Microsoft's Colossal Strategic Mistake: "We Need to Be in Advertising"
We believe the Microsoft Yahoo (MSFT / YHOO) acquisition will be a disaster. So far, in support of this conclusion, we have cited integration, execution, and operational challenges. Now it's time to look at the bigger picture. The Yahoo acquisition is also cursed because it is predicated on a colossal strategic mistake: Microsoft's misguided conviction that needs to be in the advertising business.
Microsoft wants to buy Yahoo in part because it wants to develop a global "cloud computing" platform. This, at least, is smart. The business of installing and maintaining software on local servers and PCs is giving way to web-based apps served from data centers (cloud computing), and Microsoft, sensibly, doesn't want to miss that train. (See today's NYT article).
Cloud computing appears to be a classic disruptive technology, one that will likely end up maiming or killing incumbents like Microsoft. That said, buying Yahoo is not the cheapest or smartest way for Microsoft to break into the cloud computing game. More importantly, it also commits Microsoft even more deeply to a business--ad-supported Internet media--that it simply doesn't need to be in.
In short, the threat to Microsoft from Google et al is not "free software." Consumer software is going free, but Microsoft doesn't make much money from consumers. The threat to Microsoft is "cheaper corporate software." And that's where cloud computing comes in.
Microsoft's Misconception: "Cloud Computing" = Software Supported By Advertising
The problem is the way Microsoft has always framed the "cloud computing" transition:
- paid desktop software licenses giving way to
- free web-based software supported by advertising.
This framing is wrong. It has also led Microsoft to believe it has no choice but to compete with Google in search and to buy Yahoo, aQuantive, et al, to beef up its advertising platform.
A better way of thinking about the "cloud computing" transition, in our opinion, is:
- paid desktop licenses giving way to
- paid web-based licenses
In this framework, today's stark differentiation between the "Corporate" and "Consumer" markets doesn't change. "Advertising," moreover, has nothing to do with it--except on the Consumer side, which is far less important a market to Microsoft than it is to Google and Yahoo.
The Reality: Corporations Are Still Paying License Fees
Corporations are shifting to cloud-computing platforms--Software as a Service vendors like Salesforce.com and NetSuite, Google Apps, etc--but, for the most part, they are not shifting to "free software supported by advertising." On the contrary, they continue to pay fat, per-employee license fees. Even some corporations running Google Apps pay license fees. The fees are lower than the per-seat costs charged by Microsoft, but they're in the same same ballpark (according to the NYT, big companies pay about $75 per Office seat per year vs. $50 for Google Apps).
What hurts Microsoft in this market transition, in other words, is not the growth of free consumer-based software apps supported by advertising (these constitute only a small fraction of Microsoft's license revenue). Rather, it is the invasion of the corporate market by cloud-based app vendors like Google Apps, Yahoo's Zimbra, Salesforce.com--as well as non-Windows based PCs sold by Apple.
Microsoft desperately needs to get its own cloud-based Office business up and running before it loses more share to Google. (Office Live has been years in the making, and it still inferior to Google Apps.) But this doesn't mean that Microsoft has to buy Yahoo and become a titan of online advertising.
Put differently, the part of Google that threatens Microsoft's core Windows and Office business is Google Apps, not Google Search. If Microsoft buys Yahoo, it will get Zimbra (a company that sells free and paid email and office productivity apps that compete with Google Apps), but it will also get--and pay for--an $8 billion global advertising business that it doesn't need to be in. The distraction of integrating and running this business will make it less likely that Microsoft will successfully build out Office Live.
Conclusion
Back in 1995, Microsoft decided that it had to compete in the consumer Internet media business. This was a mistake then, and it's a mistake now--which is why Microsoft has struggled and failed to gain headway in that business for 13 years. Now, Microsoft has decided to double down on that business by buying Yahoo, in part because it believes its crown jewel, the corporate desktop software market, is transitioning to "software supported by advertising."
Corporate applications will never be supported by advertising, and if Google really wants to unseat Microsoft's Office monopoly, it will have to build up the same sort of corporate sales and service organization that Microsoft already has. Microsoft should stop trying to go into a business it doesn't have to be in--advertising-supported consumer media--and concentrate on protecting the core corporate business it already rules--by committing wholeheartedly to Office Live.
One big step toward doing this? Radically changing the Yahoo deal. Microsoft should merge its Internet advertising assets with Yahoo in a much smarter Yahoo transaction--and then invest $5 billion in building out a global cloud computing platform to support Office Live.
See Also:
Microsoft in Denial: Google Threat is Classic Disruption
Google Disrupting Microsoft, Part 2: Office-Free Offices
Why the Microsoft-Yahoo Deal Will Be a Disaster
The Current Microsoft-Yahoo Deal Won't Work: Here's a Better One
1) sit and wait for a promised offer from GOOG
2) pray that MSFT ups the ante
3) consider oft-discussed merger possibilities with EBAY or DIS
4) undertake a major strategy shift
Whatever direction, YHOO is still paying the price for pursuing a strategy 5 years ago that overlook e-commerce and technological innovation in lieu of building vehicles and chasing opptys for big rich brand advertisers to do display advertising.
As we know these forms of online ads have low impact (0.02% click-throughs) and are crude, blunt instruments. They only work with huge inventory.
But advertising will surely morph into a smorgasbord of sponsored web services, mashups for hire, affiliated networks, search-oriented lead generation, pay as you use online infrastructure, multimedia informercial snippets, and --most importantly -- more intelligent matching of a buyer's needs and a seller's outreach.
In this likely case, "never" does not compute. Already social graphs provided by Facebook, et al, show how users/workers can be better targeted by acceptable metadata sharing. It's the equivalent to controlled circulation economics, down to the audience of one.
In a matter of months or few short years, the cloud will permit much richer buyer-seller interactions, things we should not rightly call advertising. Users can get what they need to be more productive, at a price. Seler find direct lines to those ready to buy, for pennies per sale. It is semantic selling in one direction, and vendor relationship management, as Doc Searls says, in the other.
And this will be a productivity boon to B2B and B2C commerce. We will soon be able to grease the skids of automated matching of buying and selling, across nearly all goods and services.
Microsoft knows that if Google dominates this next phase of online commerce it will tank. Google is well on the way to allowing these functions. Neither buyers nor sellers will be able to resist.
So if you agree that cloud computing is different and disruptive, open up the concept of advertising up as well. Cloud computing fundamentally changes commerce right along with services acquisition. And we'll see all sorts of commerce permutation, from subscription, to license to "free" to ad-based, perhaps all at once.
Thanks, and love the blog, BTW.
I still don't think you'll see any form of advertising in web-based apps that corporations pay for. As a buyer, I would be outraged if I were shelling out $750 per seat per year (as with Salesforce.com, for example) only to see ads bundled in (however cleverly disguised).
It's possible that small businesses will elect not to pay subscriptions and have ads instead, but even this seems to me to be a stretch. We're happy using Google Docs and Spreadsheets but in large part that's because they're completely ad-free. If ads appeared, we'd probably go with the paid version for $50/seat or just get Microsoft Office for $300.
I think the next wave of corporate IT will be cloud-served web apps, which will deliver savings in terms of maintenance and annual subscriptions. But I still think the vast majority of corporations will elect to pay for them.
In enterprises, the use of ad-supported software -- especially when married with ad targeting -- is generally unacceptable, especially with the ability of the advertiser to discern who’s-who via the IP address. Imagine being the CIO at Coca Cola and having your employees see ads for PepsiCo products.
And it certainly appears that the next wave of computing and software support is quickly moving into the cloud, and many corporations are already expecting this migration to happen.
Good article, sir, and I enjoy your blog.
Here's an idea that I think makes infinitely more sense. Buy Salesforce.com (CRM). Even at its hyper inflated price right now (market cap of 6bn and PE of 530), and a 40% premium, Microsoft could easily buy Salesforce without taking on any debt or diluting its equity.
Salesforce is a company built on cloud computing service provided for a cost to businesses. Its recent initiatives to build a platform and a developer community around it for any type of web business services resembles the early days of Microsoft and Windows. This is exactly the DNA Microsoft needs to inject into itself through an acquisition.
The problem, from Ballmer's point of view: Google's on its way to locking up a monopoly in search advertising and perhaps other forms as well if the DoubleClick deal closes. If that happens, Google has unlimited cashflow to fund non-ad-supported hosted apps for corporations--the disruptive business you've blogged about. Ballmer's been here before, only he was on the good side last time. He knows how hard it can be competing against a monopoly.
So this is about spending $50B to fight Google on Google's turf.
In case you haven't noticed, try as it might, the world wants and has gotten a flexible, free, commodity based, virtual driven, customizable invisible operating system and it is not made by Microsoft. Even if Linux continues to trip over its disorganized shoelaces for another twenty years, the days of thinking the world wants to forever buy operating systems from Microsoft has long passed.
While I agree that the Yahoo purchase is a stupid idea, I also feel that Microsoft's salvation will be in advertising, like it or not.
In case you haven't noticed, try as it might, the world wants and has gotten a flexible, free, commodity based, virtual driven, customizable invisible operating system and it is not made by Microsoft. Even if Linux continues to trip over its disorganized shoelaces for another twenty years, the days of thinking the world wants to forever buy operating systems from Microsoft has long passed.
While I agree that the Yahoo purchase is a stupid idea, I also feel that Microsoft's salvation will be in advertising, like it or not.