Date : August 14, 2020

Course/Subject : MBA004 - Managerial Economics

Case Study 2 : Microsoft - Increasing or Diminishing Returns?

I. INTRODUCTION/BACKGROUND
Founded in 1975 by Bill Gates and Paul Allen, Microsoft Corp. (MS), is an American multinational
technology company that develops, manufactures, licenses, supports, and sells computer software,
consumer electronics, personal computers, and related services. Its most popular products are the
Microsoft Windows operating systems, the Microsoft Office Suite, and the Internet Explorer and
Edge web browsers.

Microsoft launched Microsoft Windows in 1989, Internet Explorer in 1995, Xbox in 2001, and
Microsoft Surface in 2012. MS’s continuous innovation led them to success, such as becoming the
world’s largest software maker by revenue in 2016 and one of the world’s most valuable companies.
But just like other companies with highly celebrated success, it also faced its fair share of challenges
along the way. Among the noteworthy challenges was when the company went through diminishing
returns when they introduced MS Office 2000 in December 1999. MS Office 2000 is a program that
includes Word, Excel, PowerPoint and Access to general retail customers. It represented a
considerable advancement over the previous package, Office 97, by allowing much more interaction
with the Internet.

This study analyzes the case on Microsoft Corporation based on the concept of increasing &
diminishing returns and how to deal with undesirable effects of the law of diminishing returns.

II. POINT OF VIEW

The point of view of the study is to bring into the light how theories of demand, production and
price are moving and affecting each other, and how these factors determine the future of a
business/firm.

Additionally, this study also presents how the law of diminishing returns affects firms in the
technology industry such as Microsoft Corporation and what can be done to minimize its impacts.

III. TIME CONTEXT

The context of the study began when Microsoft introduced the Office 2000, a program that includes
Word, Excel, PowerPoint and Access to general retail customers in December 1999.

IV. STATEMENT OF THE PROBLEM

 “With other products, the market can quickly exhibit diminishing returns to promotional
expenditure as it becomes saturated.”
As current products’ upgrades and latest products have been released by Microsoft in order
to cope up with the increasing demands for the latest technology from its consumers, the
company spent huge amounts in the production, promotion and marketing.
 “However, there is limited scope for users to take advantage of these improvements. Office
97 was already full of features that most customers would 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 its capabilities.”
This resulted to not achieving the expected profit from the newly launched product because
not so many bought it since the earlier product was already more than enough for them.
From this perspective, Microsoft became a victim of the law of diminishing returns.
 While enjoying the increasing marginal returns due to MS Windows, Microsoft still had
to face the diminishing returns on MS Office 2000.

Increasing returns with respect to Windows

o Sales increase due to adoption as “industry standard.”
o Network Effect – high volume of customer base.
o Less competition – upfront costs
o Monopoly

V. STATEMENT OF THE OBJECTIVES

 To become accustomed with the law of diminishing returns.
The law of diminishing returns states that after a certain point, additional input to a system of
production will produce less and less output.
 To investigate if it is possible for a firm to experience increasing and diminishing returns at the
same time
The increasing and diminishing returns cannot exist ‘at the same time’ as there will be one
process dominating the other at a given time.
 To determine if Microsoft is experiencing diminishing or increasing marginal returns though
the scenario given and the current movement in the company.
Considering that even the techiest users cannot even exploit the full features of 97, not so
many consumers bought Office 2000 – an upgrade to 97, when it was released in December
1999. As a result, the resources invested in the production, promotion and marketing did not
result to increasing the company’s profitability. Hence, MS experienced diminishing returns.
 To learn how to deal with the situation under diminishing returns or to find a way to reduce its
undesirable effects.
By having a strong understanding of consumers’ needs, distribution channels, and rivals’
products and the theory of diminishing returns, organizations usually gain as they can create a
competitive advantage by reducing costs relating to production. This money can be spent on
 capital improvements or marketing campaigns to inform consumers about the value of their
products.

VI. AREAS OF CONSIDERATION (S.W.O.T.)

Strengths Weaknesses
 Brand loyalty. Over the years, Microsoft has  Slow to innovate
been the leading OS and software provider.  Unsuccessful acquisitions
 Brand reputation. Microsoft's brand is the 5th
most valuable brand in the world.
 Strong distribution channels. MS works with all
the major computer hardware producers and
retailers to make sure computers would be sold
with already pre-installed Windows software.
 Easy to use software.
Opportunities Threats
 The emergence of new market segments and  Intense competition on software
new niches provide business and product line products
expansion opportunities.  Changing consumer needs and
 Business diversification habits
 Innovation for computer hardware products  Lack of dominant computer
hardware products

VII. ALTERNATIVE COURSES OF ACTION

In this study, the problem needed to be addressed is how to avoid, or at least minimize the effects of
law of diminishing returns. In Microsoft’s industry, the market can quickly exhibit diminishing returns
to promotional expenditure, as it becomes saturated. However, the adoption of new industry
standards, or a new technology, increasing return can persist. Microsoft is therefore willing to spend
huge amounts on promotion and marketing to gain this advantage and dominate the industry.

Now the constraint is with Microsoft’s customers who are small business owners and home users.
These target groups are not so happy with the added features of Office 2000, or at least to say, they
cannot the justify spending more money for the upgrade. This being said, Microsoft should have the
larger firms as its priority target market, since many larger firms are willing to pay for the upgrades.
Parallel to this, Microsoft should develop a more effective marketing strategy specific for smaller
businesses and home users.

VIII. STRATEGY FORMULATION

 Product Development Strategy
A product development strategy is an approach grounded on developing new products or
modifying existing products, so they appear new, and proposing those products to current or
new markets. This typically occur when there is little to no opportunity for new growth in a
company’s current market. In this point, a company may create an updated product for a
current product in a current market, enhance an existing product for a new market, or
 simply move away from the product altogether, and cease growth. In the case of MS for
Office 2000, they opted for the first choice.
 Product Portfolio Diversification
In addition to achieving higher profitability, the following are could be among the several
reasons for a company to diversify:
o It mitigates risks in the event of an industry downturn.
o It allows for more variety and options for products and services. If done correctly,
diversification provides a tremendous boost to brand image and company
profitability.
o It can be used as a defense. By diversifying products or services, a company can
protect itself from competing companies.
o In the case of a cash cow in a slow-growing market, diversification allows the
company to make use of surplus cash flows.
Microsoft Corporation is primarily a software business that heavily relies on the popularity of
the Windows operating system. In this regard, the company has the opportunity to grow
based on diversification. For example, Microsoft can diversify through new business
development or mergers and acquisitions to establish operations in new markets or
industries. In this way, the company can take advantage of other avenues of business
growth.
Another opportunity is for Microsoft to innovate computer hardware products, to increase
revenues from hardware sales. At present, the company’s hardware products are not as
competitively strong as the products from other firms in the computer hardware market.
 Product Bundling
People naturally tend to classify products as either expensive or inexpensive, and this
categorization influences how they judge products. When an expensive item is bundled with
an inexpensive one, people categorize the bundle as less expensive, and this lowers their
willingness to pay for it.
Microsoft may benefit through the following Office and Windows will be sold on a bundle:
o Pricing opacity
o Inventory reduction
o Product-line expansion
o Marketing simplicity
o Subsidized feature development
Even if a fraction of customers uses advanced features the increase in consumers’ perceived
value—what they could do—justifies a higher price point that, in turn, funds feature
development for power users.
 Dedicated Marketing Strategy
Microsoft has an edge in the market with its aggressiveness in its marketing. And if it’s with
the marketing that it makes a lot of advantage from its competitors, and then might as well
utilized it fully by developing a market-tailored product promotion and marketing for its
updated software, Office 2000, and for its upcoming advanced software, Office 2003.
In other words, a dedicated marketing strategy per market segment should be formulated,
such as to small to medium scale businesses, as well as to home users emphasizing the
 values of Office 2000 in relation to their business daily operations and the home-user’s daily
living.
Microsoft must emphasize the benefits of the advantages of the updates it produces, not
just the mere updates, in the lives of the users/customers.

IX. ACTION PLAN/PROGRAMS

Action Dealing with the law of diminishing returns
Specific tasks To adopt to new industry standards, or new technology to make
increasing returns persist.
To allocate huge amount of budget on promotion and marketing
to dominate the industry.
To develop new or more advanced software to become market
leader
Responsible Management; Programmers

Action Develop personalized promotion and marketing

Specific task To emphasize the benefits and the values of the products’
advantages per market segment
Responsible Marketing Dept

Action Product Portfolio Diversification

Specific task To identify companies for possible merging and acquisitions to
establish operations in new markets or industries
To innovate computer hardware products to increase revenues
from hardware sales.
Responsible Management; Production Dept

X. CONCLUSION
The law of diminishing returns states that after a certain point called the point of diminishing
returns, additional input to a system of production will produce less and less output. But there’s one
thing that constantly defies this and continues to add to people’s productivity, raise capabilities and
enable the possible from the seemingly impossible, and that is technology.

One key area where this theory falls short is that it assumed that technology would be a fixed state.
The rapid development in technology has confirmed that nowadays that theory has been proven to
be irrelevant in many cases. Particularly in this case, technology has fully disregarded the theory
because if not for technology, MS would have not been able cope with the consumer’s changing
demands and reduce the undesirable effects of Malthus’ law of diminishing returns. Through
technology, decision makers were able to identify the firm’s weaknesses and worked on them while
embracing opportunities at the same time.

In other words, it is technology’s susceptibility to rewrite the rules, to create new possibilities that
enable firms, no matter how big or small, to do more and achieve more than the previous
generation.
XI. ATTACHMENT
References:
 https://en.wikipedia.org/wiki/Microsoft
 https://bizfluent.com/list-6688845-law-diminishing-returns.html
 https://businessteacher.org/swot/microsoft-swot.php
 http://panmore.com/microsoft-corporation-swot-analysis-recommendations