Microsoft Is Making Office Users Pay for AI. It Could Backfire.

A big success story for software giant Microsoft (MSFT 1.05%) over the past decade has been Office 365, now called Microsoft 365. Facing competition from Alphabet's Google Docs, Microsoft launched subscription versions of its iconic Office applications. The old model of selling pricey one-off licenses was under threat, and Microsoft successfully convinced tens of millions of consumers and businesses to pay annual fees to access its software. At the end of Microsoft's most recent quarter, the number of consumer Microsoft 365 subscribers grew to 80.4 million. While Microsoft doesn't disclose revenue directly, based on the old pricing, this subscriber base is likely generating somewhere between $5 billion and $10 billion in revenue annually. A massive price increase I say "old pricing" because Microsoft has just enacted an enormous price increase on its consumer Microsoft 365 plans. The Personal and Family plans will see a $3 bump in monthly pricing and a $30 bump in annual pricing. The annual Personal plan will now be about 42% more expensive, while the annual Family plan will be 30% costlier. This is the first price increase for either plan in more than a decade. Why the sudden spike in pricing? You can blame Microsoft's massive investment in artificial intelligence (AI). After rolling out a $20 per month Copilot Pro subscription plan in early 2024, which brought AI into the company's Office applications, the company is now bundling Copilot with Microsoft 365 and making consumers pick up the tab whether they use it or not. While Microsoft highlighted other improvements made to its Office applications over the past decade, the cost of running AI models in the cloud is almost certainly the primary driver behind this price increase. The AI features that are now part of Microsoft 365 aren't unlimited. Subscribers will get a certain amount of AI credits each month, which are consumed when AI features are used. Microsoft is keeping Copilot Pro as an option for consumers with high usage needs, allowing Microsoft 365 subscribers to upgrade and pay the additional $20 per month. An extra $30 per year from each consumer Microsoft 365 subscriber would add up to nearly $2.5 billion in extra annual revenue. Of course, there are costs associated with providing AI services, and this number assumes no subscribers will cancel due to the higher pricing. Still, that's a meaningful amount, even for a company the size of Microsoft. This move could backfire Microsoft is betting that its Office applications are important enough to its subscribers that a big price increase won't deter them from renewing their subscriptions. For subscribers who use these new AI features, the price increase may very well be worth it. But there will likely be many subscribers who want nothing to do with Microsoft's AI, and they'll be paying far more and getting nothing in return. The risk for Microsoft is not losing power users who are invested in its ecosystem but instead losing users who pay for Microsoft 365 because they have a slight preference for it over the alternatives. If you're a heavy user of Excel, for example, it would be a pain to move your spreadsheets over to Google Sheets. In contrast, if you mostly just use Word and dabble with everything else, switching costs are relatively low. Even if a meaningful number of subscribers drops Microsoft 365, Microsoft will likely still boost its revenue due to the sheer size of the price increase. However, it's hard not to view this price increase as a customer-unfriendly move aimed at recouping AI investments, and that could drive customers to alternatives in the long run. The trend of tech giants jamming AI features into existing products and then raising prices is likely here to stay as companies pour mountains of cash into AI investments. Whether consumers will be willing to pay for these AI features remains an open question.