By Paul DeGroot [bio]
Posted: Jul. 21, 2008

• Chart: BPOS Standard and Dedicated Services

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.

How partners will play in the new world of software plus services became much clearer at Microsoft's 2008 Worldwide Partner Conference in July, when the company announced prices and partner commissions for selling Microsoft-hosted services. Partners who currently do not provide hosted services could find that commissions on the Microsoft services provide additional income, while others will find themselves in competition with the company, particularly at the low end. Competitive pricing, as low as US$2 per month for some services, also signals to online competitors, such as Google, that Microsoft will compete seriously in the market for hosted applications and services.

The Case for Hosted Services

In Mar. 2008, Microsoft announced the components of its hosted services offering for businesses of all sizes, Microsoft Online Standard, which will begin to roll out in fall 2008. These services offer customers access to instances of Exchange, SharePoint, and Communications Server that are running in Microsoft data centers, rather than on the customers' local networks.

For many customers, hosted products offer higher reliability and lower cost than running these servers on their own network, because the hoster frequently has deeper technical skills, tighter patching and security procedures, better redundancy, fewer administrators per server, and more reliable backup than many customers have at their own sites. Hosted systems can also be provisioned more rapidly than on-premise systems, and they make it easier for customers to reduce their costs if their usage drops, unlike on-premise systems, where licenses cannot generally be returned to the vendor or resold.

For all services in the Standard version, customers use servers shared with other customers (known as "multitenant" hosting). The suite is also available in a high-end Dedicated version, which offers dedicated servers and some additional features. Microsoft Online Dedicated is available for customers with more than 5,000 seats. (For the features provided by each level of online service, see the chart "BPOS Standard and Dedicated Services".)

The hosted offerings position Microsoft to compete more effectively with other vendors such as Adobe, Google, and Salesforce.com, who have begun to offer online applications and services that compete with Microsoft's on-premise e-mail, collaboration, conferencing, and other servers, as well as with Office applications.

However, when Microsoft announced that it would provide hosted services, it did not say how much customers would pay.

Pricing

At the 2008 partner conference, the company announced the following monthly per-user prices for the Standard offering:

• Exchange Online will cost US$10 for each User Subscriber License (USL) and includes the antispam and antivirus capabilities of Exchange Hosted Services and Forefront Security for Exchange Server
• SharePoint Online, which provides collaboration and document management, will cost US$7.25
• Office Communications Online, which provides instant messaging and presence information, will cost US$2.50
• Live Meeting, which offers Web conferencing, will cost US$4.50.
• Combined, the four products are known as the Business Productivity Online Suite (BPOS) and are priced at US$15 per user per month, a discount of 38% from the total of the individual components.

Users each get 1GB of storage for Exchange and for SharePoint, with additional 1GB storage increments available at extra cost.

Microsoft has not disclosed pricing for the Dedicated version, which likely will vary by customer size and requirements.

The company also announced Exchange and SharePoint services for "deskless workers" such as nurses or factory-floor workers (although their use is not restricted to any particular category of workers). Priced at only US$2 per user per month each or US$3 together, they offer browser-based access to an Exchange mailbox and read-only access to a SharePoint portal.

As Microsoft announced earlier, customers who have Software Assurance on Client Access Licenses (CALs) for on-premise versions of hosted server products can pay a step-up fee (which is less than the full price of a USL) to upgrade to a USL for the same server product offered online. Customers without SA must pay the full price for a USL, even if they already own a CAL. A USL covers both the on-premise and online instances of a server. For example, an Exchange USL can be used to access both a local Exchange server and an online Exchange server.

Customers are required to subscribe for a year at a time, with a minimum of five seats, but they can add additional seats at any time once their subscription starts.

Partner Commissions

Partners who want to resell the Standard version of Microsoft Online can sign up as Online Services Advisors (OSAs) and receive a portion of the fees that customers pay.

Partners who are designated by the customer as the partner of record (POR) within 90 days of the start of the services receive 12% of the first year's net payments (less any promotional discounts) for each new seat acquired, as well as 6% of recurring revenues from the customer's agreement. Thus, the POR will receive 18% for the first year of the contract (which requires a minimum one-year commitment) and 6% thereafter.

Licensing distributors can be OSAs themselves, becoming the POR for customers whom they sign up directly for the services, or they can train other partners to become OSAs; in that case, the distributor will receive a commission for each OSA it recruits.

No fees are paid for government customers, and customers who order online services directly from Microsoft through their Enterprise Agreement do not generate rebates for partners, although Enterprise Software Advisors (ESAs) who assist with such sales will get a standard ESA fee.

Microsoft is opening the OSA program even to Registered Partners, who occupy the bottom tier of its partner program. To participate, they must sign a contract and pass an online test related to their familiarity with hosted services and Microsoft's offering. The company has prepared an online training course to assist partners in passing the test. OSAs also get a listing in a Microsoft Online Customer Portal.

Customers may designate a POR at the time of their initial order, and can change it at any time. A customer can also have multiple PORs for different orders. For example, a customer might begin with an order for Exchange Online with one POR and later sign up for SharePoint Online with a different POR.

Customers can buy online services directly from Microsoft, but do not receive a rebate or discount for purchasing without a POR.

The model employed for the most recent set of hosted services is similar to a commission structure that the company announced for its online customer relationship management product, CRM Online, at the partner conference in 2007. That service pays partners 10% of recurring revenues and is more lucrative overall because Microsoft charges much higher prices for CRM Online: from US$39 to US$59 per user per month, depending on the level of service and when the customer starts. (Prices will rise in 2009.)

Partner Impact

Partner reactions to the BPOS are mixed. Most are relieved that Microsoft has finally resolved much of the uncertainty surrounding the service, which has slowly evolved from an incubation project with one enterprise customer to a broad market offering aimed at customers of all sizes.

The new hosted offerings will provide both new competition and new opportunities for partners of many types.

Hosting partners. Microsoft Online will provide stiff competition for some partners who today offer hosted Exchange, SharePoint, and other services (although Exchange is by far the most popular hosted service). This will be particularly true of those who compete at the low end of the market, where hosted Exchange is available for about US$10 per user per month—the same as Microsoft's price.

These partners currently pay Microsoft more than US$4 per user per month (through the company's Service Provider License Agreement, which applies to companies that resell hosted Exchange) in royalties for a service comparable to what Microsoft will offer; if they try to compete with Microsoft's channel incentives, such as offering partners rebates on their services, they will have little left to finance their own operations.

Some companies are exiting the hosting market immediately. One global integrator that previously provided hosted Exchange services for enterprise customers says it cannot compete and is migrating those customers to Microsoft's hosted Exchange offering. Given Microsoft's pricing and marketing power, staying in the business is not an option, a spokesperson said: "We would be crushed." The integrator is nervous about some aspects of Microsoft's program, particularly the idea that a customer could change its POR—and the address to which commission checks are sent—at any time. When a customer has tens of thousands of seats on the service, the POR needs to ensure that it meets the customer's requirements for related services to avoid losing substantial revenues.

To survive in the hosting business, most will have to offer services that Microsoft doesn't. For example, many business customers want to use the Blackberry Enterprise Server to synchronize Blackberry smart phones with their Exchange Server, a service that Microsoft says it will not provide. Partners may also provide larger default mailboxes, higher service-level guarantees, and other incentives that will attract customers who find Microsoft's online services insufficient.

Some hosters, such as those in Canada, will be helped by limits on Microsoft data centers: until 2009, BPOS customers will be hosted in U.S. data centers, where their data is subject to inspection by U.S. authorities under the Patriot Act. As Microsoft rolls out more data centers (a new data center in Ireland will provide a European hosting center for BPOS in 2009), this concern will diminish.

Traditional on-premise integrators and service providers may have to fend off questions from customers attracted to the hosted model, particularly if customers find it costly to manage their own on-premise servers. On-premise integration partners have little experience with hosted services and fear that as Microsoft takes on critical parts of their customers' technology, the partners will lose their status as trusted advisors. These partners could evolve their services, however, acting as PORs for customers who are attracted to online services and providing other services, such as migrating customers' directories and data from on-premise to online systems, acting as the online administrator, and providing first-tier technical support for those customers.

Resellers may find that the OSA role provides a useful supplement or replacement for traditional license sales, creating an alternative revenue stream to compensate for any losses from customers defecting from traditional license sales to hosted services.

In some scenarios, resellers could even make more from reselling online services than from on-premise licenses because USLs are more expensive than CALs over time. For example, an Exchange CAL costs US$67 or less (depending on volume), for which resellers typically get a margin of about 18%, or about US$12. An Exchange USL, however, will cost $120 a year, for which the reseller will get US$21.60 in the first year and US$7.20 for each year thereafter. The reseller will lose out on server license sales, but CALs make up most of the revenue from Microsoft server products, so net reseller revenue from USLs could be higher than from CALs and server licenses.

New players. As hosting takes hold, new types of service providers are likely to emerge. One possibility: consultants who move quickly to sign up new customers for Microsoft's service with little investment of their own in any Microsoft technology. Because hosted services can be provisioned far more quickly than on-premise systems, these "online-only resellers" can use the faster sales cycle to develop a steady and growing revenue stream. But their relationship with customers may be fragile, since customers may need other partners to serve more complex technology needs. In addition, many current hosters already provide partner incentives that are more lucrative than Microsoft's, especially when the hoster offers more advanced services, such as Blackberry support and larger mailboxes, at higher prices. Some online-only resellers could offer multiple hosting options, selling higher-priced services from Microsoft partners when possible and lower-priced services from Microsoft when necessary.

Reducing the Pain

Microsoft executives have warned partners in the past that the shift to hosted services could cause pain, and it has made some effort to mitigate the damage that it could cause.

For example, Microsoft will reduce prices that it charges service providers who currently host its server products. Prices for many products on the Service Providers License Agreement (SPLA) price list will come down, and Microsoft will add pricing for a suite, similar to the BPOS, to the SPLA. That will help level the playing field for current hosting partners.

The company is also providing partners with business management tools that could be helpful in the era of hosted services. These include market research and lists of key performance indicators that could help hosters and resellers assess the likelihood that they can succeed as hosters, resellers, or promoters of Microsoft's services.

Partners could draw some reassurance from Microsoft's prediction of explosive growth for online services in coming years: one analysis says the market for such services will grow 32% per year, on average, through 2011.

One of the most important contributions Microsoft has made is validating the market for hosted services. Until recently, Microsoft has argued against widespread use of hosted services, arguing that local, on-premise technologies provide greater reliability and offline capabilities. But ubiquitous network connectivity and more mobile workforces have weakened those arguments, and with Microsoft itself now promoting hosted and online services, hitherto reluctant customers are likely to look at it differently, creating greater opportunities for a wide variety of partners and vendors.

Resources

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

Earlier online services announcements were covered in "Online Business Services Aim at Broad Market" on page 13 of the Apr. 2008 Update and "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.

CRM Online is described in "CRM Online Service Debuts" on page 7 of the June 2008 Update.