Microsoft Sees Open-Source As Major Threat

As in 2003's 10-K filing, Microsoft trotted out warnings to the SEC, the public, and its shareholders that open-source, particularly Linux, could put an end to its earnings gravy train.

While Microsoft puts its trust on the traditional commercial model "where a developer invests in research and development, then sells licenses to customers for the resulting software, " it's growing increasingly worried about open-source.

"Under the non-commercial software model, open source software produced by loosely associated groups of unpaid programmers and made available for license to end users without charge is distributed by firms at nominal cost that earn revenue on complementary services and products, without having to bear the full costs of research and development for the open source software," said Microsoft in the 10-K filing. "The most notable example of open source software is the Linux operating system."

Delve into the 10-K, and Microsoft gives the impression that there's a Linux bogeyman under every rock.

"This is pretty typical [of Microsoft]," said Michael Cherry, analyst with Directions on Microsoft. "They tend to be fairly pessimistic in their 10-K filings." Caution is the watch-word, said Cherry, not just for Microsoft, but for most companies, what with shareholders not against suing corporations when unexpected downturns put stock prices into a nosedive.

"Our direct competitors include firms adopting...the non-commercial software model [that] typically provide customers with open source software at nominal cost and earn revenue on complementary services and products, without having to bear the full costs of research and development for the open source software," Microsoft said.

"More than anything, Microsoft's worried that open-source will potentially staunch the growth of their tools and server business," added Matt Rosoff, another analyst with Directions on Microsoft.

Microsoft specifically called out IBM as a competitor in the server space because of Big Blue's love affair with Linux. "IBM's endorsement of Linux has accelerated its acceptance as an alternative to both traditional Unix and Windows server operating systems," said Microsoft in the 10-K filing.

"We believe that Microsoft's share of server units grew modestly in fiscal 2004, while Linux distributions rose slightly faster on an absolute basis," wrote Microsoft. "The increase in Linux distributions reflects some significant public announcements of support and adoption of open source software in both the server and desktop markets in the last year."

Among those open-source wins that Microsoft's alluding to are those in Munich, where the city is moving forward with plans to migrate 14,000 systems from Windows to Linux, and Bergen, Norway, which will shift servers from Unix and Windows to Linux.

Microsoft also used the 10-K to again warn that open-source could pinch its profits to the point where it would have to reduce prices to stay competitive. In a word-for-word repeat of language used in 2003's 10-K, Microsoft said, "To the extent open source software products gain increasing market acceptance, sales of our products may decline, we may have to reduce the prices we charge for our products, and revenue and operating margins may consequently decline."

There's some evidence that such pressure is already being felt in Redmond, said Rosoff as he ticked off moves like Windows XP Starter Edition and Microsoft's increased attention to working with governments on such issues as lowering prices, sticking with a proprietary operating system, and opening Windows code to researchers and developers.

In some areas, however, Microsoft may say it's threatened by Linux and open-source, but the truth is, said Rosoff, that it is its own biggest enemy in markets such as the desktop operating system and business applications. "Office suffers from what Microsoft managers call 'good enough,'" said Rosoff. "There's little reason to upgrade from Office 2000 to Office 2003, for example."

And while Microsoft may bleat about how Linux menaces Windows on the desktop, the real story is Redmond's inability to get existing users to upgrade to its newest OS. "In the desktop market, Microsoft really has it to itself," said Rosoff, "but there's a lot of room, even in developed countries, for upgrades." Fewer than half of desktops have been upgraded to Windows XP, he noted.

"While some of the threat is real on servers for instance," said Rosoff, "it's not about Microsoft getting beaten by open-source, but that they're worried that it will cause slower-than-anticipated growth."

The complete 10-K filing can be found on the SEC Web site.

This story courtesy of TechWeb News