Thomas Hawk has some insightful criticism of my post yesterday where I suggested Microsoft should give MCE away as a free download. It’s well worth reading all of Thomas Hawk’s comments, but his main contention is that Microsoft would balk at giving it away. Here’s the gist:

With regards to giving the software away, although this would be quite exciting, I don’t think that Microsoft would go for it. Microsoft LOVES XP and Office. These are cash cows at the company. Despite what they may say, they HATE IE and WMP. IE and WMP were built out of desperation. These were defensive products primarily designed to help lock down the cash cows that are XP and Office. LOVES and HATE are too harsh of words of course but I’m using them here for sensationalistic effect to make a point.

Gates sees the tv thing as really really big. He’s put a lot of his own time and energy into pushing it. If you give it away today you set a precedent where MCE cannot really be a cash cow of the future. If you gave away the application that is MCE people would just load it on to their existing XP operating system PCs. Microsoft doesn’t want that. They want to sell you an entire second operating system and get the dough that comes along with that. And if MCE is as big as it is in Gate’s head (and this is much bigger than the folks at Jupiter would guess) then giving away the software doesn’t make sense to him.

I would not disagree that these insights reflect the mood at Microsoft, but let me defend my suggestion that it would be a sound business move by Microsoft and my reasoning behind it. Let’s look at the costs and benefits.

To start, let’s look at the opportunity cost of giving it away for free. I can almost guarantee that PC vendors pay a premium for bundling MCE 2005 instead of Windows XP, so if MCE were freely downloadable, MS loses that incremental revenue. Second, assuming that it is used as an enticement for users to upgrade to a future version of the OS which contains the features of MCE, there would be a loss of incremental sales of those users who wouldn’t upgrade except for the desire to gain those features.

I concede that there is some loss of revenue, but how much is a real question. I’d say that the large percentage of PC vendors who now bundle MCE 2005 would continue to bundle Windows XP, so we’re talking about the incremental difference. As far as the potential loss of people unwilling to upgrade to a new OS because “Windows XP plus MCE” is good enough may add up for early upgraders, but over time, I think these sales would be recouped.

If anything, I can see the argument that more users who wouldn’t have upgraded to “New OS with MCE” would be more likely to upgrade to “New OS” since they got hooked on the free MCE. The old meme, supported by the Jupiter Research is that you don’t really “get” the value of a DVR until you’ve actually used one. These users would in effect upgrade their system because they like MCE and want increased performance, better compatibility or stability, or additional MCE features that “New OS” required.

Of course there are other costs associated with MCE like the Programming Guide service that MS is likely licensing from a third party. I honestly don’t have a feel for how much this costs MS, but I want to throw it into the mix. There are certainly ways to offset this, including the Tivo/DirecTV approach of limiting the Basic free service of only 3 days advanced programming vs a small monthly or single lifetime fee for premium guide data. As unit volumes go up, I would assume that this licensing fee would go down at least by driving more competition into the market to vy for the MS business.

To understand the benefits of giving away the MCE technology, I think you have to look at the value of owning a significant marketshare of the DVR usage. After you get past the basic features of the DVR such as pausing live television and automatic recording of “Desperate Housewives”, what you find is that the DVR is really the user interface for your television, and the value for a company to have some limited control over that is very large. In some ways, the DVR is both web browser and web portal combined for home entertainment. As Google and Yahoo found out that there is money to be made in advertising by giving services away for free, scaling up to a large active customer base opens up many doors.

Thomas points out that Windows Media Player has been downloaded by 90 million users and that many at Microsoft give it short shrift compared to Office. That may or may not be appropriate for WMP which has a limited ability to catch advertising revenue, but MCE has the potential of being the Yahoo or Google of the television experience.

Ignoring the Orwellian features that could be implemented in DVR technology that would be of high value to advertisers, there are plenty of advertising and partnership opportunities. Tivo has had a tough time making money from advertisers but undoubtedly it would be significantly easier for it or others to do as the customer base grows. I have to believe Microsoft, with a large installed DVR base, would be more adept and have more marketing power to effectively sell advertising, particularly if it didn’t care about future partnerships with MSOs.

I’m not the only one that believes DVR technology can be given away as a profitable business. Look at the MSOs which will give you both the hardware and software with only a small monthy stipend. I doubt the $5 a month rate MSOs like Comcast charge are covering the costs involved, and yet I doubt they are doing it simply for the benefit of mankind. In the MSO case, there are other factors involved such as retaining existing customers and attracting new ones, but I don’t think that tells the whole story. I believe they too want to own the television experience.

I don’t doubt Thomas Hawk’s overall conclusion that it is an unlikely approach for Microsoft to take. Even if they were amenable to the idea, the anti-trust litigation fatigue may be enough to sink the idea. I would continue to argue however, if you want to change the “MSO wins the DVR war” equation, giving away MCE has the best chance of success for Microsoft.