Microsoft could do that because they had the Operating System monopoly to leverage and take out both Lotus 123 and WordPerfect. Without the monopoly of the operating system they wouldn't of been able to Embrace, Extend, Extinguish.
But MS controlled the underlying OS. Letting them both throw money at the problem, and (by accounts at the time) frequently tweak the OS in ways that made life difficult for Lotus, WordPerfect, Ashton-Tate, etc.
Ahhhh, your hindsight is well developed. I would be interested to know the background on the reasons why Lotus made that bet. We can't know the counterfactual, but Lotus delivering on a platform owned by their deadly competitor Microsoft would seem to me to be a clearly worrysome idea to Lotus at the time. Turned out it was an existentially bad idea. Did Lotus fear Microsoft? "DOS ain't done till Lotus won't run" is a myth[1] for a reason. Edit: DRDOS errors[2] were one reason Lotus might fear Microsoft. We can just imagine a narritive of a different timeline where Lotus delivered on Windows but did some things differently to beat Excel. I agree, Lotus made other mistakes and Microsoft made some great decisions, but the point remains.
We can also suspect that AMD have a similar choice now where they are forked. Depending on Nvidea/CUDA may be a similar choice for AMD - fail if they do and fail if they don't.
This is a key point. Before windows we had all the dos players - WordPerfect was king. Microsoft was more focused on the Mac. I’ve always assumed that Microsoft understood that a GUI was coming and trained a generation of developers on the main gui of the day. Once windows came out the dos focused apps could not adapt in time
Worked fine for MS with Excel supporting Lotus 123 and Word supporting WordPerfect's formats when those were dominant...