What the Next Microsoft Will Look Like

Nobody knows which company will become the next Microsoft, but investors can understand the company's recipe for supremacy: controlling the value chain, dominant market share, and a tectonic shift in computing. Let's take a look at those marketplace principles.

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By John Del Vecchio (TMF Fuz) and Mike Trigg (TMF Tonto)
December 4, 2000

Attempts to find the next Microsoft (Nasdaq: MSFT) have reached legendary proportions, resembling such storied endeavors as the plight of the Mayflower and Armstrong's journey to the moon. Rather than lead investors to believe that such a company exists, however, we've chosen to identify three key factors --controlling the value chain, dominant market share, and a tectonic shift in computing -- that helped Microsoft achieve world domination. A company able to garner even one or two of the aforementioned metrics could be well on its way to creating significant shareholder wealth.

Controlling the value chain
The Microsoft success story begins with the company's large value chain, a string of companies working together to satisfy market demands. In his book The Gorilla Game, Geoffrey Moore discusses how the process of determining competitive advantage has shifted, particularly in the high-tech industry, from focusing on the actions under a company's direct control -- such as cost controls -- to the role it plays in large cooperative ecosystems. 

"These cooperatives are called value chains because they involve the linking up of numerous entities to fulfill a specific value proposition to a target customer," he writes. "Like all other human institutions, value chains need clear and stable power structures to sustain themselves going forward. The companies that gain ascendancy within these value chains, however, not only have the power over the chain, they have the power of the chain. That is, they can compete using the chain itself as a weapon, not just their own company's offers." For more on these concepts, check out the Fool's Gorilla Game discussion board.

A 1998 McKinsey study estimated that Microsoft's revenues made up a mere 4% of its entire value chain, consisting of applications and services developed for the MS Windows platform. By powering the chain, and allowing others to provide value-adds, the company and its partners were able to stay within their core competencies and provide the best solution to the market. Four percent might not sound like much, but consider that the $15.3 billion in revenues Microsoft posted in 1998 came from a value chain worth nearly $383 billion. Similar stories exist in relation to Cisco Systems'(Nasdaq: CSCO) and Intel's (Nasdaq: INTC) domination, leaving the wolves to fight for the market's bloody scraps.

Database and software provider Oracle Corporation (Nasdaq: ORCL), however, has chosen a much different path, attempting to dominate every e-business software market (see The Motley Fool's Research Report on Oracle for more). The company has been catapulted into direct competition with pure-play leaders, such as SAP (NYSE: SAP) in the back-office, Siebel Systems (Nasdaq: SEBL) in customer relationship management (CRM), i2 Technologies (Nasdaq: ITWO) in supply chain management, and Ariba (Nasdaq: ARBA) in procurement. By acting as the entire value chain, Oracle has potentially limited its technology, products, and sales channels. A sea change in technology could mean "Game Over" for CEO Larry Ellison.

E-business software vendor BroadVision (Nasdaq: BVSN) has been hard at work creating its own value chain with partners that include BEA Systems (Nasdaq: BEAS), Commerce One (Nasdaq: CMRC), i2, and Siebel. The company is vying to become the standard provider of front-end applications -- what the customer sees -- providing an enhanced interactive Internet experience. As was the case with Microsoft, issues like compatibility will ultimately build market share, making it difficult for customers to operate without using BroadVision's set of applications.

Market share
Microsoft has the dominant market share in the personal computer operating systems (OS) market. According to market research firm IDC, Microsoft's 1999 market share in the OS market was 91.8%, with Linux running second at 3.3%. Its seemingly insurmountable lead has generated enormous economic returns for Microsoft and extended its power into other spaces, such as personal productivity suites -- such as Microsoft Office -- where its lead is also substantial.

Market share is important because the software industry exhibits increasing returns, a phenomenon explained by W. Brian Arthur of the Santa Fe Institute. His theory states that once a company gets a market share lead, it gets farther ahead while competitors fall farther behind. This happens because technology buyers are conservative and they demand technologies that are standard and work effectively with the rest of their infrastructure. As more copies of a leader's software are sold, it increases the likelihood of its becoming the standard, causing even more copies of software to be sold and reinforcing the growth cycle.

Siebel is the epitome of a software vendor capturing increasing returns. Siebel is the clear leader in the customer relationship management (CRM) space, and its lead is growing over competitors such as Oracle, PeopleSoft (Nasdaq: PSFT), and Nortel Networks (NYSE: NT). Over the past year, Siebel Systems has extended its lead, while the competition has toiled in mediocre performance. The table below, taken from The Motley Fool's research report on Siebel, illustrates how Siebel's lead has expanded in various CRM applications:

                          1999              Q3 2000
Product Segment       Market share      Market Share
Sales Automation           70%                75%
Field Service              21%                48%
Call Center                48%                50%
Product Configuration      15%                26%
Marketing Automation       20%                34%
Channel Management         23%                51%
Internet Self Service       5%                28%
The Mid-Market             25%                56%

Source: Siebel Q3 conference call

Clearly, Siebel is continuously improving its competitive position, and it may very well have reached "escape velocity," the point at which competitors can no longer catch up.

Tectonic shift in computing
Tectonic shifts in computing create opportunities for new companies and technologies to dominate the market. When IBM (NYSE: IBM) entered the PC market to usurp Apple Computer (Nasdaq: APPL) in the early 1980s, Microsoft became the operating system of choice. New generations of processing power developed by Intel and AMD (NYSE: AMD), as well as applications from Microsoft, Intuit (Nasdaq: INTU), and Adobe (Nasdaq: ADBE), led to the proliferation of PCs onto nearly every desktop.

By the 1990s, the need to network computers created another shift in computing. Cisco, Lucent (NYSE: LU), and Nortel Networks led the charge, and the networking of computers accelerated the growth of the Internet.

The leaders of the next tectonic shift are in the storage sector. The Internet has created unprecedented demand for storage networking. For example, e-commerce companies require trillions of bytes of storage capacity to manage the information created from customers and suppliers to provide better services and foster competitive advantages. Once considered an afterthought, storage has become a primary component of every company's information technology (IT) infrastructure.

Software is the secret sauce of the storage sector. Software applications will reduce the complexity and expense of managing storage networks, and promote better network performance. The storage software sector is poised to explode in the future as the adoption of storage networks accelerates. Dataquest projects that storage software will grow into a $14.7 billion industry by 2004, representing an annual growth rate of more than 28% and providing many attractive opportunities for investors.

While EMC (NYSE: EMC) and Network Appliance (Nasdaq: NTAP) garner plenty of attention, the fastest-growing independent software firm in this space is Veritas Software (Nasdaq: VRTS). In its most recent quarter, Veritas grew revenue by 73%, far outpacing the competition. Veritas is well-positioned to benefit from the shift toward storage, and management believes that it can sustain a 50% growth rate over the next three to four years. Veritas has breadth in its product line, and is not tied to a proprietary architecture, making it a primary choice for companies implementing storage solutions. As its mind share and market share continue to grow, Veritas could become the Microsoft of the storage networking revolution. (The Motley Fool examines the network storage market in Industry Focus 2001.)

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