SOPHISTICATED FINANCE

Outsource IT-Amazon Web Services

Any new business should review its business model and look for ways to replace fixed costs with marginal costs. One way to achieve this is to outsource as many functions as possible, which allows you to convert upfront investment into pay as you go monthly charges. Examples of available outsourced services include the online version of QuickBooks, the enterprise version of Gmail, salesforce.com and ADP payroll services, to name just a few.  All of these services eliminate the investment in people, overhead, IT and computer support. I think concerns about the security and privacy of data stored on the web are overrated. Most of these companies referenced know more about data security than anybody you are likely to hire. Also, I assume the U.S. government is capturing every voice and data communication in the U.S. (if not the world), so concerns about privacy are somewhat mute.

At this point you are probably thinking that Hacker's outsource model may work for a small business, but not for a fast growing business such as an Internet application or social network. To achieve fast growth, typically the biggest challenge is learning to scale the business whether it be adding stores for a retailer, adding data storage for a website, training staff for a call center or addings POPs for a telecom company. Only 1.7% of startups achieve sales in excess of $5 million by the fifth year. A large part of the reason is that the entrepreneurs can not manage scaling the business.

Increasingly, the inability to manage IT and the related services is becoming a primary reason for the failure to successfully scale. Large customers expect their smaller suppliers to be fully integrated electronically. Customers expect their sales person to have complete information about their order, complaints, disputes, etc. 24/7/365. On top of all this, employees are finding better, free applications on the Internet than their employers make available and are surreptitiously introducing them into the corporate IT environment.

The good news is that Amazon is providing a solution to some of these issues through its Amazon Web Services (AWS) offering which began in 2006. I have been following AWS for awhile and a couple of weeks ago I read in a blog that AWS uses more broadband capacity than the Amazon website for books and merchandise. To use this much broadband capacity, AWS must already be serving a large customer base with large data requirements. Today in a blog called Amazon Web Services they describe a project by AWS for the New York Times. Through AWS the NYT processed "4TB of raw image TIFF data (stored in S3) into 1.1 million finished PDFs in the space of 24 hours at a computation cost of just $240". (TB are terabytes or 1024 gigabytes; huge amounts of data.) I believe this may be part of the recently announced project where the NYT converted its entire historical archive into a searchable, web-accessed database. For AWS to have handled this project, we are talking about serious outsourcing resources.

AWS includes three major services--EC2,S3 and Hadoop (maybe these names make sense to someone more geeky than me :)).

• EC2 provides resizable computing capacity or more specifically "EC2 presents a true virtual computing environment, allowing you to use web service interfaces to requisition machines for use, load them with your custom application environment, manage your network's access permissions, and run your image using as many or few systems as you desire".
• S3 is expandable online storage or more specifically "S3 provides any developer access to the same highly scalable, reliable, fast, inexpensive data storage infrastructure that Amazon uses to run its own global network of web sites".
• Hadoop provides distributed data processing (on a large scale) or more specifically "Hadoop distributes the data and processing across clusters of commonly available computers" for parallel processing.

In summary, through AWS one now can dynamically resize the data, applications and processing resources of their company and pay only the marginal cost for the resources used. Effectively, everything but applications development can be outsourced. Very, very cool!

There is one other important point about strategy that should be noted from the AWS example. In developing a strategy one should focus on using the company's core competencies. Many companies do not do this and many more do not even know what their core competencies are. Amazon ran a large distributed IT infrastructure for many years to support its books and merchandise business. Very few organizations run a bigger infrastructure--maybe Google, NSA and a few others. AWS grew out of Amazon's recognition that they had a core competency in distributed IT infrastructure on a very large scale and there were few potential competitors. Build your business by focusing on your core competencies and when the competency is unique you have something special.

Note: I think AWS is going to be a special company that we should all follow (think Google) and an easy way to do it may be to read their blog.

 

Change the World

When I worked in Indonesia we built a company with US$1 billion in annual revenues, but the accomplishment that I am most proud of is that we created 29,000 jobs for our employees. We were the largest private sector employer in the country and the salaries we paid fed and clothed hundreds of thousands of people in a very poor country.(At the time Indonesia had official unemployment of 25 percent and unofficially it probably approached 35-45 percent.)

Today in Gaping Void, a blog that uses cartoons to explain a wide range of business issues, Hugh McLeod tells the story of how a doodle (below) of his generated a lively discussion at Microsoft UK and became an unofficial mascot of the company. Obviously, the implication is to change the world "for the better", but I sometimes think Microsoft needs this part explained. How many for profit companies can you point to where you can confidently say they are changing the world for the better?

I used to admire Intel until the nonsense with OLPC where Intel rescinded its offer to provide $18 million in funding for third world PCs. I used to admire Citibank until their recent horrific problems in the home mortgage market. (If Citi had applied some analysis to the underlying mortgages, they would have realized the low credit standards being used by the packagers and turned off their funding.) I used to admire Merck until their problems with Vytorin and other drugs.

For a company to claim that they are changing the world for the better I think they have to treat their employees well and develop them, believe in integrity, be a market leader (how ever you want to define the market), have decent financial performance and operate on a large scale. These are the necessary conditions (because first you have to take care of your own employees and protect their jobs), but the most important condition is that one must do something to make people's lives better. Salesforce.com is a great company, but I don't think they make very many lives "better". Kellogg's is a great company but it is debatable whether they make many lives better. Johnson & Johnson is a great company and they make lives better--every day.

I am not advocating that everybody start a medical products company. Nokia is a great company that makes the world better. There are many different kinds of businesses that can make the world better. When you consider starting a business, ask yourself whether this company will make the world better. If the answer is "no", maybe you should reconsider the new venture or maybe you should start it in Africa or Indonesia. The process of reconsidering the venture in a bigger context may lead you to some interesting conclusions that improve your plan, and maybe you will make the world a better place.

Microsoft's Strategy with Yahoo

The Sunday New York Times had an interesting article on Microsoft's acquisition of Yahoo. In part I found the article interesting because it followed the same logic that I outlined in Microsoft Yahoo Makes Little Sense. The NYT basically said that Microsoft would be better off acquiring an enterprise software company like SAP rather than Yahoo. According to the NYT, approximately 50 percent of Microsoft revenue comes from business customers. Therefore, if a company was going to make acquisitions, they should be in their core business. I faulted Microsoft, in part, because Yahoo's online advertising was not part of the core Microsoft business and required different core competencies to succeed.

The article got me thinking about the benefit to shareholders from acquisitions in the core business. The NYT article had cited Oracle as one example of an acquisitive company that focused on its core competency. Oracle made 37 acquisitions in the period 2005-7. I also looked at Cisco, the network equipment manufacturer, who made 29 acquisitions in the period 2000-2. Basically Cisco acquires new products to compliment its product line through acquisitions. I then considered Intel as a non-software computer-related technology company to compare to Cisco. Interestingly, Intel appears not to have made any significant acquisitions since 2000. I also included Microsoft, whose acquisitions are all over the map. With the exception of Great Plains and Solomon (SME accounting packages), Microsoft  has rarely acquired in the business/enterprise software area.

The return on the stocks (excluding dividends) for the period 2003-7 is shown below. (A pretty Yahoo Finance chart is here.)

Recognizing that the sample is limited, focused acquisition strategies (Cisco and Oracle) where the company is acquired for its product (not the business) generated better returns in the period than Microsoft's wide ranging acquisition strategy. Intel, with its laser focus on its core business, also outperformed Microsoft. The fact that the NASDAQ index outperformed all four companies probably shows that young, fast growing companies generate better returns than the mature company examples I chose. Of course, on a risk adjusted basis Cisco and Oracle look pretty good.

Start a New Web Business?

Many people tell me that they want to leave their jobs and start a new business, and, of course, a web-based business is a frequent choice. There were two good posts recently on starting a web business, but before I discuss them I need to set the stage.

Two important facts need to be kept in mind:

• 55 percent of new businesses do not survive the first five years
• There is about a 1.7 percent chance that your business will achieve revenues in excess of $5 million by the fifth year

The key factors to overcome the odds and succeed in a new business are:

1. Pick the right industry. Ever wonder why venture capitalists do not back restaurants and retail concepts and strongly prefer computer related businesses. Restaurants and retail have an over 70 percent likelihood of failure and computer related businesses have the highest likelihood of success.
2. Use mentors and advisors. Chosen well, they can help you avoid the fatal mistakes. An investment group in Latin America uses world class mentors for each company they invest in, and 87 percent of their companies have revenues over $5 million and are still in business after 7 years. (The investments are startups and early stage companies in emerging markets, which in many ways is even more challenging than the U.S.)
3. Have adequate capital. We have talked about adequate capital here so many times I will not repeat myself, but I would like to remind you that web-based businesses are comparatively capital efficient. See this post to read more on capital efficiency.

(Note: I have not listed the size of the market opportunity as a key factor. This is not a post on raising venture capital (although the three success factors above sound like an advertisement for venture capital funding). A lot of people start new businesses as a means to be able to work for themselves and have no intention of building the next Google. Makes no sense to me to put all that effort in to build a small business, but a lot of people do it.)

Now to the two posts, which I thought were very helpful to the aspiring entrepreneur. Paul Buchheit built Gmail for Google and then left to start FriendFeed, which is a site that allows you to follow the content of your friends on their blogs, delicious, flickr, etc. Suffice it to say, the man knows his technology and how to write code. In a recent post he basically makes two points:

1. It is more important to get your product in the market and get feedback from customers than it is to perfect the technology. He cites as two example of so-so technology and commercial success YouTube and Facebook.
2. Do not get hung up on perfecting the design of the website. His examples of commercial success with so-so design are Myspace and Google.

Buchheit believes the market is moving so fast that you need to stake out your space (application) before somebody with so-so technology and design becomes the market leader (and it is too late). The full post is well worth reading, except for the part about models not being important :).

To summarize so far, we have chosen to start a web-based business in part because it is a capital efficient model, found an excellent mentor and we are not spending all our time perfecting website design and technology. So where should we be spending our time? Dan Rua, Managing Partner at the venture capital firm Inflexion Partners (based in Florida), provides a good answer.

In a post titled "Nice idea, but how will you get visitors?", Dan talks about all the web investment opportunities he sees where the founders have given inadequate attention to developing website visitors (which makes it nearly impossible to believe there will be a commercial success). Rather than just stopping at the point where he tells you to focus on sales (a VC mantra), Dan goes on to list the seven ways to develop visitors for a website. I should force you to read Dan's full post (by not providing the list), which is well worth reading, but here are Dan's seven ways to build traffic:

1. organic search
2. sponsored search
3. viral adoption
4. referral tools
5. affiliate marketing
6. display advertising
7. distribution relationships

Dan closes the post by saying that the key point is to show how the traffic building strategy matches the target customer's behavior toward the website. For example, people looking for research on a topic may  not be likely to respond to viral marketing techniques.

If you do not fully understand Dan's closing point, you may not be ready to start investing in code. If you fully understand Dan's point, remember what Buchheit said. Perfect technology and design is not the objective. Traffic and customer feedback is the first goal. Which brings us back to Dan's advice.

After you get the traffic, then you need to monetize the visitors, but that's a whole new subject for another post.

Real Estate Excel Model

It is a very busy week for me with due diligence on two client acquisitions and the blogging muse is not speaking very clearly to me. So I thought I would post on another Excel model. This time I have posted a real estate model. Real estate is not an industry I specialize in, partly because there are so many specialists in the field and also because it is project related rather than an ongoing business.

A few words about the model:

1. It was for a town house project in Central America where the new owners buy their properties outright
2. In real estate projects the use of proceeds is particularly important in order to clarify when the developer is getting their return (after the lenders being preferred)
3. This project has a more involved debt structure than the last model (which was for a startup); there is senior debt and mezzanine debt, which has an interest component and an equity participation component (if it was a business model I would have added a current portion of mezzanine debt to reflect a repayment schedule)
4. I hate to rebuild models for new assumptions so I built this model so you could easily change the construction time to build a town house and the time to sell the unit by just changing one cell (G47 and G48 respectively on the Assumptions tab); mostly I was concerned about a slow down in the market affecting sell through
5. Cash flow is managed by draw downs and repayments on the debt schedule under the construction loan; personally I find it confusing to use the cash flow statement to manage cash

Download the model by clicking this link. Download real_estate_model.xls

Now I need to get back to figuring out VAT taxes in Central America.

Humor-The Auto Industry Needs to Change

Everybody talks about the need for the auto industry to change, but for such change to have an effect it must be dramatic.

clipped from geekandpoke.typepad.com

International Entrepreneurship

I have worked in many, many countries and the number continues to grow. Much of my business experience has been gained in the third world markets of Asia and Latin America. My interest in things international was spawned in part by the Cuban Missile Crisis in 1962, when I discovered that the world extended beyond the small town in upstate New York where I grew up and Little League baseball. The fact that my father was born in South Africa was probably also a contributing factor.

A recent post, Startup Excel Model, has proven quite popular, in part because it was highlighted in a blog called Startup Cube. In addition to a really cool name (I like the mix of business and database), this is a Russian language blog that covers entrepreneurship amongst other topics (according to one of my Russian speaking students). Given that I have benefited so much from my international experience, and most of us read blogs in English about American thinking on business and entrepreneurship, I want to extend an invitation to the readers of Startup Cube to send me their thoughts on entrepreneurship, startups, new business ideas, etc. and the difference in perspective on these subjects between Americans and Russians. Submissions in Russian, English or any other major European language will be fine. I will get the submissions translated and post them here. (My email is rhhfla1at yahoo.com )

Maybe this is a bit of a wacky idea, but it's Monday morning so hopefully you will cut me a little slack. If this works maybe the readers in La Paz will follow up with a similar submission.

Web 3.0

When I wrote my most popular blog post ever (1100 readers), Microsoft Yahoo Makes Little Sense, I struggled with how to describe Yahoo's failing strategy. Finally it came to me. Yahoo failed to realize the change in the Internet to where people now "live on the web". No longer is the Internet about portals, static content and pushing information to readers. Today the Internet is the place where people have their social, intellectual and professional lives on display, in large part through content they produce.

As I consider the future of the Internet, a point my wife (who is much smarter than I am) always makes guides my thinking. She always says, "the computer is just a tool". Thinking about the future of the Internet, the Internet is just a tool to create and collect information. More sophisticated ways to create and collect information, not the technology, will drive the future direction of the web. As Sramana Mitra (another woman) at ReadWriteWeb said, "Web 3.0 will be about feeding you the information that you want, when you want it in the proper context".

Two recent developments support my view:

1. Reuters, the international news conglomerate, launched Calais. Basically, Calais automatically generates metadata (subject) tags from any XML document using artificial intelligence. Tags are generated automatically about event, company, organization, person, country, city and people. Producing the tags permits the document to be more easily discovered through a search. Now every Reuters story, and any document that uses Calais, will be much easier to find. Reuters obviously supported the development of Calais in order to facilitate the discovery of more of their proprietary information, but Calais can be used by anyone.
2. Google now offers the ability to translate any web page into any one of 13 major languages, but the really useful feature is that I can enter a Spanish search term, search Spanish language web pages and receive the pages translated into English, French, Russian.... Next time you need to research a foreign country or company, you are no longer limited to the English language pages (or whatever language you prefer).

A recent post on Research Recap, an excellent blog for new research on a wide range of subjects, highlights another interesting development. According to Forrester Research, 64% of consumers prefer to read user reviews of products (rather than manufacturer specs). This finding makes clear to me that we have more confidence in each others content than in content from companies, the media or the government. This is why blogging is so popular :), del.icio.us bookmarks has so many users and Ning's growth has been fueled by specialized subject social networks. There is a social component to all these examples, but I believe that it is the user generated content that is driving their popularity. A newly launched site, Docstoc.com, is another example that user generated content is the future. Docstoc allows users to upload and share a wide range of documents on subjects ranging from business and legal to creative and educational. Next time you need a sample contract try Docstoc.

What I expect to see in the near future is the following:

1. The ability to subscribe to a particular search on Google or any other search engine and receive updates via RSS as the search results are added to or change. This would be particularly useful to people interested in SEO, search engine optimization, or staying updated on a particular subject. I think it would be easier than saving a Google search or relying on a clipping service to collect pages on a particular subject.
2. While much is made of vertical market search engines, I think that a better alternative may be for several users with a common interest to be able to collectively post their bookmarks on a subject. Rather than having to view the hundreds of low quality subject tags on delicious, you could go to a specialized search engine that, for example, utilizes the bookmarks from four professors at MIT that are subject matter experts (sort of a Ning for search engines).
3. Another search option that I think will be coming is the ability to direct the search engine to certain particular databases that may not show in results frequently. For example, the Social Science Research Network is an excellent source of academic articles on a wide range of subjects, but I rarely see links there from a business topic search on Google.
4. I think there is a big opportunity to develop expert answers, similar to the questions feature on LinkedIn. Almost every question on LinkedIn has a rating of the best answer, yet these responses are only available to LinkedIn users. The other difference between LinkedIn and, for example Yahoo Answers, is the quality of the respondents (very high on LinkedIn). I think there is a business model based on a subject matter website where real experts (not hacks) answer questions and revenue comes from advertising.

Enough user generated content for today. Have to go check the Google searches that brought readers to this blog.

Loyal Readers

Through the Feedjit widget on this blog (lower left column) I have been able to identify some loyal readers in far away places--India, Singapore, the Middle East and La Paz, Bolivia. Especially noteworthy are my readers in Moscow  who have translated occasional posts into Russian for their own blog  (with attribution). Thank you.

For those of you who I can not identify from Feedjit, thanks for reading.

A special note should be made of the people in the U.S. armed forces who read this blog from overseas. This post is for you. I see you every night on my blog. Be safe! You are not alone.

Startup Excel Model

About half of the readers of this blog originate from Google searches. The most popular searches involve Excel, financial models for startups, sources and uses, CAPEX and headcount plans. In an effort to fill the apparent void on the Internet related to complete financial models built with Excel, I have posted a  model which includes examples for all of the frequent search terms that bring readers here (cash flow, CAPEX, sources and uses, headcount, etc.) The model is complete and a good example of what to send to a venture capital or private equity firm or a hedge fund to raise any type of financing.

A few words about this model:

1. It is a real model that I built for a client (prospective clients you can see my work)
2. It is not a template for you to use (I suppose if you changed all the assumptions it's usable, but...), but the component parts are recommended for capital raising
3. The model is for a "triple play" telcom business (cable, voice and data) so the cost of sales part of the model is over 100 assumptions and the CAPEX is fairly involved including physical constraints; this "complexity" is designed to show industry knowledge to financing sources; for more on the purposes of financial models see this post
4. The model includes the following tabs:
   • Sources and Uses
   • Assumptions (which also includes the Financial Summary--P&L and balance sheet information)
   • Financial Statements (which includes the P&L, balance sheet, revenue detail, COS detail, CAPEX row 178, and debt schedule row 251)
   • Cash Flow Statement
   • OPEX (operating expense detail and the headcount plan)
5. The model makes extensive use of named fields (after you open the model press F5); named fields make it easier to understand formulas because you use a name instead of a cell reference in the formula
6. In addition to being a startup, the strategy called for a  series of acquisitions (a rollup) which are modeled
7. The model uses a customer acquisition cost driver for the organic growth of subscribers

A few things that would have changed the model design include:

1. If I had a complex debt structure (combination of a line of credit, term loan and mezzanine debt) I would have used a separate tab for the "debt schedule" to make it easier to find
2. If I had an operating company (instead of a startup) I would have included historical information for at least three years in the "financial summary" and probably have given it a separate tab; if you have a good operating history of revenue growth or a turnaround I would include five years of historical data
3. If I had historical information on each acquisition, I would have forecasted/modeled each acquisition on a separate named tab (with a separate P&L and a balance sheet) and then consolidated them; such a presentation would have made it easier to understand the economics of each business unit and to evaluate the reasonableness of the purchase price
4. If the headcount additions were based on time instead of capacity requirements (as shown in the model) I would have used date triggers to drive headcount additions

Click the following link to download a copy of the model. Download sf_blog_model.xls
The auditing tool bar in Excel may aid in understanding. Click View>Toolbars>Formula Auditing

Please remember that the complexity of the model serves a purpose--to demonstrate knowledge of a complex industry. Most models can be successfully built with fewer assumptions about revenue and cost of sales. Some additional thoughts on detail in models are here.

Venture Capital Decision Making

Some of the most popular blogs on the Internet deal with venture capital and the entrepreneur's pursuit of such funding. Google Analytics shows that many of the readers of this blog read at least one venture capital blog. A new academic paper shows that VCs may not be articulating their decision making criteria accurately! While they obviously understand their own methodology, they may be under weighting certain factors when they explain how they make their funding decisions.

The new paper is titled Uncovering Knowledge Structures of Venture Capital Investment Decision Making and was published by Pankaj Patel and Rodney D'Souza, two PHD candidates. This paper won the SBA Office of Advocacy award for the best doctoral paper in 2008 and was funded by them. (Yes-this may be a rare example of tax dollars well spent.)

Using 144 real technology business plans, half of which were actually funded by VCs and angels, a group of experienced VCs (average 18 years as VCs) were asked to evaluate each of the 144 plans for funding based on the criteria below. The criteria was developed by the VCs and vetted using some advanced statistical techniques (which basically eliminated bias). The 14 criteria were:

1. Startup experience
2. Industry experience
3. Leadership experience
4. Management experience
5. Market size
6. Customer adoption
7. Revenue generated
8. Entry timing
9. Competition
10. Technological advantage
11. Strategy
12. Intellectual property rights
13. Value added
14. Profit margins

(Nice checklist for an executive summary or Powerpoint for a VC or angel investor.)

Drum roll--the conclusions from the study were:

1. Market opportunity (5,6,8 and 9 above) is the most important factor when VCs fund a business
2. Management team (1,2, and 4 above) is the most important factor when a business does not receive funding
3. Satisfactory team, great opportunity beats great team, so-so opportunity in the funding process

You need a decent management team to get through the first screen, but the quality of the market opportunity (market size, competitive landscape, customer buying behavior) largely determines if you will get funded. I always say that Michael Porter's Competitive Strategies: Techniques for Analyzing Industries and Competitors is one of only two books that every entrepreneur should read. Looks like the VCs may agree.

The complete paper can be downloaded through the link. Download rs315tot.pdf

Microsoft Yahoo Makes Little Sense

Much has already been written about the Microsoft's acquisition proposal for Yahoo, so I will not bore you by repeating the financial terms, posting Steve Balmer's letter to the Yahoo Board or speculating on the private equity firms considering to bid against Microsoft.

I do not think that the deal makes sense strategically for Microsoft. Despite the fact that the acquisition would be a significant departure from Microsoft's organic growth strategy, which is always a loud warning bell (see this post), I have other concerns:

1. The Internet Issue
2. Strategic Complexity
3. Advertising is like Expedia

The Internet
Do you ever wonder why you dislike your phone company. The answer is that almost all these companies evolved from monopolies where there was little concern for either product innovation or customer service and great attention was paid to legal issues and regulators. Because of its dominant position in operating systems, Microsoft behaves in a similar way with limited product innovation, minimal concern for customer service and first class legal talent. (Yes--Microsoft has some of the best programming minds in the world, but what they produce rarely delivers a great product experience for the consumer or the enterprise (although a lot of people like .net, their server software and their "geeky" stuff.)

Now we turn to the turnaround of Yahoo--great lawyers and great programmers from Microsoft will not be the key. Synergies between the two companies in online advertising will not be a panacea. Yahoo's problem is that they offer no compelling proposition to the customer. Almost nothing that Yahoo offers is a market leader, almost everything they innovate is quickly surpassed by a competitor (not always Google) and they no longer understand their target customer (if they even know who that is). What Yahoo needs is leadership that understands the current Internet and the customers that "live" there. At an accelerating pace, the Internet is becoming the infrastructure for our social, intellectual and professional lives. Yahoo missed the change from portal visitors to people who "live" on the Internet. Microsoft almost missed the Internet (until Windows Explorer) and still has not made much of an inroad in the current Internet of Web 2.0. When it comes to the Internet, one company is almost blind and the other can only see with one eye.

Strategic Complexity

Microsoft faces a major strategic issue. Given the growth and popularity of web-based applications and SAAS (software as a service), how do they position Windows Office. Office is a major revenue and profit generator, but the market (both consumer and enterprise) is moving away from desktop applications. Yahoo, on the other hand desperately needs a web-based service similar to Google Docs in order to offer a  more complete service package to this new user that lives on the Internet. With the acquisition of Yahoo, Microsoft not only has to consider how to address their own strategic dilemma but now they must also consider how the decisions may affect their $40+ billion acquisition.  Or conversely, any success Yahoo may have with an online Office-like offering comes at Microsoft's expense. As a friend of mine used to say, "there is no technology that has yet been invented that can measure the complexity of these kinds of decisions".

Advertising is Like Expedia

Microsoft launched one of the first travel sites-Expedia-and subsequently sold it off. They sold it because travel sites require the ability to package travel offerings and this was not part of the Microsoft skill set. Programming, Microsoft's strongest competency, was not critical to succeeding in the travel business. Roll forward to today and we see Microsoft proposing to acquire Yahoo to improve its position in online advertising distribution. Programming is becoming less and less important to the success of online advertising. With the proliferation of Web 2.0 offerings, attracting the customer is becoming more important than the underlying programming. Good programming is necessary, but customer acquisition (and the related traffic) is becoming the critical skill. Since the days when Microsoft established its near monopoly in operating systems for PCs, the company has shown little expertise in acquiring consumer customers in market leading numbers (with the possible exception of Office and that may be debatable).

To clarify, I am not a Microsoft basher. I think their ability to establish a monopoly in PC operating systems will probably go down as one of the greatest accomplishments in business history. I just think that the acquisition of Yahoo does not make strategic sense. It is also very disturbing that Microsoft is so significantly moving away from a strategy of organic growth. I don't know which issue bothers me more, but I know that great companies grow organically.

Now, who should buy Yahoo? Very tough question, if you eliminate Google for anti-trust reasons (and I am sure that Microsoft's crack legal team would do all the staff work to show why such a merger is anti-competitive). Let's look at who has the leadership to turnaround Yahoo. Who understands this new Internet consumer who lives on the Internet? Who in the Internet space has the record to warrant a $40 billion investment? Very few candidates come to mind.

Jeff Bezos and Amazon might be a candidate. Amazon stock has basically tripled since 2002, the Kindle reader looks like a great success and their web service infrastructure business is roaring (broadband traffic for the infrastructure business exceeded the traffic for Amazon's website in 4th quarter 2006). Now if a private equity firm were to approach Amazon for a "joint" bid for Yahoo that would be interesting. Only problem is I think Bezos is too smart to divert from his own organic growth strategy.

What I think is more likely is that Yahoo will merge with a Web 2.0 company that is valued at over $10 billion dollars as a defensive move to thwart Microsoft (which may not work given Microsoft's market cap of about $280 billion) or the pressure from potential shareholder lawsuits will force the Board of Yahoo to do the Microsoft deal.

Wonder what Rupert Murdoch is doing this weekend?