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Win10: Not a "Free Upgrade" But a "Marketing and Promotional Activity"

Although Microsoft has itself described its upcoming plans to provide a no-cost copy of Windows 10 to Windows 7, Windows 8.1 and Windows Phone 8.1 devices to those who move up in the first year after its release as a Free Upgrade Offer, the company describes this plan as a “marketing and promotional activity” in its latest 10-Q filing with the Securities and Exchange Commission (SEC). Why is this difference in reporting to SEC versus how plans are described to the public important? In a word: Money.

The actual text is too big to turn into a compact screen cap, so I just grabbed some salient language.

The language in the 10-Q filing reads somewhat differently, and for a very good reason. If the company calls it a free upgrade, MS must defer some of the earnings on the current version of Windows (8.1) to defray the costs of the new release. If it’s a “marketing and promotional activity” MS is entitled to allow revenue from “new sales of Windows 8 … to be recognized as delivered” (see section entitled “Application of Critical Accounting Policies” in the 10-Q Filing Document).

While this may sound like mere accounting gobbledygook, there’s some serious money involved. ComputerWorld explains the potential costs in a story on the filing as follows:

The last time Microsoft offered a discounted upgrade to customers was prior to the launch of Windows 8. During an eight-month stretch from early June 2012 to the end of January 2013, people who purchased a new PC pre-loaded with Windows 7 were eligible for a $15 upgrade to Windows 8 Pro.

Microsoft deferred just under $1.1 billion in revenue for that upgrade program over a three-quarter stretch, then recorded that money as income during the first quarter of 2013.

I take this to mean that a one-year stretch for the deferral costs of the upgrade to Windows 10 would have to be at least $1.46B, if not higher, because the time period is longer and the number of potential upgraders higher (Windows 7 and Windows 8.1 users, plus Windows 8.1 Phone users, are all covered, whereas the earlier upgrade applied only to those who bought new PCs during the 8-month period of coverage for the $15 offer). Approximately $1.5B and potentially much more is not chump change, and with Windows revenues already trending down because of lower OEM licensing rates, and with no consumer upgrades likely to occur (except for serious procrastinators), this will probably result in even lower revenues for Windows OSes once Windows 10 hits General Availability. I think CW is right to interpret this move on Microsoft’s point as an attempt to head off downward pressure on the stock.

All this does raise an interesting question, though: How will MS and its stock fare when one of its revenue mainstays — namely, Windows OS monies from consumer license purchases and upgrades — takes a one year vacation? We’ll be finding that out later this year.