If Microsoft's $44 billion acquisition of Yahoo! looks like a big business story, it is—but not necessarily for the reasons you've been reading about these past few days. Yes, it's a Big Gulp of a deal that will pay a 60%-plus premium on the share price. And yes, it's a transaction that marries two high-profile brands of the technology world.
That's only the beginning.
If the Microsoft-Yahoo deal is consummated, what seemed increasingly to be Google vs. Everyone Else on the Web will become simply Google (GOOG) vs. Microsoft (MSFT). As a standalone brand, AOL won't be around for long, and the list of major online players drops off sharply after that. Without consolidation of massive proportions among the remaining giants of the online world, no one company has a chance at catching Google in the race for online ad dollars—unless Google were to develop a bad case of "Big Company Disease" and derail its own momentum.
Scale, Features, and Analytics
The new online reality is that scale and features attract online users and the advertisers who want to reach them, and analytics—the tools that help sites target ads to users more effectively—build ad-pricing power and therefore margin. Scale is simply the traffic or number of unique visitors a site attracts. Features are the applications and services a particular Web site can deliver. In both cases, more is usually better. But analytics is an area that looks like art but is rapidly becoming science. It's the way sites parse users' profiles and click streams using behavioral targeting, predictive intelligence, and other database manipulations to boost ROI metrics for marketers spending advertising dollars online.
Google has it all: scale (more unique users than any other online site), an endlessly expanding array of features (tools and applications released continuously in beta versions on its site), and clearly superior analytics (which started with search-based advertising and is now expanding into extensive data mining of millions of search patterns and user profiles).
That's why Google has proven pre-eminent when it comes to turning its huge online audiences into its very own cash machine. In the last quarter, Google reported revenues of $4.8 billion, compared with $1.8 billion for Yahoo (YHOO) and $863 million for Microsoft, even though unique visitors for Google and Microsoft are roughly equivalent. (In December, Google registered 125 million unique visitors, and Microsoft 123 million.)
An Unattractive Choice
The fight for scale became clear when four companies—Google, Yahoo, Time Warner's (TWX) AOL, and Microsoft's MSN—emerged as the overwhelming winners in the competition for advertising on the Web. Even as the online ad market accelerated at growth rates of 25% to 35% a year, the Big Four search portals and aggregators increased market share, establishing a veritable oligopoly in the online world. Each of these companies could claim more than 100 million unique visitors a month, making them the most-trafficked sites online and paving the way for dramatic growth in online advertising.
By our estimates at Marketspace (an affiliate of Monitor Group), in 2006, the Big Four captured 85% of the U.S. online advertising market as measured in overall ad dollars. The top 10 online sites, including the Big Four and others operated by companies such as News Corp. (NWS) and InterActiveCorp (IACI), captured 99% of overall ad dollars in 2006.
That means the remaining 100 million or so sites on the Web outside the top 10, and whose businesses are predicated on online ad revenues, must choose between giving up pricing power by selling through the Big Four (and other major players like them) or selling directly but competing with everyone else for their sliver of the last percentage point of online ad market share. (In the U.S. market, that last percentage was worth about $220 million in 2007.) This unattractive choice applies to just about every major media, content, or entertainment brand doing business online.
Online advertising is a big business and rapidly getting bigger. Last year, the average major corporation spent 7% of its marketing budget online, while U.S. consumers spent over 30% of their total media consumption time with digital media, according to our analysis. As marketers close this gap between brand budgets and consumer behavior, it's no wonder that the U.S. online ad market in 2007 hit $22 billion, that it will top nearly $30 billion in 2008, and that it's projected to reach $60 billion (and $80 billion worldwide) by 2011. It's also why Steve Ballmer, CEO of Microsoft, observed not long ago that "the future will be ad-funded," at least as far as digital business is concerned.
Which brings us to the question of how Microsoft and Yahoo combined could expect to compete for position with Google's rapidly expanding scale, features, and analytics. By acquiring Yahoo, Microsoft doubles its unique visitors to nearly 240 million, roughly twice Google's (not counting the reach of DoubleClick, its recently acquired ad network). Even discounting for duplication of visitors, Microsoft gets to mark up its online traffic easily by 50%, to 180 million visitors, which vaults it to the top traffic position on the Web. Combined online revenues last quarter would amount to $2.6 billion, still only half Google's, but nonetheless establishing a powerful No. 2 position. While the aQuantive acquisition helped Microsoft close the competitive gap in online analytics, Yahoo brings traffic and features with the kind of sex appeal Microsoft itself could never achieve.
All that still makes this a long bet. With the acquisition, Microsoft has finally cried 'Uncle,' admitting to the world it cannot not build its way into online dominance, despite billions of dollars spent on online content, search technology, and analytics. Meanwhile, Yahoo has fallen far from its perch as the world's dot-com darling, and, at $31 a share, the acquisition price is only a quarter of its all-time high during the Internet boom.
…By Consolidating Players
Now get ready for more consolidation—from the Big Four to the Big Two. Time Warner has been looking to shed AOL for years, so consolidation of AOL is pretty much a sure thing. Yes, Microsoft needs the Justice Dept. and its European counterparts to sign off on the deal. And, yes, it needs to avoid a bidding war with News Corp. for Yahoo. And if AOL goes to Google (Google has flirted with AOL ever since the former went public), we'll soon see the online world divided between two iconic technology titans. If this really is a scale game, then it's a game only the supersized can play.
Sure, the "creative disruption" for which Silicon Valley is known will undoubtedly change the game at some future date. But, for now, there is an immediate need: More than $400 billion in global advertising is looking to make sense of online media, and no garage-based startup, no matter how visionary, can meet such high-volume needs. For the foreseeable future, it will be the reigning behemoth of the PC operating system vs. the emergent giant of the online world, competing for online consumers with resources of gargantuan proportions.
Who wins? Even with Microsoft's dramatic move, the answer is clear. It's a face-off, for sure, but it's still advantage, Google.