Microsoft and The Yahoo Buyout

 

February 2, 2008
Talking Business

A Giant Bid That Shows How Tired the Giant Is

Oh, how the mighty have fallen.

This may seem like an odd way to characterize a company that just announced its willingness to plunk down $44.6 billion to make its first hostile takeover ever. A company that will probably generate somewhere around $60 billion in revenue when its fiscal year ends in June. A company whose market share in its two core products is still so high — despite recent inroads by a certain flashy competitor — that it qualifies as a monopoly.

But this is Microsoft we’re talking about, and if its proposed acquisition of Yahoo signals anything, it serves as a confirmation that Microsoft’s glory days are in the past. Having failed to challenge Google where it matters most — in online advertising — it has been reduced to bulking up by buying Google’s nearest but still distant competitor. In many ways, the company has become exactly what Bill Gates used to fear the most — sluggish, bureaucratic, slow to respond to new forms of competition — just as I.B.M. was when Microsoft convinced that era’s tech behemoth to use Microsoft’s operating system in its new personal computer.

The I.B.M. PC was introduced in the summer of 1981. Here we are nearly 27 years later, and Microsoft’s core product is still its operating system, now called Windows — that and its suite of applications, called Office, that run on Windows. They generate billions of dollars annually for the company. The most recent version of Windows, released almost exactly a year ago, has already been installed in 100 million computers. Yet in technology, 27 years is a lifetime, and there is a powerful sense that while it has spent enormous effort over the years protecting its monopoly, the world has passed it by. In particular, the technology world now centers on the Internet, where Google reigns supreme, and Microsoft has never succeeded in making serious inroads. Years ago, it started its own online service, MSN. It has made efforts to develop a search engine that could compete with Google’s. It has developed an advertising infrastructure to both place ads on other Web sites —another Google specialty—and to generate its own ad revenues. In every case, it has come up a day late and a dollar short. For instance, only 4 percent of Internet searches worldwide are done with Microsoft’s engine, compared with over 65 percent done with Google’s.

"Of its five major divisions," said Brent Thill, the software analyst for Citigroup, "the online division is the only one that loses money. They are software engineers at Microsoft," he continued, "and their DNA is very different from the DNA of someone who builds online assets. It’s just a different mind-set."

Besides, the old strategies that once worked so well for Microsoft — strategies that worked when the world still revolved around Windows — have no place in this new world. In the mid-1990s, when Netscape posed a threat to Microsoft’s hegemony, Microsoft created its own competing browser, Internet Explorer, made it an integral part of Windows, and used its desktop monopoly to fight back. Eventually, Netscape was reduced to also-ran status — and the Justice Department took Microsoft to court on antitrust violations.

Today, Microsoft lacks both the weaponry and the nimbleness to compete with Google. Its operating system monopoly gives it no advantages in this battle. People can use Microsoft’s operating system and browser to get to the Internet — and to Google — or they can use Apple‘s. It truly doesn’t matter. Meanwhile, with every new Internet fad, like the current frenzy over social networking, Microsoft is invariably caught flat-footed and has to race to just get a foot in the game. But that’s always the way it is when companies get big — and it is why real innovation always comes from small companies that don’t have a predetermined mind-set, or monopoly profits to protect.

Will the purchase of Yahoo — assuming it goes through, which is far from a foregone conclusion — be a game-changer for Microsoft? Anything is possible, I suppose. I spoke to a number of technology experts Friday who were convinced that it made some sense. Andy Kessler, the technology investor and writer, called it "a smart offensive move." Mark Anderson, the president of Strategic News Service, said, "They are getting the No. 2 online guy in the ad business at a good time and a good price." Rob Enderle of the Enderle Group told me that it was only a matter of time before somebody made a bid for Yahoo — "and it makes sense that it’s Microsoft."

But let’s be honest here. Microsoft isn’t exactly buying a high-flier. Even after a Microsoft-Yahoo merger, Google would still have twice the search market of its competitor. Its ad placement service is superior to either Microsoft’s or Yahoo’s. And Yahoo has struggled enormously in the last few years. It, too, could have been early in social networking; its chat rooms could have lent themselves easily to something that might have rivaled Facebook. Just like Microsoft, it missed the opportunity. It is quite clearly a company that has lost its way, and the question of whether Microsoft can refocus into a viable Google competitor, well, let’s just say I’m dubious.

I also have to wonder about what Yahoo gets out of the deal — other than a premium for its depressed stock. "Does it help their brand?" asked Mark Mahaney, who covers Yahoo for Citigroup. "No. Does it give them better search technology? No. Does it give them a better ad sales force? No. I suspect this is the question being asked in Yahoo’s boardroom right now," he added.

What was most striking to me Friday was Microsoft’s own expectations for the deal. To put it bluntly, they are awfully low. When I spoke to Yusuf Mehdi, Microsoft’s senior vice president for strategic partnership — and the man who had been driving much of its online efforts in recent years — he never once talked about crushing the competition, or even catching up.

A Yahoo deal, he told me, "will be good for consumers who want another search engine, Web publishers who want another ad placement service, and syndicated advertisers" — who also want a choice other than Google. He continued: "Because of Google’s heavy volume and its algorithms, they are a very efficient buy. But people are rooting for a credible No. 2. We got lots of calls today from Web sites and others saying, ‘We’re with you.’ "

Was he really saying that Microsoft would be content as a "credible No. 2?" I had a hard time believing it. But when I pushed him on this point, he reiterated it. "Online advertising revenues are going to be $80 billion within a couple of years," he said. (They’re about $50 billion now.) "That is going to mean a tremendous opportunity to all players. There has to be a place for another credible player."

I think back to the fall of 2005, when Bill Gates visited The New York Times, and an editor asked him if Microsoft "would do to Google what you did to Netscape?"

"Nah," laughed Mr. Gates, "we’ll do something different." This ain’t it.

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