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Big Microsoft Licensing Changes Ahead for Service Providers

In late August 2022, Microsoft announced significant changes to several of its licensing models that will have big impacts especially on cloud and hosted solution providers and the services they offer to their customers. While the new licensing terms are not set to be revealed until October 1, 2022, potentially affected businesses should set their expectations and start planning now, in the short term, for modifications to their software asset management (SAM) practices and procurement strategies, and in the longer term, for potential disruptions to their industries.

In summary, the announced changes:

  • Introduce a new licensing model – “Flexible Virtualization” – that would allow Microsoft products to be used in a hosted offering without requiring SPLA licensing,
  • For the first time, allow for licensing Windows Server based on virtual cores, rather than physical processor cores, in some circumstances,
  • Expand virtualization options for Windows OS under M365 licenses,
  • Expand the number of products that can be licensed on a subscription basis through Microsoft’s CSP channels, while also offering new hosting options for CSPs, and
  • Place new limitations on where companies can use software licensed under SPLA.

In more depth, the announced changes include the following:

    1. Enhanced Outsourcing Options

“Flexible Virtualization” will be added to the collection of benefits included with Software Assurance (SA), which is Microsoft’s primary software maintenance offering for volume licensing customers. With Flexible Virtualization, a licensee will be able to use its licenses “to build and/or install solutions and run them on any outsourcers’ infrastructure…dedicated or shared.” This would represent a new licensing option for companies wanting to offer hosted solutions without having a burdensome and potentially risky Services Provider License Agreement (SPLA) with Microsoft.

However, it remains to be seen what constitutes a “solution” and whether Flexible Virtualization will be an option for companies’ wholly internal use of Microsoft products. It also remains to be seen whether or to what extent Flexible Virtualization will require licensees and outsourcers to jump through the same set of administratively burdensome hoops that currently are required to take advantage of the similar License Mobility benefit under SA. If so, then companies offering outsourcing services likely will want to be hesitant about jumping into the Flexible Virtualization waters, as our experience indicates that License Mobility has been a source of significant exposure for such outsourcers.

It also is worth mentioning that licensees will not be able to use Flexible Virtualization for software deployed with any “Listed Providers,” which currently include Alibaba, AWS, Google, Microsoft (with Azure), and any outsourcer using a Listed Provider as part of the applicable outsourcing service. However, in connection with other licensing models, Microsoft previously has crafted loopholes itself that still allow customers to use Azure for deployments that otherwise are barred to other Listed Providers, so it remains to be seen whether it will take a similar approach here. (It also remains to be seen whether such an approach would represent further bait for antitrust litigation.)

    1. Windows Server Virtual Core Licensing

To date, Microsoft’s licensing for Windows Server (either under the current per-core model or under the per-processor model that preceded it) always has required licensees to calculate and assign the necessary number of licenses based on physical processor resources. Many licensees in our experience have made the mistake of thinking that they can determine their Windows Server licensing requirements based on virtual processors or cores, but those approaches have been contrary to Microsoft’s rules and typically have led to licensing exposure.

Microsoft now appears to be conceding somewhat to the realities of how most businesses configure and manage their IT resources (especially in outsourced configurations), and it will be revealing a new Windows Server licensing option as part of the Flexible Virtualization benefit under SA. Under that model, “customers can elect to license Windows Server by the number of virtual cores they are using in virtual machines.”

However, keep in mind that this option apparently will be available only in connection with Flexible Virtualization. That means the deployments in question may have to be used to support “solutions” (whatever that means). It also means that Listed Providers will be excluded as outsourcing options, so companies with deployments at Alibaba, AWS, Google and (perhaps) Azure will not be able to utilize Windows Server virtual core licensing for any purpose on that infrastructure, at least in the near term.

    1. More Flexible M365 Windows Virtualization

Likely at least in part responding to the demands of customers with increasingly remote workforces, Microsoft will begin allowing users with certain M365 licenses (F3, E3 or E5) but without Windows-licensed, physical workstations to deploy virtual Windows workstations without requiring additional VDA add-on licenses. This will reduce Windows licensing costs for companies wanting to deploy virtual workstations without having to purchase and license physical workstations. The virtual workstations can be deployed either on a licensee’s own servers or with an outsourcer, though, again, Listed Providers will be excluded from those outsourcing options.

    1. Variable CSP Subscription Terms for More Products

More titles will be added to the list of products that solution providers can sell to customers on a subscription basis. Microsoft has been transitioning channel sales within Cloud Solution Provider (CSP) program to its “New Commerce Experience” (NCE) model over the course of 2022. Under NCE, CSPs seeking to sell seat-based license products such as M365 and Dynamics 365 have been able to structure their deals with these products as monthly, annual or three-year subscription offerings. With the upcoming changes, that list will expand to include Windows Server, Remote Desktop Services (RDS), and SQL Server.

This could be a good deal for end users, but its value to CSPs remains to be seen. NCE has been problematic for many solution providers, who have complained that the pricing is too high for monthly or annual subscriptions, but that the risks are too high for more competitively priced three-year plans (since customers could terminate and leave the CSPs holding the bag). We will be interested to see whether Microsoft begins offering some risk-balancing relief for CSPs interested in selling longer-term subscriptions.

    1. CSP-Hoster to Replace QMTH

CSP partners will have enhanced options for making Microsoft products available to their customers. Currently, the Qualified Multi-Tenant Hosting (QMTH) offering allows CSPs to host O365/M365 or Windows for their customers under those customers’ licenses for those products (which the CSPs may sell). Microsoft will be replacing the QMTH program with a new “Cloud Solution Provider — Hoster” (CSP-Hoster) program, which according to Microsoft “will enable participating CSP partners to pre-build hosted desktop and server solutions that they can sell to customers along with licenses in CSP (license-included hosting), or to customers that already have licenses (customer BYOL-to-partner solutions).

As with Flexible Virtualization, it remains to be seen how Microsoft will define a “solution” for purposes of this licensing option. However, given the expanded options for CSP licensing, if Microsoft structures this option with sufficient flexibility, it could end up being a viable option for companies seeking to avoid the burdens and risks associated with participation in Microsoft’s SPLA licensing model.

However, Microsoft’s announcement notes that initially, “this program will be limited to CSP Direct Bill partners only.”

    1. Limitations on SPLA Outsourcing

Finally, Microsoft has made the decision to further exclude Listed Providers from its outsourcing options for software licensing by prohibiting SPLA partners from deploying SPLA-licensed software in Listed Providers’ clouds. Given the wide use of Listed Providers as outsourced datacenter providers, this change likely will prove to be very disruptive and potentially expensive for solution providers across many industry segments. However, it also could prove to be a boon for smaller cloud providers, who could find themselves with new growth opportunities for customers that want to continue using their own SPLAs to license the solutions they offer to their own customers.

We would not advise any Microsoft licensees to start making any significant changes based solely on the content of Microsoft’s announcement. However, potentially affected businesses should watch this space and plan on carefully scrutinizing the new licensing rules once Microsoft releases them in October. Depending on the details of those rules, big changes to infrastructure, procurement and sales strategies could prove to be in order.