Microsoft's response to competition from Google and open source platforms

¶ … Turbulent Times at Microsoft

(Microsoft has drastically accelerated their product development and product introduction plans in three core areas of their business in response to the worsening economic condition globally. These three areas of focus include online advertising, enterprise applications, and open source operating systems including Linux and OpenOffice, an open source and license-free competitor to Microsoft Office.)

Complacency kills companies faster than competitors do, and this is certainly the case of what nearly happened to Microsoft with the rapid ascent of Google as the global leader in search engine and hosted or Software-as-a-Service (SaaS) applications including G-Mail and many others. Microsoft Office and personal productivity applications generated enough revenues and loyalties to underwrite massive investments in advertising models specifically designed to compete against Google in their core market, AdWords. Microsoft has yet to recover from Google's quick dominance of the online advertising market and as a result has missed out on major revenue opportunities during a very difficult recession. Online advertising generates on average $300M in revenue every financial quarter for Google, which is what is fueling their ability to grow into other areas. Microsoft missed this opportunity and may never recover, and the recession has must made their financial condition worse, as can be seen from the following table of their quarterly results for Fiscal Year (FY) 2010 compared to previous years (Lai, Gralla, 2008). All of these factors combined have placed Microsoft into the position of having to significantly speed up their product development programs in the areas of online advertising, enterprise applications and competing against open source platforms by concentrating on integrating to these platforms instead of trying to under-price them. As can be seen from Figure 1 Microsoft continued in 2009 to see significant drops in revenue due to the combined competitive forces mentioned in this analysis, exacerbated by the worsening global economy. As Microsoft had defined the end of their fiscal first quarter to get the majority for their new products launched, the turn-around to $19B in revenue in the 2nd quarter of FY2010 can be seen in the table below.

Figure 1:

Microsoft Revenue - Quarterly Results (in Millions)

FY (06/10)

FY (06/09)

FY (06/08)

1st Qtr

12,920.0

15,061.0

13,762.0

2nd Qtr

19,022.0

16,629.0

16,367.0

3rd Qtr

NA

13,648.0

14,454.0

4th Qtr

NA

13,099.0

15,837.0

Total

31,942.0

58,437.0

60,420.0

Advertising Models Google, Yahoo & Search

Google's dominance of the online advertising market and the ability of this Microsoft competitor to stay focused on adding new features and customers in the midst of a worsening recession illustrates how different both of these company's cultures are. Google owes the creation of the AdWords platform to the Rule of 20% they instituted at the founding of their company (Gawer, Cusumano, 2008). The Rule of 20% states that any development or engineering employee can spend one day a week on the projects of their choice . As of their latest fiscal year, the Rule of 20% now accounts for over 50% of total revenue and this is growing over time (Hof, 2008). Nurturing innovation by allowing this level of freedom is critical for the company to continually grow, and this mindset pervades the senior management at Google. The mindset at Microsoft however has been transformed from innovative and quickly reacting to market conditions to being more top-down in its hierarchy and much more formal in its new product development and innovation processes. These variations in the cultures of the two companies are what are leading Microsoft to face an even more difficult challenge of overcoming economically challenging times. Not only are they battling a contracting level of spending on advertising, they are also facing competitors who move much faster than they do on large-scale, very profitable business models, as is the case with Google AdWords vs. paid search at Microsoft. As a result, Microsoft has had to completely redefine their product development and product introduction strategies and their underlying processes to keep pace with Google and the rapid changes in the market. All this has taken on an increased level of urgency as their core businesses in office automation applications see revenue shortfalls due to both the economic conditions globally and the onslaught of open source competitors in the personal productivity software markets.

Microsoft's senior management realizes that for the company stay at its current revenue levels it must aggressively move into entirely new, high growth businesses. The online advertising market has by far the greatest revenue and profit potential and as a result has the most in-demand software engineers globally. Microsoft actively competes with Google for the top talent in this area (Puliyenthuruthel, 2005) more than any other and it is common to see defections from Microsoft to Google as the compensation, freedom of the Rule of 20%, and the upside of stock options (Shipman, 2006). As a result of the shortage of engineering talent and the fact that Google is now two product generations ahead of them in this strategic growth area, Microsoft is now going after partnerships in online advertising with more focus and intensity than ever before. The partnership with Yahoo, which has been continually nurtured by two generations of Microsoft management finally was finalized and signed last year. Carol Bartz, CEO of Yahoo, and Steve Ballmer, CEO of Microsoft were able to finally resolve differences in search strategies and advertising models to create an alliance which gives Yahoo access to Microsoft's technologies (Iansiti, Richards, 2009). Microsoft in return gets access to the yahoo customer base. Arguably if the recession had not occurred and both the national and global economies were growing at between 3 and 5% the competition between Microsoft and Yahoo would have accelerated. There would be a continual battle over talent between Google, Microsoft and Yahoo (Gomes, 2009). Industry analysts are saying that it is feasible for Microsoft and Yahoo's alliance toe effectively challenge the dominance of Google in the global online advertising marketplace as well (Hill, 1997). Just as product development efforts, strategies and the systems and processes that support them have accelerated, Microsoft has had to take a much more collaborative stance on partnerships with companies that during better economic times they would have seen as competitors. Indirectly the worsening economic recession actually forced a premature consolidation of the online advertising market, making Microsoft completely re-think their strategies and approaches to profiting from this market.

The Potential and Peril of Enterprise Applications

Another significant source of revenue for Microsoft is their server operating systems and applications used in enterprises, those companies with sales over $1B annually who often have locations globally. Prior to online advertising's dominance of global spending by companies, enterprises often spent the majority of their information technologies (it) budgets on their infrastructure. A key component of infrastructure spending in enterprises is for server operating systems and application suites that can be scaled across the entire company globally. Chief Information officers (CIO) are very interested in having server operating systems and applications that are easy to maintain across multiple locations and time zones. Microsoft's core server business is based on selling new upgrades to existing operating systems to CIOs. With the economy becoming much slower in terms of spending, both due to the credit crunch and the lack of funds being invested, many CIOs have been told to not only trim their budgets by 30% at the least, they have been told to trim back on software purchases. This aspect of the recession has hit the server operating systems business of Microsoft very hard, and the lack of spending on Microsoft Office licenses across entire enterprises has also been felt acutely in their core business, which are personal productivity license renewals (Weiss, 2008).

As a result of the economic conditions having such a rapid and significant impact on enterprise software sales, Microsoft has had to turn to a division that historically generates just $100M in revenue a year and has a stable 3 to 4% growth rate in exceptionally strong years. This division sells their Enterprise Resource Planning (ERP) systems based on Great Plains Software, a company Microsoft bought over a decade ago who originally was producing accounting software for mid-sized companies (Babu, Dalal, 2006). Microsoft Dynamics platform products including Customer Relationship Management (CRM) applications are also included as part of this division. As enterprise software often requires a substantial investment on the part of enterprises, this area of Microsoft's business has also contracted since the recession began in 2007. Microsoft has attempted to revive sales in this area of their business by rushing the development of Web-based equivalents of these applications, translating them to their Microsoft .Net architecture, and even bundling them together and reducing the price. Yet this area continues to be exceptionally difficult for Microsoft. The latest direction the company is taking is to be significantly speed up the development of their next generation of CRM and ERP applications. Microsoft's direct sales force has also struggled to make larger, over $1M sales which are common in enterprise software, and as a result the company is starting to cultivate its own indirect channel of resellers as well (Babu, Dalal, 2006). Selling enterprise software with channel partners requires Microsoft to create a separate department just for training, coordination of pricing and product requests, and also define entirely new delivery platforms for the applications as well. The Software-as-a-Service (SaaS) platform has been legitimized by Salesforce.com. Microsoft is reinventing itself to in this area so they can better sell with resellers and partners, and also better capitalize on the growing popularity of the SaaS platform as a delivery option for their software. The catalyst of these major shifts in strategy is a direct result of the global recession drastically slowing down the sales of enterprise software.

Conclusion

Thesis: (Microsoft has drastically accelerated their product development and product introduction plans in three core areas of their business in response to the worsening economic condition globally. These three areas of focus include online advertising, enterprise applications, and open source operating systems including Linux and OpenOffice, an open source and license-free competitor to Microsoft Office.) From the analysis presented in this paper it is clear how dependent Microsoft is on a stable economy for growth. Only a small percentage of the company's many product divisions have long-term recurring revenue stream associated with them, and as a result when the economy worsens it impacts Microsoft exceptionally fast. In the case of the online advertising business models the company has continually tried to implement, the formidable competition from Google has amplified the effects of a down economy. The battle of talented engineers continues with Google winning often due to their culture being more oriented towards freedom to innovate. The global economic slowdown has made Microsoft concentrate on partnerships in this area; a strategy the company rarely took on during more economically stringer times. A second area where the economic conditions globally have hit Microsoft particularly hard is in enterprise server and application software sales. As the credit crunch has forced many businesses to forestall or even eliminate software upgrades, Microsoft's selling strategy in enterprises had been consistently focused on annual license fees. This has been difficult for many companies to afford and as a result, they have chosen to move on to open source applications. Microsoft has initially focused on litigation to attempt to slow down open source competitors, yet has been forced to integrate with them or face the possibility of losing customers. All of these factors taken together have made Microsoft concentrate more on new product development as a priority and continually strive to make the processes included in this area as efficient and customer-focused as possible. Economic conditions amplified these competitive challenges for Microsoft, forcing the software company to a new level of urgency.