The Yahoo-Microsoft Saga

Microsoft’s decision to drop its bid for Yahoo illustrates how a breakdown in negotiations can have potentially profound repercussions on the paid search ecosystem. The current chapter of this saga also provides some interesting insights into the management teams and strategies of both Yahoo and Microsoft.

While this week’s news may only be a chapter in the story of the number two and number three search engines, the saga has included so many twists and turns that it begs for a bit of review, analysis, and postulation.

Yahoo rejected an offer of over $47 billion. Based on comScore’s latest numbers, Yahoo has 139.5 million unique visitors a month in display and search combined. Those visitors doing the searching generate 2.39 billion searches. If I’ve done my math right, Microsoft was willing to pay approximately $337 per unique visitor. Imagine what kinds of interesting promotions could be devised and deployed to acquire and retain visitors at a value of over $300. Given the typical power distribution curve, it gets even more exiting if you imagine that a power searcher and heavy Internet surfer is probably worth more than $1,000 because she’s three times more active.

A fascinating part of the saga thus far was Steve Ballmer’s offer retraction letter. It may go down in history as one of the best-crafted business letters ever. I marvel at how it accomplishes much more than simply letting Yahoo know that Microsoft isn’t interested in upping the final offer put on the table.

In the letter, Microsoft illustrates that steps Yahoo had already initiated essentially poisoned the company’s worth to Microsoft but were also potentially poor management decisions. The letter speaks to each of the following potential constituencies: Microsoft shareholders, Yahoo shareholders, the press, government regulators, Yahoo’s staff, Microsoft’s staff, and marketers. It read in part (interspersed with my comments):

We regard with particular concern your apparent planning to respond to a “hostile” bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo! today. In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo! undesirable to us for a number of reasons:

First, it would fundamentally undermine Yahoo!’s own strategy and long-term viability by encouraging advertisers to use Google as opposed to your Panama paid search system. This would also fragment your search advertising and display advertising strategies and the ecosystem surrounding them. This would undermine the reliance on your display advertising business to fuel future growth.

This is a direct dig at Jerry Yang and management for engaging in a strategy that would decouple search from display. I’ve discussed before the importance of behavioral retargeting of searchers and the ability to build voluntary profiles for the users of a search engine against which to serve hyper-relevant display advertising. Clearly this is a major Microsoft strategy. Microsoft is aware that Yahoo shares (or shared) a road map that includes our ability as advertisers to buy display inventory that offered search as a targeting parameter. Yahoo already has Smart Ads and would need to retain the ability to target searchers even when not selling the search advertising. It would seem that Microsoft thinks that display media sales are best made on a unified basis along with search traffic.

Given this, it would impair Yahoo’s ability to retain the talented engineers working on advertising systems that are important to our interest in a combination of our companies.

This one is my favorite, because in 28 words it both provides an open invitation to any engineers who might want to come over to Microsoft and lays a foundation for retention of key engineering talent should Microsoft ever want to reopen negotiations and take over Yahoo after all.

In addition, it would raise a host of regulatory and legal problems that no acquirer, including Microsoft, would want to inherit. Among other things, this would consolidate market share with the already-dominant paid search provider in a manner that would reduce competition and choice in the marketplace.

This would also effectively enable Google to set the prices for key search terms on both their and your search platforms and, in the process, raise prices charged to advertisers on Yahoo. In addition to whatever resulting legal problems, this seems unwise from a business perspective unless in fact one simply wishes to use this as a vehicle to exit the paid search business in favor of Google.

This is an invitation to government regulators to look into the Yahoo-Google relationship as well as question the wisdom of Yahoo exiting the search business. It’s also a dig at the fact that Yahoo would even consider exiting the search business.

It could foreclose any chance of a combination with any other search provider that is not already relying on Google’s search services.

And the nail in the coffin that a Google relationship represents is that it removes any incentive for Microsoft (or any other search provider, as if there are any others) to partner with or acquire Yahoo.

While it’s hard to imagine Microsoft changing its mind and coming back to the table, it’s entirely possible and Microsoft can be patient. Some investors even think Microsoft will return to the table soon, a hope that may be propping up Yahoo’s stock.

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