Strategic Hunger at Microsoft

David Schatsky | May 06, 2008, 12:14 PM

Microsoft’s aborted acquisition Yahoo! was widely understood as attempt to dramatically improve Microsoft’s strategic position in “online services,” which today means mostly online advertising and search. Online services are vitally important to Microsoft in part because Internet-based applications threaten to offer a substitute to the desktop software that is Microsoft’s bread and butter. But Google has proven that online services can be a highly profitable business as well—in the first quarter of this year Google’s operating margins were 30%, about the same as Microsoft’s in that quarter (and that includes some of Microsoft’s unprofitable and barely profitable lines of business).

Michael Porter Applied to Google, Microsoft and Yahoo!

I dusted off Michael Porters’ five-forces strategy analysis framework to help me understand Google’s strategic position and assess Microsoft’s options for competing. In Porter’s analysis, 5 competitive forces determine the profitability of an industry:

1. Bargaining power of suppliers
   
2. Bargaining power of buyers
   
3. Threat of substitute products or services
   
4. Threat of new entrants
   
5. Rivalry among existing competitors
   

If those forces are intense, says Porter, then industry profitability is low; if they are weak, industry profitability is high. It’s easy to see that the first two forces are weak in online search. Commodity suppliers provide interchangeable infrastructure elements like computing power and bandwidth. Buyers are advertisers, and they are free to contract with any search provider they like. It is hard to envision a substitute to search advertising today, though display advertising is a complement. Because of Google’s dominant position, and the limited number of credible potential competitors, Porter would characterize rivalry here as weak.

That leaves the threat of new entrants. More on that in my next post. Till then, check out David Card's post on what Microsoft needs to do now.