Yesterday’s announcement that Microsoft would write-down the 2007 acquisition of aQuantive raised my opinion of Steve Ballmer another notch. Steve makes mistakes, but he also owns up to them. So let’s travel back and see how Microsoft got into this mess.
In the late 1990s Microsoft was busy fighting the U.S. DOJ’s antitrust action and it was a major distraction for CEO Bill Gates and a number of other senior executives. To keep the company running executives not caught up in the day-to-day antitrust battle stepped up to fill the gap. Steve Ballmer became President and later CEO. As the financial pressures from the antitrust suit, the collapse of the Internet bubble, and then the post-9/11 economic downturn took hold a lot of non-core or non-performing efforts were eliminated or cut back. This was particularly true of MSN-related efforts. Sidewalk (whose vision was to be what Yelp, Trip Advisor, and some of the other hot web properties of today are) was sold. Expedia (then and now the leading on-line travel agency) was IPO’d and then Microsoft’s majority stake sold. Efforts to build a search engine were abandoned. Eventually the pioneering Slate magazine was also sold. Many other on-line properties became little more than portals to third-party content. While on one hand this was necessary so Microsoft could refocus on its core businesses, on the other it was unclear how to generate significant revenue from them. Expedia’s transactional revenue aside, everything else relied on advertising to generate revenue. And on-line ad revenue, already insignificant in the late 90s/early 00s, further collapsed in the post-9/11 recession. It just looked like a horrible place to be. As it turns out, Microsoft had just entered (and then left) the market too early. By the mid-2000s online advertising revenue was on an upswing, particularly revenue from Search Click-Through. And Microsoft had taken itself out of participation. Google, on the other hand, had ridden this wave to perfection and proven it to be an economic model that rivaled the Microsoft-lead PC ecosystem.
Now it’s 2007 and Microsoft is trying to dig itself out of a number of problems. First, of course, is that Vista has just shipped ending the five-year Longhorn morass but at the cost of a poor release. Microsoft has to rebuild the Windows team and figure out how to take the product forward. “The Cloud” is emerging as something real, and Microsoft has to put in place effort(s) to address that trend. Apple’s iPod has brought them back from a near death experience and turned them into a competitor for the hearts and minds of the consumer. And Google, funded by click-stream ad revenue, has emerged as an across-the-board competitor. Microsoft decides to act in the search and advertising space both because its economic model can add to Microsoft’s bottom-line and the need to blunt Google.
The problem with going up against an entrenched dominant player like Google is that head-on attacks are (perhaps) necessary but not sufficient. Typically head-on attacks yield fractional market share gains. So if you have a competitor with 80% market share and you gain 1/2% to 2% a year against them does it matter? With fractional market share gains Microsoft would neither reach profitability on its search efforts nor blunt Google. And so it has been on a multi-track plan, trying to chip away at Google’s market share in a head-on attack while simultaneously seeking to change the game as new paradigms unfold. So for the former, after bringing its Core Search capabilities up to par, it has spent $Billions on Search Default and Toolbar deals, partnerships with Facebook and Yahoo, TV advertising, etc. As predicted this has resulted in only fractional market share gains. And sadly, Microsoft has still not reached the knee of the curve for advertising revenue. Given that search advertising is an auction system the price-per-click is determined by the number of bidders for any individual keyword. The more searches you do the more advertisers want to use you and thus the more bidding you have for keywords. At some point you have enough searches and bidders for those keywords that your revenue and profit explodes. Microsoft doesn’t have to beat Google for its Search efforts to payoff, it just has to make it past the knee of the curve on revenue per click.
One observation back in 2007 was that while Google was the absolute leader in search advertising, it was not a major player in Display advertising. If memory serves, Yahoo was actually the Display advertising leader at the time. Microsoft is thinking big and wants to be a major player in all forms of advertising, including Display since it is on a rebound. Google is also working to expand its reach into Display. Of course if Search is mostly a technical problem, Advertising is mostly a business problem (with some technology behind it). And Microsoft doesn’t have much DNA in the advertising space.
With so much on its plate, and Goole having such a big lead, Microsoft needs to put its balance sheet to work. So it goes looking for acquisitions, and one of those was for help building up its Advertising DNA. With few Digital Advertising companies out there, and Google having bought DoubleClick, Microsoft pays an outrageous amount for aQuantive. It also recognizes that if it acquires Yahoo it would hit the knee of the curve on search share and revenue, and become the leader in Display Advertising. And on a smaller scale it acquires travel meta-search company Farecast in an attempt to become the leader in the lucrative travel search category.
Of course the Yahoo acquisition attempt fails, and leads to a partnership that has yet to yield the desired benefits. Farecast is now part of Bing Travel, but sadly enough only the fare prediction part of Farecast remains. The actual fare search is handed off to Farecast’s former metasearch competitor Kayak.
And aQuantive? None of the expected benefits of acquiring aQuantive seem to have come to fruition. Of course if Microsoft had paid a few hundred million dollars for aQuantive, which objectively was the most it was worth, then none of this would really matter. It would purely be a footnote explaining why Microsoft had shaved a few pennies off its earnings this quarter. Instead it highlights how poor Microsoft has been on big acquisitions and how desperate it was back in 2007. And raises a question about what Microsoft’s overall Search and Advertising strategy is now.
Although the aQuantive write-down is making headlines today it is really water under the bridge. The real negative aspects of this, and the other Online Services Division (OSD)acquisitions, is that it pretty much shut down medium to large acquisition activity across the rest of the company. With so much money and management attention focused on aQuantive, Yahoo, and even Farecast other divisions apparently dropped acquisition efforts that might have yielded far more concrete returns. What Microsoft would have looked like had it pursued these other acquisitions rather than aQuantive et al is something that can only be guessed at (particularly since we don’t know what other acquisitions would have occurred).
Yesterday’s write-down of the aQuantive acquisition signals the end of the “win search and advertising” at all costs era. What still isn’t clear is what Microsoft’s current strategy and expectations in this space have become. I have a guess, hinted at in some other blog entries, but it deserves a blog entry of its own.
Fortunately Microsoft’s recent acquisitions have made a lot more sense, even if the prices raise eyebrows. Skype is a really positive addition to Microsoft’s “secret sauce”, and Yammer looks to be a big help in keeping Microsoft relevent to its key information worker user base. If aQuantive was a big mistake, it looks like Microsoft has learned lessons from it.
To me there are three phases in Steve’s leadership of Microsoft. In the first phase, while he was President and the first few years as CEO, he mostly focused on keeping the ship from sinking in the face of anti-trust and economic concerns. Efforts started during this time were heavily influenced by that environment, often with positively ugly results (e.g., Vista). Next came a couple of years of panic where it seemed Microsoft had fallen behind on all fronts and a frantic set of efforts were launched to catch up. The aQuantive acquisition was part of this. It was an era where Steve and Bill still shared leadership of the company, and where business units had lots of freedom to prioritize their individual strategy and tactics over an overall corporate strategy. Some things succeeded, like Windows 7. But others…. Now we are in the third phase where Steve has fully taken the reins and the Microsoft we are seeing is his Microsoft. It’s not all positive (particularly for employees), but for customers the 2012 product wave is probably the best in the company’s history. Microsoft is finally back. So for me the aQuantive write-down is the last major step in Steve putting the panic phase behind him. History is going to measure Steve ‘s tenure as Microsoft CEO on what happens in 2012 (FY 2013 for those into financial measures) and beyond, not what happened in the 2000s.