Microsoft Looking Through Windows

Can it succeed with vertical product integration too?

By No Analyst or Consultant

September 20, 2006 — CSO —

Consider the latest news from Microsoft: The company is busy creating a music player and service, dubbed "Zune," to compete with Apple Computer's iPod, and on Aug. 17 it signed up EMI Group as a music video partner. The company's Xbox is a money-losing venture, but remains a hit with gamers. Meanwhile, Microsoft is offering PC makers design kits so they can dress up their computers to match the company's new Vista operating system due in early 2007.

The common thread: Microsoft, well known as a software giant, is increasingly dabbling in hardware and playing a bigger role in product design. The big question is: Why? While some analysts dismiss Microsoft's efforts as Apple envy, experts at Wharton say there is a bigger picture. Microsoft wants more control over integrating its software with the gadgets that could open new markets. Its real mission: Find new vertical markets to dominate so it can continue to grow even if its Windows monopoly erodes.

"Microsoft understands that software, its core business, is becoming increasingly commoditized. It needs to find new revenue streams if it wants to keep growing," says Wharton legal studies and business ethics professor Kevin Werbach. "Across the computer industry, value is moving from the desktop to network-connected services. Integrating software, hardware, content and services, as Apple has done so effectively with the iPod, can be a wonderful business model if you can do it right."

If the vertical market playbook sounds familiar, it is. Microsoft has $34 billion in cash and short-term investments as of June 30, largely because it profits by controlling a PC ecosystem that revolves around Windows. In other words, Microsoft's Windows has become a de facto standard. Apple is using the same approach in music by pairing the iPod with the iTunes music portal along with its digital rights management (DRM) software, which controls how content is used. All three pieces of the iPod ecosystem have become dominant standards.

To Wharton operations and information management professor Eric Clemons, Microsoft's forays into new markets tell a larger tale of the software giant's insecurity. "The bigger story here is twofold: Microsoft's continued fear that it may lose its power and pricing in operating systems, and Microsoft's continued need to show rapid growth in a world in which it already owns nearly the entire market in its core product areas," says Clemons.

What remains to be seen is whether Microsoft can make the right moves in its products and strategy to own a new market. In many respects, market domination is the equivalent of a lightning strike. Other companies, such as Google with its search engine and Apple with the iPod, have also developed hits due to fortuitous timing and well-designed products. "There's this notion that Microsoft lies in wait and then dominates a new market," says Wharton marketing professor Peter Fader. "But it's not true. Microsoft fails as much as it succeeds."

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