Tools > Options > Source Control - Visual Studio Team Foundation Service > Configure User Tools...
For both Compare and Merge I've set the extension to
Compare Arguments for DiffMerge: /title1=%6 /title2=%7 %1 %2
Merge Arguments for DiffMerge: /title1=%6 /title2=%8 /title3=%7 /result=%4 %1 %3 %2
Diffing Word Documents
Better yet, you can configure TFS to Diff Word documents.
Save the diff-doc.js somewhere convenient and reference it as the Command. Then give it the Arguments %1 %2