Dogfight in IT Industry: Google vs Microsoft∗

Hemant K. Bhargava
Graduate School of Management and
Department of Computer Science
University of California at Davis
Davis, CA 95616
hemantb@ucdavis.edu

August 18, 2009

Abstract

The battle between Microsoft and Google will shape how our society makes use of technology,
computing, and information. It will determine which firm will shape and control the future of
computing, and ultimately profit from it. This face-off pits a world of computing which the operating
system serves as the centerpiece of computing capabilities delivered on a computer, against a new
one in which the network delivers information and computational applications to many different
devices. Microsoft’s dominance of the existing world is threatened by Google and other firms whose
technologies make the operating system dispensable. Simultaneously, Google has demonstrated
search advertising as the place to make big profits on the Internet, making it imperative for Microsoft
to challenge Google’s dominance in this arena.

∗
For ANALYST, publication of the ICFAI University Press, India.

Electronic copy available at: http://ssrn.com/abstract=1457101

 Dogfight in IT Industry: Google vs Microsoft

It has been a hot summer in the IT industry. First, Microsoft, the industry giant in computer

operating systems and office productivity software, launched its new search engine, Bing. Bing finally

won Microsoft some positive acclaim in its long-running effort to challenge Google’s dominant role in

search advertising. Soon after that, Microsoft found success in another long-running effort, signing a

10-year alliance with Yahoo! The deal gave Microsoft substantial property rights on Yahoo!’s search

advertising technologies.1 Google, the search engine giant wasn’t sitting idle. Google lobbed another

shell into the world of operating systems, the new version of its Chrome Web browser first introduced in

2008.2 Chrome is actually a mini-operating system, a feature that can motivate software developers to

write applications that run inside Chrome (rather than on Windows). This can eventually convince end-

users to buy network computers or low-cost netbooks that have no need either for the Windows operating

system or for Microsoft Office. This ongoing battle between Microsoft and Google will determine how

our society makes use of technology, computing, and information, and which company reaps big rewards

in the IT industry.

The Battle for the Future of Computing

In the 1980s and 1990s, the world of computing was defined by operating systems, a business charac-

terized by network effects and increasing returns.3 As more people use a particular operating system,

it becomes more valuable to everyone else since they can interconnect and share documents; the large

user network then attracts more application developers to that operating system, which further increases

its value to end users. Microsoft Windows—the operating system for 95% of PCs in the 1990s—was

extremely hard to compete against—unless one changed the game itself, through technologies that make

the traditional operating system obsolete.

One game changer appeared in the 1990s, when the Internet went mainstream. Web-based technologies—

including platform-neutral languages such as Java, and technologies that shifted the computational tasks
1
“Microsoft, Yahoo! and Google: Taking Sides”. The Economist. July 29, 2009.
2
“The World Wide Web: The Second Browser War”. The Economist. September 4, 2008.
3
Brian W. Arthur, “Increasing Returns and the New World of Business”, Harvard Business Review, July-Aug, 1996.

Electronic copy available at: http://ssrn.com/abstract=1457101

to web servers—caused a shift towards platform-independent Web computing. These technologies made

it unnecessary to use a Microsoft computing platform just to communicate with colleagues or run par-

ticular applications. But Microsoft survived this shift through shrewd competitive strategies. As the

PC market exploded, Microsoft moved to undermine Java and other web standards, and launched its

own Web computing technologies such as .Net, ActiveX, Internet Explorer, IIS web server, etc. Despite

losing some market share, Microsoft did very well in an absolute sense. It was also successful in lever-

aging its dominance beyond operating systems. The Microsoft Office suite became a standard business

productivity tool. Many job announcements today require knowledge of Microsoft application software.

The Microsoft ecosystem thrived. As shown in Table 1 Microsoft’s Client (i.e., Operating Systems)

and Business (Office) software account for over two-thirds of its revenue and, despite being mature

products, deliver very high profit margins (over 60%).

Table 1: Microsoft’s revenue and income for 2009. Source: Microsoft’s 10-K Filing, August 2009.
(in millions) Client Business Online Server and Tools Entertainment
Revenue 14,712 18,894 3,088 14,126 7,753
Operating Income 10,856 12,141 (2,253) 5,327 169

One reason that Microsoft is facing off with Google today is that Google has stepped out of its

home turf (search) with a potential game-changer that competes directly with Microsoft’s most prof-

itable products. Google’s Web-based software for word processing, spreadsheets, email, and other tasks

(packaged as part of “Google Apps”) are available free of charge to individuals and at very affordable

prices to businesses. This is a direct threat to Microsoft’s Business division.4 But an even bigger threat

is the potential of Google’s Chrome browser to change the role of the operating system. In Google’s

worldview for computing, software can be designed as Web applications that run inside Chrome rather

than installed on a PC and run under Windows. Such a move threatens to break Microsoft’s stranglehold

on computing and hurt the long-term profitability of its existing business model.5

Naturally, Microsoft wants to defend itself. Firing back against Google Apps, Microsoft has in the

last couple of years tried to convince businesses of the disadvantages of running business applications
4
Steve Lohr and Miguel Heft, “Google Gets Ready to Rumble With Microsoft”, The New York Times, December 16,
2007.
5
Ironically, the newest version of Chrome runs only on Microsoft Windows! This might well change by the time this
article appears in print.

Electronic copy available at: http://ssrn.com/abstract=1457101

over the Internet. And, now, Microsoft has responded more directly, with its own Web-based Office

applications, in both free and paid flavors. This could be a dangerous move for Microsoft. If truly

successful, Web-Office would only negate Microsoft’s own criticisms of web-based office computing, and

also cannibalize on its profitable Office product line. However, Microsoft probably hopes that it could

dissuade Google from making bigger investments on Google Apps. And it is also likely that Microsoft’s

Web-Office could either sour business users on the “web office” idea, or that it could lock users into a

profit-producing relationship with the regular Microsoft Office.

The Battle for Search

Microsoft has also been attacking Google’s core profit center, Web search. Today’s consumers live on

the Internet and navigate it using search engines, which makes for a highly lucrative market in search

advertising. The top five search engines received 14 billion search requests from U.S.-based users during

just one month (June 2009), and Google again dominated the market, handling 65% of search requests.6

Google has demonstrated that the profitability of search technologies that deliver highly targeted ads

alongside search results (or other web content). In the 2008-2009 fiscal year, Google earned more than

$15 billion, 97% of which came from advertising revenues (66% on Google Web sites, and 31% from

affiliate sites).7 While Microsoft came a few years too late to the “Internet party” (and late again

to “search/advertising”) it did recognize many years ago that computing was shifting to the Internet.

Microsoft feared that if it remained irrelevant in search and Internet services, it would gradually become

irrelevant in the world of computing as well. In the last five years, Microsoft has invested heavily

into search engines and search advertising. However, the results—in terms of winning market share or

creating more income—have been less than inspiring. Microsoft’s market share in search barely touched

two digits and has declined over time.8 And its “Online” (search) division has always been unprofitable:

it produced $3 billion in revenue in 2009, but the cost of producing this revenue was over $5.25 billion

leading to a net loss of $2.25 billion (see Table 1). Whether Microsoft’s latest initiatives (the Bing search

engine, and the 10-year license on Yahoo’s search technologies) will be any more successful remains to
6
comScore Press release.
7
Source: Google’s 10-K Filing, July 2009.
8
http://www.webdesignseo.com/seo/google-search-market-grows.php

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be seen.

Both firms have also made other moves to weaken and counter each other. Revenue from search

advertising is a direct function of how many users visit each search engine, and this is often governed

by the choice of default search engine on the web browser. Surveys reveal that many people simply

use the search engine that is built into their browser. Microsoft has employed its relationship with

computer makers to ensure that its web browser, Internet Explorer—which features Microsoft search—

is pre-installed on computers and then helps guide them to Microsoft search. Google has raised this

issue with government agencies as an anti-competitive action. But at the same time, Google has a

similar alliance with Firefox which makes Google the default search engine on Firefox browsers!

Impact on the IT Industry

At one level, the Microsoft-Google incursions into each other’s turf are insignificant for both, at least

in the short term. Google makes no revenue on the products that encroach on Microsoft—the Chrome

browser/operating system, Google Apps (email, word processor, spreadsheet), etc.—and there is no

indication that Google wants to become the new Microsoft or split profits in Microsoft’s traditional

areas. Conversely, Microsoft’s “Online” (search) division accounts for less than 5% of Microsoft’s

revenue, and it is a loss-maker. So, what explains the fierceness of competition between these two firms

when they could potentially be amicable giants on two separate battlefields?

A big factor in the Google-Microsoft war is the shifting landscape of computing. In the old world

dominated by Microsoft, the operating system was the centerpiece of computing, and computing hap-

pened on end-user machines. But the operating system is no longer a huge competitive advantage in

a world of platform-neutral Internet-based computing. More people will access the web via phones and

other handheld devices than with PCs. More computing will happen in the “cloud” rather than under

the control of the local operating system. While many other companies and technologies have led or

facilitated this shift, Google is the large player which could well emerge as the central firm behind the

transformation. If Google wins, it would dislodge Microsoft as a fulcrum of the IT industry. Application

developers, computer makers, peripheral device makers, and other firms would no longer be beholden to

Microsoft. Thus, the threat to Microsoft is real, a clear and present danger. However, whether Google

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would replace Microsoft in this role is unclear, because until now Google has championed openness and

consortium-based technology development (except on its own turf of search advertising).

Beyond this shift in the nature of computing, one important factor is that within Silicon Valley—

and its culture of egalitarian computing—there is an undercurrent of hostility and mistrust towards

Microsoft, the giant who is not only based elsewhere but has also run its computing business along

a different (albeit, very shrewd) set of competitive practices and methods. I believe that Google—

like other computing biggies such as IBM, Oracle, Sun, and Apple—is not particularly enamored of

Microsoft’s ability to leverage its platform dominance into other aspects of computing. Over the years,

Microsoft has smothered many potential giants that emerged from Silicon Valley—think of Netscape,

RealNetworks—despite having only an inferior technology, but with the advantage of bundling this

technology into the operating system.9 Perhaps Google fears a similar fate in search or, at the very

least, wants to stop Microsoft from spreading its tentacles across the computing industry.

Will this ongoing battle advantage or disadvantage consumers? Conventional wisdom suggests that

these confrontations should be to consumers’ advantage. Google’s web-based office software has spurred

Microsoft to release a free web-based Office. Both firms (and others) have to constantly upgrade their

free email products, provide more features, greater storage etc. Microsoft’s “maps” products have put

similar pressure on Google Maps. If Microsoft is more successful in search advertising, this should reduce

the cost of search advertising, and cause the search engines to innovate faster in their quest for a larger

market share. In general, more competition implies more innovation and lower prices. The move to

more open standards, and the reduced emphasis on the operating system, should also shift surplus from

the firms to consumers. It should lead to more product variety and lower prices. At the same time, if

the disentanglement of platform-based computing leads to a complete free-for-all with no standards or

a multiplicity of standards, this might cause some chaos in products and industry structure.

The Google-Microsoft battle is not an isolated one, because the underlying technological and strate-

gic considerations affect other related industry sectors as well. Consider the telecommunications industry,

where Google has introduced several innovations (such as the Android mobile operating system, Google

audio/video VOIP service, and Google Voice).10 Traditionally, the business of wireless telephony has
9
Michael A. Cusumano, “More Lawyers than Programmers?”, Communications of the ACM, July 2004, Vol 47., No. 7.
10
Miguel Helft and John Markoff, “Google Enters the Wireless World”, The New York Times, November 6, 2007.

5
been controlled by the big telecom service firms (such as AT&T, Sprint, Verizon) while handset makers

played a secondary role as suppliers. However, this is changing as the mobile phone becomes more of

a computer with a well-defined operating system; in this new world, power shifts to the OS maker,

and application developers are no longer at the mercy of the telecom service provider. Google entered

this field by sponsoring the Android mobile operating system in partnership with an alliance of telecom

service firms as well as hardware makers. Thus, Google’s rivalry in this sector is with other firms that are

trying to create platforms out of mobile phones. This puts Google directly into competition with Apple,

rather than the traditional mobile phone operating systems such as Symbian (now owned by Nokia),

Palm, and Blackberry. It was Apple which—soon after its successful launch of the iPhone—launched its

Appstore (a collection of ‘Apps’ - third-party applications that run on the iPhone) to capitalize on the

strategic value of using the iPhone as a platform. While Apple doesn’t presently derive enormous rev-

enue through third-party Apps, the significance of having thousands of Apps (and billions of downloaded

applications) is that it establishes iPhone as the must-have phone. Android threatens this dominance.

There is an underlying philosphical parallel in Google’s forays into the world of Apple’s iPhone and

Microsoft’s Windows. The iPhone/Apps is a closed, proprietary platform. Apple retains full control and

can approve or disapprove any App for whatever reason. Rejected applications typically are the ones that

threaten the economic objectives of Apple and its partner AT&T (e.g., Apps that enable voice calls that

bypass AT&T). This is where Google ran directly into Apple’s path when it introduced Google Voice,

which Apple rejected (after which the Google CEO, not necessarily in response, stepped off the Apple

board). Google’s Android, on the other hand, is based on open standards, runs on a Linux kernel, and

involves a different set of economic incentives (so, for example, Google Voice runs on Android-based

mobile phones). Google’s initiatives in mobile and VOIP telephony could therefore diminish the profit

potential of existing telecommunications firms and device makers.

Exciting times lie ahead. And, while all signs point to a continued rivalry between Google and

Microsoft, you never quite know what lies ahead. The big players in the computing industry are each

other’s foe’s on one battlefield or the other—and, sometimes it is better to be a friend with your enemy’s

enemy, even if that firm is also your own enemy. For example, Microsoft and Nokia are competitors on

mobile operating systems, but they just formed an alliance to counter Blackberry which is their common

6
enemy; similarly, Google and Apple are foes on mobile operating systems but have been friendly in other

areas. So it’s quite conceivable that in a few years Microsoft and Google will actually come close

together to fight some other firm that begins to dominate the market. It could be Apple, Facebook, or

someone else, anyone’s guess at this time!

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Hemant K. Bhargava

Professor Hemant K. Bhargava joined the Graduate School of Management at the University of Califor-

nia, Davis, in summer 2003, and also holds a joint appointment as professor of Computer Science. He

has previously worked at the Naval Postgraduate School, Carnegie Mellon University, and Penn State

University. Bhargava studied in India - at Delhi University and the Indian Institute of Management - and

did his doctoral work in Decision Sciences at The Wharton School, University of Pennsylvania. Bhargava

is an internationally recognized expert in the technology and information industries. His current research

is in the economics of information systems, and covers pricing, product design, marketing and operations

for IT-intensive products and networks. He has also done extensive work in the design of computer-based

modeling languages and decision technologies. He has worked and consulted with several leading tech-

nology companies and government/military institutions. His work has appeared in INFORMS Journal on

Computing, Management Science, Information Systems Research, Journal of Management Information

Systems, Decision Support Systems, and IEEE Computer. His research on DecisionNet won Best Paper

Awards at leading Information Systems conferences. Bhargava was awarded the Menneken Prize for

Excellence in Research at the Naval Postgraduate School in 1998.