If Microsoft’s walkaway from the Yahoo deal is indeed a ploy to save $5 billion, Microsoft CEO Steve Ballmer may have proven himself pennywise and pound foolish. He was prepared to spend billions to finally make Microsoft a serious rival to Google. For a bit more, he may have destroyed Microsoft’s chance to get there.
Despite what I’m about to write, I like Microsoft. I’ve got many friends who work there (and at Google & Yahoo), and as a company, I actually want Microsoft (along with Yahoo) to provide a strong counter-balance to Google.
Five Years, Nothing For Microsoft To Show
Microsoft’s basic problem is this. After five years of going after Google in search, Microsoft has failed to make a dent in the big G. Millions — billions, I suppose — have been spent on the project. Huge technological effort has gone into the challenge. What’s to show for it? Google’s at all-time highs in the US and Microsoft has lost share.
Three out of four major ratings services now report Microsoft to have a single digit share of the US audience. Microsoft hasn’t even been able to challenge Yahoo (still in low double-digits), much less Google. In desperation, Microsoft signaled its defeat by proposing to buy Yahoo and get into the number two spot by proxy.
Maybe Microsoft will still get Yahoo. Certainly Ballmer’s letter, annotated below, sends a warning that steps Yahoo thinks it can take to remain independent may backfire. Perhaps Yahoo’s stock will plunge, and along with lawsuits, cause a change in Yahoo’s board that makes a Microsoft deal ultimately happen. But then again, maybe Yahoo will pull off being the number two in search and online advertising that Microsoft wants to be, while Microsoft becomes weaker as the foundations of what it’s built on, the Windows operating system and software, begin to erode in the face of free apps.
Microsoft has no brand in search. It literally has no brand. Relatively speaking, virtually no one knows what Live Search is (more actually use MSN Search) or who is behind it (Microsoft, by the way), nor does Live Search have widespread adoption. As a product, there are a few features that are innovative (infinite scroll in image search, video previews), and it has been a leader in some areas (such as allowing users to annotate maps). But no one outside of product placement is going to say they "Live Search it." They’re going to "Google it" because Google is the search brand that is largely known and loved by the typical consumer.
The Live Search branding mess is evident just by talking with any Microsoft employee. Kid with them about how bad the name is, and they either readily agree or smile with embarrassment. If Microsoft morale is down after this flubbed deal with Yahoo, I’d hope the company execs at least throw them a booster by dumping the Live brand and going back to MSN. Or here’s a thought — just call the damn thing "Microsoft Search." At least consumers DO know who Microsoft is.
Aside from the branding mess, we’ve had a revolving door of Microsoft executives who all come in very keen on seeing Microsoft do well in search but haven’t gotten it there. Pick an exec, and you’ll find they’ve done their homework about search. They all make the right noises about search still being in its infancy, how the PC industry had radical changes over its 30 year history, and how it is too early to rule anyone (including Microsoft) out. All of this is true. But it’s also the same big-time spin we got from day one of Microsoft’s effort to rule search.
When’s "It’s All Still New" Old?
How long does Microsoft get? At what point does Microsoft seem to be pushing the O/S 2 to Google’s Windows, the operating system that’s just never going to catch on? Five years doesn’t sound that long until you consider that Google itself isn’t even 10 years old. With everything Microsoft’s put into search, how has it managed to achieve less than Google has, in terms of marketshare, in that period of time?
Well, it’ll get there. After all, few companies have the resources to jump into search as Microsoft has. So Microsoft tells us, and it’s sort of true, in terms of web search. Then again, people like Cuill would have you reconsider that assumption for web search. In video search, which relied on providing free video hosting, YouTube came along and trumped both Microsoft and Google.
Microsoft, which rightly makes a big deal that it might succeed in vertical search areas because of how new they are, also simultaneously by that pitch makes the case that anyone might succeed in vertical search. And if you’re top talent, you might decide to do that cool vertical search thing on your own, not within Microsoft. Certainly that might prove more lucrative.
Could Microsoft really have flubbed it in an unrecoverable way with search? Sure. As I’ve said, it has failed to build share. It could well continue to lose share while both Google and Yahoo grow. And if Yahoo grows, it could become even too pricey for Microsoft to acquire in the future. If there can only be two players — as Microsoft has tried to suggest on occasion — it might be that in search, Microsoft gets shut out.
I’ve been asked by many people what I thought should happen in the deal, what I’d like to see happen, what each of the players should do. I don’t have clear answers.
Buying Yahoo is probably the single most important thing Microsoft could do to really leapfrog in search, because so much revolves around having a sizable audience. But as I’ve written before, a Yahoo-Microsoft combination is by no means a guarantee for Microsoft’s success. The combo would have been fraught with difficulties. To me, the biggest likely issue was that I doubt Microsoft would have let Yahoo run on its own as the flagship brand and independent unit handling search. Still, no matter how awkward the merger might be, it would have sealed Microsoft in for some time to come as the number two in search. Instead, it looks likely to be number three for the near-to-medium term.
Ballmer’s Threatening Letter
It’s not over yet, of course. Microsoft has walked away from the deal, but publicly, it’s signaled a war that might drive Yahoo back to the table – perhaps at a cheaper cost. Let’s go to Ballmer’s letter sent yesterday to Yahoo CEO Jerry Yang about dropping the deal.
It recaps the price gap. Microsoft originally offered $31 per share, which at the time of the offer was worth $45 billion. Last week, Microsoft upped that to $33 per share — another $5 billion in total. But Yahoo apparently wanted $37 per share, and that was $5 billion more too much.
Microsoft, of course, could have fought a hostile takeover to gain Yahoo – as many were expecting it to do. But Yahoo has made clear to Microsoft that if it attempts this, Yahoo will wed itself to Google and effectively ruin itself for Microsoft’s purposes. As Ballmer’s letter describes it:
We regard with particular concern your apparent planning to respond to a “hostile” bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo! today. In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo! undesirable to us for a number of reasons
In particular, Yahoo has experimented with using Google’s ads. If Microsoft tries to force itself on Yahoo, then Yahoo appears ready to sign a long-term deal with Google that might prove difficult or expensive for Microsoft get out of. Talk about the ultimate poison pill. To make such a threat, Yahoo must also know that Google is ready to back it with a lucrative revenue guarantee as the company has done for others such as MySpace and AOL — so lucrative that it might keep Yahoo stockholders happy.
Ballmer’s letter then attempts to knock down Yahoo’s plans blow-by blow:
First, it would fundamentally undermine Yahoo!’s own strategy and long-term viability by encouraging advertisers to use Google as opposed to your Panama paid search system.
Not necessarily. I was one who thought Yahoo would be shooting itself in the foot by dumping its own ad program. But if Yahoo’s management wants to stay independent, sacrificing paid search is a way to do this. That’s because it might be only a short-term sacrifice.
By accounts, Yahoo is not exclusively going to use Google’s ads. It will continue to use its own system in addition to Google’s. Taking on Google lets Yahoo buy some time to learn and improve its existing system and play catch-up to Google. (As a side note, it’s just weird to see Yahoo talking about the "Panama" paid search system — a code name for improvements to the Yahoo Search Marketing system that were rolled out over a year ago. Still using the code name just feels out-of-touch. But maybe Yahoo is continuing to use it as well.)
Ballmer then warns:
This would also fragment your search advertising and display advertising strategies and the ecosystem surrounding them. This would undermine the reliance on your display advertising business to fuel future growth.
Sound risky for Yahoo to do. Not necessarily. Imagine it this way. Pretend Yahoo is a company that sells both radio and TV ads. It decides to outsource the radio ads. Does that put TV ads at risk? Perhaps not, considering that not everyone that buys radio also wants TV and vice-versa.
Search ads are completely different creatures from display ads. This is a fundamental concept that executives from the major companies selling them confuse — both accidentally and intentionally.
- A search ad appears before a consumer with an active desire for something,
targeted to their particular need, and thus is one of the most valuable forms
of advertising we have today.
- A display ad appears before a consumer that is often not considering buying something nor even thinking about the particular need being shown by the display ad. This is why it does not generally convert as well as search.
Display ads can build desire — can indeed work with search and even tie into past search behavior. But you can also argue that by focusing just on display, Yahoo – already the leader – could take that space above and beyond where it is today without being distracted by search.
Next, Ballmer puts out a "come work for us" sign to Yahoo employees:
Given this, it would impair Yahoo’s ability to retain the talented engineers working on advertising systems that are important to our interest in a combination of our companies.
My read of this is Ballmer saying that Yahoo working with Google would mean it is not serious about the search ads side of the house. Perhaps that fear-mongering will work. But then again, working with Google provides an attractive challenge to Yahoo employees that they cannot get from Microsoft. They can work with a search volume well above that of Microsoft’s, plus actively see how what they are doing compares to Google monetization.
As you’d expect, Ballmer next brings out the legal threats:
In addition, it would raise a host of regulatory and legal problems that no acquirer, including Microsoft, would want to inherit. Among other things, this would consolidate market share with the already-dominant paid search provider in a manner that would reduce competition and choice in the marketplace
In other words, "you won’t get away with it, Yahoo!" Microsoft is warning that they’ll be challenging any search ads partnership. Unfortunately for Microsoft, since Google is not actually buying Yahoo, Yahoo indeed might get away with it. So far, the signs haven’t been negative.
Moreover, Microsoft continues to play a dangerous game talking about consumer choice in the marketplace when it by far remains the company most dominant in the computer world. Imagine a court case where Google comes in and argues that Microsoft is trying to limit Google’s ability to partner with people on ads because those ad revenues are in turn fueling Google’s ability to offer software to people for free; i.e., Microsoft is trying to block the deal to protect its computer hegemony. Spun that way, a Yahoo-Google deal could improve consumer choice in some areas, not harm it.
Next, more legal rumblings. Price fixing!
This would also effectively enable Google to set the prices for key search terms on both their and your search platforms and, in the process, raise prices charged to advertisers on Yahoo. In addition to whatever resulting legal problems, this seems unwise from a business perspective unless in fact one simply wishes to use this as a vehicle to exit the paid search business in favor of Google.
Really, an amazing statement — the most hostile of the letter. Microsoft is setting up a case to say Google is fixing prices. Yep, Google has a pretty "black box" pricing system where no one quite knows what’s going on. But that system actually lowers prices for some advertisers who perform well. The Google system is designed to maximize revenue, which is not the same thing as raising or fixing prices.
The concluding point:
It could foreclose any chance of a combination with any other search provider that is not already relying on Google’s search services.
Such as? Clearly, it’s not going to be Microsoft, at the price Microsoft wants to pay. The only other notable search provider is Ask, and Yahoo has no need to combine with Ask.
What happens if Yahoo stays independent? Has Yang pulled off a coup? Will he build a company that’s worth more than $50 billion in value for his shareholders?
Again, I have no clear answers — nor does anyone, of course. At the moment, I can’t help but feel the letter of "calling the deal off" is really a last ditch effort by Ballmer to get Yahoo back to the negotiating table. There’s still time for Yang to go back before tomorrow’s opening day on the stock market, where a possible stock decline would put him in a weaker position. But the variables! Microsoft’s stock itself might also plunge, taking the value of a cash-stock deal again lower.
As an independent, Yahoo should have a strong future. Frankly, I feel the company was undervalued to begin with — constantly overlooked as the number two in a battle over search that many analysts over the years mistakenly have presumed was between Google and Microsoft. Yahoo has had to pull back and lost in some countries outside the US, but similarly, it could strike a deal with Microsoft to be a partner in some of these places.
At the very least, I certainly feel that Yahoo understands the web and future of online better than Microsoft does. Yahoo was born of the web. Yahoo doesn’t have an operating system to protect or software revenues that generate billions and make it hard to offer free apps and services, if it so chooses. In spirit, Yahoo is far more a competitor now to Google than Microsoft is.
If the two, Microsoft and Yahoo, do come together somehow, personally, I’d hope Yahoo’s allowed to run its course in a largely semi-autonomous fashion. Microsoft wants Yahoo because of its success, a success especially in search that Microsoft hasn’t yet been able to replicate. Let Yahoo continue to run that space, put everything into the player that has earned and maintained the number two spot, and perhaps that’s what will get it closer to number one.
There’s much discussion on the news, of course. I’d encourage everyone to check out the following resources:
Microsoft walks: Five reasons why it’s a good move: From Larry Dignan at ZDNet Between The Lines, this post covers well argued reasons why Ballmer should have walked away from Yahoo, including how Microsoft’s own shareholders might have balked at the deal, how the EU might have blocked a Microsoft-Yahoo tie-up, the duplication of services, and more.
Microsoft takes its ball and leaves Yahoo on the Web 2.0 playground: From long-time Microsoft watcher Mary Jo Foley. "I’d go so far as to say Microsoft’s decision to walk restores my faith in the future of the company," she writes – arguing that the money could be better spent. I’d argue that maybe Microsoft just offered too much to begin with. Rather than mark-up Yahoo’s stock at 60% of the current asking price, why didn’t they offer slightly above rather than effectively force the market to jump Yahoo immediately to that level? Perhaps Microsoft could have had Yahoo and billions left over.
MicroHoo: The Odd Couple Meetings Led Nowhere: From Kara Swisher at AllThingsD, the post recaps meetings that have gone on for the past few weeks in between the two companies. It covers Yang wanting $38 per share, his worries that a combined entity might be rejected by regulators as too dominant in some areas such as email, and the idea of just doing a search ads deal with Microsoft.
Microsoft Withdraws Its Bid for Yahoo: From the New York Times, a very nice telling of meetings this weekend and over the past weeks, possible ways forwards, possible partnership blocks all around — an excellent overview.
Microsoft Withdraws Yahoo Offer After Attempt to Bridge Gap in Price: From the Wall Street Journal; reports sources on both sides saying the walkaway isn’t a negotiating tactic.
Yahoo’s Nightmare Scenario: I’m From Google and I’m Here to Help!: Also from Kara Swisher, this post raises the specter that by outsourcing to Google, Yahoo will become just another Google outpost like AOL — and dwindle like AOL. But the comparison isn’t accurate. AOL sold its own core search technology way back in the 90s, nor was it that strong of a search player. AOL’s traffic seemed largely to have come off its lock-in with internet access accounts, and as that business went away, so did much of AOL’s share. AOL has had many other troubles, of course. Yahoo is keeping core search tech, already will keep thousands of advertisers in its existing search ads program, and is far more focused than AOL.
Analysis of the Microsoft Decision, Plus Yahoo’s Hari-Kari: Paul Kedrosky assigns blame all around: "This has a been a risky and poorly managed affair from end-to-end. Both CEOs deserve immense blame — Ballmer for vacillating; Yang for running a public company without the foremost regard for shareholders – and they are likely to be the two people who suffer the most indignities (including possible termination) over the coming weeks and months."
Email From Steve Ballmer To All Microsoft Employees: From TechCrunch, Ballmer tells the troops: "Ultimately, our goal is to build the industry-leading business in search, online advertising, media, and social networking. We are absolutely committed to being the leader in each of these areas. Now is the time to do what we have always done best—be tenacious, focus on the long term, innovate, and keep working hard."
That just makes me ask — and should make anyone ask — if you expect you can do this alone now, why offer up to $50 billion in the first place? Why not have stuck to the long-term plan rather than the drama of the past three months?
The answer, in part, from another Wall Street Journal article just before the walkout seems to be that Microsoft just felt all that money would get them there more quickly:
WSJ: Yahoo is the biggest, easiest way to get that scale. But if that doesn’t happen, are other acquisitions necessary to get that scale?
BALLMER: No, no, not at all. It could just take more time. Look at all the properties on the Internet — everything on the Internet. There’s really only five or six that have any scale. Worldwide, you’d maybe get seven or eight. You have MySpace, Facebook, MSN, Yahoo, Google, Baidu, AOL. But then — boom — it really falls dramatically after that. So there are really a few guys and [if] something works, it works. And if it doesn’t, it doesn’t. But then we’re just taking longer to build the scale [on our own].