's offering could promote the concept of hosted rather than on-premise services. As more customers adopt the model, these hosters could accommodate demands for customization or specialization that Microsoft does not offer—if these hosters could survive long enough for such markets to emerge and if Microsoft itself does not provide greater customization.

Independent software vendors. Others that could be hurt by BPOS are vendors who build applications that extend or complement Exchange, SharePoint, or Communications Server. Applications that work fine when running on the same machine as a server application may break if the server application is running on a Microsoft-hosted system that does not permit extensions, add-ons, or significant customization. Customers may need to maintain an on-premise server, stop using the add-on application, or see if the add-on can be rewritten by the vendor. Customers for whom such add-ons or customization provide a critical business function may have to rule out BPOS for some or all of their systems.

Migration, Management Opportunities

Gaps in Microsoft's offering could bring other opportunities to partners, however.

Migration. Migrating Exchange mail or SharePoint document libraries from an on-premise to a hosted system is not part of the BPOS offering, so integrators or specialists may be required to assist in such deployments.

Mixed deployments. Most midmarket and larger organizations are unlikely to move their entire server infrastructure to BPOS, as least as it is currently designed, and they will continue to need IT staff or partners to manage and enhance on-premise systems.

Desktop management. One of the most notable gaps is the decision to not offer desktop management. Desktop software is one of the hardest entities to manage because of its variability, but desktop management can be a strategic role for a partner because it positions the partner to offer many more services and can keep competitors out of an account—managed desktops are typically locked down and standardized, and any changes to IT systems that require changes to desktop systems must be carefully tested and vetted by the firm that provides desktop management.

Market Impact

The impact of BPOS will depend a great deal on pricing, the experiences of early adopters, and how quickly Microsoft can roll out a more comprehensive offering.

Customer experience. Hosted services present a list of new concerns for customers, including server uptime, network outages, and whether or not the move to hosted services saves any money. Because BPOS is not a complete offering for midmarket and larger customers, they will need to retain their own IT staff for on-premise server maintenance, troubleshooting (such as printing, remote access, backup, and restore), and application development. The incremental costs of hosted servers may not pencil out for many of them. Customers will also need assurance that they have an escape route—the ability to replicate hosted data locally or to move it to another service provider who offers a better deal. Reliability could be another problem: while Microsoft has had considerable experience with broadly available hosted consumer applications, such as Hotmail, they have failed, in some cases for relatively long periods of time. Business customers who are paying for the service may not tolerate outages, and compensation from hosters when they fail to meet service-level agreements often covers only a fraction of the customer's actual costs and lost business opportunities. In addition, customers may be frustrated with having to deal with two vendors, their network service provider and Microsoft, when things go wrong. Finger pointing by suppliers can quickly lose customers.

Customer segmentation. Because many of the competitive services offered by Google, Zoho, and others are free or very inexpensive (e.g., US$50 per user per year), customers currently using those services are unlikely to be attracted to Microsoft's offering, although Betz says it will be well below US$30 per user per month. Small businesses and startups that want to avoid dedicated IT staff and on-premise servers entirely may get by with these free or low-cost services and could perceive the Microsoft offering as relatively expensive. As a result, it is unlikely that BPOS will have much impact on Microsoft's competitors for Web-based applications and services.

Current Microsoft customers may switch to hosted services to save costs, but that will provide only modest incremental revenue to Microsoft.

Partner impact. If partners are critical to the success of BPOS, Microsoft may have to sweeten the pot beyond its usual slim margins on volume software. Other than resellers, partners typically make little or no money from selling software—their payoff comes from maintenance and services, such as deployment and customization. Those opportunities disappear when partners sell services that Microsoft itself will run and manage. Other services sometimes mentioned by Microsoft, such as selling advertising or promoting Microsoft services, are nonstarters for Microsoft's traditional partner community, which focuses on its technical skills and product knowledge. Additionally, current hosting partners could lose the "low-hanging fruit" that helps them amortize their expenses over high volumes of customers, placing more responsibility for the success of hosted Microsoft servers on Microsoft itself.

Competitive moves. The feature sets of competitive Web-based business productivity services are likely to increase over time. For example, Zoho Writer now lets users work on documents offline (using Google Gears, a browser plug-in), mitigating a common concern about Web-based applications. The most important threat posed by these inexpensive services is to Microsoft's relatively costly Office suite, and secondarily to its servers, such as Exchange and SharePoint. By giving business customers some of the same offline/online flexibility with hosted SharePoint and Exchange, Microsoft strengthens the role of its client software and servers.

Product development. Moving servers online and providing a comprehensive environment for customization and optimization will be essential for the long-term success of Online Services. With its CRM product, Microsoft has suggested that the product's full feature set will be available regardless of where it runs, but the company's older products may require substantial revision to meet that goal. Unless the company's product teams can achieve a high degree of parity between its on-premise and hosted offerings, the latter may appeal only to a subset of customers.

Resources

The home page for BPOS is www.microsoft.com/online/default.mspx.

Earlier online services announcements were covered in "Hosted Messaging and Collaboration Services from Microsoft" on page 10 of the Nov. 2007 Update.

The rising profile of services and subscriptions was described in "Software Plus Services Becomes Urgent," on page 29 of the Aug. 2007 Update.

Expansion of managed services was covered in "Managed Services Strategy Broadens" on page 27 of the July 2007 Update.

Software Plus Services was outlined in "'Software Plus Services' Strategy Explained" on page 33 of the May 2007 Update.