Microsoft's Bid to Buy Yahoo! Why it Makes Sense.
Feb. 1, 2008
Microsoft's bid on February 1st to buy Yahoo! for $44.6 billion has set off a storm of commentary and speculation. IDC gathered top analysts from multiple industry segments today to provide clarity as to what a merger of the two companies would mean for the industry. More in-depth documents will follow.
Yahoo! and Microsoft have been in negotiations before—in May 2006 and May 2007. Nothing came of the talks then. This time, the offer is concrete, and Yahoo!'s image is a bit tarnished, following disappointing earnings and Google's relentless assault on the company's market share.
While previous discussions have failed, the two companies have a history of cooperation as well as competition. Yahoo! created a new Yahoo! Messenger client for Vista last year, and worked closely with the Vista team to provide feedback on Vista. And Microsoft hired Gary Flake, formerly Yahoo's principal scientist, several years ago to run Live Labs.
A Search powerhouse in the making
The Yahoo! bid follows closely on Microsoft's proposed acquisition for $1.2 billion of Fast Search and Transfer (FAST), an enterprise search company with Web search roots. The two may be related. Or, at least they should be. Coincidentally, FAST sold its Web search business to Yahoo! several years ago. But the scalability of its enterprise search platform has always been a selling point, and that is directly related to its Web origins.
To compete with Google, Yahoo! has attracted some of the greatest minds in large-scale search to its research group in recent years. In addition to the FAST Web group, they boast search luminaries from Verity, Alta Vista, ClearForest, and IBM. Of course, Microsoft is not lacking in search talent either. If Microsoft can cross fertilize this wealth of knowledge, we can expect some innovative approaches to Web search to emerge. It would also distinguish Yahoo!-Microsoft from its more narrowly focused competitors.
In acquiring Yahoo!, Microsoft would buy a very strong brand, and we would expect that they support and nurture it. For a long time, Yahoo! was seen as an important online alternative to Microsoft (the "anti-Microsoft") by many consumers. Things are no longer so black and white, but some users may continue to harbor similar feelings. Retaining the Yahoo! brand would be an important step toward keeping these long-time users.
The acquisition would also represent a significant expansion of Microsoft's online consumer reach and advertising revenues: a classic #2 and #3 combining to compete with #1. IDC's data on online search behavior and advertising revenue shows that a Microsoft-Yahoo! merger creates a credible challenger to Google's Web hegemony. Together, Yahoo! and Microsoft command 22.7% of the Online Advertising market share, in contrast to Google's 32.5%.
U. S. Advertising Market Shares After Microsoft/Yahoo! Merger
U. S. Internet Audience Reach After Microsoft/Yahoo! Merger
As Figure 2 shows, Google's Internet Audience reach would be only slightly higher (80%) than the combined Microsoft-Yahoo! businesses that total 73.7%. Separately, they have 51% and 62%, respectively (many consumers visit more than one search site, so that the total is greater than 100%).
Advertising writ large
In most areas, a merger between Microsoft and Yahoo! would be good for both. In Web search, pooling forces will bolster their position, even if gaining ground against Google will still be hard. In display ads, adding Microsoft's share will make Yahoo!'s market leader position nearly invulnerable.
In emerging segments, this marriage would also help. Yahoo! is already strong in mobile advertising, and adding Microsoft's advertising assets and mobile technology (Windows Mobile ad company ScreenTonic and voice recognition company TellMe) might well give them the upper hand over Google. In behavioral targeting, Yahoo! is already strongly positioned with the acquisition of BlueLithium, where Google has nothing comparable in its portfolio. Adding Microsoft's engineering skills will only reinforce Yahoo!'s position. In video advertising, however, both Yahoo! and Microsoft have nothing that comes even close to the popularity of Google's YouTube, even if Google still has a long way to go to monetize the service. (Coincidentally, Yahoo! bid $150M for Maven Networks today, a video advertising vendor, a fact that has been lost in the bigger news about the Microsoft acquisition.) Finally, social networking is a weak spot for all three contenders.
The long view, however, reveals the strategic importance of Microsoft's bid. IDC's recent modeling of the digital marketplace predicts that Web search revenue growth will begin to flatten for the major search engines over the next 3-5 years. This is already happening, not because there are fewer searches, but rather, that despite what some Internet tracking companies suggest, the bulk of searches are not going to any one destination, be it Google, Yahoo, Amazon, ESPN, or any other specialized site. IDC's research shows that roughly two thirds of searches go directly to sites that can answer a question or provide a product, rather than going to a general Web search engine. As these sites, particularly newspapers, publishers, sports, and other topical aggregators of special interest content, become smarter about monetizing their content and their specialized audiences, IDC predicts that these sites will begin to manage their own advertising, and at a premium rate.
This gets more interesting, though, if we consider a Microsoft-Yahoo!-FAST combination. Microsoft is largely a business-oriented software vendor. It makes sense for them to get into the business of selling infrastructure software or middleware to businesses that want to monetize their audience and their content. FAST's Ad Momentum is a product that provides this capability, and it goes nicely with a company that looks at the business side of Web commerce.
There are many other areas where Microsoft's bid for Yahoo! will have implications. Looking beyond the PC, Yahoo! has established strong relationships with several large service providers including AT&T, which is on the forefront of delivering integrated voice, video, Internet, and mobile applications over an IPTV platform built primarily by Alcatel-Lucent in a partnership with Microsoft. Even within the walled garden of today's VOD networks, on-demand video programming is quickly increasing in volume, and search will ultimately play a critical role in navigating to this content.
In the mobile arena, access to Yahoo's search tools and talent, would shore up Microsoft's play in the mobile space with respect to search, location-based services and advertising—three key revenue growth areas of the future. Yahoo! also has one of the most sophisticated and easiest to use mobile services suites with Yahoo! Go 3.0. Yahoo! has a solid understanding of the needs of mobile consumers, and it will be incumbent upon Microsoft not to lose this, especially in light of Google's aggressive stance in mobile (Android, Google's mobile apps suite, bidding in the 700 MHz spectrum auction, etc.) and the mobile brand strength of Apple (via the iPhone and services integration of iTunes).
Microsoft continues to enjoy unprecedented success in the enterprise space for distributed system software and productivity applications. The clear and emerging threat is SaaS applications, perhaps funded through advertising revenue, delivered, potentially, to the mass-market. By acquiring Yahoo!, Microsoft creates the opportunity to move "enterprise" technology to the mass-market. Because the mass-market technology moves at a more rapid pace, it is likely that interesting technology innovations will quickly be spun from this activity—creating the opportunity for Microsoft to draw consumer, mass-market technology back into the enterprise space. But as the software industry moves to software as a service to deliver software to customers, they have debated whether they could enter this arena without jeopardizing their traditional products. This acquisition gives them the opportunity to create a "consumer" sub-brand. By sub-branding their SaaS activities, Microsoft can protect their fee-based software license business while aggressively driving growth in the "Consumer" space.
What does the bid portend for other heavyweights in the IT industry? Google, of course, will take even stronger aim at the combined company. It would be wise to consider the strength of Yahoo! overseas, and especially in China, where Google's search market share is small, especially compared to Baidu. Yahoo! could be a major asset for Microsoft in this market.
The deal will probably push Adobe more into the arms of Google-Adobe has been collaborating with Yahoo! on new products to monetize content and plug in advertising, and we can expect those to stall now. Meanwhile, Microsoft will push Silverlight.
In summary, this acquisition appears to have enough positive aspects for both Microsoft and Yahoo! to make it work. Leaving Yahoo!'s brand, spirit and culture intact would benefit both companies, while encouraging the kind of cross fertilization that could make the combined
Without combining forces, Microsoft and Yahoo! would only catch up to Google in the long run (5+ years), and only if the stars aligned in the right way. With a merger, that goal is much closer.
Copyright 2008 IDC. Reproduction is forbidden unless authorized.
All rights reserved.