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?

Comments

[Marco V. Principato]

Hi, frankly I've found your post really interesting, looking to things in a strongly different perspective. Monopolies have always forged human thought to alter the vision one should have, the real one.
Words about this mega-fact have been written all over the world, and, frankly once again, I'm pretty curious to know what Murdoch is doing NOW.
Kind regards,
Marco V. Principato
Roma, Italy

[SMP]

I don't agree with your assessment. Yahoo would be a poor buy for someone not intending to abuse a monopoly. However for someone buying with the intention of abusing an existing desktop and office suite monopoly, Yahoo is a goldmine.

Don't underestimate Microsoft's ability to abuse it's market monopoly and in particular it's monopoly on it's MS Office file formats and OOXML, to force customers to do whatever it wants. Microsoft is also fully aware from past experience that the law acts too slowly to prevent it from doing what it wants - by the time the law acts on to prevent anti-competitive acts from damaging the competition, the competition has already been eliminated.

If Yahoo offered an online Office suite which was not fully compatible with MS Office, then it would not be very popular. If it offered an online office suite that was compatible with Microsoft's proprietary Office formats inlcuding OOXML as implemented in MS Office, then it would be a competitor and would take market share from Microsoft. However Microsoft's Office suite and desktop OS monopolies will allow Microsoft to circumvent this, by having Yahoo offering storage on-line, but requiring a local copy of MS Office to access the online serveic (by virtue of Microsoft's control of it's lock-in file formats like OOXML and binary formats)

This is what Microsoft is aiming to do with Yahoo:
1) Offer an online service like Google docs but to access it you need to buy MS Office and install it on a Windows PC. By using proprietary file formats like OOXML as implemented in MS Office, only the Yahoo online service will be compatible with MS Office's proprietary formats and leveraging Microsoft's monopoly of the Office suite market will allow Microsoft to eliminate Google docs from the competition and extend it's desktop office suite and desktop OS monopoly to the online office suite market as well.
2) With a Yahoo monopoly on online office suites, Microsoft, by data mining the office documents in Yahoo's online data, can extend it's desktop and office suite monopolies to the online advertising market and search engine markets by making these more targeted, therefore eliminating future more targeted search and advertising competition from Google.
3) OOXML as implemented by MS Office will be proprietary to Microsoft due to patents, undocumented behaviours and formats, proprietary extensions and updated versions compatible with MS Office but not the OOXML version submitted to ISO for approval and therefore not covered by Microsoft's patent covenant.

If Microsoft tried to grow it's online office suite market organically, it would take time, and the anti-trust authorities would surely step in to stop it before Microsoft's activities become a fait accompli. However if Microsoft buys Yahoo which is would not be an abuse of monopoly as things stand when Microsoft buys it, it would allow Microsoft to capture a significant market share of the office suite and search engine market immediately, and once Microsoft has bought Yahoo, overnight Microsoft can put into practice it's Monopoly abuse strategy described above. This should allow Microsoft to leverage it's existing monopolies to kill off Google docs and in the longer term Google search, before the anti-trust authorities can work the legal procedures to prevent it. Microsoft's strategy here is brilliant, and it will absolutely work, unless the anti-trust authorities place conditions on Microsoft to prevent it leveraging control of it's proprietary file formats to online services to extent it's monopoly to online services. In other words other office suite vendors and online service providers should not be locked out of full compatibility with MS Office or Microsoft's proprietary formats and protocols.

[Gary Layng]

I think there's more than Google worrying Microsoft and driving their side of the MS+Yahoo equation. With their office suite and their operating system, the two consistent cash cows of the company, under serious threat, they need a third source of revenue in order to guarantee corporate continuity.

In the office suite side, more and more of the world are adopting Open Document Format (ODF) in an effort to halt vendor lock-in and maintain long-term vendor-agnostic data retention. There are quite a number of suites now that default to ODF for the file format of choice, including Google's online service, OpenOffice.org, and KOffice, and soon IBM's Lotus SmartSuite. This is providing Microsoft with something it hasn't had to worry about for a number of years, office suite competition.

In the operating system side, Vista requires significant investment in computer hardware, resulting in resistance from potential users who are now checking out Linux and the Mac. Linux runs most of the top-20 fastest supercomputers, runs some 2/3 of the active websites, is competing strongly in the cellphone and PDA markets, and is showing increasing strength in the sub-$400 notebook and desktop markets. More and more organizations are turning to Linux from server room to desktop/laptop. The Mac is likewise being quite competitive in the midrange to high end laptop and desktop markets.

The organic growth that you mention may not be possible for Microsoft anymore. Someone's changed the soil in their flowerpot.

[Robert H. Hacker]

I believe that Microsoft has become overly reliant on its "monopoly" just like many phone companies. This reliance has created huge issues given the changing landscape of computing, the Internet and other technologies such as wireless. Never the less, if Microsoft is going to be a great company it should rely on organic growth. It has the talent to develop the new businesses it needs. I just don't think Internet advertising is a good choice because it does not play to their strengths.
Bob

[Ed]

Several questions: Microsoft was built on organic growth?

They purchased QDOS, and sold it as MSDOS 1.0 with minimal modifications (evidence: various MSDOS 1.0 files contain QDOS copyright texts in their binaries; successive versions contain fewer of these, until they're finally eliminated.)

They purchased various components which were turned into word, excel, and powerpoint, and built into MS Office.

They built MS BOB from scratch, and it bombed.

Many of the new features of various OS updates turned out to be from other companies; for example, their original compression code included competitor Stac Electronics's copyright marks.

I could go on. Now, I admit readily that Microsoft has done some amazing things with these products *after* they acquired them, but the point is, most of the good stuff Microsoft has was originally someone else's product. Going down the list of their successful software titles, I can't think of one that doesn't contain something they didn't acquire from someone else in some form or fashion.

Given Microsoft's ability to purchase products, re-label them, and successfully sell them, I fear that they may very well be able to take Yahoo and turn it into something.

I am excited to hear that they may be about to blow around 14% of their money on it, but otherwise the move worries me.

Disclaimer: I am concerned about Microsoft's monopoly. I would not be opposed to the company, except for the fact that they specifically exploit their monopolies to attempt to create other monopolies, and they engage in various maneuvers besides software excellence to maintain their existing monopolies.

[Nobody]

People like their geeky stuff? Actually, those folks are well into the minority. A lot of people use it in their day job, but that only leaves a lot of us geeks bitter about having to support their crap.

You're right, though, that they don't put their customers first. They try to control us, and for at least some of us, that really touches a nerve.