It’s over. Isn’t it? Microsoft/Yahoo, continued

a killer klown“It’s over. Isn’t it?”

— the end of Killer Klowns from Outer Space

Act 1 ended with a temporary resolution: Microsoft deciding not to “go hostile” and instead withdrawing their offer to buy Yahoo! After a brief intermission, Bill Gates’ announcement of Live Search Cashback is bang-up start to Act 2, featuring guest star Carl Icahn, with the finale already scheduled at Yahoo’s repeatedly-postponed shareholder’s meeting … grab some popcorn!

So it seems a good time to revisit what I said back in February in Yahoo!!!! (was Yahoo!?!?!): Why, after further reflection, I think Microsoft’s offer for Yahoo! is a brilliant strategic move, especially:

If Microsoft acquires Yahoo!, it’s clearly #2 in a duopoly in search and in advertising, at least for a while. On the other hand, if Yahoo! rejects the offer and melts down, then Microsoft probably picks up more of their search and advertising share than anybody but Google — and Microsoft becomes #2 in both duopolies. Either way, looking a couple of years out, this alone could bring an additional ~$5-10 billion/year in profits even if the deal doesn’t go through

Three key points to keep in mind:

  • in both search and online advertising, Microsoft is likely to be very profitable if it’s in a duopoly with Google; if there are three or more big players, it’s more likely that Google wins and everybody else breaks even at best.
  • the dynamics of the advertising business are based around a virtuous cycle: more inventory means more advertisers which makes the inventory more valuable which leads to more inventory …
  • search market share is extremely valuable inventory for advertising, so it’s a huge advantage to have offerings in both

Yahoo! partnered with Google as part of its strategy to fend off Microsoft, and is testing Google providing the ads for Yahoo!’s search results. This gives short-term revenue to Yahoo, but dramatically weakens Yahoo!’s own advertiser platform. A couple of years ago, when the Ad Astra project was exploring game-changing strategies, we proposed a similar strategy for Microsoft*; we estimated that it could bring in $1B+ additional short-term revenue, but the consensus was that it also would have destroyed any market position in advertising. I don’t know any details of the Yahoo!/Google discussions, but I suspect the same applies.

In fact, simply by pursuing the deal with Google, Yahoo!’s sent a strong message to all of their advertising partners: “we think we can get more money for our inventory by selling ads via somebody else”. Their partners may decide “hey, if Yahoo!’s advertising isn’t good enough for Yahoo!, maybe we should look somewhere else too.”

If people do decide to move away from Yahoo! advertising en masse, well, it’s great news for Google, of course, because that’s where a lot of them will go. It’s even better news for Microsoft, though. First of all, especially in the display ad area, Microsoft (and aQuantive) can hold its own with Google (and DoubleClick), so there’ll be a chunk o’ new business. Even more importantly, if Yahoo!’s advertising business falls apart …

Guess who’s in the duopoly?

Moving on now to search … Jessica Mintz’ AP article Microsoft lures search traffic with cash rebates has a good summary:

Under the cash program revealed Wednesday, Web shoppers who sign up for an account and buy items found using Microsoft’s Live Search cashback site will receive a percentage of the purchase price deposited into their account.

When the total reaches $5, the shoppers can redeem their “cold, hard cash” via eBay Inc.’s PayPal. Microsoft said the rebates are funded with a portion of the money it collects from advertisers.

So far, more than 700 merchants, including Home Depot and, have listed products on the site.

Microsoft Chairman Bill Gates said in a speech that he believes the cashback program will boost the number of people using Live Search for shopping, at least. More grandly, he predicted it will change the economics of the search advertising market as advertisers shift from paying for click on links to paying for concrete actions, like completing a purchase.

Michael Arrington’s summary on TechCrunch looks at this through the lens of competing with Google; he describes it as “both desparate and brilliant,” and makes some excellent points, including

A year ago Microsoft basically did a trial run of Live Search CashBack with Live Search Club, which lured searchers to Microsoft with offers of prizes to users for using Live Search. Microsoft went from 10.3% to 13.2% market share in a month, a nearly 30% rise. Live Search CashBack, which gives a much more straightforward payout to users, should see significantly better results.

This only applies to ecommerce related searches for now. But frankly that is all that matters. Only about a third of searches are commerce related, but those searches generate 80% of search revenue. Get the commerce searches and you’ve got the revenue. And here’s another interesting statistic – 68% of online purchases begin at a search engine or shopping comparison site. Only about 30% are from direct navigation to the ecommerce site itself

Yeah, this could work.

Of course there are as always pitfalls; some early users have reported usability problems, the prices need to be cheaper at Live Search than elsewhere, and Live Search results need to be good enough to be usable. Still, even if it’s less than 100% successful it’s likely to be a huge win. Note how it stimulates the advertising virtuous cycle as well — and, as a special added bonus, gives people incentive to sign up for Windows Live IDs, one of the key metrics Microsoft is using for the success of its entire online effort. Great timing, too, with people so nervous about the economy; saving $5-$10 here and there starts to look mighty attractive. Brilliant indeed.

However, I think Michael overlooked an even more interesting aspect: the effect on Yahoo!

Assume that Microsoft once again gets a 3% market share bump from this. Where are they going to come from? For a bunch of different reasons, a majority are likely to come from Yahoo!. So Yahoo!’s search query share takes a hit.

At exactly the same time as they’re dealing with potential shareholder lawsuits — and the need to keep their stock price up.

How will they respond? The most obvious approach would be to try to match Microsoft and give cash back to consumers. But even assuming this neutralizes Microsoft’s advantage, it’s a real problem for Yahoo! Picking numbers out of a hat, suppose both companies wind up spending $1B in the first year on that.

For Microsoft, it’s no big deal; for Yahoo!, this would probably mean game over (see aforementioned Carl Icahn and lawsuits for why). Guess who’s in the duopoly?

There are other possible responses, of course. Yahoo! does have several natural partners here — eBay, Amazon, Ali Baba, Google, and of course Microsoft. One interesting outcome is a joint venture of some form in the search area. It seems to me, though, that in most of the scenarios, Microsoft’s got a very good chance at coming out way ahead in search share; and many also further weaken Yahoo! in advertising.

And all of this is in addition to the value that Michael talked about — and the increase in Windows Live IDs. Good job, Microsoft.

And great job having Bill announce it! It’s a brilliant strategic move, and when combined with everything else is yet another sign about how serious Microsoft is about its online businesses. Work on this has been going on for quite a while; we even had some small roles in it with Ad Astra, for example as part of a competitive simulation (working with McKinsey) in May 2006, proposing a business-focused search “Quey” in a ThinkWeek paper in January 2007 that got excellent reviews, and helping out with a demo for a big executive offsite in spring 2007. Bill’s been pretty deeply involved; in fact, the first time I saw such clear numbers about the importance of commercial search was in email from Bill when I was prepping for our mashup meeting with him and Ray.** If it works it’ll turn around the search business … what a great curtain call that would be!

As for Yahoo!, probably the best outcome from their perspective is to sell their search and advertising businesses — or spin them off into joint ventures, a topic explored by Elise Ackerman and Brandon Bailey in Microsoft talking with Yahoo again: possible deal related to search ad business? in the San Jose Mercury News, Then Yahoo! can focus on their core of communication, community (Mail, Messenger, Flickr, Answers, …) and content (portal and their partnerships). It’s hard to see how they’ll get there from here, though. We shall see …

Popcorn, anybody?


* in a particularly tasteless example of Microsoft culture, a senior technical leader in an email discussion compared me to Neville Chamberlain for suggesting this. Because, y’know, Microsoft temporarily ceding some of the advertising business to Google is really the same level as WWII and the Holocaust.

** this was also the meeting where we pitched the idea of doing politically-oriented MsDewey clones. A nd look, a mere 17 months later, check out Digital Inspiration’s quick description of Microsoft’s LeftVsRight. Alas, I couldn’t get beyond the cringeworthy sexism in the opening clip … oh well. It remains a great idea, especially if coupled with Microsoft Research’s BLEWS. Maybe v2 will be better.