Rationale And Challenges Behind Microsoft's Bid For Yahoo

The rational behind Microsoft’s bid for Yahoo

1) Compete with Google

Microsoft has recently invested heavily in honing its own search engine and advertising technology, but neither it nor Yahoo have helped close the gap with Google, which dominates Microsoft and Yahoo in U.S. search queries and related advertising revenue. As the Google continues to consolidate its position in the growing market, Microsoft needed a big move to try to catch up in the online business.

Microsoft’s acquisition bid for Yahoo is aimed to create a more credible competitor to Google, to deepen Microsoft's position in the market for online business software, and to grab the growth opportunity of booming online advertising market, which is forecasted to double from US$ 40 billion in 2007 to nearly US$ 80 billion in 2010.

The combined company would increase the competition in the market place, which should bring down the price of online advertising and improve the customer and user experience. The vast majority of Google's net income comes from online advertising. An entry by a combined Microsoft and Yahoo into this market could hit Google hard.

The combination will allow Microsoft to leverage its control of IE, the operating system and its enterprise software to build a more intelligently combined desktop and online computing experience that will leave Google playing catch up. Although Google is extremely powerful in online advertising and is a famous provider of some online services (GMail and youtube), Google's reach is currently limited to the internet. A combined Microsoft and Yahoo would be a significant second player in online advertising as well as the dominant player on the desktop and within the enterprise.

The Google challenge to Microsoft extends beyond online search and advertising. Google is at the forefront of companies offering software as online services, including Web-based alternatives to Microsoft’s lucrative desktop products like word processing, spreadsheets and presentation programs. This is providing Microsoft with something it hasn't had to worry about for a number of years, office suite competition. The acquisition of Yahoo will allow Microsoft to extend its desktop office suite and desktop OS monopoly to the online office suite market as well. The combined company could offer an online service like Google docs but to access it consumers need to buy MS Office and install it on a Windows PC. By using proprietary file formats like OOXML as implemented in MS Office, only the Yahoo online service will be compatible with MS Office's proprietary formats. With a Yahoo monopoly on online office suites, Microsoft, by data mining the office documents in Yahoo's online data, will be able to capture a significant market share of the online office suite and search engine market and eliminate Google docs from the competition.

2) Create massive reach

Many of Microsoft and Yahoo's businesses would benefit from greater scale. The companies already have instant messaging that is interoperable, but a single product would doubtlessly be more attractive. The increased scale of the combined search entity would lead to improved monetization due to a number of advertisers, which positively impact coverage, click-through rates, and pricing. Microsoft's command of access points through Windows, Xbox, and Internet Explorer would enable it channel yet more search.

The combined larger subscriber base of Microsoft and Yahoo will see a major change in the online advertising industry. One of the strengths they both had against Google was that they had a lot of demographic data about their end users. Google might have the biggest end user base, but not the biggest subscriber base. With MSN/Yahoo together, they should be able to offer demographic targeting to advertisers that will far surpass what Google is testing.

Both companies have been invested heavily to scale their online business. Yahoo has built its own 140,000-square-foot facility in Quincy, Wash., right down the road from one of Microsoft's main data centers and is reportedly building others in such far-slung places as Switzerland. These physical assets should provide Microsoft with new horsepower to scale services for consumers and businesses alike.

Furthermore, the combined company will have a much stronger content network with Yahoo's existing sites and MSN's new partnership with the Wall Street Journal Digital network.

3) Leverage strengths at both companies

The two companies tend to be strong in different regions. In Europe, for example, Yahoo tends to be weaker and Microsoft stronger. In the U.S., the two companies tend to attract different audiences with their mail products--Yahoo Mail appealing to younger and more savvy users, while Windows Live Hotmail has strong roots as an e-mail service for non-techies.

A few of Yahoo's popular services fill niches where Microsoft is either unpopular or doesn't have competing services, especially in the social realm with sites like Flickr and Del.icio.us, as well as popular investor site Yahoo Finance. The combination will allow Microsoft to bring Internet experiences into Office and Windows. The possibilities are numerous, including a combined Yahoo-Microsoft instant messaging client included with Windows, a Windows Live suite that includes photo sharing through Windows Live Photo Gallery but with the social networking aspect of Flickr, and the addition of Yahoo's small business online store services to Office Live.

The integration faces significant challenges

1) Incompatible technology

Microsoft’s intention of using Yahoo to create a broad advertising and services platform as a foundation for its online activities involves tremendous technological complexities. Yahoo is a mixed bag of technology with a large proportion of its systems running open source or Unix software. Microsoft is, of course, mostly a Microsoft shop. The two companies' data centers reside on drastically different infrastructures,