Case study 5.1: Microsoft - increasing or diminishing returns?

In some industries, securing the adoption of an industry standard that is favourable to one's own product is an enormous advantage. It can involve marketing efforts that grow more productive the larger the product's market share. Microsoft's Windows is an excellent example.2 The more customers adopt Windows, the more applications are introduced by independent software developers, and the more applications that are introduced the greater the chance for further adoptions. With other products the market can quickly exhibit diminishing returns to promotional expenditure, as it becomes saturated. However, with the adoption of new industry standards, or a new technology, increasing returns can persist.3 Microsoft is therefore willing to spend huge amounts on promotion and marketing to gain this advantage and dominate the industry. Many would claim that this is a restrictive practice, and that this has justified the recent anti-trust suit against the company. The competitive aspects of this situation will be examined in Chapter 12, but at this point there is another side to the situation regarding returns that should be considered. Microsoft introduced Office 2000, a program that includes Word, Excel, PowerPoint and Access, to general retail customers in December 1999. It represented a considerable advance over the previous package, Office 97, by allowing much more interaction with the Internet. It also allows easier collaborative work for firms using an intranet. Thus many larger firms have been willing to buy upgrades and pay the price of around $230.

However, there is limited scope for users to take advantage of these improvements. Office 97 was already so full of features that most customers could not begin to exhaust its possibilities. It has been estimated that with Word 97 even adventurous users were unlikely to use more than a quarter of all its capabilities. In this respect Microsoft is a victim of the law of diminishing returns.4 Smaller businesses and home users may not be too impressed with the further capabilities of Office 2000. Given the enormous costs of developing upgrades to the package, the question is where does Microsoft go from here. It is speculated that the next version, Office 2003, may incorporate a speech-recognition program, making keyboard and mouse redundant. At the moment such programs require a considerable investment in time and effort from the user to train the computer to interpret their commands accurately, as well as the considerable investment by the software producer in developing the package.

Questions

1 Is it possible for a firm to experience both increasing and diminishing returns at the same time?

2 What other firms, in other industries, might be in similar situations to Microsoft, and in what respects?

3 What is the nature of the fixed factor that is causing the law of diminishing returns in Microsoft's case?

4 Are there any ways in which Microsoft can reduce the undesirable effects of the law of diminishing returns?