Microsoft and Yahoo: Too Little, Too Late, and a Little Update

So the two gladiators, Microsoft and Yahoo, have finally stopped slugging it out and announced a ten-year search deal. And while the structure is interesting, with Microsoft providing the search back-end and Yahoo becoming the sales agent for the combined effort, you have to wonder if this is too little, too late.

According to a press releaseprepared statement, Microsoft CEO Steve Ballmer said:

“Through this agreement with Yahoo!, we will create more innovation in search, better value for advertisers and real consumer choice in a market currently dominated by a single company,” said Ballmer. “Success in search requires both innovation and scale. With our new Bing search platform, we’ve created breakthrough innovation and features. This agreement with Yahoo! will provide the scale we need to deliver even more rapid advances in relevancy and usefulness. Microsoft and Yahoo! know there’s so much more that search could be. This agreement gives us the scale and resources to create the future of search.”

But, honestly, it’s not about “consumer choice,” unless you take that to mean the choice to use something other than Google for a change. No, this is about market share, ego, and that perennial favorite topic, money.

The money immediately shows up in what Yahoo gets, which lets you understand why CEO Carol Bartz was able to swallow her ego and forgo the “who needs Microsoft” attitude:

• Yahoo gets 88 percent of search revenue in the first five years.
• Microsoft will guarantee search revenue baselines on a per-country basis for 18 months.
• Yahoo expects that, once up and running, the deal will add $500 million to annual operating income, reduce capital expenses by $200 million, and increase cash flow by $275 million.

Whew. If those estimates are right, and you always have to be leery of the starry-eyed expectations of CEOs on a roll, that could be a profit swing of $700 million annually. Given the company’s revenue in recent quarters, that could be roughly equivalent of adding a full 10 percent to the bottom line, which is major. Of course, that’s assuming that the $500 million number is actually additional. Given that Yahoo has had some degree of success, you might wonder whether part of that is revenue the company already sees. To paraphrase Mark Twain, there are lies, damned lies, statistics, and accounting.

So what does Microsoft get out of this?

• It pays a whole lot less than the $47.5 billion it offered to buy Yahoo last year.
• Microsoft gets to ride on Yahoo’s coattails when it comes to sales, so it’s no longer getting “leftover” money, so hopes for a more regular form of income.
• Offloading the ad sales work to Yahoo means that Microsoft can reduce expenses and headcount in its online division and possibly make it look like it’s profitable.
• The two companies together get to make the argument that advertisers have a better chance of getting ads clicked on than with Google.

The last point is the potential big one to make. Yes, when combined, the search business of Yahoo and Microsoft is still much smaller than Google’s But at the end of the fiscal period, the point is to make more money, because that’s the ultimate measure. Maybe Yahoo and Microsoft think that their combination would allow them to take a bigger chunk of profit than market share of the actual searches done. After all, advertisers want the greatest chance that ads will bring results. However, it’s not clear that the combined search ad businesses of Microsoft and Yahoo are any more of a competitor to Google than when taken separately. Now for the dangers to the participants that the deal represents:

1. False hope. Executives and employees might rah-rah themselves into seeing this as a way of tackling Google, but it’s not.
2. Distraction. If, indeed, the hope of Microsoft and Yahoo lies in getting Google out of the way, trying to take on the company is fine. However, what if search advertising is a profitable dead end? Instead of finding the next big thing, both companies are chasing a ten year old business model.
3. Wasting time. False hope and distraction are bad enough when things aren’t critical. But when a company such as Microsoft or Yahoo is now facing declining revenue and profit, no matter what the rationale, every moment spent strolling down the wrong path takes away from the time needed to craft a solution. Eventually they get the temporal equivalent of credit card poverty, where interest on the debt becomes so high that it’s virtually impossible to catch up and get ahead.

Yahoo and Microsoft Sitting in a Tree, K-i-s-s-i-n-g [David Weir, BNET Media]

Microsoft Wins, Yahoo Folds, Google Still Reigns in Search Game [Diane Mermigas, BNET Media]

Yahoo On Sunset Boulevard [Michael Hickins, BNET Technology]

[UPDATE: As I read the piece by my colleague, Michael Hickins, I suddenly wondered if we all weren't being a bit snookered by this deal. Although a number of commentators have sadly shaken their heads at the lack of upfront money to Yahoo and the potential for the company to be left with nothing if things go wrong, Bartz is no dummy. As I've always understood it, Yahoo's big claim to fame in advertising revenue has always been in display, which is explicitly left out of this deal. So maybe the big payoff is getting a return while unloading the expense of maintaining search and freeing itself up to focus on the big revenue driver.]

Image via Flickr user Caveman 92223, CC 2.0.