Microsoft + Yahoo = Microhoo: Can it beat Google?

Microsoft announced on Friday that it would offer $44.6 billion for Yahoo, the ailing search giant. The offer of $31 a share represents a 62 percent premium to Thursday's closing share price. Yahoo shareholders could elect to receive either cash or stock. Microsoft's announcement was unsolicited and its premium unusually high, marking it as an aggressive bid that could turn hostile - a classic case of a buyer overbidding to keep any potential competitors out of the race.

There are four central ideas that surround this deal -

1) Search engines are crucial tools because they have become a central hub in hugely profitable ad networks. Advertisers around the world are expected to double their spending on the Internet during the next three years as more people get their news and entertainment on the Web instead of television, radio, newspapers and magazines.

The trend is expected to create an $80 billion online ad market in 2010, up from an estimated $40 billion last year.  Google already controls 58-62 percent of the worldwide search market, and has been widening its lead. By combining, Microsoft and Yahoo would have a 16 percent share of the worldwide search market.

To put that in perspective, if the deal goes through, the No. 2 and No. 3 companies would merge to create a larger No. 2 that's still only about half the size of Google in terms of search. Google's dominance in search, its soaring overall traffic, its incredibly efficient ad service and its acquisition of online advertising company DoubleClick has created an entity that either Microsoft or Yahoo couldn’t tackle alone.

 
2) At first glance, Microsoft's proposed acquisition of Yahoo for $46.6 billion is only about growing its consumer advertising and portal business to better compete with Google. However, another piece is also how the acquisition would help Microsoft execute its software-plus-services strategy for delivering business apps over the Internet faster and better – a strategy that would at least allow Microsoft compete with Google's own business-apps initiative.

Google Applications (pure web-based apps) might pose a real threat to Microsoft Office in the long-term and Microsoft needed to accelerate its move in online services (where Yahoo’s engineers would play a pivotal role) to prevent this or atleast have a defense to protect its turf.

 
3) The common wisdom is that neither Microsoft nor Yahoo is a real force in social networking. Both companies own multiple social media properties, and the only resounding success among them is Yahoo's Flickr (and Microsoft’s foothold in Facebook).

Social networking, in addition, will be a tasty slice of the Web for a hypothetical Microsoft-Yahoo because it's also one of the few niches of the Web on which Google doesn't already have a stranglehold. Its OpenSocial developer initiative isn't ready yet and its Orkut social network has only gained traction in a few regions of the globe. Yahoo and Microsoft have a huge asset in e-mail address books and instant-messaging buddy lists, which are essentially a social graph – a critical success factor in the Social Networking world.

 
4) Culture – which is totally different between Microsoft and Yahoo. Most experts claim that for any acquisition to be successful, there needs to be a cultural fit between the two companies – and majority of acquisitions fail due to this precise reason. Time Warner – AOL is a typical case in point. Microsoft being the uptight, blazer-tie, essential product based company and Yahoo being the outgoing, cool, web-based company. Opposites attract, but not in mergers definitely.

If Microsoft dreams of achieving its stated target of $1 billion savings after acquisition, the way it is going to handle the clash of cultures is going to be critically important.

 
There is, however, no guarantee that Yahoo would be willing to sell to Microsoft. What would Yahoo exactly derive out of this deal except for the premium it is about to receive on its depressed stock? It doesn’t help their brand (Microsoft is bound to kill it somewhere down the line), it doesn’t give better access to search technology (Yahoo’s is already better than Microsoft’s), it doesn’t give them access to better online advertising sales force – so why would Yahoo sell itself to Microsoft?

On the other hand, Yahoo has a ton of interesting web properties like groups, finance etc. which Microsoft can only dream of. A better fit in terms of content advertising, value-add and culture would be NewsCorp (the media behemoth, owner of MySpace), which I think personally would be the white knight in this deal.

The anti-trust departments in U.S and Europe claimed that they would look at the deal closely. However, given Google’s dominance in the search market – the deal might be given a go-ahead in the next six months after the usual talk and furor over competitive and regulatory issues. The only issue that might cause delay is that Microsoft and Yahoo combined would be cornering 95% of the email market, which flies directly in the face of anti-trust issues.

Watch out for the privacy groups too which might oppose the deal in a big way. This acquisition, if it goes through is going to take atleast a year to materialize.

However, one thing struck me as most poignant: in many ways, Microsoft has become exactly what Bill Gates used to fear the most — sluggish, bureaucratic, slow to respond to new forms of competition — just as IBM was when Microsoft began its ascendence. A typical case of Déjà vu – Google’s ascending and Microsoft is clearly struggling to come to terms with it.