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Ventsislava Rydzewski

Case due September 23, 2009

Microsoft’s Diversification Strategy

The General environment for Microsoft is comprised of two segments

mainly– technological, political and legal. The global segment could be considered
to some extent as well – the change in the existing markets, important international
political events and some critical cultural and institutional characteristics of these
global markets. The general environment that highly affected Microsoft is political
and it posed threats to the company and the other companies in the same industry,
for that matter, that were beyond the companies’ control. U.S. Justice Department
filed antitrust charges in 1998, claiming that Microsoft had stifled Internet browser
competition and limited consumer choice. In March 2004, the European Union (EU)
fined Microsoft and ordered it to take out its media player software from European’s
Window version. Although Microsoft recovered, it faced the threat of many new
entrants who were faster and popular programs such as e-mail, desktop search
engines and instant messaging over the Internet appeared. The fierce competition
forced Microsoft to extend its software products into Web-based services for
business and consumers. Therefore, the technological segment of the external
environment for Microsoft introduced numerous innovations and product
development, and applications of knowledge.

Microsoft has dominated the desktop software market since it was found by
Bill Gates in 1975. The early 2000s, however, posed a threat on its future growth.
The fast-changing competitive environment forced Microsoft to reinvent itself.
Microsoft faced many strong new competitors in new segments of the highly
monopolized desktop and server software industry. Its primary industry was no
longer providing the desired average returns to support the company’s future
growth, due to the fast pace of technological innovation. The beginning of
Microsoft’s strategic decision was the purchase of QDOS (quick and dirty operating
system) from Seattle programmer and renamed it the Microsoft Disk Operating
System (MS-DOS). Later, Microsoft successfully introduced Windows, a graphics-
based version of MS-DOS that borrowed features from its rival Apple’s Macintosh
system. Microsoft then developed Window NT to compete with UNIX. As the desktop
software market saturated, the burst of the, and entertainment’s trend, in
November 2005, Microsoft announced its new diversification strategy to move
beyond Windows-based PCs and aggressively expand into other industry sectors.
Microsoft faced tremendous challenges since it had no proprietary advantages in
those new markets.

Economically, the IT industry remained at positive growth. However,

customers started to expect more out of their technology investment and express
more concern about the value of IT. The first annual decline of aggregate capital
expenditure of US Companies on IT followed in 2001. The Bargaining Power of
Buyers dramatically increased and the IT industry was considered in the midst of
period called “the technology digestion”. CEOs looked at the ROI before investing in
IT and procurement departments became more involved as well. In order to meet
the changing business needs of its customers, companies leveraged the concept of
SOA (service –oriented architecture). Cost effective and easy to use new entrants

and substitute products and services threatened to replace the static Web pages
and desktop software, created mainly by Microsoft. Google was its main competitor
at the time, launching these programs free to customers-desktop applications, ERP,
SCM, and CRM software. In response, Microsoft regrouped its resources and
integrated new capabilities into its core competencies. The Platform Products and
Service Division developed its own search capability after MSN to compete with
Google. Its Business Division was the second most money-generating. The
Entertainment and Devices Division introduced Xbox and replaced Sony’s
Playstation 2.The entertainment industry was an industry with opportunities that
could be exploited by the company’s resources and capabilities. It was another
external opportunity for Microsoft that created competitive advantage and made
Microsoft a key player in the market. In 2002, the first Windows based Smartphone
was launched, a leading ODM in Taiwan. Also, by partnering with the French
telecom technology provider, Microsoft became the leading IPTV technology
provider. Microsoft also acquired a number of midsized companies after e-mail
Hotmail in 1997; like the Great Plains in 2001 and Navision in 2002 Microsoft
Business Solutions, which allowed it to develop new capabilities that added strength
to its core competencies. The company started to offer a huge variety of software
applications in different business segments as accounting, e-commerce,
management and human resources.

Microsoft has been able to develop its key areas of expertise which are
distinctive to the company and critical to its long term growth. These areas of
expertise are developed in the critical, central areas of the company where the
most value is added to its products and where they really affect its competitive
advantage. Some of Microsoft’s core competencies are:
- Software Development Tools (customer relationship management, sales and
marketing, computer science research),
-Custom Development Solutions (application and web development), and
-Information Workers Solutions (messaging, office client development and
portals content management),
-Advanced Infrastructure Solutions (system and active directory
-Licensing Solutions (license delivery and software asset management)
These core competencies have changed in response to changes in the company's
environment. Towards 2005 some new competences have started to bring value
and generate revenue for the company, mainly in the entertainment markets. As
Microsoft evolved and adapted to new challenges and opportunities, so did its core
competencies. The key core competencies for Microsoft are those that enable the
creation of new products and services. Thus, the core competences that drive these
products provided access to wide variety of markets for the company. The apparent
customer benefits of Microsoft’s products are mainly to be connected (connecting
people, processes and systems), to be productive (in managing business), and to be
flexible (in use of software). The valuable key products that contribute to those
fundamental customer benefits are the operating systems and office tools which are
driven by the core competencies mentioned above. Microsoft leverages on its core
competencies to bring innovative products to the market at competitive prices.
Thus, they are very difficult for competitors to imitate. The company has proved to
always stay on top with innovations and try to move a step ahead of its

Although with no competition worth the name to challenge its existence
especially on technology advancements, Microsoft had managed to keep up with
the needs of its customers and its niche remained strong. The IT industry offered
almost limitless opportunities for companies like Microsoft; however, there were
also threats. For example, alternatives to Microsoft products were improving and
gaining brand recognition, such as Linux and Macintosh. Another threat has been
the inability to manage security vulnerabilities in Microsoft software. In addition,
Microsoft lost revenue from decreasing public and private sector industry
technology spending budgets.

During its few years strive to improve its future growth, Microsoft showed a
number of weaknesses. It had an inefficient approach to new product development
at first that gave its new competitors the ability to churn out popular programs like
e-mail, desktop search engines and instant messaging. Another weakness was the
inability to launch the new generation Windows Vista, which showed up two years
behind its original schedule. That was the longest interval between versions and a
strong reminder for the so strongly needed restructure.

The success of Microsoft’s Diversification strategy had positioned it to

accomplish continued growth. The largest enterprise software vendors such as SAP
and Oracle drive operating margins around 27.30 and 37.10% at the end of
2005.But the change in % for the two consecutive years hovers around a point or
two. Google kept its dominance in the online search markets and showed an
operating margin of 34.30% in May 2005 with a change of 11%. In comparison,
Microsoft’s 36.60% was down almost 5% since 2003 but still at a high and healthy
level. Since this ratio best describes a company’s pricing strategy and operating
efficiency, a healthy operating margin is required for a company to be able to pay
for its fixed cost. It gives an idea of how much Microsoft made (before interest and
taxes) on each dollar of sales. Microsoft is in the lead of its competitors. Apple’s
operating margin, even though low, showed a tremendous climb of almost 12 %,
which indicates Apple as one of the soon to be new strong Microsoft competitors.
IBM stays at a steady 10-11%.

The dividend per share ratio- another indicator of the success of Microsoft‘s
diversification strategy- showed that Microsoft has paid the highest dividends to
outstanding number of shares – 3.40. Its dividends have increased from 0.08 to
0.16, to a high 3.40. This shows the company moved past an aggressive growth
phase and into one of more stable and predictable growth. Microsoft was followed
by Sony, IBM and SAP. Red Hat, Google and Yahoo declared 0. Cancelled dividends
per share usually suggest that we have to look further into the financial statement
of these companies to find out why.

In discussing Microsoft’s profitability compared to its rivals, we refer to the

Net Profit Margin. Drastic changes are shown by Red Hat and Yahoo; with 20%
increase for Yahoo and almost 23% for Red Hat, Apple with 10% and Google with
15%.The higher the net profit margin, the more effective the company is at converting revenue
actual profit. Microsoft is at a steady 30%. Only Yahoo after its 23% climb shows a better margin for
2005 of 36.10%.