Yahoo Offer Is Strategy Shift for Microsoft
Published: February 2, 2008
Bill Gates, the chairman of Microsoft and a global philanthropist, called upon fellow business leaders at the World Economic Forum last week to pursue a kinder form of capitalism.
But on Friday, the brand of capitalism practiced by his company’s chief executive, Steven A. Ballmer, came with a decidedly hard edge.
Microsoft’s $44.6 billion bid for Yahoo, pushed by Mr. Ballmer, was hostile. And during a conference call Friday with analysts and in a subsequent interview, he never once uttered the word “Google,” referring to the Internet search giant that has humbled Microsoft only as “the leader” in the online world.
Mr. Ballmer, 51, is a famously fierce competitor. To him, failure is never an option. “If we don’t get it right at first, we’ll just keep coming and coming and coming and coming,” he said in an earlier interview.
Microsoft’s bid for Yahoo is thus a tacit, and difficult, admission that the company did not get its online business right. The bid also represents a sharp departure from Microsoft’s well-thumbed playbook of building new businesses on its own. In the past, when Microsoft moved beyond its stronghold in desktop computer software — and into areas like video games and data-center software — it has done so mainly with in-house investment, patience and tenacity.
Microsoft stuck to that formula for years with its Internet search and advertising — without success. It did buy an online ad agency, aQuantive, last May for $6 billion, a sizable move given Microsoft’s tradition of making small, niche-filling acquisitions.
The losses, however, continue to mount in Microsoft’s online business, while Google makes billions in profit.
The Google challenge to Microsoft extends beyond online search and advertising. Google is at the forefront of companies offering software as online services, including Web-based alternatives to Microsoft’s lucrative desktop products like word processing, spreadsheets and presentation programs.
Mr. Gates, Microsoft’s largest shareholder, has said that Google is the company that most reminds him of Microsoft in terms of its broad ambitions and demanding corporate culture. Mr. Gates, who is spending more time on philanthropy these days, blessed the Yahoo bid, but it is Mr. Ballmer’s brainchild.
And Mr. Ballmer clearly views the Yahoo bid, and the Google threat, in broad terms. A Yahoo deal, he said, would represent “the next major milestone in Microsoft’s transformation.”
Microsoft, too, is moving to offer more software features as Web-based services, though it sees a future that revolves around both personal computer software and online services.
Microsoft has been forced to adopt a new strategy for a different kind of threat than it has confronted, and usually dispatched, in the past.
“This shows just how worried Microsoft is by Google,” said David B. Yoffie, a professor at the Harvard Business School. “Microsoft has faced competitive threats before, but none with the size, strength, profitability and momentum of Google.”
In the conference call, Mr. Ballmer conceded that Microsoft needed a big move to try to catch up in the online business. “The market continues to grow, and the leader continues to consolidate position,” he said.
Microsoft, analysts say, finds itself in a battle where improving its search algorithms and online ad software is not going to be enough. Google has impressive technology, to be sure, but it also enjoys the torrid growth that falls to the leader in highly networked businesses like Internet search and ads.
Google’s edge in search traffic then attracts more advertisers and Web publishers, so there are more ads in Google’s auctions, which makes them more efficient. Each advantage reinforces the other, in what economists call “network effects.”
One measure of the network advantage, analysts estimate, is that Google collects 40 percent to 100 percent more revenue per search than either Yahoo or Microsoft.
Microsoft, of course, is no stranger to the power of network effects. It was the master of that strategy in the personal computer era. Its early lead in PC operating systems, and its efforts to encourage independent software developers to write applications for Windows, paved the way for Microsoft’s dominance.
More programs ran on Windows than on any other operating system, so more users bought PCs running Windows. Apple, by contrast, never built up the developer network as Microsoft did.
In the Internet era, network effects are working against Microsoft as it battles Google.
With the Yahoo bid, analysts say, Microsoft is trying to buy a big enough share of the market to be a credible alternative to Google with online advertisers.
In the most recent quarter, Microsoft had online revenue of $863 million, compared with $4.8 billion at Google. Yahoo and Microsoft together had more than $2.6 billion in revenue, still trailing well behind Google but in a far stronger competitive position.
But the trends in online advertising are working to Google’s advantage as it continues to gain share. The more Google’s momentum accelerates, the more difficult it will be for Microsoft to catch up, no matter how much it might improve its search technology.
While $44.6 billion is a hefty price tag, many analysts say it will be worth it if Microsoft can close the gap with Google. On Wall Street, Microsoft suffers from the perception that it is several steps behind in the march toward the Internet future.
Microsoft, analysts note, has grown solidly for years, but investors give it little credit. Its stock price has long been stagnant, despite the company’s extremely profitable businesses. The Office division alone had quarterly revenue of $4.8 billion — equal to Google — and an astronomical $3.2 billion in operating profits. The Windows unit is even more profitable.
“Microsoft needs to show that it is going to make the online business work, and this is about shaking things up that needed shaking up,” said Charles di Bona, an analyst for Sanford C. Bernstein & Company.
Asked whether the move amounted to an admission of failure of the company’s earlier strategy, Mr. Ballmer replied that some people might take that view.
“But I made the judgment that for the long-term health of this company, and for the long-term interests of our shareholders, that acquiring Yahoo is a good thing,” he said.
