Computing the future for Yahoo and Microsoft

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Analysts on Friday struggled to find the right search query to answer why Microsoft would seek a merger with Yahoo.

Charlene Li, internet analyst with Forrester Research, summed up the scepticism of many observers in a blog note: “Why Microsoft + Yahoo makes sense – and why it won’t work.”

In its favour, a deal would combine two of the largest online audiences. According to comScore, Google has 528m unique users globally, compared with 527m for Microsoft and 478m for Yahoo. Stripping out the duplicated audience, that would give Microsoft/Yahoo 634m users.

Yahoo and Microsoft together would also dominate display advertising, in spite of Google’s recent acquisition of the DoubleClick online display advertisement company, which may have intensified the two rivals’ merger discussions.

Ms Li said the two together would also have tremendous technological strength, given the level of Microsoft investment in research and Yahoo’s skills at display advertisement management. Yahoo would also bring significant internet media experience to the deal and successful “Web 2.0” acquisitions such as Flickr and Del.icio.us.

The main reason for the deal for Microsoft would be the declining importance of the Windows operating system, relegated into the background as users turned to web browsers to run applications such as e-mail.

“To survive going forward, Microsoft needs to have a robust online strategy and Live.com/MSN just doesn’t cut it,” Ms Li said.

But she concludes that a merger would be messy, of limited benefit to Yahoo and is not likely to happen soon. Integrating brands and management would be difficult and the distraction of a merger would not allow the new entity to gain ground on Google.

Last month’s first quarter earnings revealed a mixed picture on advertising dollars being earned by the main competitors.

Google’s $2.53bn were 65 per cent up on the year before, Yahoo’s $980m were up only 9 per cent, while Microsoft took in an estimated $350m, up 23 per cent.

For Microsoft, this was good news, as AdCenter began to show results. AdCenter is an advertising system it built and which had led to its ending a partnership for advertising technology with Yahoo.

Asked at the Web 2.0 conference last month about whether Microsoft could still be a big online player, Jeff Weiner, head of Yahoo’s network division, said: “You never ever count Microsoft out. We were strong partners and I would have loved to see that partnership stay intact as long as possible.”

John Battelle, author of The Search, the story of Google’s success, says Microsoft may be trying to renew that partnership now.

“Microsoft is in a strategic bind at the moment, they don’t have significant leverage when it comes to online ad growth. They need scale, they don’t have a way to get there without a significant acquisition,” he told the Financial Times. “I can’t imagine it’s going to be an easy deal if it’s going to be put together. I’d say there is as much chance of a significant partnership as an M&A.”

Any merger would see Microsoft’s MSN service being folded into Yahoo, he predicted, with Yahoo having more success in the content business.

Financial analysts also saw the strategic rationale for Microsoft. Mark Mahaney at Citigroup said while it had enjoyed limited success in internet advertising, MSN had continued to lose search query share and had underperformed the internet advertising market.

But he questioned whether any merger would gain users and advertisers from Google.

“Two simple questions,” he said. “Would Microsoft owning Yahoo change consumers’ clear strong preference for Google’s search engine? We doubt it. Would advertisers – who have been appreciative of a third search engine in the past, though disappointed with Microsoft traction – switch ad dollars from Google? We doubt it.”

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