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Announcement

On Oct. 15, Microsoft (MSFT) made the following announcement:

Beginning Dec. 1, 2013, any [educational] institution worldwide that licenses Office 365 ProPlus or Office Professional Plus for staff and faculty can provide access to Office 365 ProPlus for students at no additional cost. [...] Office 365 ProPlus includes all the familiar and full Office applications - locally installed on up to five devices and available offline.

Why It Matters

Around half of Microsoft's operating income comes from its Office product family. (10-K, p. 6-7; Earnings Release) In other words, Office is a must-win battle for Microsoft.

The problem has been that Google (GOOG) Apps are free for consumers. Similarly, Apple (AAPL) recently made its productivity suite iWork free for new iOS mobile devices. Students as a consumer category need productivity tools, but at the same time don't really have the money to pay for them. Therefore Google Apps at no cost is an attractive alternative to Office, especially for students.

Students are nevertheless a very important customer group, because they can become paying customers in the future. The value of a company is the present value of its future cash flows. By offering free productivity tools, Google has been winning over future paying customers from Microsoft. As a result, the potential amount of future cash flows derived by Microsoft from Office has declined.

Empire Strikes Back

Currently, Microsoft Office is superior to Google Apps. If both were free, Office would be the clear winner among students. Now that Office 365 becomes free for many students, Microsoft is making the choice very easy. It's a strategic move aimed to strengthen the long-term competitive position of Office. As a result, Office is more likely to be able to provide sustainable and growing cash flows for Microsoft.

Students are a probably a key customer group for competitors offering free productivity tools. As Microsoft strengthens its value proposition for students, the competitors are less likely to gain market share. Therefore competitors are also less likely and able to invest in their productivity tools to make them more competitive with Office.

Needless to say that Office has also significant network effects with other Microsoft products. The more popular Office is, the more popular the whole Microsoft ecosystem is.

The educational institutions providing Office 365 for their students at no cost act as a marketing channel for Office. Microsoft says the following:

Today, more than 35,000 institutions are automatically eligible to deliver the Student Advantage benefit to their students.

Office is around 90% of the former Microsoft Business Division's revenue. Only 15% of the Microsoft Business Division's revenue comes from consumers. (10-K, p. 7) Students are only a (small?) portion of those consumers. Therefore it's unlikely that this move would have a significant negative impact on Microsoft's bottom line.

Conclusion

Making Office 365 free for students is a wise strategic move aimed to create sustainability of competitive position and prevent disaster scenarios from occurring. It's also an asymmetric move: for Microsoft, there's very little to lose, but a lot to gain from this.

Source: Office 365 Free For Students Is A Big Deal