Directions

The Opportunity Cost of the Microsoft Defense

A lesson can be learned from Microsoft's strategy to squeeze the competition out of markets until it's the only one left standing.

• By Paul DeGroot
• January 01, 2006

One strategy worth reviewing is what our team at Directions on Microsoft knows as the "Microsoft Defense." The goal of that strategy isn't necessarily to win a market, but to deny it to anyone else. Microsoft is one of the few companies capable of this type of defense, which costs billions of dollars to execute.

The best known example is Netscape. Microsoft feared that Netscape would turn the browser into a platform for running applications, and platforms and applications are Microsoft's core businesses. So Microsoft "de-monetized" Netscape's business by creating and widely distributing free versions of everything that generated revenue for Netscape, particularly the browser and Web server. The cost was high, by anyone's standards except Microsoft — perhaps $1 billion poured into producing a browser and Web server that generated no direct revenue, but did remove a competitor.

MSN was another defensive play that generated little revenue but, by our estimates, sucked several billion dollars out of Microsoft — and much more than that from competitors who did not have Microsoft's deep pockets.

Today, the defensive strategy can still be seen in game consoles, where Microsoft has pumped perhaps $3 billion into money-losing Xbox consoles that keep Sony and Nintendo from building ever-more-flexible consoles that could become alternatives to the PC.

Sometimes the defense won't work, as in the case of Linux, where there's no revenue stream to dry up because the operating system is free. In fact, what's most frightening to Microsoft is that the open source movement is actually using its own variation on the Microsoft Defense: de-monetizing the most profitable parts of Microsoft's business, such as operating systems and desktop productivity software.

Even greater costs of the Microsoft Defense have been ignored. They're what economists call opportunity costs. What if, instead of choking off its competitors' air supply, Microsoft had endeavored to be a partner? What if, instead of spending billions to compete with AOL and other Internet service providers, Microsoft had put all that energy into ensuring that no matter what they did, their businesses would make money for Microsoft? Microsoft would make sure it produced the best client; it would have the best servers, the best-embedded platform and the best development tools. All these products and platforms would help partners succeed, but Microsoft wouldn't go after its competitors'direct revenues. Instead of losing billions to compete with them, it would make billions by underpinning their success.

I raise all this not merely to revisit history, but to point out that competitive strategies have costs. By definition, competition is little more than a zero-sum game. Your loss is my gain, but the total amount of money that changes hands is the same (or less, if we drive prices down). In contrast, a partnering strategy may produce a win-win scenario. Witness the partnership that, in so many ways, made Microsoft — the deal to provide an OS for the IBM PC. From that came not only an OS business, but an application business and about 300 other businesses.

The Microsoft we're seeing today is driven by a variety of pressures, such as competition from open source, a lackluster record on Wall Street and Google's leadership on the Internet, so I can't say that this change of heart is driven entirely by repentance for its earlier cutthroat competitiveness. In fact, there's ample evidence that the company's competitive instincts are undiminished as it takes on Intuit in low-end accounting or Salesforce.com in CRM. Besides, a lot of us benefited from Microsoft's competitive approach: browsers are free, Web servers are free, instant messaging is free, many other technologies are free or cheap.

But there's a lesson here. If your competitive roadmap doesn't include substantial cooperation and partnering, it's not complete. And you learned that by watching Microsoft.