The team at Valuecruncher have posted a useful analysis of Microsoft’s strategic situation:

It created one of the dominant global businesses of the late 20^th century but has struggled to move beyond the core products that drove this success.

The Client (Windows), Server and Tools (enterprise solutions) and MBD (Office) divisions drive 83% of revenues and over 100% of operating profits (the On-line Services and Entertainment divisions are still operating at a loss).

Microsoft has spent a lot of money and resources (especially senior management focus) on the aborted (maybe) attempt to acquire Yahoo (YHOO). We agree with the analysis that the pursuit of Yahoo is an attempt to compete with Google (GOOG) in what has become one of the dominant global businesses of the early 21^st century (on-line advertising driven by search). ….

At Valuecruncher we are not convinced by this strategy of competing with Google - we are not alone. We completely respect Microsoft’s previous successes in following into and then dominating markets. But in the on-line advertising and search market we see some of the same network effects that suggest a “winner takes all” competitive situation. …

Microsoft should be directing their strategic efforts – not competing head-to-head with Google in a market their competitor dominates.

Overall I agree.  I’ve previously opined that Microsoft’s attempt to acquire Yahoo must be driven by something more subtle than a head-on clash with Google.  Despite what the technorati think about instant messaging and collaboration tools, email is still the dominant communication medium especially between people who are not in close work relationships. Microsoft and Yahoo still control the lion’s share of that business. Doing something clever with email could create a whole space where Google may struggle to go.  With the new work collaboration tools and methods, Google is struggling to gain credibility with business users. Not only are their groupware and email applications limited in scope, they aren’t robust.   According to ex-Googler Sergey Solyanik:

Google as an organization is not geared - culturally - to delivering enterprise class reliability to its user applications.

All of which gives Microsoft plenty of room to move, based on less risky, more certain development of its strengths in email, groupware and enterprise solutions, while exploring ideas for “the next big thing”.

Valuecruncher finishes with this:

Our analysis gives a valuation of US$33.01 which is 20% above the current share price of US$26.03. The market appears to be placing a negative value on the noise around an acquisition of all or part of Yahoo. Focusing on the harvesting the core business and innovating (by making small bets) beyond that core appears to be the highest value strategy for Microsoft.

As usual, Valuecruncher encourages you to play with their valuation model to perform your own valuation.

Update: You should note that I own Google shares - their money machine is formidable. I’m having a bob (10c) each way.