Whether you’re attending college or working for a major business, it is nearly impossible to go without Microsoft’s office suite software, Microsoft Office.  However, this software is not without its flaws, which can cause problems when trying to perfect a 12-page paper with embedded charts and tables.  Furthermore, this software can cost anywhere from $149.99 to $499.99 at most retailers.  How does Microsoft sell this product at such a high price?  Is this price justified in relation to its usefulness?  This post will examine these questions, and more.

Office Software Market Overview

Firstly, we must understand the market for office software.  This market can be defined as an oligopoly, with only a few players having true impact on the market.  The products which dominate most of this market are Microsoft Office, OpenOffice, Corel WordPerfect, and Apple iWork.  This market is interesting because open-source software, which is freely editable by anyone and can be collaborated on to make improvements and changes, competes with software that consumers must pay for.  However, open source software is somewhat less reliable as it is not designed and maintained by a large in-house team.  A recent addition to the market for office software is Google Docs, which will be discussed later in this post.

The degree to which Microsoft has control over the market is showcased by a recent study by a German company which found that in the United States, 75% of web users use Microsoft Office, 9% use Open Office, 3.7% use Corel WordPerfect, and 3.3% use Apple iWork.  Other studies have put the Microsoft market share closer to 94%.  In either case, Microsoft holds a significant majority of the market.  Reuters reports that 47% of Microsoft’s revenue comes from Office, following only Windows itself.  Therefore, Microsoft has a significant amount to gain or lose by how well their office productivity suite fares in the market.  Also, their high market share gives Microsoft significant control over the market, yet it is not a true monopoly.

Product Characteristics

In an oligopoly, we expect to see companies differentiate themselves from their competition.  Microsoft is banking on the fact that consumers are comfortable with their software in order to keep them from going over to a competitor.  In fact, consumers are generally so comfortable with Office that they routinely fail to upgrade and instead continue to use older versions of the software.  Microsoft Office is routinely bundled with new computers that run Microsoft Windows, which is perhaps the most commonly used OS today.  Furthermore, transitioning from older versions of Office to newer versions is never very complicated; over the course of Office’s 21 year span, the interface with the software has changed relatively little, making it easy for users to stay with the same software.

OpenOffice seeks to attract consumers based on its less tangible benefits.  While many people consider the software to be somewhat inferior to Office in terms of speed, integrated features, and usability, OpenOffice is freely editable by anyone, with the code fully available to the public.  Many consider this a good thing, as it promotes openness in software.  Furthermore, OpenOffice is completely free, making it, in theory, a great alternative in terms of cost to Office.  Also, OpenOffice uses ISO-compliant document standards, making it easier for governments worldwide to comply with regulations that may require (as the Freedom of Information Act does in the U.S.) for digital documents to be readily accessible not only today, but far into the future.

Apple’s iWork hopes to draw consumers in with Apple’s trademark user friendliness.  Much as Apple computers are easy to use, even to a computer rookie, iWork hopes to appeal to those who may be intimidated by Office’s complexity, as well as to the younger generation typically targeted by Apple’s advertising.

Corel WordPerfect was the standard word processing software in the 1980s and early 1990s until it was overtaken by Microsoft Office.  While Corel attempted to market WordPerfect as an alternative to Office, Corel’s numerous financial difficulties and burdensomely large product line may have prevented WordPerfect from being a true competitor.

The Power of Microsoft

Other oligopolistic characteristics are present in the market for office productivity software.  There are substantial barriers to entry in the market, as producing a competent line of office software requires the investment of hundreds of thousands of man-hours of coding.  Furthermore, the software will only be user friendly with a thorough knowledge of user preferences, which may require market research and user test studies.  One must also be able to distribute your product.

Microsoft is one of the largest companies in the world, and one of the most profitable.  This makes competing with Microsoft in terms of advertising extremely difficult.  When a new version of Office is about to be released, advertisements are nearly impossible to avoid, especially on the internet.  Apple is capable of competing with this advertising blitz, but no other product on the market has the financial backing to do so.  The products are not quite identical, however they generally use the same document formats and offer the same suite of features: a database editor, a spreadsheet editor, a presentation program, and a word processor.  However, consumers in this market do not enjoy perfect information.  Considering the opportunity cost of time, a user may prefer to stick with Office rather than investigate alternatives simply because it would take too long.  Doing research to find what alternatives are available, researching OpenOffice, and getting used to OpenOffice’s different interface may provide enough difficulty to prevent the switch.

Microsoft also utilizes an economic trick to increase their profits on Office: second-degree price discrimination.  By offering a lower price to a group with a high need for their product but a very high elasticity of demand, meaning that sales would decrease sharply at higher prices, Microsoft is able to increase overall sales.  The group that Microsoft targets is college students: by using a .edu e-mail address to verify enrollment, students can purchase the complete Office suite for $79.95.

By bundling commodities, in this case different software programs, Microsoft is able to extract more consumer surplus and receive a higher profit for each good sold.  If these programs were sold separately, Microsoft would only be able to price them according to consumers’ demand for each individual product.  By only offering them as a portion of a complete package, Microsoft ensures that it can charge a higher total price for the package, thus maximizing per-unit profits.

It’s hard to know how much money Microsoft spends on producing Office, but suffice to say that it prefers a significant return on its investment.  Because of this, and because Office enjoys such market power, Microsoft can set their price in the market.  Even with competitors offering their product for free, Office can be sold for as much as $499 for the following reasons:

• It enjoys an established user base already familiar with its features

• Barriers to entry prevent a significant number of firms from entering the market

• Advertising allows Office to be broadly known, whereas competitors must rely on consumers’ ability to do their own product research

• Microsoft’s substantial market share allows them to set prices with few restrictions

• Microsoft also produces Windows, common on new computers and often bundled with Office

Unfortunately, this means that Office will continue to be priced very high unless a significant competitor can emerge to drive prices lower.

The New Challenger: Google Docs

While Microsoft continues to enjoy substantial market share, Google is now edging in on its territory.  Not only is Google competing against them with their internet browser (and soon a new OS), Google offers free office software via Google Docs.  Google Docs works entirely in-browser, and files are saved on a remote server that can be accessed anywhere.  Showing the importance of this technology, Microsoft is now offering a very similar service with new versions of Office.  This shows the trend towards storing data in “the cloud”, allowing users to edit and manage documents without carrying around a flash drive or being tethered to a certain computer.

However, Microsoft still enjoys a user base of 500 million; Google Docs is accessed by around 25 million users.  Time will tell if Google has the power to knock Microsoft from their #1 spot in this oligopoly, but for now they’ve at least changed the playing field slightly.

(Header image credit °Florian via flickr.)

The Office Software Oligopoly by Steve Richey is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 Unported License.

This post was originally submitted for a class on Managerial Economics.