A Beautiful Mind: Microsoft over Google

Includes: GOOG, MSFT
by: Mark Hines

There is an Oscar winning film directed by Ron Howard, titled "A Beautiful Mind," where mathematician John Nash develops his Nobel Prize winning game theory. It seems Microsoft may have taken a page out of the game theory playbook as it is developing an alternative competitive strategy that will eventually help Microsoft crush Google.

Bill Gates (founder and Chairman of Microsoft) recently spoke at the University of Chicago, and I was most interested in two of the themes in his presentation. One, Mr. Gates emphasized the huge opportunities in the poorest two thirds of the World which are largely ignored today. Two, he discussed the development of new natural user interface tools (e.g. touch screens, pens, speech recognition, and cameras) that will eventually become as much a part of Internet life as the mouse and keyboard are today. I believe it is these two themes that will allow Microsoft to capture enough data and Internet traffic to eventually develop a search engine that will dethrone Google.

In terms of search engines, Google is currently number one with more U.S. and International traffic than any other search provider. Google has gained a competitive advantage in the Internet search space due largely to the massive amounts of data it has collected and continuously uses to improve its search engine. (granted, Google's search algorithms and programmers are amazing too, but these are things that can be copied by anyone with enough dollars, whereas Google probably won't ever sell their proprietary data). It seems nearly impossible for a competing search engine to ever catch up to Google. It would take years for a competitor to gather an equivalent amount of data, and by that time, Google will have already advanced further. Here is where John Nash and game theory comes in...

Rather than choosing to compete with Google head to head, Microsoft has chosen an alternative strategy that would make John Nash proud. Microsoft aspires to develop a set of user interface tools that will revolutionize the Internet in much the same way that Windows revolutionized personal computing. Internet users will freely choose to access Internet data via Microsoft over Google because the Microsoft solution will simply be so much better.

Further, Microsoft will tap into the ingenuity and information of the poorest two thirds of the world which is already demonstrating its massive desire and aptitude to be productive (check out page 9, paragraphs 5-7, of this Bill Gates presentation for an example of the poorest two thirds demonstrating phenomenal promise). As I've written before (Why I sold Google at $741), Google has already demonstrated fear of flattening revenue growth due to key Word prices inflating to breakeven levels for advertisers. Two of Google's latest attempts to combat this fear are Open Social and Android. Both are truly genius ideas, but I still like the Microsoft strategy better because it is so much bigger.

In the short term, Google shares look attractive because of it's increasing market share lead, superior search engine, and attractive valuation (market cap has dropped approximately 1/3 since November and price/earnings ratios are below historical ranges), whereas Microsoft will likely face challenges with the bidding for, and eventually integration of, Yahoo. However, if I had to pick one of the two companies to own over the long term, I'd pick Microsoft because it is positioning itself for much bigger rewards. After all, even Warren Buffett has so much faith in the abilities of Bill Gates that he bequeathed over $30 billion of his fortune to the Bill & Melinda Gates Foundation.