Amidst a slew of product upgrades yesterday, Apple announced the tenth major release of its operating system – codenamed OS X Mavericks. Named after a notoriously dangerous surfing beach, Mavericks is unique in that it is the first major operating system that is completely free. However this comes as no surprise for Apple analysts as the Cupertino hardware maker has been reducing the cost of OS X since first launching over a decade ago.

Mavericks Free
Cost of OS X Mavericks
Image credit: Wired

What’s telling about Apple’s decision to ship the operating system gratis is the shift in importance towards hardware (i.e. MacBooks, iPhones, and iPads) and services (i.e. iCloud and the App Store) and away from one-off costly pieces of software.

In this article, I will look at the growing trend of companies to offer software free and then charge a premium for services.

A Brief History of Hardware and Software

Microsoft was one of the pioneers in popularizing the concept of software having value. Before Gates & co. came along software was simply the lines of code that came packaged with whatever hardware consumers decided to buy. In the 70s, IBM was the king of vertically integrated systems – with hardware and software coming bundled together in the ubiquitous IBM PC. However, what was missing was the idea of a “platform ecosystem” – a burgeoning software aftermarket. It was only with the launch of Windows and its successors did people start to associate software with actually having some value.

Since then, hardware entered a long phase of commoditization. Murphy’s Law produced incremental upgrades, but a series of “me too” PCs from the likes of Dell and HP provided little innovation. It was only in software that there was real competition and excitement. Microsoft’s Windows was a prime example of how a simple software package could propel a company into becoming one of the most valuable in the world.

Apple’s App Store Changed the Mobile Game

Fast forward a few years and the software landscape is changing dramatically once again. The launch of Apple’s iPhone in 2007 and the “App Store” in 2008, ushered in the next generation of the hardware/software stack. The combination of the iPhone, iOS (then iPhone OS), and App Store, was a vertical integration the likes of which the world had not seen since IBM. Apple controlled the hardware, the software, and the related services. Hence, they could afford to give away the mobile OS and reap the rewards of the hardware sales and service fees. With over 60 billion cumulative downloads, the App Store is an unprecedented success. More importantly, it is highly lucrative.

The trend, since the launch of the App Store, is to provide a mobile operating system with an app marketplace for free. Mobile operating systems (iOS, Android and Windows) come pre-loaded on the device, while third-party apps are by and large free or inexpensive. Google and Microsoft have followed Apple’s lead with the Google Play Store and the Windows Store, respectively.

The software and operating system business has come full circle. In the growing mobile ecosystem, tightly integrated vertical markets are king. Whether it’s Apple’s App Store ecosystem or Google’s Play Store, OS developers are subsidizing their operating systems to reap the rewards of profits generated from third-party software and hardware sales. In Apple’s case they are banking on the incredible sale of the iPhone and iPad and related services. In contrast, Google is happy being the dominant search platform for mobile devices and selling ads.

The Burgeoning Services Business

Windows sales once totalled 47% of Microsoft’s revenues. Last year they dipped to as low as 25%. What this trend tells us is that even Microsoft has realised that one-of software purchases are no longer sustainable, even on the desktop. Instead the focus is shifting towards providing services, which subsidizes the cost of the primary software. In Microsoft’s case Office 365 is their first gamble at pivoting into a services company. Rather than sell software for hundreds of dollars, they are asking users to pay on a yearly basis for additional features such as cloud syncing and continuous updates.

This model has caught on for everything from mobile games to enterprise software. Zynga was one of the first mobile gaming companies to build its business around a freemium ad model. Their games are all free, but each come with in-app purchases. As a user you can choose how much money (and time) you reasonably want to invest. Numerous other mobile gaming companies now give away their games on iOS and Android in the hopes that users will make in-app purchases.

Similarly, software vendors are riding the SaaS (software as a service) wave, whereby they provide basic options for free, with premium features being behind a paywall. For instance, at Zopim we offer a forever free Lite package, that serves the needs of most small single-users. However, for more demanding users we also offer Basic and Advanced plan.

This “freemium” or “SaaS” models benefits companies and users greatly. Instead of paying thousands of dollars upfront for one gargantuan piece of software, users can choose exactly what features they want and pay bit by bit. Similarly, companies can keep innovating with the knowledge that there is a steady monthly income, not based on yearly product cycles. The income from premium features also enable companies to provide a free alternative for users who cannot pay.

Apple’s OS X Mavericks is the final straw for one-off software purchases. With more and more companies adopting a SaaS model, the free software is going to keep getting better.