Microsoft + Yahoo? An Analysis of Microsoft's Blockbuster Offer for Yahoo

On Friday, February 1, 2008, Microsoft unexpectedly announced a massive $44.6 billion offer to purchase ailing online giant Yahoo (see my news story about this event for details). Since that time, I've been analyzing how this attempted takeover will affect Microsoft and the consumers who use the various online products and services made by both companies. I've never been much of a prognosticator, and I'm certainly no business expert. But I've been watching Microsoft, Yahoo, and Google for years now, and here's what I feel are the most important takeaways of this offer, in no particular order.

This is a hostile takeover attempt. Make no mistake: Microsoft's offer for Yahoo is as hostile as they come, with both implicit and explicit threats to Yahoo's executive leadership. The deal is structured in such a way that the company's shareholders would be insane to not accept it immediately, with the $44.6 billion offer representing a 62 percent share price premium. (Yahoo's stock was trading at just $19 a share when Microsoft presented its offer.) Microsoft CEO Steve Ballmer sent a letter to Yahoo's board of directors on Thursday, informing them that it would then publicize the offer, and the letter itself, 24 hours later. Thus, Microsoft forced Yahoo's hand, providing the executive staff with little time to deliberate. Yahoo is expected to formally respond to the offer quickly. But my guess is that shareholders, stung horribly by the Dot Com bust, are eager to accept Microsoft's Godfather-like offer.

Google is a new kind of competitor and needs to be addressed differently. While Microsoft's founders and chief executives have over the years expressed a desire to avoid the fate of becoming the next IBM, it's pretty clear that today's Microsoft is indeed the same lumbering beast that IBM was by the early 1980's. What worked in the past--creating a me-too browser product, Internet Explorer, and "integrating" it into their dominant desktop OS product, Windows, in order to defeat an up-and-coming competitor who "got" the new world order, Netscape--won't work today. The reasons for this are complicated, but they boil down to two salient points. First, Google is now big enough to benefit from the same network effect that made the PC market such a success story for Microsoft: Its dominant product aren't great per se, but they're widely used, and thus generate more online traffic, which becomes more valuable to advertisers; that value is then pushed back into the system on the reverse side because Google's search results become more relevant because of targeted advertising. Thus, the system feeds itself. (Ironically, or perhaps coincidentally, Microsoft's attempts to duplicate its network effect successes with Windows in other markets, like video games, cell phones, and digital media, have failed miserably.) Secondly, as Apple knows all too well from its efforts in the PC market, it's almost impossible to make huge gains against an entrenched competitor with dominant market share, no matter how successful you are and how good your products are. Google's sheer size simply affords it benefits of scale that Microsoft can't match or catch up to on its own.

Finally, Microsoft is Getting Aggressive. It's too early to tell if Microsoft's surprisingly aggressive bid for Yahoo will be seen as the beginning of a corporate turnaround or the final death knell of a struggling dinosaur, but consider this: While far too many people have criticized Microsoft's behavior in the past, the truth is that the software giant has a responsibility to shareholders to increase the value of the company. This is done via competition, and by defeating those that would steal your customers, market share, and revenues. When a Microsoft executive says he wants to "cut off the air supply" of a competitor, for example, this isn't a bad thing unless the subsequent actions of the company are illegal: In fact, it's arguably what a shareholder would want to hear from a person helping run the company. Business isn't about morality, it's about winning legally. That said, Microsoft was clearly humbled by its antitrust troubles around the globe during the past decade, and acted in what I think are bizarre ways, betraying it as a company that was clearly losing its edge.

Consider the following: Why would Microsoft spend five years (so far) dickering over technical documentation that would allow competitors to make products that better interoperate with Microsoft's workgroup server products but then turn around and quickly agree to every single change that competitors demanded in the buildup to Windows Vista? Think about this for a second. On the one hand, you have competitors seeking to interoperate with a non-dominant product. And on the other, you have competitors seeking to weaken your most dominant product of all. You fight voraciously to prevent the former, but you roll over and play dead on the latter? Really? That's ridiculous, and if I were a Microsoft shareholder, I'd be outraged. As a Windows user, I am outraged: Vista has been compromised by the desires of Microsoft's competitors, and will be further compromised by the release of SP1.

This hostile bid for Yahoo suggests that Microsoft is ready to start being more aggressive again. And that's a good thing, really, for users of its products and the hundreds of millions of people that rely on Microsoft every day.

This is Steve Ballmer's Microsoft. Sure, he's been CEO for 8 years, but Steve Ballmer has always lived in the shadow of his predecessor and former Harvard buddy Bill Gates. Even though Gates apparently "gave his blessing" to the Yahoo bid, this deal has Ballmer's aggressive nature written all over it. Ballmer is a fighter, willing to do what it takes to win. And this proves it, as the Yahoo deal is as much an admission of past failure as it is strategic for the future. I find it somewhat fascinating that Microsoft never uttered the word "Google" in its promotional materials about this bid, in its letter to Yahoo, or in a conference call with the press on Friday: This is clearly Ballmer's will at work.

Microsoft needs Yahoo's DNA. Microsoft is a huge company full of really smart and talented people. But its successes are all based around very similar and increasingly dated experiences, and it's very clear that the company simply doesn't "get" the Internet and cloud computing. Sadly, this has always been the case. In the mid-1990's, while the rest of the technology industry was going ga-ga over the World Wide Web and Netscape, Bill Gates, then Microsoft's CEO, published a book about the tech future called "The Road Ahead" that only passingly mentions the Internet. Meanwhile, Microsoft was also busy creating an old-school online service called The Microsoft Network (MSN) that would duplicate the out-of-date model used by companies like CompuServe and Genie and not provide any links to the Internet at all. Over a decade later, the company is still trying to bolster its traditional products instead of pushing ahead with innovative technologies tied to cloud computing: The company still doesn't "get" the Internet. But Yahoo does get it, even though it's been doing poorly of late. Its engineers, executives, and employees can provide a much-needed jolt to Microsoft which the software giant can ignore to its peril. (Vegas should take bets right now on which side will emerge the winner. If it's "Old Microsoft," you can start the death clock countdown immediately. Arguably, it started with the release of Windows 95 and MSN in 1995.)

It's not about the technology. Looking over Yahoo's product line, I see precious little that would interest Microsoft directly, and it's clear that Yahoo's search engine and advertising engine don't offer any real word technological benefits over Microsoft's. Instead, I think we can expect Microsoft to integrate Yahoo's products, and individual technologies, into existing Microsoft products where appropriate, or get rid of ones that are outright duplications. For example, it's easy to see how Yahoo Mail could be subsumed into Windows Live Mail, and how the best features of Yahoo Messenger could simply be added to Windows Live Messenger (all while dropping the incompatible Yahoo networking scheme). These transitions will take a long time, yes, and I'm sure Microsoft is counting on losing a certain percentage of Yahoo customers as a result. The goal here would be to keep that number as low as possible.

It's about market share and the people. So if Microsoft isn't interested in Yahoo's technology, why merge? Even though a combined Microsoft and Yahoo would not equal the market share and search ad revenues of Google, it does provide Microsoft will a much-needed market share boost that will make its online platform more credible to advertisers and thus will raise ad revenues, which, by the way, is how all these companies make money on this stuff in the first place. Yahoo also brings its ingrained vision for cloud computing, a business model Microsoft has not fully embraced because of the success of its traditional PC products. So even if what we're left with is a familiar-sounding set of Windows Live services, those services will hopefully be influenced and improved by the ranks of Yahoo employees that will flood Microsoft's online business. And for whatever its worth, Microsoft may trash cloud computing in public, but the scope of this deal--which seems specifically designed to ensure that Yahoo can't say no--suggests that Microsoft takes the Google cloud computing threat very, very seriously. Put another way, Microsoft's actions speak louder than its words.

Antitrust issues won't be a sticking point ... in the US. But the EU could still screw this up. While Yahoo's shareholders would be crazy to walk away from Microsoft's overvalued bid for the company, there is one outside force that could still completely scuttle this deal: The European Union's European Commission (EC), which has shown itself incapable from walking away from even the slightest possibility that Microsoft might be harming competitors. Assuming Yahoo accepts Microsoft's offer, I expect antitrust regulators in the US to back the deal, as it would simply level the playing field online and ostensibly help consumers as a result. The EU won't see it that way, and I expect them to do everything they can to prevent this purchase. Ironically, EU complaints could have constructive results. For example, Microsoft could agree to ensure that all of its Web services and products work equally well on, say, the top three Web browser platforms in order to receive the EU's blessing. This move would prevent Microsoft from tying its online products to its dominant IE browser and give consumers real choice.

Microsoft could still screw this up, too. Imagine a future in which Yahoo accepts the Microsoft bid and antitrust regulators around the globe give it their enthusiastic endorsement. Microsoft could still screw this up by keeping Yahoo "alive" as a separate entity in California, creating products that continue to compete with and duplicate its Windows Live offerings. The company might be inclined to do this in order to convince Yahoo to accept its deal, and to avoid alienating the millions of people worldwide that it won't be killing their favorite Yahoo Web products. Too, there will be talk about the value of the Yahoo brand, which is certainly considerable.

It would be a mistake, however, to do anything other than integrate Yahoo fully into Microsoft. My advice would be to keep the Yahoo brand and use it for all of the combined company's consumer-oriented online services. (And seriously, don't even considering using "Yahoo Live," Microsoft.) There should be no duplication of products or services, obviously. And Microsoft should consider permanently locating it's Yahoo/online offices at Yahoo's California locations, far away from Redmond and the influences of product teams that still seek to kill any competitive threat, be internal or external. Microsoft's online team is the future, not the past. Let them operate in isolation, please. Otherwise, some overreaching executive from the Windows Division, or the Office group, or wherever, will kill a product that is, perhaps, a little too close to something they're doing. It's happened in the past.

While we're at it, Microsoft really needs to split off its Live services division from its Windows business, regardless of whether the Yahoo deal is finally approved. Currently, both Windows and Microsoft's online consumer services (Windows Live, Live Search, MSN, and so on) are consolidated together under Kevin Johnson's Platforms & Services Division. This is a mistake, and the combination of Yahoo + Live will make that doubly true. Whatever the combined Yahoo/Live business is called, it should be completely separated from Windows.

Ultimately, this deal is about ad revenue. While I tend to focus on the products that end users actually use online, this deal isn't really about the products per se, but is rather centered on Google's commanding lead in revenues related to search-based text advertising. This is essentially a business that Google invented and then refined into a streamlined money-making machine.

The combination of Microsoft and Yahoo surpasses Google's Web traffic and is at least competitive from an ad revenue perspective, so the deal does make sense if only for this reason. But looking to the future, Google, Microsoft, and Yahoo are all positioning themselves for the next big online advertising trend, so-called display ads, which are highly graphical, animated, and often interactive. Today, most ad revenue online comes from the text-based ad types that Google popularized. I'm sure Microsoft and Yahoo both hope that Google isn't able to parlay its success in text-based ads directly in display ads, but obviously Google has a considerable head set.

We're not done consolidating. Microsoft shouldn't stop with Yahoo. The company should also consider aggressively courting Time Warner for AOL. Time Warner doesn't need it or want it, and the division of these two entities would let Time Warner focus on what it does best (content), while a combined Microsoft, Yahoo, and AOL could take on Google online via advertising, search, and other online services. This is the natural evolution of this market, I think, and a world in which there were two main competitors (think Coke and Pepsi) would work well for consumers. Sometimes too much choice is confusing and prevents progress (think Coke, Pepsi, and RC Cola). But no choice at all--a world dominated by just Google--is even worse.

What's next? The future of computing is pervasive mobility: This means mobile devices like smart phones as well as emerging connected devices that aren't quite phones and aren't quite notebook computers as we now know them. I think of the trend towards pervasive mobile computing as "convenience computing," because it can happen when it's convenient. For example, maybe you're standing in checkout line at the grocery store. Instead of leafing through a copy of "People" magazine in the aisle, you can pop out your smart phone or other mobile device and scroll through the headlines of "The New York Times" or whatever. There are hundreds of examples of where this would and could happen (and you know people can and will do this while stuck in traffic, regardless of the risks.)

Microsoft's traditional platforms are hugely profitable now but the world is moving on. Yes, PCs will always be around but traditional PC use (sitting at a desk using a mouse and keyboard) will become less and less common for non-office workers and other niche markets (like hard core PC gamers). Computing will become more pervasive and more mobile, thanks to everywhere-anywhere wireless access and hardware miniaturization efforts. The exact form these technologies take doesn't matter. Microsoft needs to anticipate the needs of this shift and be ready with the solutions consumers will expect. The Yahoo deal is a step in the right direction, I think.

Final thoughts

I support Microsoft's efforts to purchase Yahoo and combine that company's assets with its Live services business. Both companies have an interesting mix of online products and services, but Microsoft desperately needs to embrace the move to cloud computing and stop hedging its bets in that area by focusing too much on its traditional and aging core businesses. Yahoo will bring a healthy attitude about platform-agnostic cloud computing to the insular world of Microsoft and, hopefully, inspire the company to reach for the future instead of just defending the past. As a user of these systems today, I'm excited by the possibilities. As a close observer of Microsoft for many, many years, I'm fearful that the company has become too short-sighted and isolationist to do the right thing. But Microsoft's aggressive move to acquire Yahoo suggests a self-awareness of its problems. I hope this trend continues.