For the last several decades, Microsoft Office (Office) has been the dominant office productivity suite, with over a 95% share of the market. According to Microsoft’s latest annual report, Office produced a staggering $21.592 billion in revenues and $14.147b in operating income, accounting for 30% and 65% of Microsoft’s total revenue and operating income, respectively. 
Despite the current financial success of Office, there are signs that Office is vulnerable to disruption. Drawing on work by Clayton Christensen, the classic indicators of disruption are as follows:
1. The current technology is overshooting the needs of the mass market.
Due to a regular revision cycle every several years, Office now includes thousands of functions and features that are superfluous for the average customer.  Because the curent version of Office (Office 2010) is so feature rich, and because many users are transitioning their spending from PCs to next generation computing devices (e.g., smartphones and tablets) there is less incentive for existing customers, especially consumers, to upgrade to the next version of Office (Office 2013). 
2. A new technology emerges that excels on different dimensions of performance.
While Office excels at individual office productivity with advanced functionality, Google Apps (Apps), which includes Google Docs, is a software-as-a-service (SaaS) solution that excels at online connectivity and collaboration. These features are becoming increasingly important as individuals work across multiple devices, often on the go, and collaborate with others across geographies and organizations.  Apps, which in addition to Docs includes email, calendar, and cloud storage, is also free for individuals and educational institutions and is priced considerably lower for businesses and government in comparison to both Office and Office 365, Microsoft’s relatively new SaaS solution.
3. Because this new technology excels on a different dimension of performance, it initially attracts a new market segment.
While Office is the software of choice for the average PC owner, especially among professionals in business and government, Apps with its reduced pricing and collaboration benefits has gained momentum among price sensitive customers, such as students, educational institutions, startups and small businesses, as well as groups and teams, especially dispersed teams. Apps also has a unique opportunity to reach customers of Android- and Chrome-based devices (e.g., Android smartphones and tablets, Chromebooks) given these two operating systems (OS) are also supported by Google.
4. Once the new technology gains a foothold in a new market segment, further technology improvements enable it to move up-market, displacing the incumbent technology.
With a foothold among select customer segments (e.g., Apps now has 5m business customers, primarily smaller organizations), Apps continues to improve. It’s now slowly moving up-market into government and larger companies. During 2012, Google and Microsoft competed for 42 federal government contracts. Google won 23 deals while Microsoft won just 10 (VMware won the remaining 9). As examples, Apps is now used by 30,000 employees at the City of Los Angeles, 90,000 at the U.S. Department of the Interior, 80,000 at Hoffman-La Roche, and 30,000 at Shaw Industries, a subsidiary of Berkshire Hathaway.
5. The new, disruptive technology looks financially unattractive to established companies because the potential revenues are seemingly small and uncertain.
Microsoft launched Office 365 to compete with Apps and other potential SaaS solutions. How financially attractive is Office 365 for Microsoft compared to traditional Office?  In a first scenario, let’s assume the office productivity market increases by 25%, Microsoft maintains its current market share of 95%, and Office 365’s current published pricing holds.  In this case, Office could produce about 2.5x of its current revenue. Now let’s consider a second, less optimistic scenario, that takes into account the softening of the PC market and the competitive threat posed by Apps and its aggressive pricing (i.e., free for consumers and educational institutions and an average of $7.5/month per business or government user). In this scenario, let’s assume the office productivity market shrinks by 25%, Apps captures 30% of the market, and Microsoft is forced to match Apps pricing to avoid further market share erosion .  In this case, Office will produce just under 40% of its current revenue, or about $8.5b per year. The first scenario is quite attractive for Microsoft, and the second must less so.
Before we jump to any conclusions and assume that Office is in imminent danger of being disrupted, it’s important to note important contradictory evidence. First, commentators have argued as early as 2001 that Office was overshooting the needs of the average customer. Microsoft’s revenue has grown roughly 3x since this time, with considerable growth in Office revenue. Second, Docs was first launched about seven years ago and its market share gains have been fairly limited during this timeframe. Also, Docs wasn’t the only threat to Office during this period, with several credible and competitive open source offerings, such as OpenOffice and LibreOffice. Collectively, these alternatives along with Apps have gained just a 5% share of the overall market. Third, Microsoft isn’t standing still. It launched Office Live and then 365, a SaaS solution, which offers many of the same benefits as Apps (e.g., online connectivity and collaboration). Reviewers have generally given Office 365 high marks. Microsoft is expected to launch Office 365 apps for Android and iOS devices in the first quarter of 2013. Lastly, Microsoft is a highly profitable software company. It has both the financial resources and capabilities to build and maintain a competitive solution in this area. Simply put, Microsoft isn’t a company (e.g., Kodak) trying to shift to a new area that is completely outside its domain of expertise (e.g., traditional film to digital imaging).
Conclusion & Recommendations
In view of the analysis above, and despite the counter evidence, it appears Office is vulnerable to disruption, even if this disruption is not imminent. First, although Google has streamlined its offerings over the last several years, it appears more committed than ever to its Apps business. Like Microsoft, Google also has the financial resources and capabilities to develop a highly competitive product in this area. Second, because Google generates the bulk of its revenues and profits from search advertising, it can continue to invest in and offer Apps at aggressive prices (and even for free) without concerns about cannibalizing its core business and primary source of revenue and profits. Third, Google has a unique opportunity to push Apps to the customer base of Android- and Chrome-based devices (e.g., Android smartphones and tablets, Chromebooks). Android, in particular, looks like it could be the dominant operating system in a post-PC world, at least until the next paradigm emerges. Microsoft’s advantage of controlling the operating system is eroding. Lastly, two critical barriers to entry that historically precluded other companies from entering this market — compatibility (i.e., everyone needing Office to share documents) and switching costs (i.e., the costs of learning how to use a new product) – are much less of an issue than they once were.
Microsoft is taking a slow and cautious approach, looking to slowly transition its users from Office to Office 365. But this approach will give Apps a further opening to gain significant market share. Apps is now a highly competitive product at a substantially lower price point. To maintain its dominant position, Microsoft should immediately reduce its Office 365 pricing so it’s more in line with Apps pricing. It should also launch an aggressive marketing campaign to transition its existing users from Office to Office 365, so users commit to 365 before they consider and engage with Apps as an alternative. These two actions will ensure that Office maintains the bulk of its current market share, with a product that provides value and pricing that is highly competitive. Lastly, Microsoft should develop and launch office productivity software that is well suited for customers using post-PC devices, especially Android and iOS devices. Although it’s expected that Microsoft will soon launch versions of Office 365 for these platforms, it’s quite possible that Microsoft will need to pursue a different paradigm of office productivity software given the significant differences between these devices and PCs.  This will ensure that Office stays relevant and even grows its market as customers move beyond the PC.
How will these actions affect Office revenues? Let’s assume Microsoft matches Apps pricing, retains 90% of the office productivity market (ultimately losing just 5%), and grows the market size by 25%. In this case, Microsoft could roughly maintain its current revenues. Not too shabby when your revenues are over $21b.
 According to its latest 10-K filed with the SEC, “Microsoft’s Business Division” (MDB) earned $23.991b and $15.719b in revenues and operating income, respectively. The Microsoft Office system “(comprising mainly Office, SharePoint, Exchange, Lync, and Office 365) generates 90% of MDB revenue.” This gives us 21.591b in revenues and 14.147b in operating income.
 Several years ago I attended a pre-release presentation of PowerPoint 2010. The presenter was the product manager that oversaw PowerPoint development. There were so many features and functions that even he struggled to find certain functions that were requested by the audience.
 Reports indicate that Office 2013 was made available to business customers and members of Microsoft’s MSDN and TechNet programs in the fourth quarter of 2012. It’s expected that individuals will be able to purchase Office 2013 in the first quarter of 2013.
 There are of course other significant differences between Office and Apps.
 I wasn’t able to find any public data on the number of worldwide customers that are active and have paid for office productivity software. We need this figure to estimate the number of customers that will, in theory, subscribe to Office 365. I estimated the number of potential subscribers as follows. According to Microsoft, they sold 100m copies of Office 2010 from its launch in June 2010 to June 2011. During the period that Microsoft sold 100m copies of Office 2010, I examined 90% of MBD revenue (see Footnote 1) and calculated that the average selling price (ASP) for Office was about $200. Now let’s assume the ASP for Office held steady in the previous few years and any user that paid for Office during the previous three years, July 1, 2009 – June 30, 2012, would be willing to subscribe to Office 365. This three year cut off seems like a reasonable estimate. We then can calculate total Office sales based on dividing 90% of MBD revenues during this three year period by $200. This shows that Microsoft sold about 300m copies (or slightly less if we were to back out Microsoft Exchange and SharePoint revenues). Therefore, I estimate that Microsoft could expect about 300m users to subscribe to Office 365, with a total addressable market of roughly 315m. Remember Office has a 95% market share. Note, Microsoft states there are 500m current users of Office, but this figure includes users that have paid for Office, users that obtained Office in other ways (e.g., customers that have installed Office on multiple computers, possibly pirated copies), and non-active users. Therefore, it’s reasonable to assume the actual number of active, paying customers is significantly lower.
 The latest pricing for Office 365 is on average of $5.82/month for consumers and $15.83/month for business and government.
 I wasn’t able to find any data that breaks down Office customers by segment type (e.g., consumers, business, government). In its latest annual report, Microsoft reports that 80% of MBD revenue is generated from sales to business. But I’m assuming the ASP for consumers is lower than businesses and government, even after volume pricing, since businesses and government typically purchase Office Professional, which includes additional software and features (e.g., Access). Furthermore, consumers have the option of installing Office on multiple PCs. For this analysis, I’m assuming that two-thirds of customers are business and government and the remaining one-third are consumers. This means that Microsoft would lose roughly one-third of its paying customers, should it offer Office 365 for free to consumers.
 Needless to say, the success of Windows 8 in smartphones and tablets is also important, but Microsoft is well behind here.