MSFT-YHOO: Why this deal makes sense for Microsoft

As Microsoft and Yahoo! continue to entertain us with what is becoming great high theatre, we’ve been hearing a couple of themes repeated over and over by the bloggers and journalists.  First, that this acquisition is some kind of desperate act by Steve Ballmer and Microsoft, a last gasp effort to catch the mighty Google before Microsoft melts away.  And then there’s the assertion that Microsoft is so far behind in advertising that it must resort to such desperate moves, that the whole endeavor is basically beyond hope, and that Microsoft should have never gotten into the advertising business in the first place.

Microsoft is setting exactly that trap in order to pull off an acquisition that will greatly enhance its position.  Microsoft wants to be seen here as the great underdog.  It wants the Justice Department and the EU think that it is far behind in advertising, and that search share equals advertising potential.  However, as a new report by IDC (U.S. Internet Advertising Grew by 27% to $25.5 billion in 2007, According to IDC – Google Loses Market Share for First Time in Two Years) points out, the far more significant numbers show Microsoft, especially with the addition of Yahoo!, to be in a much better position than most of the TechMeme top 100 would lead you to believe.

According to IDC, a MSFT-YHOO combination would put Microsoft at some 17% of online advertising, to Google’s falling 23%.  That’s not text based search ads, that’s all online advertising, which is what Microsoft is after, and which, by the way, is growing at its fastest pace ever.  It’s why MSN makes sense, it’s why adCenter makes sense, it’s why acquiring Yahoo! portals makes sense, and it’s why acquiring all the eyeballs that a combined Hotmail/Yahoo! Mail and IM merger bring to that advertising platform makes game changing sense.

A Yahoo! acquisition puts Microsoft in a strongly dominant position in mail and IM, where Google has been making inroads but would be far behind the combination of Microsoft and Yahoo!.  Mail and IM are important because they are sticky.  Search isn’t sticky.  There’s nothing to keep you from switching search providers if you find something better.  However mail and messenger are different stories.  Changing email addresses is a pain.  Being on an IM service where your friends aren’t just doesn’t make sense.  And when online advertising really starts to take off, then a huge numbers advantage with an audience that’s not going anywhere, with built in demographics information, becomes, well, a huge advantage.

Google, on the other hand, while it is the far and away leader in text based search advertising, really has no where else to go.  While Gmail has done well, with about 60 million mail users (to something over 10 times that for a combined Microsoft – Yahoo!), and Google Apps is a good idea and may actually be the way we do things in the future, the numbers using Google Apps now are laughably small.  Google has nothing to bridge the gap between the time when Microsoft’s search begins to really catch up in relevance and users (a gap possibly narrowed with a Live Search – Yahoo! combination), and that time in the hazy future where Google Apps has taken down the mighty Office ogre.  That clean white screen brought Google lots of users but there is no other compelling reason to use it other than search. Google has no way to attract eyeballs to rich online advertising.  Yes, there’s YouTube, and significant inroads into China (in the same old text based search advertising), and mobile, but Microsoft isn’t giving up in mobile, either.  Microsoft + Yahoo! could change the game quickly in a quickly changing space.

And then there’s cloud computing.  I swear, sometimes I think that people think that “the cloud” really exists in some kind of cloud, that you can store all this Web 2.0 goodness “up there” somewhere.  The cloud, however, requires massive investment in data centers.  The storage required for Flickr or for Office Live Workspaces is miniscule compared to what is coming, and that is going to require not only investment, but engineering expertise in how to build and maintain massive data centers.  Microsoft has been building data centers as fast as it can, and so has Yahoo!.  A combined Microsoft – Yahoo! effort there will greatly enhance Microsoft’s position.

So, for a mere 40 some billion dollars, Microsoft is instantly only percentage points behind Google in total online advertising, has leapt well ahead in mail and IM, combines MSN and Yahoo! portals to provide a compelling reason to view all the new rich ads that are rapidly heading online and away from television and print, gets a great jump start on data centers, and causes a hell of a stir all at the same time.  This deal is a no-brainer, and we get to watch a hostile takeover, too.  Doesn’t get much better than that.