Friday, March 11, 2005

The difference between Oracle and Microsoft

A companies revenue may grow in three ways: the total market may increase, a company's market share may increase, or it may begin operating in new markets. In its early days, AT&T had a monopoly on telephone systems, so the focus was on increasing the size of the telephone market by installing more lines. Coke and Pepsi have fought over a relatively constant pie. Berkshire Hathaway has become a huge company in part by buying companies in a variety of markets. Raytheon made its name (literally) in vacuum tubes and then diversified into microwaves and missile systems.

For most companies, total market size is outside of their control and expanding to new market, either organically or through acquisitions, is risky. So one of the most reliable indicators of future growth is the increase from one year to the next in market share. This is especially important in industries where it is possible to establish a long-term advantage which isn't impeded by growth. For instance, Wal-Mart has built a strong reputation on being the low-cost leader in nearly everything it sells — an advantage that won't quickly disappear. In fact, its growth helps it put price pressure on the companies that sell to Wal-Mart thereby increasing the advantage.

Some industries resist monopolies. For instance, restaurants must carefully balance growth with the danger of over saturating the market. I know people who would gladly eat every meal at McDonald's, but most of us prefer variety. It's no surprise that there are only four Spago locations, but ten times as many "Wolfgang Puck" cafes. These businesses scale with difficulty.

Software is an industry that scales very easily. More customers mean more developers, which means more features, reliability, and performance, which virtuously cycles into more customers. Incremental costs are vanishingly small. Bigger is better in nearly every way. Which brings us to Microsoft, the biggest, richest company in an industry that rewards success like no other. When I was considering buying Oracle a few years ago, I worried most about Microsoft. It seemed to me that with all its cash, brand recognition and legions of developers, no software company could be safe. Oracle had held back the tide in the database market, but for how long?

The final chapters have not been written yet, of course, but I think Oracle will continue to have better growth for years to come. Think about the ways that a company can grow: market share, market size and new markets. Currently Microsoft has 85% of its core "client operating system" market. The market is growing, but not at the same rate as it did during the 1990s when most families bought there first computer. It's difficult to know how successful Microsoft will ultimately be in some of its newer endeavors, but many of them are not strictly software (Xbox, MSN, hardware, etc). The recently instituted dividend serves as a clear signal that Microsoft doesn't know what to do with all the cash it generates.

Meanwhile, Oracle controls about 40% of the database market. Picking up market share may be a struggle, especially since customers are reluctant to switch once they have made a purchase. But Oracle enjoys all of the advantages that the biggest enjoys in the software industry. Microsoft is still far behind technically and in terms of brand. There are fewer barriers to overall growth in the server market than the client side, since growth depends more on business needs than on new PCs. Finally, Oracle has already seen success expanding into new markets with products that are closely related to its database product. PeopleSoft will help tremendously, simply by bringing in more customers.

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