Microsoft and the Limits of Scale

David Schatsky | May 08, 2008, 04:26 PM

Why has Microsoft found it so difficult to fulfill its online ambitions? After all, according to comScore, Microsoft properties attract a vast number of visitors, not too far behind Google properties (in the US, 121M vs. 137M). With such a gigantic audience, all that would seem to be missing in its competition with Google is a competitive search experience. Doesn’t it seem that Microsoft would have as good a shot as any company to field a competitive experience, considering the vastness of its resources compared to Google:

Over 4 times as many employees
Over 5 times as many employees in R&D
Over 3 times as much R&D spending
Nearly $12 billion in cash on hand as of March 31 (a hair less than Google’s cash on hand).

All of this is surely enough to neutralize scale economies as barrier to entry, as I wrote about yesterday.

But those vast resources are spread across multiple Microsoft businesses. And Microsoft’s Online Services Business is losing a billion dollars a year. Meanwhile, the company cannot afford to neglect its cash cow and other emerging businesses either. So focus is one advantage that Google has. Another would have to be incumbency, Porter’s #5 mentioned in yesterday's post. No matter how many resources you throw at competing with Google, you can hope--for but not count on--matching or exceeding the technological breakthroughs that have given them this lead.

Acquiring to Change the Playing Field

Microsoft seems to have reached this conclusion, leading them to make an aggressive acquisition bid that they hoped would allow them to reap further scale benefits and enhance their competitive position not so much in search but in the portal and display advertising business. That logic still applies. The question is whether Microsoft will turn its attention to acquiring some other online player with a similar rationale.

Hence today's reports that Microsoft has been in talks with Facebook.