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Weekly Column

Invincible: How Microsoft and Wal-Mart Can Lose, but Can't Be Beaten

Status: [CLOSED]
By Robert X. Cringely

Bentonville stands in the northwest corner of Arkansas only a few miles from Missouri, Kansas and Oklahoma. It is a little city in the Ozarks with a fine town square where once there stood a Ben Franklin variety store owned by Sam Walton. Today, that store on the square is a museum, and Bentonville is the headquarters of Wal-Mart, the biggest retailer in the world. There is nothing fancy about Wal-Mart, and that certainly applies to its corporate headquarters, a nondescript brick building where every day suppliers from around the world come to peddle their wares. The place where would-be suppliers meet Wal-Mart buyers looks like an old Quonset hut from World War II. The hut is filled with folding chairs and metal tables where the meetings are held. This, with no exceptions, is how business is done, and that Quonset hut explains exactly why Wal-Mart is bigger than all its competitors and strikes fear in smaller retailers the world over.

Redmond stands on the eastern suburbs of Seattle, a city dominated by its largest employer by far, Microsoft, the world's biggest software company and the world's single most profitable company. No Quonset huts here — just a gleaming campus where 50,000 of the smartest people there are work to fulfill the business ambitions of their leaders, Steve Ballmer and Bill Gates.

On the surface, there seems to be little to connect Wal-Mart and Microsoft other than the obvious fact that each company dominates its industry. Wal-Mart is the giant of low-margin retailing, while Microsoft dominates — even monopolizes — high-margin software sales. But at their hearts, each business is successful because it has managed to reduce its cost per transaction until it is lower than all its competitors, though each goes about it in a different way. The result is that each company, UNLESS THE GAME IS SOMEHOW REDEFINED, is virtually invincible in its market. Let the local shopkeepers complain and other software makers file suit, but as the game is currently played, they haven't a hope.

This idea about transaction costs is hardly new. It comes from the work of Ronald Coase, a University of Chicago economist who won the 1991 Nobel Prize. Coase's 1937 paper, "The Nature of the Firm," was recommended to me by a reader. He said it proved that an organization could only continue to grow until its transaction cost — nominally the cost of doing business — increased to the point where it was cheaper to hire the work done outside than to do it inside the firm. At that point, said my reader with a note of satisfaction, the firm would fall apart.

Not quite.

If you think it through, the phenomenon is actually more complex than that. Certainly there are organizations that continue in business despite horrendous transaction costs. Look at the U.S. Post Office. Look at Amtrak, the U.S. passenger rail system. If it came down to simple transaction costs, both outfits would have folded long ago. There are political or even emotional reasons why such operations continue. Probably the purest example of this is a church, which probably ought to be viewed as having an infinite transaction cost since we typically pay in this life and are supposed to be rewarded in the next. And yet churches survive and even compete with each other. So it must be something other than pure transaction costs that keep some outfits in business.

Wal-Mart is a pure example of keeping transaction costs low as exemplified by the modest global HQ and the Quonset hut meetings with suppliers. But it's what goes on during those supplier meetings that is even more important, because Wal-Mart buyers are notorious for demanding product design and packaging changes from suppliers — changes that are usually more intended to lower costs than to increase customer appeal. As long as Wal-Mart buys more from a supplier than any of its competitors does, Wal-Mart will get the best prices, which can be converted into the most sales, the most profits or the highest market share, depending on what Wal-Mart values at that time. So if you can keep transaction costs down, bigger is better, way better. Since the playing field is never truly level for this reason, Wal-Mart will always have an advantage, and small town retailers will always be threatened. There is nothing illegal about this, either. There is nothing illegal about being big.

Of course, it could all change if Wal-Mart got smug and decided to change its cost structure by building massive office buildings and making their stores more chic. But all Wal-Mart has as its identity is its low overhead and the pushy nature of its procurement process. To change these things would be to change Wal-Mart.

Things are a bit different over at Microsoft. The profit margins in software are such that Microsoft can have a fancy corporate campus, and still, the transaction costs are so low as to be lost in the commercial noise. For Microsoft, the game is more about making competitors' transaction costs higher than about lowering Microsoft's. Microsoft competes for the best people, forcing competitors to pay more for talent. By dominating shelf space, concentrating on market share, and making product feints into segments it doesn't really care about, Microsoft keeps many potential competitors literally off the field. And unlike the image of big stolid companies that can't change focus quickly, Microsoft has proved that it can do exactly that time and again, playing catch-up in graphical interfaces, networking, and the Internet to the extent that the company now dominates all those areas. Microsoft's nimbleness suggests there is plenty of room still for growth in Redmond.

So what's to be done about these two giants? Nothing. There is nothing that can be done. No matter what government or competitors do, both companies will continue to dominate and grow. Neither can be beaten by anything except itself IF the underlying game remains the same. Microsoft and Wal-Mart can screw-up and by that lose their dominance, but no direct competitor will put either out of business or even threaten their preeminence.

IBM might compete with Microsoft, for example, and its recent flirtation with Linux is aimed at exactly that by lowering transaction costs. But what it is really allowing is for IBM to preserve its lower-margin hardware business. If IBM really intended to compete with Microsoft it would COMPETE WITH MICROSOFT, which would require exiting the hardware business completely. But IBM sees itself as a hardware company and would never do that, which is why IBM doesn't threaten Microsoft. No company does.

The only thing that threatens Microsoft, in fact, is a change in the game, an industry zig to Microsoft's zag. The Open Source software movement does that to a certain extent, since it has by definition a transaction cost of zero. Remember, though, that the Open Source movement doesn't define its success by Microsoft's failure. So it isn't really a contest at all.

Microsoft could fail if its profit platform went away, if the PC business matured to the point where people stopped buying new ones. What if we all traded our PCs for really smart mobile phones with voice interfaces and computing capability? That would hurt Microsoft, but it is the very reason why Microsoft is putting billions into alternative platforms like games, interactive TV, and wireless.

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