Microsoft vs. Google: The New Battle for Your Network

If Microsoft (NASDAQ: MSFT) had optimized expenses in the quarter ended June 30, 2007 the company would have earned $6.3 billion. Its actual earnings were $4.0 billion. Management threw $2.3 billion down the drain by over spending on everything in its competition with Google (NYSE: GOOG). In their book Blue Ocean Strategy, Professors Kim and Mauborgne of INSEAD don't tell us what Microsoft might do for a second act. That's because Microsoft may have been born in a blue ocean, but now the company is living in a red one.

According to the latest Interbrand report published in Business Week, Microsoft is the second most valuable brand on the planet. Google, incorporated in 1998, is number 20 on the list. Both of these companies were born in a "blue ocean" of their own creation. But today Microsoft, at 32 years old, already is long in the tooth for an IT company. Management now must survive in a sea of "Red Ocean" expenses. Hounded on all sides by Google as well as newer upstarts. However appealing blue oceans may be, nearly every company ends up in a sea of red ocean expenses. At that point the most compelling question is how to manage expenses in this environment. Theoretically, the best way to do that is to "optimize" these costs. This is the 8th in my series of posts on corporate brands in enterprise marketing.

The Old Battle For Your Desktop

IBM (NYSE: IBM), founded in 1898 as the Tabulating Machine Company, today is the third most valuable brand in the world. This makes it easy to forget that the company drifted into a sea of "red ocean" expenses by the early 1990s.

IBM dominated the world market in computers. Its sales revenues in 1991 were $64.8 billion. In that year IBM captured 76.6% of combined revenues in a strategic group with Hewlett Packard (NYSE: HPQ), Dell (NYSE: DELL) and Compaq Computer. At that time the company had a huge "red ocean" spending problem amounting to about $7 billion. Just when the company was about to be spun off into five or six independent parts Lou Gerstner came to the rescue. Under his leadership IBM's sales increased to $88.4 billion in 2000. But its share of revenues in the same group fell dramatically to 41.9%.

How did Mr. Gerstner solve the problem? He and his management team increased the marginal earnings delivered by each 1/100th of a market share point and decreased its marginal cost until the two were almost exactly equal. This chart tells the story.

How did they do that? You can read the details in Chapter 6 of my book Competing for Customers and Capital -- "The Battle for Your Desktop."

The New Battle For Your Network

Microsoft and Google are the leading players in the new battle for your network. This table show how they stood as of June 30, 2007. With sales of $13,371 million Microsoft dominated the market, capturing 77.5% of the combined revenues.

Microsoft's total costs were $9,382 million compared with Google's $2,767 millon. A closer look at these numbers, standardized as the cost per dollar of revenue, reveals an important problem: the two companies apparently applied very different financial accounting rules to their income statements.

Google reported its cost of goods and services [COGS] was $0.40 per dollar sales, while Microsoft reported it was just $0.23 per dollar sales. Meanwhile GOOG reported sales and marketing [SNM] expenses as $0.09 per dollar, while MSFT reported they were $0.23 per dollar. Looks like their financial accountants have very different definitions of these two costs. Unexplained differences like these can play havoc with optimizations. Yet, research and development [RND] costs per dollar as well as general and administrative [GNA] costs per dollar were about the same. The only way to resolve these differences, without access to their books, is to add up all the expenses and run the optimization on each company's "Total Costs."

Microsoft Threw $2.3 Billion Down the Drain

A simple static analysis will serve as a first take on Microsoft's performance. The horizontal axis of this chart is Microsoft's share of combined revenues. The vertical axis is the company's marginal earnings (green schedule) and marginal costs (red schedule) per share point. The company actually captured 77.5% of combined revenues in the quarter ended June 30, 2007.

Sometimes it's great to be the market leader. But in this case it's not. Microsoft shelled out $539 million for that 77th share point. And it was worth only $172 million after total costs. Not a good thing. To maximize earnings (by optimizing total costs) the company should have captured only 60.3% of the market. That's the point where the marginal cost and earnings per share point were exactly equal.

But, wait a minute. Microsoft management would never give up revenue to "optimize" costs. Exactly so. They wouldn't "give up revenue." But, like Lou Gerstner, Bill Gates may be forced by customers to watch their major "blue ocean" competitor add billions to revenues that remain beyond his reach. With the result of a sinking share of future revenues.

This chart shows the theoretical impact on earnings of optimizing Microsoft's total "red ocean" costs of competing with Google in 2007. The horizontal axis is share of revenues. The vertical axis is earnings before interest, taxes, depreciation and amortization.

Microsoft's earnings were $3.991 billion at its actual revenue share of 77.5%. At the optimum level of competitive spending Microsoft's revenue share should be 60.3%, generating earnings of $6.271 billion. The difference is the $2.3 billion in theoretical earnings that management threw down the drain in the 2nd quarter of 2007.

Is Microsoft the IBM of the 21st Century

We probably won't know the answer to this question for several years, if not for a decade. But the parallels are there. A brash young upstart (Google is Microsoft's Dell to IBM) steps in with a game changing "Blue Ocean" strategy. At first Google was not considered a threat. When the upstart became just that Steve Ballmer, Microsoft's CEO, called Google a "one trick pony". Sticks and stones! Is it likely that Microsoft can change its underlying "desktop" business model to compete with Google for dominance of your network? What do you think?

Comments

[GRiddick:]

Interesting analysis, Victor. But too statistical for my graphic artist blood. I go as much on instincts, and real world experiences, as I do on the numbers. Perhaps that's why I am not a member of the Forbes' billionaires club like so many of the "visionaries" out there at both Microsoft and Google.

But I did work for IBM when they were "the King". I have seen invincible "empires" come and go in this technology industry. I know what arrogance, hypocrisy, and greed can do to a company. Once your customers, and formerly loyal business partners, start to turn on you, all the accounting maneuvers in the world won't save your ass.

Thought you and your readers might enjoy the article I wrote a month or so back on these two corporate giants. As you can see, in my view, unless some major changes are made at the top, I don't expect either one of them to win this game in the long haul.

Wanta bet me a billion or so on that one?

George

**********************...

It's the "Battle of the Titans" on 5 simultaneous fronts ... but the outcome of this "war" may surprise you

That's the way I see it, anyway ... perched comfortable on my deck ... Blackberry and laptop in hand ... watching the birds chirp away and wondering why everyone doesn't come to see Virginia in the fall. It's absolutely beautiful!

"They're probably afraid they'll catch one of our 'high humidity holdover' days from August", I say to my new Cardinal friend.

Anyway, I read a few interesting articles this morning and it occurs to me that this intra-industry technology "war" is quickly coming down to two major players. I call them the "titans" ... and everyone else is trying to choose their sides.

Look at some of the recent news:

* IBM now supports OpenOffice more aggressively and is throwing Lotus Notes into the mix
* Microsoft officially introduces its "live online" Office Suite in late September
* Google teams up with Sprint and is testing their own set of "advertising supported" mobile phones
* Novel essentially sells out to Microsoft at the expense of many of its long term allies
* Brazil applies to become an official subsidiary of Google, any spreads piracy throughout South America
* Microsoft takes over half of India ... both here and there .. and sponsors it own international cricket tournament in the process
* Google continues romancing China like a teenage boy in a French Class
* Apple sits back and enjoys the battle knowing full well its market value will sharply increase with controversy
* Google's market valuation shoots past IBM, and starts to close in on Wal-Mart ... in just 3 years!
* Sun, IBM, and Google seem to be having a new and interesting "affair"
* Microsoft and AT&T sign up to testify in Washington against Google as a monopoly

If this were a conventional war, "Poor little Google" wouldn't stand much of a chance. But those folks from Mountain View have changed the playing field and they have Microsoft running scared. They're fighting this one out in the jungles, across the sandy deserts, in outer space, as well as in the dark corners of Main Street, Wall Street, and Madison Avenue. They are also well aware of the unique blend of greed and "techno-hype" that drives both Wall Street and Washington. And a few thousand rocket scientists don't hurt their cause much either ... except perhaps when "common sense" comes into play.

The Googlelites are street fighters. They know how to align themselves with the gullible masses. They are excellent at attracting third world cultures and emerging markets. They sponsor elections. They rob from the middle class and give to the poor ... and "donate" to select members of the middle and upper class as they see fit, as well. They make virtually all of their money by selling advertising on web sites, many of which are nothing more than willful piracy sites talking advantage of our youth and our underprivileged ... let alone the undereducated.

They anointed themselves as the organizer of all the worlds' information ... and that includes everything and everyone who don't want the Googlelites to touch their private information or property, as well. Google apparently held a public forum on the issue, but no one showed up to vote other than their senior scientists, CEO, departing CFO, General Counsel, a few members of their Board, half the lawyers in California, and, of course, all of the venture capitalists and investment bankers who helped develop the Google war plan in the first place.

Microsoft has a decided advantage in armament and in size. Problem is, too many of the plain citizens don't like them. Their expense structure is so large they have lost forever what it might take to stay nimble and adjust to changing tides ... let alone lead the innovation train. Doesn't look like the federal and state governments care too much for Redmond, either ... except perhaps some of those who have accepted free software and other bribes along the way.

Another problem is some (let's make that "many") people still believe monopolistic business practices are evil in this country ... especially when they have to pay more for software than is logical and are forced to upgrade in order to use many new hardware devices and software features that might actually help them improve their position on both the economic and self-esteem totem polls. This silent majority is becoming "no so silent" anymore these days.

Case in point. Microsoft had the perfect opportunity to do what was right this fall and modify its "image search" engine functions to comply with the long standing copyright laws in this country ... and guess what? ... they chose not to do so. I know. I brought it to their attention in May and was politely told to "pound sand". Perhaps they thought honesty from Microsoft would give Google an even further marketplace lead. And don't these folks from Redmond depend on the adequate protection of copyrights for their own survival?

I, for one, can't stand hypocrisy. It's probably the only business practice I hate more than piracy.

So, Microsoft has the bulk of the soldiers, all dressed up meticulously in their corporate colors and standing at their guard posts all around the world ... but Google has the guerrilla warriors hiding behind semantic shells and bricks and mortar as well ... let alone innocent women and children who blindfully follow their lead ... and, all the while taking full advantage of the anonymity of the Internet.

So who is going to win this "Battle of the Titans"?

Here's my view. Microsoft will win some battles and Google will win some battles, but NEITHER one of them will ultimately win the war. A new player, or set of players, will emerge. I am almost certain of that. Players who respect honesty and fair play. Players who will not sell out our morals and business ethics for all the oil in the Mid-east, or all the toys in China. Players who respect copyrights and the hard work of the hundreds of thousands of artists, songwriters, musicians, writers, photographers, journalists, illustrators, cartoonists, and poets, who make our country so unique and so wonderful. Players who believe in both the "fair use" of copyrighted works for research and innovation, and the honesty of the "Public Domain" ... but only within the confines of what is legal and what is not.

People who respect the law of the land. Even if they wish some laws would change faster than they do.

People who shoot straight with their customers, their suppliers, government regulators, members of the legislature ... and the judiciary ... and with their shareholders. A new set of players. A new breed of business ethics, honesty, and fair play. A culture that can once again be respected around the world. It will come about. I'm convinced of that. It's simply a matter of how long it will take to evolve.

If the gourmet free lunches and cricket tournaments have to bite the dust in the process, then so be it. The rest of us deserve an honest shake in all of this Web 2.0 excitement as well. And we expect our leaders to have some class, be honest, and set the proper examples for our kids.

Not these two Titans!

George P. Riddick, III
Chairman/CEO
Imageline, Inc.

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2007 Oct 09 01:09 PM