Analysis: Microsoft could stumble in quest for ad speed

Merger challenges could undo the benefits of the deal

Microsoft executives said very little on Friday about the undeniable challenges of integrating the company's internet division with Yahoo, largely avoiding the proverbial elephant in the room that could delay or, in some cases, eliminate benefits of the deal.

At the heart of the acquisition is Microsoft's goal of giving its online advertising and online services business a major boost, ending years of business and technology defeats at the hands of common rival Google.

Specifically, Microsoft wants to make sure that, as online ad spending doubles to about US$80 billion in the next three years, it will be in a much better position to grab a larger piece of the market, specifically in sponsored search, which is the biggest online ad segment and where Google dominates.

As CEO Steve Ballmer, President of Platforms & Services Division Kevin Johnson and Chief Software Architect Ray Ozzie said repeatedly during the news conference announcing the bid, Microsoft wants to swallow Yahoo to accelerate its pace in online advertising. With Yahoo's online services, engineers and ad platforms, Microsoft hopes to become a stronger competitor to Google than it is today.

That all sounds fine in theory, but Ballmer and his colleagues said little about the energy and know-how they will need to make this proposed $44.6 billion (NZ$56 billion) acquisition work, considering that the companies have a significant overlap in online services, markedly different cultures and an abundance of inflated professional egos at every level.

Not to mention that Yahoo these days is far from functioning as a well-oiled machine. Yahoo has been in significant turmoil for more than a year. Seasoned executives who are experts on its business have struggled and largely failed to restore the company's technical edge and business focus. That's a mess that Microsoft will inherit and will have to solve in order for the deal to work its expected magic.

In short, Microsoft must make sure that, in its quest for scale and speed, it doesn't end up getting stuck, its wheels spinning, trying to mesh Yahoo with MSN, while Google speeds further ahead. It's clear that to take advantage of the online ad growth, companies will need to innovate and change quickly, and not be sidetracked by acquisition distractions.

Among the many emerging opportunities in online advertising are: the mobile sector, which is expected to go from almost nonexistent to vibrant in the coming years; social web properties, such as social networks, blogs and social news sites, which haven't been monetised properly and hold great promise; and video, both in the form of video ads and ads in videos.

There were indications during Friday's news conference that Microsoft may not have taken the time to fully assess the magnitude of the integration complications. Despite Ballmer's assurances that he personally has thought "long and hard" about the Yahoo acquisition, there is evidently a level of urgency about the move, or else the deal wouldn't have been an unsolicited offer, as Yahoo has portrayed it.

If, as Ballmer indicated, the companies have been in on-and-off talks for about 18 months about a possible acquisition, it's fair to ask -- as a financial analyst did -- why they couldn't sit down privately and present, jointly, a more cooked deal. Basically, Ballmer admitted that Google keeps expanding its empire and time is of the essence.

"Any large integration process has risks associated with it. We've all thought about it. We could have hired [more] engineers, but at the same time the market continues to grow and the leader continues to consolidate positions and there's nothing quite like putting together two larger sophisticated R&D organizations," Ballmer said.

Along with the inherent opportunity to sell more ads, Nick Patience, managing analyst at The 451 Group, also sees a "potential integration headache" with having to integrate Microsoft's ad platforms -- AdCenter and aQuantive -- with Yahoo's. Patience is also skeptical about the possibility of merging search indexes, and believes that the search engines will most likely have to continue to operate independently. Overall, the integration work would represent for Microsoft "a step into the unknown," particularly since this would be by far the largest acquisition in Microsoft's history, Patience said.

Gartner analyst Allen Weiner also sees potential integration challenges, particularly because he doesn't think either organisation has a powerful leader who can take the reins of the combined entity and lead it into the future. "They need someone like a Steve Jobs or a Bill Gates that has the charisma, vision, technical knowledge and consumer knowledge to lead," Weiner said.

On paper the acquisition has interesting potential, but it will all come down to how the integration is carried out, Weiner said. "It's all about the execution," he said. "The devil is in the details."

Despite numerous acquisitions over the past few years in advertising and Web 2.0 technologies, Yahoo has struggled to jump-start its business, said JupiterResearch analyst Michael Gartenberg. "At the end of the day, it hasn't all worked out for them," he said.

While Microsoft executives are stressing that a deal with Yahoo would give it the scale to compete with Google, wrapping the two companies' diverse technologies together won't be simple, Gartenberg said. "In order to get to that scale, you've got to be able to fit all those pieces and parts together," he said.

Despite the integration concerns, Microsoft has good processes in place for managing acquisitions of large companies, said Gartner analyst Mike McGuire. However, it will be key for Microsoft to quickly put a senior management team in place, as Google will continue to propel ahead as Microsoft sorts out the details. "They are going to have to start showing some traction, or at least a really solid vision for how they will combine the companies ... early on," McGuire said.

Matt Booth, a Kelsey Group analyst, thinks that the integration challenges will be major, but predicts that Microsoft will work through them methodically, starting on the back end and linking services in a way that, as much as possible, is transparent to end-users, be they advertisers, publishers or consumers. For services that are just too difficult to integrate, they will likely be kept separate. The last thing Microsoft wants to do is drive users away, Booth said.

In a research note, Citigroup financial analyst Mark Mahaney said he is skeptical that a combined Microsoft-Yahoo would improve its search products enough to affect Google's position, since they both have been losing search market share and, in his opinion, seeing a decrease in their search innovation.

"Given what would surely be immense integration challenges, it’s hard for us to see how a Microsoft-Yahoo combination would create a greater technology competitor to Google at least for the foreseeable future," he wrote.

"We could see a scenario by which Google would actually gain more market share due to industry uncertainty over the integration of the deal," Mahaney added.

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