Time has always seemed to be Microsoft Corp.'s (MSFT) ally. In the company lore, the software giant takes three cracks at a market before establishing supremacy. The Windows operating system stumbled for years before achieving domination; so did Microsoft's server software.
But when it comes to developing a viable Internet strategy, Microsoft may be running out of time. It has long trailed Web leaders Google Inc. (GOOG) and Yahoo! Inc. (YHOO), in the use of its search engine and in search-ad sales. Now it's losing ground. In February, 2005, Microsoft's MSN Search accounted for nearly 14% of all Web searches, compared with a 46% share for search leader Google, according to research firm Nielsen//NetRatings. Just two years later, Microsoft's rebranded Windows Live Search has a 9.6% share, compared with Google's nearly 56%. That amounts to nearly 300 million lost searches per month. The sense that Microsoft is slipping was reinforced with a recent shuffling of top executives.
Microsoft's search problems present it with a huge quandary. The company's revenue from online advertising is relatively small--just $836 million in the first six months of the fiscal year ending in June, vs. $5.9 billion in sales of the Windows PC operating system. But the Web is increasingly the place where computing gets done. Everything from e-mail to customer-relationship management applications is moving from programs on a PC to services on the Net. Meanwhile search advertising is exploding: Piper Jaffray & Co. (PJC) says it should hit $44.5 billion by 2011, up from $15.8 billion in 2006.
If Microsoft can't keep pace, it risks seeing its Windows and Office software franchises erode as Google and others launch Web-based rivals. "It behooves Microsoft to be there," says Charles Di Bona, an analyst with Sanford C. Bernstein & Co. (AB). "If they don't get there, it gives others a platform from which to attack Microsoft's core business."
Just as troubling, Microsoft's search problem reflects its approach to new markets in general. It spends little time focusing on tiny, emerging niches that generate little, if any, sales. But those are precisely the markets that can quickly blossom on the Net into meaningful businesses. "Bill [Gates] and Steve [Ballmer] and the leadership don't understand the value of small things," says Robert Scoble, a former Microsoftie whose blog recently took the company to task for its Web missteps. "That cripples their entire Internet strategy from the start."
Microsoft has already squandered much of the time it spent developing the search business. Until February, 2005, it licensed search technology from two companies, Overture and Inktomi. Then it launched a homegrown search engine, saying at the time that it would win over Web searchers with results that were more relevant than Google's. Last fall, Microsoft Chief Executive Steven A. Ballmer told BusinessWeek editors and reporters: "I think in the next three years, people will say, 'Hey, these guys are really a major player in online consumer and advertising.'"
There are a number of reasons that hasn't happened yet. First, Google has performed near flawlessly. Early on, Google used its simple Web site to cement the impression that to search is to "Google." And because more people search there, Google has more data with which to target relevant ads. The result: By some estimates, Google nets at least 50% higher revenue per search than No.2 Yahoo and other search sites--allowing Google to keep investing more in improvements. For instance, on Mar. 21 it revealed a new program to give advertisers the opportunity to pay only when someone responds to an ad--by purchasing a product, filling out a form, or some other action--rather than merely when they click on it. That may be more attractive to advertisers who want concrete results.
Meanwhile, Microsoft has managed to confuse searchers. It elbowed into the search business on the back of its MSN franchise, a modestly successful online services business known mostly for its dial-up Internet access operation. Then Microsoft muddled its message in November, 2005, when it launched the "Live" initiative designed to turbocharge Web services, including search, with programs running on PCs. But Microsoft continued to use the MSN prefix on some Web sites, such as its portal and shopping page, while using Windows Live for its e-mail and search services. "You've got people who know Microsoft really well who don't know what Live means," says Danny Sullivan, editor-in-chief of searchengineland.com, which covers the business.
For its part, Microsoft says Windows Live services are those users can personalize, while MSN ones are preprogrammed content. Concedes Microsoft spokesman Adam Sohn: "We could have been a little crisper." Steve Berkowitz, who was hired last May to rev up the Web business as senior vice-president for Microsoft's Online Services Group, declined to comment.
With product challenges comes the inevitable Microsoft executive shuffle. Blake Irving, vice-president of the Windows Live Platform group, sent out an e-mail to his colleagues on Mar. 5 announcing plans to leave the company later this year to travel the world. Three days later, Christopher Payne, vice-president of Windows Live Search, who spearheaded search development efforts, announced he would be leaving to launch his own company.
Then on Mar. 21, Microsoft created a job at the same level as Berkowitz' to oversee the search and Web ad business. The idea is to increase the urgency of search by moving it up in the organizational structure. Satya Nadella, a vice-president who just six months ago took over the company's small-business software unit, will run the combined group, reporting directly to Kevin Johnson, president of Microsoft's platform and services division.
There's plenty of pressure to make this fix stick. Last May, Microsoft launched adCenter, a technology that takes demographic data (gender, age, Zip Code) of Web surfers who sign up for various MSN and Windows Live services and lays it over their search queries. That lets advertisers tailor ads to specific types of customers and should allow Microsoft to charge more. But the strategy packs a punch only if Microsoft boosts its share of search.
Microsoft could still do that. It is betting search will move beyond the all-purpose Web site where users plug in a query for any bit of information. That's not a bad idea; many analysts believe the search world will fragment into vertical sites that focus on niches. The eye-popping success of YouTube Inc., now owned by Google, is one example. More than just a place to show off your creations, YouTube has become a place to search for videos. Microsoft announced plans in February to buy Medstory Inc., a health-care search engine for consumers. And on Mar. 14 it said it would buy Tellme Networks Inc. for what one analyst estimated to be more than $1 billion. Tellme should give Microsoft a leg up in the emerging market for voice-activated search over a mobile phone.
Microsoft is also trying to nudge its massive customer base over to its search engine. On Mar. 13 it struck a deal with PC maker Lenovo Group (LNVGY) to preload machines with the Windows Live toolbar, which leads users into its search engine. Microsoft also launched a "trial program" where it offers some large businesses service and training credits--from $2 to $10 per computer--to get employees to use Windows Live Search.
Sure, that amounts to buying business. But with all it has at stake in search, Microsoft will take it any way it can.
By Jay Greene, with Robert D. Hof in San Mateo, Calif.