STRATEGIC MANAGEMENT Microsoft s Search Jorge Tarzijan
Main learning objectives To review the concept of competitive advantage, in a setting where there are important network effects. To evaluate a competitive (dis)advantage. Discussion of company s goals and their relation with company s behavior.
Microsoft 1. Why the market for operating systems is dominated by a single player and why Microsoft is that player? What about the market for office applications? 2. Does Microsoft have a competitive disadvantage in Internet search and search-related advertising in 2008? 3. Why is Microsoft pursuing the market for search and search-related advertising?
Why is the market for operating systems dominated by a single player and why is Microsoft that player? (a) Direct network effects: Users want their PCs to be compatible with the PCs of other users, since the value of the OS grows as other users consume it, (b) Indirect network effects: Independent software vendors write for the OS with the largest base of users, and users buy the OS with the largest selection of software. (c) Increasing returns (cost function with decreasing average cost). Once the master disk is created, Microsoft incurs zero variable costs!!!! Implications of (a), (b) and (c) for industry structure?
Does Microsoft have a competitive disadvantage in Internet search and search-related advertising in 2008? Static analysis (2008) Microsoft is at third place, with a market share of 8.3% (Google s, 63.5%). Its online services segment is losing lots of money. So Microsoft appears to have a competitive disadvantage. A company has a competitive disadvantage when the gap it generates between WTP and cost per unit is smaller than the gap achieved by competitors for target customers. The second part, a dynamic analysis, reveals that, if this market continues on its natural trajectory, Microsoft s position is likely to deteriorate even further.
Search Engine Comparison (Exhibit 6) Google Yahoo MSN/Live Average price per click, Q2, 2008 (in $/click) 0.71 0.51 0.59 Share of U.S. search queries, 2007 (in %) 58.2 24.1 10.8 Share of U.S. search revenue, 2007 (in %) 66.2 17.1 7.0 Average price per click relative to Google, Q2, 2008 (in %) 100 72 83 Revenue per search relative to Google, 2007 (in %) 100 62 57
COMPUTATION OF REVENUE PER SEARCH WTP = Revenue per search = clicks per search x price per click = 0.69 x0.83 = 0.57 Clicks per search = In what % of the web-searches people click for an ad? 69% means: when a user goes to a webpage is more likely to click on an ad in a google page than in a Microsoft page. Why the click-through rate is lower on Microsoft than on Google (100% - 69% = 31% lower)? Because it has more advertisers, it is more likely that Google have some relevant ads. It seems that Google does a better job than Microsoft of presenting searches with ads on which they want to click, in a way that makes them likely to click (superior algorithms?) Active searches -far more common on Google than on MSN (p 10)- are more likely to click on ads.
PRICE PER CLICK Why are advertisers paying less for a click on Microsoft s search engine (100-83 = 17% less)? After all, the click from either search engine send the searcher to the very same destination webpage: Because Google has far more advertisers than Microsoft (400.000 vs 60.000, pag 11), it has more advertisers bidding for each page of search results. This drives up the winning bid. A click is not just a click. A click is more valuable for an advertiser if there is a good match between the advertiser and the searcher. It is also possible that advertisers will pay more for a click from Google because Google s users are a more attractive demographic segment (on average).
COST How does Microsoft s cost per search compare to Google s? Some inferences from the case: Search is ultimately a fixed-cost business. Competitors invest enormous amounts in building up engineering staffs, data centers and so on. Marginal cost of an incremental search is almost $0 Who has the low-cost position in an industry dominated by fixed costs? Typically the firm with the largest market share does, in this case Google. Two examples: Google deploys twice as many engineers as Microsoft to improve search algorithms, but fulfills 7.7. times as many search requests as Microsoft. Google has 15 data centers to Microsoft s four. Thus, on a per share basis these figures suggest that Google s cost is: 15/4/7.7 = 49% of Microsoft s.
Why are advertisers paying Microsoft less money per search than they are paying Google? The discussion also highlights a general phenomenon: Underlying most examples of large and sustained competitive advantage, we can typically spot some positive feedback loop that reinforces and amplifies the advantage over time. In the search market, Google is a beneficiary of such loops...and Microsoft a victim.
Why is Microsoft pursuing the market for search and search-related advertising? Should Microsoft persist in the search business? If they re losing money, losing share, incurring higher costs to generate lower WTP, and facing a growing disadvantage, why bother? Two possible rationales for Microsoft to push onward in search. The first is an offensive rationale: Search is an attractive business for Microsoft. The second is defensive: Microsoft must be in search in order to protect other businesses. More broadly, a manager should know his or her objectives, offensive or defensive, before choosing an action. Managers should be cautions with defensive rationales.
Main learning points Direct and Indirect network effects are very important to determine industry structure. WTP and Cost are the main determinants of Competitive (dis) advantage. Network effects and increasing returns affect both WTP and Cost. It is always important to make an effort to compute the value being created (captured) by a firm. The numerical analysis can be somewhat more complicated in network businesses because of the different sides involved (and also different dynamic).