Microsoft vs. Yahoo: What About the Customers?

Since I was flat on my back in the hospital when the Microsoft move on Yahoo kicked off, I'm a bit behind on this one. With the Yahoo board voting over the weekend to fight the takeover attempt, now is a good point to think about the value proposition or lack thereof.

The VC Angle

Before getting to the bigger picture, I've gotten some queries about my take on the effect of the transaction - if consummated - on the venture capital climate. I score it a wash. In the short run, it would remove one large M&A player from the Valley / 'Web 2.0' scenes. However, Yahoo has really never been that acquisitive, so it would just narrow the list a bit when seeking an exit on compatible ventures. In the long run, almost any large merger can be expected to shake out executive and engineering talent, given time, frustration, and the expiration of stock options. When they leave, the startup-minded Yahoos will carry with them some hard won wisdom on what real users are actually doing out there on the net, and it's talent and experience that drive the venture cycle.

Qui Bono?

Yahoo has three constituencies that can be considered customers in some sense:

1. End users. While few of them are making direct payments for the services used, it's the users that make the whole game work. As I have cynically noted before, both the Yahoo and Microsoft Web constellations are largely destination sites now, having lost most of the search audience to you-know-who. What do they come for? Yahoo's core audience is still largely built around its community and communications functions - groups, mail, messaging and now Flickr.


2. Advertisers. The monetization comes from advertisers, who are there only because of the end users. If there isn't some distinguishing value to Yahoo or Live as an advertising venue vs. Google, they likely have a mild bias towards having fewer players and greater simpliciity.


3. Developers, including merchants. I'm putting them into the same bag because both increase Yahoo's value by building on some portion of its platform.

If a MSFT / YHOO transaction is to create lasting value, it should have solid benefits for at least one of those customer classes. I know the i-bankers are talking about all the expense savings to be found. But in a market as fickle as the Internet, if that's all you've got going, you might as well write 'wasting asset' and move onward. So where might such customer benefits be found?

The Wrong Way

Microsoft's knee-jerk strategy is often to push everything onto its own development platforms, and attempt to proliferate those platforms everywhere. This pattern has been partly responsible for repeated losses in the online arena, all the way back to the propriety MSN of the mid-90s. Of the open Web Services offerings out there now, it's Live that insists on the use of Microsoft tools, while others give support to approaches and tools such as REST, JSON, Eclipse. Trying to cram Yahoo into the Microsoft technology straightjacket would have few customer benefits. Many of the odd bits of Yahoo code and interface exist due to architectural or security holes or slow implementation of Microsoft products in the first place.

A Better Way

If there's a benefit to be found, it may be in clarifying and improving things for the advertisers. Doing so doesn't necessarily mean a head-to-head slugfest with Google. If Yahoo and Microsoft are now largely destination sites, they might move to create a critical mass in this type of advertising and offer targeting differentiated from what is possible with search based ads. That would require alliances with other destination sites, as well as some fundamental work in how best to reach users when they are engaged in topically or community based activities, as versus focused search. Ever more intrusive banners, vids, interstitials and the like have quickly turned from novelty to annoyance. At the worst, they can build an uber-market for destination site placements. At the best, they might figure out the browse-side equivalent to what Google has done with algorithms on the search side.

The Basic Problem

That's a nice fantasy, but color me skeptical. Look, Yahoo's in this position for one fundamental reason: They are too slow. They couldn't build a decent search fast enough, so they outsourced it, and look what happened. They decided they needed an advertising engine, went out and bought one, found out it was a clunker, and then took too long to rebuild it into Panama. Yahoo has had years of experience with numerous, vibrant online communities build around its rather minimalist offerings, and yet has repeatedly let others beat it to defining and leveraging new social features like photo sharing and friends lists. The company spent too long staring into the content sun, and let other nerves atrophy. I had hoped to hear some crisp strategy points from Jerry Yang at the end of January, to rationalize the headcount butcher's bill and signal the end of the peanut butter era. I'd still like to hear that, but the burden of proof is very much on the company.

Will a merger with Microsoft help the basic problem of the too-long decision loop? Give me a break. As Henry Blodget points out, the immediate effect of a deal will be to freeze the companies for a year or so. Then we get to enroll the remains of Yahoo in Microsoft's decision process. And for that, I have one word: Vista. Microsoft's culture is the very antithesis of the nimble, market responsive type of behavior needed to revitalize the Yahoo franchises. (Update: Here's a nice analysis that supports this point.)

Microsoft At Risk

This is not a trivial deal for Microsoft. The original bid would consume all of MSFT's $21 billion cash pile, and require going to the debt markets for about as much. That's likely to increase in order to close a transaction. In additional to the balance sheet implications, there are also significant opportunity costs in terms of the company's focus. Again as Blodget details, Microsoft is competing with everyone from SAP to Nintendo. Very few companies can manage that wide a battlefront successfully. The core Windows and Office franchises are now under greater threat than in many years. Vista is a mixed success at best. More pointedly, the whole virtualization phenomenon is a dire threat to the one-box/one-install model that still lurks at the core of Microsoft's business model (something I've only fully appreciated since a short project late last year). Can Microsoft have its best talents wrapped up in reworking Yahoo and Live when that battle's just being engaged?

Over To You, Jerry

Yahoo is in this mess due to its own failings. It's incumbent on management to offer some clear way ahead to restore shareholder value. If it's not forthcoming, tired investors in YHOO will be justified in selling their shares to Microsoft. The result will be a disaster to both companies and their customers.