The lowdown on Microsoft's Yahoo offer

Linda Rosencrance answers some frequently-asked questions

Does a Microsoft-Yahoo deal make sense? Probably. As separate companies, Microsoft and Yahoo duplicate systems and staff. Microsoft CEO Steve Ballmer said a merger could save US$1 billion (NZ$1.26 billion) annually. According to industry observers, the time is right because Yahoo's stock is down, and the company hasn't improved its results even after co-founder Jerry Yang took over as CEO in the middle of last year. Plus, Microsoft's offer, initially 62% over Yahoo's share price, is a very good deal for Yahoo shareholders.

In most areas, a Microsoft-Yahoo merger would be good for both companies. For example, in display ads, adding Microsoft's share would only improve Yahoo's position as the market leader. And because Yahoo is already a powerhouse in mobile technology, adding Microsoft's advertising assets and mobile technology would help the combined company battle Google for the leadership position.

Market research firm IDC says Microsoft, with access to Yahoo's search tools and talent, could buttress its play in the mobile space with respect to search, location-based services and advertising -- three key revenue growth areas of the future. And, IDC says, acquiring Yahoo would allow Microsoft to move enterprise technology to the mass market.

However, not even a combined Microsoft-Yahoo could challenge Google in video advertising, where YouTube is the overwhelming leader.

"This acquisition gives [Microsoft] the opportunity to create a 'consumer' sub-brand," according to IDC. "By sub-branding their SaaS activities, Microsoft can protect their fee-based software licence business while aggressively driving growth in the consumer space."

Will the Microsoft-Yahoo deal work or will it be a disaster? For one thing, merging two giant companies is very difficult. Look at US Airways and America West, Vodafone and Mannesmann AG, America Online and Time Warner, Pfizer and Warner-Lambert, and Glaxo Wellcome and SmithKline Beecham.

Imagine trying to merge the cultures of Microsoft and Yahoo, as well as the technologies. Silicon Alley Insider founder Henry Blodget gives some reasons why the deal will be a "disaster".

According to Blodget's website, it will take a year from the time Yahoo agrees to the deal for the transaction to be finalised. During that time, innovation at both companies will be stifled because developers probably won't want to launch new products when they could be about to lose their jobs. Yahoo/Microsoft employees will be wondering if they'll have jobs, and if they do, they'll be trying to figure out where their loyalties lie. Meanwhile, "Google will be steaming full speed ahead", Blodget says.

In addition, Blodget says the internet division at Microsoft will always take a "back seat" to the Windows/Office division. While Google wants to use the internet to build out its business, Microsoft wants to use it to protect its Windows and Office business, he says. "If Microsoft wants a combined Yahoo-MSN to succeed, it has to give it the freedom to destroy Windows and Office," he says. "As long as the entity is under the same corporate roof as Windows and Office, this will never happen."

Also, Blodget says, Microsoft is already doing too many things. Once the deal goes through, Microsoft will be competing with companies like IBM, Oracle, SAP, Salesforce.com and many other software-as-a-service providers in enterprise software. In addition, it will compete with Apple, Sony, Nintendo and others in consumer gadgets, gaming and PC platforms; and Google, Time Warner, Comcast, AT&T, and others in media, advertising and technology.

And because each of these businesses requires different skills, relationships, strategies and expertise, Microsoft will have a hard time winning in all those areas, he says.

"Google is indeed a threat to Microsoft, but so are Oracle, Apple, IBM, RIM and a host of other companies," Blodget says.

How will a combined Microsoft-Yahoo affect users? At some point, you'll probably see some glitches if Microsoft merges MSN and Yahoo, Live Search and Yahoo Search, Hotmail and Yahoo Mail, as well as the two instant messaging services.

And, experts say, as Google and Microsoft get more competitive over ads, you'll see new kinds of ads, including mobile ads. And because both companies want your traffic, they might not be above engaging in dirty tricks to get it. In fact, some observers are worried that a combined Microsoft-Yahoo would divert users searching the web to its own pages rather than the pages that have the most relevant information.

Privacy groups have vowed to fight the deal, saying it would raise serious privacy issues. Their concerns centre on the possibility of vast amounts of consumer tracking information being consolidated in the hands of a single vendor.

They claim that the proposed acquisition would only intensify the practice of tracking the online activities and behavior of internet users in order to serve up highly targeted ads to them.

Some industry experts say a combined Microsoft-Yahoo would be good for competition because Google has such control over the online advertising market. They say the deal would create a competitor strong enough to challenge Google, not only in search and online advertising, but in online services and software as well.

Could this deal be good for Google? While Google might not think so, some analysts disagree. For instance, while Microsoft and Yahoo are trying to deal with integrating the two companies, Google will continue to innovate and possibly come up with new technologies such as improved ad formats. And that's an incentive for advertisers to stick with Google.

Can a combined Microsoft-Yahoo beat Google at its own game? That's the approximately US$41 billion question — originally the US$44.6 billion question, but Microsoft's stock has gone down a bit since it made its initial offer.

Although the combined company will be in a better position to gain ground on Google, there's really no guarantee. More users go to Google for their web searches than to either Microsoft's or Yahoo's search engines, according to Nielsen//NetRatings. To attract more advertisers, a combined Microsoft-Yahoo would have to capture more of those online users. But that won't be easy because Google has more than a 60% share of search in the US, and it's hard to get users to change their preferences.

Is Google scared? Well, the search company is making a lot of noise about the deal. Just recently Google CEO Eric Schmidt said he was concerned that there were things Microsoft could do that would be "bad" for the internet, such as disrupting the free flow of information.

Google says a combined Microsoft-Yahoo could exert "the same sort of inappropriate and illegal influence of the internet that it did with the PC". Google is particularly worried that the combined company could have a monopoly in instant messaging, web email and portals.

In not so many words, analysts say it's like the pot calling the kettle black, because Google nearly has a monopoly on search and online advertising.

Any chance Microsoft will increase its offer? According to analysts, the bullish financial projections Yahoo recently released could lead Microsoft to raise its original US$44.6 billion offer. Recently, a Citigroup analyst said it was likely that Microsoft would offer more.

That was probably the reason Yahoo detailed its three-year financial plan and said it expects to double operating cash flow from US$1.9 billion to US$3.7 billion and generate US$8.8 billion in revenue, excluding traffic acquisition costs by 2010, an annual growth rate of 25% in 2009 and 2010.

"We believe that the Microsoft-Yahoo deal [will ultimately] go through, and that [Yahoo's] argument could push Microsoft to sweeten its bid to avoid a hostile takeover, which may alienate Yahoo employees," said RBC analyst Ross Sandler in a research note issued the day Yahoo released its financial plan.

So it the deal goes through, what would the new company be called? The most commonly cited name is Microhoo, but other monikers for the new company, including Yicrosoft, Yasoft, Yahoosoft and Yahmicrohoosoft. Others say it's unlikely that Microsoft would wipe out the Yahoo name.

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