Yahoo!!!! (was Yahoo!?!?!): Why, after further reflection, I think Microsoft’s offer for Yahoo! is a brilliant strategic move

Plunking down $44.6 billion, or whatever the number turns out to be, for “change” and “social software” sends a huge message — although bizarrely enough a lot of Microsoft employees, on MiniMSFT and internal email discussion lists like Litebulb, have managed not to hear it.

It’s been several weeks since Microsoft’s unsolicited offer for Yahoo. My initial reaction was that while high-risk, it’s a good deal for Microsoft. Since then, on further reflection … I think it’s a brilliant move on Microsoft’s part — whether or not the deal goes through. And despite all the coverage around the web, I haven’t seen anybody discuss a couple of the most important strategic issues. So I thought I’d take a stab at it.

Update, 2/27: Press roundup (with some commentary) in a new thread; a meditation on cool in a comment. Also, MiniMSFT’s new thread Because the last acquisition went so well links back here, without comment, under Other perspectives. There’s plenty of discussion over there, and I’m crossposting some of my responses here as well.


To start with, Microsoft’s willingness to make an offer of this size — something that would fundamentally and irrevocably shift the center of gravity away from Windows and Office *and* outside of Redmond — is a huge signal that while some internal battles may continue, the board, CEO, and executives are willing to place a huge and risky forward-looking bet. And this is part of a coherent strategy and model; like I said in my original post, it was really striking to me how the discussion in the analyst call was couched in terms of “as we discussed six months ago”. These are both very good signs that the turnaround at Microsoft is going a lot better than anybody realizes.

And while most of my analysis here is going to be in terms of why this is good from Micrsosoft’s perspective, they’re not the only ones that matter. Sure, Sergey Brin has a vested interest, but he speaks for a lot of us when he says that he finds this deal unnerving (although interestingly enough, Marc Andreessen appears unconcerned). Anti-trust regulators here and abroad need to take a close look at this deal — especially Yahoo!’s and Microsoft’s dominance in many countries of Messenger and Mail. Microsoft has made some good recent promises in terms of openness; there’s a lot of (deserved) skepticism, and any approval of a Yahoo! deal should be contingent on the ability to hold Microsoft accountable. In the security and privacy space, the FTC Consent Decree on Passport will need to be extended to the Yahoo! properties that Microsoft acquires. And so on …

Presumably Microsoft’s anticipated this. It seems to me they really mean it when they say “we got pushed into this openness thing but now see that it’s good for us.” If that’s the case, then it’s in their interest to reinforce their commitments and be held accountable. Still, there’s no question that there’s a long history of bad behavior here; I think people are right to be skeptical — and demand a detailed anti-trust evaluation, if the deal does go forward.

Which it might or might not. Yahoo is resisting fiercely — they’ve adopted a new retention and severance package which could cost Microsoft an estimated $1-$3 billion. (Kevin Johnson’s “internal” mail published last Friday seems to imply that layoffs would be minimal, but who knows.) Yahoo!’s also frantically looking around for partners or a white knight. Microsoft has said they won’t raise their offer; they’re still mum on whether or not they’ll try to stage a proxy fight.

If the deal doesn’t go through, it’s a disaster for Yahoo! — and doesn’t really hurt Microsoft at all. Yahoo! was already reeling, laying off 1000 people, and with a major vesting (the “RSU”) in early February — right after the stock had bounced thanks to the offer — “everyone was just biding their time for the RSU to vest and the Microsoft bid just gives everyone an excuse to leave.” Thus far, their partner explorations have revealed that … hmm … they don’t have a lot of great options. If Yahoo! rejects the deal (or Microsoft takes their offer off the table), Yahoo!’s stock most likely plunges, which will add fuel to the fire of the class action lawsuits that have already started. Sometimes all you can say is “sucks to be you.”

Most people think that the search and advertising markets are both likely to be extremely profitable for the top two players if there’s a duopoly; if on the other hand it settles down as a triopoly, then the margins will get squeezed and #2 and #3 will have a hard tie doing better than break-even. Right now, in the US, Google’s #1 in both, with Yahoo! #2 and Microsoft #3.

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.

Of course there are other possible scenarios … still, what’s fascinating is that it’s possible that just by making the offer, Microsoft has significantly altered the market.

Obviously, I think it would be a lot better for Microsoft if it *does* go through. Start with the geographical and cultural considerations. Silicon Valley is also on the west coast of the US, so on the one hand (depending on how the international aspects of the deal are structured) this doesn’t address Microsoft’s desperate need to globalize development … however, adding Yahoo! to Microsoft’s other resources establishes a power base outside of Redmond as formidable as Windows or Office. And this would be a huge shot in the arm for the folks at Microsoft Silicon Valley who along with some Redmond allies (Ray Ozzie’s org, Popfly, me for a while, etc.) are taking the lead at helping Microsoft to transform itself.

Clay Shirky’s excellent point about Yahoo!’s social DNA relates to this as well:

There is one thing that is true of Yahoo! and not of its rivals–it gets social apps, and it always has. Google is an algorithm-driven company. If there is a pattern in the data from which to extract value, they have a team on it, right now, and their team is smarter than your team. Microsoft has always had the individual user at the center of its universe–though they seem to have lost that particular spot with Vista, their Office suite remains the center of most business-users’ days. But only Yahoo! understands, natively, how to either build or buy applications that are designed for groups.

Indeed. Plunking down $44.6 billion, or whatever the number turns out to be, for “change” and “social software” sends a huge message — although bizarrely enough a lot of Microsoft employees, on MiniMSFT and internal email discussion lists like Litebulb, have managed not to hear it.

As for more traditional business value: not to sound like a broken record, but the positively-scaling dynamics of the search and advertising markets mean that the combined market shares are worth much more than either company’s individually. There are similar positive sum effects in Mail, Messenger, and “portal” (potentially recharging MSN’s offerings as well — everybody disses ’em, but MSN and the butterfly are hugely valuable brands). The combination of Flickr + Spaces + Photosynth + client-side photo mangement in Vista (and Zune, and XBox, and smartphones) is a powerhouse … and speaking of devices, how about customized Yahoo! experiences for Zune and XBox, and leveraging Yahoo!’s content deals? Then there’s the potential combination of Yahoo! groups + Outlook; great analytics from Yahoo! cross-fertilized with Microsoft Research; Popfly + Pipes, Mashups + Hack Days

Yeah, okay, it probably won’t all work out. And it’s possible that Microsoft really is sooooo messed up that it’ll turn into a fiasco. There’s risk. Still, the upside if even a few of these things come through is huge, and there isn’t really a huge downside other than embarrassment if it becomes a quagmire.

Apparently Microsoft was willing to offer $35/share in December, and then Yahoo! blew the quarter, and now it’s 10% less. Yahoo! may be able to get more; then again, they may well be a lot cheaper in six months. We shall see.

So to recap: while risky, there’s huge upside for Microsoft if the offer goes through. Even if it doesn’t, it’s accentuated the stresses on a competitor, and staked Microsoft’s claim to be #2 in the search and advertising duopolies.

Well done.

jon

Update, April 29: An excellent post by Marc Andreessen looks at the options if Microsoft goes fully hostile.


Comments

12 responses to “Yahoo!!!! (was Yahoo!?!?!): Why, after further reflection, I think Microsoft’s offer for Yahoo! is a brilliant strategic move”

  1. I would however say that Kevin Johnson’s being a little overoptimistic when he says

    “Respect for both the creative and analytical aspects of advertising is core to both companies, along with recognition that advertising is an industry that represents opportunity and growth.”

    In fact, many people at Microsoft don’t understand or accept, let alone respect, advertising; and join Henry Blodgett in scoffing at the opportunity. Unsurprisingly, these folks are mostly in Redmond, and mostly in Windows and Office. As usual, Mini is a great place to keep up with their views.

  2. There were various responses to my post on Mini, so I’m dialogin’ over there in a couple of threads. I’ll cross-post here as well …

    Anonymous@8:59PM: Most of my response will be in the new thread, but one thing in particular I wanted to cover here.

    I don’t understand or accept advertising. Why should I? It’s a sleazy, filthy business that decent people should have nothing to do with.

    Whether to work at a company engaging in business practices you feel are problematic is something everybody needs to wrestle with for themselves.

    If you’re going to stay there, even if you never decide to accept advertising personally, I strongly recommend that you at least understand it — and start learning to view your colleagues as decent people who just happen to disagree with you about this subject.

  3. And in response to somebody who asked whether it was me who wasn’t listening, and pointed to a couple of “Alley Insider” links:

    Anonymous@9:38PM: Thanks for the links, although I couldn’t follow (or find) the second one. Henry Blodget’s Jeff Lanctot interview is great — pulls no punches indeed!

    As I read it, Blodget distorted things in his headline: Lanctot didn’t say the deal as a whole was irrelevant, he just highlighted that spend is moving away from portals to the networks. I agree, and “the networks” (media, communication, social) are all Yahoo!’s strengths along with portal.

    No idea whether Blodget simply missed this or whether he’s spinning things this way for some reason….

    jon

  4. And one more — I’m a busy little bee this morning!

    Thanks for the link, Mini. I have no idea what Ballmer did and didn’t say to his senior leadership; in what way do you think he “basically lied” and to who? It’s really hard for me to believe that KJ, Ray Ozzie, Chris Liddell, etc. weren’t in the loop on this…

    And a response to Anonymous @8:59PM from the other thread:

    I see no convincing reasoning other than the same old economy of scale argument

    The strategic advantages I’m highlighting include market structure (being in a duopoly), culture, geography, and moving towards social software. If there are reasons you — or others — disagree with them, I’d be interested in hearing them.

    Economies of scale on the search/advertising market do translate to significant revenue. Of course it’s making a bet on just how large the two company’s market share will be after regulatory approval and integration, but it’s a very safe bet that Yahoo! + Microsoft > Microsoft — by quite a lot really. I agree this isn’t the primary strategic reason to do the deal but just to keep in perspective: we are probably talking at least several billion dollars a year here even if both companies continue to lose market share in the interim. That’s significant.

    jon

  5. The negativity on MiniMSFT often leads to very bizarre moments. One poster argued against the deal on the grounds that Microsoft is a failure at being cool.

    When you think about this, though, this is actually a very strong argument for the deal: there’s no way Microsoft can succeed in the consumer market without improving here. And Yahoo! does understand cool, so adding a critical cool-infused mass of Yahooligans (primarily located outside of the far-from-cool Redmond area) will make a huge difference.

    Anyhow this got me thinking about the subject. As somebody who kept getting attacked for having DJs and pink beanbag chairs at my events, I totally agree that cool’s been devalued at Microsoft.

    If you just dropped Yahoo! into a sea of ultra-terminally-uncool Microsoft, the antibodies would kill it. But things are changing.

    Ballmer and KJ prioritized this in last July’s town hall, and Ray Ozzie went into some detail in his response to the open letter. The set of design-related ThinkWeek papers last fall got broad visibility, and the design community is working with senior executives and putting a lot of attention on the issue.

    In parallel, the business units are increasingly decoupled, which helps reduce the drag on coolness between the enterprise and business markets (where cool is perceived as a disadvantage) and consumer. MSN, XBox, Zune, and Microsoft Research have all built successful consumer-facing brands with at least somewhat more coolness than “Microsoft”, “Windows”, and “Office”.

    Also, while there have been a lot of, um, less-than-stellar attempts, there are also a bunch of recent successes: Club Live. Popfly. MsDewey. Playtable. Halo, for heaven’s sakes. Microsoft can be cool, at least in the right situations; the challenge is to be able to do it more frequently and better, with a lot less pain for all involved.

    So if things go ahead, Yahoo!’s brands and experiences — and thousands of Yahooligans, centered outside of Redmond — will swiftly reinforce design culture not only in the Internet space, but consumer-oriented Windows and devices as well.

    And while there have been a lot of, um, less-than-stellar attempts, there are also a bunch of recent successes: XBox. Club Live. Popfly. MsDewey. Playtable. Microsoft can be cool, at least in the right situations; the challenge is to be able to do it more frequently and better, with a lot less pain for all involved.

    Over time, if things go ahead, the Yahooligans will wind up reinforcing design culture not only in the Internet space, but consumer-oriented Windows and devices as well.

    Like I keep saying: the cultural aspects of this deal are huge.

    jon

  6. […] and publishing) by contrast highlights that “a duopoly is better than a monopoly.” See, I’m not the only one who uses the word. Of course a true multi-player market would be better yet (at least from consumers and […]

  7. This graphic from Louise Story’s New York Times’ article on behavioral tracking points out two other advantages of this deal from Microsoft’s perspective: the huge amount of data Yahoo!’s accumulated, and the instrumentation that lets them track their users so panoptically. Thanks to Adam of Emergent Chaos for pointing this out!

    They know more than you think

  8. 22 out of 23 analysts surveyed expect Microsoft to buy Yahoo without raising their price, which has sunk to about $40B. Eric Auchard and Daisuke Wakabayashi-Analysis discuss for Reuters.

    Meanwhile, folks on Mini have spent the last two weeks lamenting in That whistling sound. Many of the comments about Neelie Kroes (context here) and open source are great examples of the reality distortion effect in Redmond, although as always there are good perspectives in all directions amidst the negativity and bitterness.

    Oh, and Microsoft and Yahoo! execs met; Slashdot discussed. flyingsquid’s summary:

    Cornelius, in the bank office, clutches the mortgage in his bony fingers, then twists his long, black moustache. He throws a chair across the office, laughing in triumph. But who is that figure silhouetted against the horizon? That handsome, broad-shouldered man wearing a white hat and riding a white stallion? The reflected sun shines from the gleaming sheriff’s badge on his chest, which reads, ‘Don’t be evil’. But can he possibly come soon enough to save the fair Miss Yahoo? Next week, the exciting finale!”

    We shall see.

  9. Microsoft’s behavior with OOXML is part of the “and so on…” in my original post, illustrating why I think regulators need to take such a deep look at the Microsoft/Yahoo! merger. The latest episode: an official protest from Steve Pepper about the Norweigan vote to approve.

    I am writing to you in my capacity as Chairman (of 13 years standing) of the Norwegian mirror committee to ISO/IEC JTC 1/SC 34. I wish to inform you of serious irregularities in connection with the Norwegian vote on ISO/IEC DIS 29500 (Office Open XML) and to lodge a formal protest.

    You will have been notified that Norway voted to approve OOXML in this ballot. This decision does not reflect the view of the vast majority of the Norwegian committee, 80% of which was against changing Norway’s vote from No with comments to Yes.

    The reports I’ve seen are that only two companies (including Microsoft) voted in favor of changing Norway’s vote to Yes, but that’s the decision that got reported to the ISO. Hmm.

    Glyn Moody’s Microsoft’s Great Besmirching in Linux Journal has an excellent wrapup of the issues around the world. Here’s the intro:

    I have been covering Microsoft for over 25 years – I’ve even written a few books about Windows. During that time, I’ve developed a certain respect for a company that just doesn’t give up, and whose ability to spin surpasses even that of politicians. To be sure, Microsoft has crossed the line several times, but it has always worked within the system, however much it has attempted to use it for its own ends. No more: in the course of trying to force OOXML through the ISO fast-track process, it has finally gone further and attacked the system itself; in the process it has destroyed the credibility of the ISO, with serious knock-on consequences for the whole concept of open standards.

    Of course, all companies try to bend the rules in the their favour, and it would be unfair to pick on Microsoft for doing the same. But what has happened over the last year and a half goes so far beyond the accepted rough and tumble of the standards game that cumulatively it can only be considered as an all-out attack on the machinery of standards-making. Consider the evidence.

  10. Microsoft’s April 26 deadline for Yahoo! to respond has passed; Yahoo! continues to believe they’re worth more. Wendy Tanaka surveys Microsoft’s options in Forbes, and thinks a proxy fight is most likely.

    Marc Andreessen thinks it’s a great deal for Microsoft, according to Mary Jane Irwin (also in Forbes). Marc’s also got a very detailed analysis on his blog of the scenarios if Microsoft goes hostile.

    On the other hand, Mary Jo Foley suggests that the opposition of most Microsoft employees is another reason to abandon the deal. She also quotes one of the several good responses on MiniMSFT to a comment I had made about how unlike their Redmond-based colleagues, Microsoft employees I’ve talked to in the Valley tend to favor the deal. As I said on Mini,

    She suggests “using a good part of that $40-odd billion to hire a SWAT team to help Windows Vista.” How forward-looking.

    Marc’s in the Valley; Mary Jo’s in Redmond. Just sayin’.

  11. Jessica Mintz reports in the Huffington Post that the Wall Street Journal says Microsoft will go hostile.

    It’s linked as a political story from Natasha Chart’s daily roundup on OpenLeft (where she comments “Google is fighting this in DC”) and near the top of the front page of HuffPo as I write this. There are still only 8 comments, one of which is me pointed them to MiniMSFT. A couple interesting ones: lookingahead’s

    Instead of going crazy over yahoo gives us back windows xp and put vista up your bum. Greedy people going crazy again just because you embarrassed yourself with ME don’t shove vista down our throats and take away a program that works. Leave Yahoo alone and work on bringing back the XP.

    and illustrating how the contentious Democratic primary is creeping into everything this year, Tathagat’s

    Obamamo above has said it… the press brief should read…. We are going Hi_Liary about Yahoo… Yahoo Media Portal and Election coverage is leaning on the right… loads of Fox videos and crazy female Rush Limbaugh…

  12. […] 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…, especially: If Microsoft acquires Yahoo!, it’s clearly #2 in a duopoly in search and in […]

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