Entrepreneurs confidently tell Venture Capitalists "Microsoft will acquire my company". VCs roll their eyes...they have heard it a million times. But, Microsoft does have a rich tradition of acquisitions. The first, and most important, acquisition was QDOS from Seattle Computer Products which became MS-DOS. What kind of companies does Microsoft acquire? How do they decide to acquire versus build internally?

First lets start with a review of some of the most successful Microsoft acquisitions. Some of these may surprise you.

QDOS became MS-DOS

ForeThought became Powerpoint

SoftDesign became Microsoft Project

Vermeer became FrontPage

PlaceWare became Live Meeting

Vicinity became a key part of MapPoint

nCompass Labs became Content Management Server

Bungie Studios became Halo

HotMail

Visio

Great Plains

Groove Networks

Microsoft has acquired an average of 10 companies per year over the past 10 years. Many of them are smaller (less than $50M) acquisitions that go unnoticed by the press. These smaller acquisitions usually provide a great team of people, and a few key features in a much larger existing Microsoft product. At the other end of the spectrum, Great Plains is an example of a multi billion dollar acquisition that created a whole new business unit for Microsoft. For a more complete list of Microsoft investments and acquisitions see http://www.microsoft.com/msft/InvestmentandAcquisitionsList.mspx

What is most important to Microsoft when making acquisition decisions? People are the most important factor in any acquisition. Microsoft looks for talented engineering teams with vision and passion and experienced management teams. Second is technology and IP that can add value to an existing Microsoft product. Third is the opportunity to acquire stand alone products for existing customers. Examples include Visio, Hotmail, and Vermeer. Another, more rare, decision point is the opportunity to enter whole new markets. Great Plains and PlaceWare are excellent examples.

How does Microsoft decide to acquire rather than build internally? This is the toughest question in any acquisition discussion. Microsoft has thousands of very talented software engineers that can build just about anything. How can you justify paying hundreds of millions or even billions for something a team of 30 engineers could build in a year or two. That translates to about $12M of development cost versus a huge acquisition cost. Technology is not the issue here. It is all about marketing channels, sales expertise, and market leadership in segments where Microsoft is not strong.

It comes down to this; if the company in question has a product that is squarely in the domain of an existing Microsoft product than the valuation is a small premium over the internal development cost. If the company has market leadership in a new product space or market segment than the valuation goes up significantly.

Entrepreneurs should remember this. The "barriers to entry" are most often market position, not technical brilliance. I have heard start-ups say "we have a two year lead on our closest competitor". In fact, I have said it myself at previous start-ups. I was wrong. Most technologies can be replicated by a talented engineering group within a year or less. Many times a similar technology can be licensed immediately and a new product shipped within months.

Many start-ups have failed by focusing too much on their technology and not enough on the value they bring to customers and the channels they use to service the customer. Many times the early innovator fizzles, and a "fast follower" comes in and makes all the money. That will be the subject of my next post.