Changes Are Coming to Microsoft's $19 Billion Cash Cow

By Markets Fool.com

Despite stumbling a bit with Windows 8,Microsoft forges ahead with its iconic operating system.

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For years, the OS dominated the computing world putting Microsoft in the driver's seat with its partners. Desktop and laptop manufacturers, until fairly recently, had little to no leverage. It was Windows or nothing -- Applehas never licensed its OS while Linux never captured more than a tiny, niche audience of technical users.

That has made Windows an enormously successful division for the company, producing just over $19 billion in revenue in 2011, $18.4 billion in 2012, and $19.2 billion last year. The division has also been very profitable earning $12.3 billion, $11.5 billion, and $9.5 billion in those respective years. Even in a down year, that makes Windows the second most profitable sector for Microsoft, just behind the company's business division (the group which houses Office and other software).

However, the market is changing. Microsoft has to alter its business model for Windows, or it risks seeing $19 billion dwindle to nothing.

Rise of the tablets
Windows still dominates desktop operating systems with a market share over 90% as of November 2014, according toNetMarketShare.com.However, sales of those machines have been falling steadily since 2012,IDCreported. At the same time, a forecast fromGartnersuggests that sales of traditional PCs will continue to fall, while tablet and smartphone sales will climb.

Consumers have embraced tablets powered by Apple's iOS and Google'sAndroid operating system. To a lesser extent, laptops running Google's Chrome OS have also become an alternative for certain users -- the education market most notably -- and Microsoft no longer represents the only choice for consumers and manufacturers.

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Any company can make an Android or Chrome-based device without paying Google a licensing fee, and the public seems more than willing to buy those machines. That has already forced changes to how Windows is licensed and Microsoft COO Kevin Turner, speaking at a recentCredit Suisse Technology Conference, said more changes are on the way.

Free Windows is working
In April 2014, Microsoft made Windows free on devices with screens under 9 inches. Turner said this strategy is working as it has resulted in increased production of Windows devices almost immediately from when the deal was announced:

We've seen that momentum continue to accelerate. And you're seeing a whole new level of innovation in the marketplace running Windows today. You're seeing $200 laptops. You're seeing $99 Windows tablets, embracing and extending the ecosystem by lighting up some of these new business model scenarios, allowing us to monetize the lifetime of that customer through services and different add-ons that we're able to be able to incorporate with that solution.

Charging for Windows on tablets, phones, and other sub-9 inch devices drove manufacturers to Android. Giving it away for free has brought some of them back, leading to a flurry of new Windows devices and at least a chance for Microsoft to make some money on a market it had more or less lost. Giving away a product the company has made billions on may seemcounter-intuitivebut having people use Windows machines -- even if the OS brings in no revenue -- at least offers some chance for future monetization.

Windows 10 is a big deal
Windows 10 won't just be for PCs and tablets -- it will also power Windows Phone, be embedded in Xbox, and power any forthcoming Internet of Things connected devices from Microsoft, Turner explained. This means developers can now create one app which will work across the full spectrum of devices.

"That gives us the capability of having one store, which also gives us the capability of having one experience tailored to every device," he said

Creating one Windows for all devices gives Microsoft am integration from PC to tablet to phone, which neither Google nor Apple can currently offer to consumers or developers.

Windows 10, seen here in a screenshot from the current consumer preview, will combine many of the features of Windows 7 and Windows 8. Source: Author

Will Windows 10 be free?
While Turner said that Windows 10 pricing has not been finalized, he did admit that it would be a "loss leader" for the company.

"We've got to monetize it differently," he explained. "And there are services involved. There are additional opportunities for us to bring additional services to the product and do it in a creative way."

That may not mean free Windows across the board, but it should mean pricing the OS in a way that will maximize the number of devices using it.

Slow to the party
Microsoft may have been late to react to the shift in the computing world caused by tablets, phones, and other devices running Google and Apple operating systems, but the company is making up for it by being decisive. Many companies have fallen attempting to wring every last dime out of a once successful business model. Microsoft is being proactive and changing, even if it means sacrificing money in the short-term for market share.

With Windows 10 attractively priced or given away entirely, the OS positions the company for future growth and success. There is no guarantee consumers pick Windows-powered devices over competitive offerings running iOS, Android, or Chrome, but this strategy at least ensures they will have the choice.

The article Changes Are Coming to Microsoft's $19 Billion Cash Cow originally appeared on Fool.com.

Daniel Kline owns shares of Apple and Microsoft. The Motley Fool recommends Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.