When Microsoft CEO Steve Ballmer warned last week that the “fundamental transformation to Software and Service... is upon us, and it will affect us all”, he probably had Microsoft loyalists such as John Joseph squarely in mind.

Joseph is president of J4 Systems, a small but thriving value-added reseller (VAR) in Rocklin, California.

A Microsoft Gold Partner, J4's bread and butter is installing and maintaining Microsoft software on-premises for a wide variety of small businesses in the Sacramento area.

That's the sort of business model that Microsoft executives repeatedly said at last week’s Worldwide Partner Conference in Denver was at risk of becoming obsolete, as Microsoft starts launching web-hosted versions of its software, starting with its Dynamics Live CRM service early next year.

industry change

“The industry will change,” says Allison Watson, corporate vice-president of Microsoft’s worldwide partner group.

The lead champion within Microsoft for the interests of its 400,000 partners worldwide, Watson nevertheless urged vulnerable partners to either jump on the Software and Services bandwagon or develop deep strategic or vertical industry expertise to offset the drying up of lucrative integration work as customers move to web services that are easy to set up.

“It’s one of the hardest things any company can do, but it’s what keeps them alive over time,” she says.

Yet Joseph has no plans to overhaul J4's business. While he likes Dynamics Live’s low initial setup cost and expects to start offering it when it is released, he says he doesn’t expect much demand except from extremely small companies. And Joseph was adamant about resisting Microsoft’s call to specialise.

“Around 95 per cent of our clients are within a half an hour of driving,” Joseph says. “It just doesn’t work in [a small-to-midsize business] market to go vertical. If you do, you run out of clients fast.”

Nevertheless, Joseph is sanguine. On-premises software is not going away anytime soon, he says. And even if it does, Microsoft is doing enough to ensure that foot soldiers like himself in Redmond’s army of partners will remain well-fed.

“I think there is enough in it for us,” he says. As for on-premises software, Joseph says, “we've always known that everything has to be led by a conversation about solving business pain points. And that’s not going away.”

Hear, hear, says Microsoft. While Ballmer called Microsoft’s embrace of hosted services “priority number one” he also made it clear that software still had a long future ahead.

“This is a long-term migration,” he says. “It’s kind of like we’ve been saying at Microsoft for at least 27 years that the mainframe is going away. Well, it’s still going away.”

Microsoft is also trying to cushion the blow for partners who insist on remaining in the on-premises arena.

COOr Kevin Turner promised partners a “feeding frenzy” when the vendor launches 2008 versions of Windows Server, SQL Server and Visual Studio simultaneously next February.

Microsoft partners that have traditionally supported Windows Server or Microsoft Office can now also make money reselling and supporting its Forefront business security software. Partners can earn up to 30 per cent of the value of certain Forefront licences sold.

Other goodies include new ways to support and manage Windows Vista, as well as new tools for partners supporting Microsoft’s controversial Software Asset Management (SAM) program.

“We are committed to a well-rounded partnering relationship,” says Watson. “We are not Salesforce, we are not Google, who are not set up to be partnering companies.”

That’s music to the ears of Bill Breslin, president of the US branch of the International Association of Microsoft Certified Partners (IAMCP).

partner reassurance

Before last week’s conference, “there was a lot of trepidation,” says Breslin, who is also a director at reseller Insource Technology. But now, he said, partners see that “Microsoft will do nothing to leave their partners behind. When you see what the reality is, that's why we still love Microsoft.”

To be sure, many VARs, systems integrators and independent software vendors are starting to clamber aboard the hosted bandwagon.

Hosting providers – companies that offer Microsoft software on-demand to their own network of resellers – with booths at the conference reported strong interest from attendees, many of whom only use on-premises software today.

“This has been a wake-up call,” says Bill McVicker, director of operations at CRM On Target, a hosted provider of Microsoft Dynamics.

Lorenzo Pappalardo, partnership manager at Italtel SpA, a Milan, Italy-based technology provider, says the company is interested in adding a hosted version of Microsoft’s unified communications software to complement the unified communications software it already resells from Cisco Systems and Microsoft.

The hesitation for Pappalardo and many others is the big hit they expect to take in revenues. Gone would be much lucrative integration work, replaced by small but steady slices of monthly subscriptions.

“If you are getting 10 per cent of a company’s 100 subscribers to Dynamics Live, that’s $440 a month (£215). That used to be three hours of consulting time. I don't see how that's equal," said Ravi Agarwal, CEO of GroupSpark, a third-party host of Microsoft software.

Others fret that with Microsoft managing more of a hosted customer’s relationship, partners will have less opportunity to sell customers on related services.

The flip side, according to Microsoft, is that providing support to remotely-hosted customers will be cheaper and easier to deliver.

Moreover, partners can wrest back control of the customer by going the independent software route, building custom industry systems on top of hosted Microsoft software, according to Greg Olsby, manager of Microsoft’s hosting and software as a service (SaaS) division.

“This doesn't require deep understanding of a vertical; it requires deep understanding of the typical pains of a vertical industry,” Olsby says. “So if you can talk about time and billing, you are an instant expert to a lawyer.”

New revenue streams

Independent software vendors can also augment their income by delivering web advertising in their custom offerings, according to Tim O’Brien, director of platform strategy at Microsoft.

Finally, most partners should be able to earn enough from subscriptions to make up within two to three years their revenue from on-premises software integration, according to Brad Wilson, general manager at Microsoft’s Dynamics division.

Wilson, who oversees all online and offline versions of Dynamics, said he is equally happy whatever way customers come to Microsoft.

That heartens existing SaaS partners of Microsoft, who arguably have the most to lose from Microsoft's move into directly hosting its software.

Microsoft's CRM foray will still “give us the ability to differentiate”, says Simon Spencer, CTO of Australian digital service provider BlueFreeway. The company offers managed versions of Microsoft Dynamics and Exchange software directly to about 5,000 companies through the web, as well as through its own reseller network.

“We operate in markets that Microsoft is not interested in,” Spencer says. “And not everyone will want to host with Microsoft, anyway.”

Barring major acquisitions by Microsoft, Spencer says he doubts that Microsoft will control more than a third of the hosted CRM market within five years.

Others, such as Anthony Graziano, director of channel sales at long time Exchange hosting provider USA.Net, says that Microsoft will augment their own marketing efforts.

“It definitely adds awareness,” he says.