Judo Economics: Bringing Down Microsoft

April 24th, 2008

Author: Michael Krotscheck

Category: Articles

Tags: apple, corporate strategy, google, judo economics, microsoft, nintendo

A few years ago I took what must have been one of the most entertaining courses of my graduate career: Business Game Theory. It was run using the Harvard Case method, but with no supporting textbook and no explanatory lectures before a case was assigned- we simply received a problem and were expected to solve it by the next lecture. The problems themselves were simple: we were given a situation and asked a fairly straightforward question. Should Company B enter a particular market, how will a competition play out, can you predict the next step in a competition given certain parameters, things like that. Most of us got the first problems blatantly wrong- the tacit requirement to do our own research didn’t sink in until after the first discussion- yet after that reality check it became one of the most engaging classes ever: The problems were challenging but not beyond rational analysis, and though I spent hours at a time bending my brain around decision making in a risky environment and other situations, I can still name the topics and methodologies for every case.

As a result I was practically giddy when I recognized a real world example of Judo Economics, a situation where a player uses the strength of their opponent against them. Consider a simple case: There exist two markets for a single product and two companies that can produce said product. The first market is large, however serving it comes with a high cost and therefore a low margin. The second market is small, but serving it is cheap and therefore comes with a high margin. The first of the companies must serve both markets, has deep pockets, while the second is considering market entry, but can only serve one of the two. Each company can only set one price against both markets. The question posed is: What will happen?

The answer is as follows: The entrant will enter the smaller, more profitable market and undercut the larger company to the point where the larger company would suffer a net loss by matching their price. Why? Well, without drawing the decision tree it turns out that net profit for the system will be larger for the big company because the entrant can continue to undercut it until the margin in the smaller market disappears entirely. Quite simply, they cannot match the entrant because they are forced to serve the both markets. Ergo: Their strength is used against them.

The Real World

Now lets take this example to the real world: Microsoft is currently serving the vast majority of the desktop market. In fact, it’s difficult to imagine a desktop computer that doesn’t run Windows, and even in the laptop market they command a substantial segment. Microsoft has gone to great lengths to solidify their position within that market, releasing their own languages, developer toolkits, IDE’s and whatnot. Buy Microsoft, by Microsoft, for Microsoft, anything you want to do on a computer you can do with Microsoft.

Unfortunately, by winning the war for the desktop market they’ve now locked themselves into serving it, and as any marketer knows you can’t really segment a market that size perfectly, at least not without severely diluting your brand. At most we’ve seen three versions of Windows, usually targeted at the Office User, the Power User, and the Home User. From both a product management perspective and from a branding perspective they’re pushing the limit of how many versions of windows they can support, especially if you take into account all the legacy versions still in circulation.

The number of versions actually doesn’t really matter- what matters is that Microsoft has to charge a price that the majority of said segment is willing to pay while at the same time accommodating for the development cost of meeting the needs of the entire market. Some consumers might be willing to pay more than they’re charging, others less, and the end result is that the margins average out to something marginally profitable.

The Competition

This is where the case for Judo Economics begins to take shape. Microsoft in the late 90’s and early 00’s could serve the entire market and did so, winning a dominant position. Since then the competition has identified users’ specialized needs and focused on them, effectively fragmenting the formerly homogenous user base of computer users into smaller segments: gamers, office workers, mobile computing, social networking, online productivity and so forth. They’ve each chosen their target market segment, have specialized their product offering for that particular segment, and are reaping the benefits of customers who are willing to pay more for a more specialized offering.

In the meantime, Mr. Gates still has to serve everyone else. The long and short is all the geeks who were angry about Microsoft’s antitrust practices vis-a-vis netscape and IE/browser integration/exclusion should have been cheering them on. A monolithic operating system and environment cannot be truly customized to the individual anymore, and they incur the massive cost of having to develop not only all the functionality they’ve supported up until now, but any new features that are identified in the market. In the world of the Long Tail their ability to meet all of a users general needs rather than all of a users’ specialized needs puts them at a significant disadvantage which their competition is busily exploiting.

So who are the competition?

Adobe: You might not think of Adobe as much of a competitor to Microsoft, however the recent introduction of Silverlight shows this is an area that Microsoft has identified as profitable (they’re good at identifying opportunity, I’ll give them that). Unfortunately Adobe has a lock on the real driving force behind the online experience: Designers. As long as they continue to focus on supporting them, the decisions of what technology to use will remain firmly in their court. Yes, purely technically designed websites and RIA’s will likely fall to Microsoft, but quite frankly I don’t think Adobe cares about serving the online accountant.

Apple: In 1999, the book on this fight seemed to have been written. Apple soundly lost the battle for the desktop, and was classified even lower than Linux, a computing platform for rabid advocates that would eventually follow the Amiga into obscurity. And now where are they? Apple is sexy. Apple is hip. Apple is targeted at a consumer segment that is affluent and to some extent image conscious, taking those users away from Microsoft. All those fat margins that could have been earned by Bill are now wandering off to the upmarket offerings provided by Apple, who doesn’t ever want to be in the position of having to serve everyone… or do they? (more on this in another post).

Nintendo: The XBox 360 is everywhere, Halo was a huge deal. We know that Microsoft was succesful here, and will continue to be so for the forseeable future. Yet this market shows some of the same signs as Apple’s position in the Desktop and Laptop market, because the XBox has become a commodity- everybody has one. Everyone does not have a Wii, and the speed at which they fly off the shelves shows a level of demand much like that of the iPod. The Wii is cool, while the XBox has become the console equivalent of a beige box. How this will play out in the long run is hard to say at this time, however given Redmond’s recent strategic moves into community gaming I feel they won’t give up their share so readily.

Google: It’s hard not to mention Google here, and even though I think they’ve jumped the shark and will lose their innovative edge in the very near future, their dominance in the search market is too big to ignore (just look at the Yahoo hostile takeover- Microsoft’s not ignoring them). Here we once again have a company that has to do everything: browser, search, ads, etc, competing with a company that’s just really, really good at one or two of those. Guess which one is dominant? I thought so.

So that’s the argument in a nutshell: Microsoft has to serve the entire market, and as a result is too crippled to actually compete for the plumb market shares. Looking forward we can already see them becoming more aware of their situation though: The next version of windows is supposedly modular and thus more customizable to individuals’ needs. They are attempting to acquire Yahoo, and opening up the XBox for community developers is a dangerously O.P.E.N. tactic. I’m calling the score tied, lets see what happens in round three.