February 8, 2008

A game theorist’s view of Microsoft/Yahoo

Edit:  Microsoft/Yahoo could easily end up being an all-cash deal.

Larry Dignan encourages a game theoretic view of the Microsoft/Yahoo merger, following Trip Chowdhry. I actually have a Ph.D. in game theory, so I’ll bite. 🙂

In most negotiation games — including pretty much all in which money can change hands — there’s one outcome that makes the most sense for all concerned. They should agree to that outcome, and haggle about nothing except price.* In this case, the best outcome for Microsoft and Yahoo is a quick Microsoft takeover of Yahoo. That’s what I thought all along, due to a whole lot of Microsoft/Yahoo synergies. Michael Arrington reports, in confirmation, that there are no viable alternative bidders.

*A fancy way of saying that is “The feasible set has a continuous and effectively one-dimensional Pareto frontier.”

In such cases, the haggling over price depends a lot on each side’s “threat point” — i.e., their fallback position, and the (un)desirability of that fallback position for each side. Yahoo’s fallback position is probably one or more aggressive deals with other major internet players. Merely outsourcing its search business to Google would be stupid. Selling the search business to Google could fetch a wonderful price, because Google would be even more entrenched — but for exactly that reason, it would surely fail to pass antitrust muster. That’s why the Amazon idea that’s been floated is so crucial; a Yahoo/Amazon merger would actually be synergistic in its own way, and hence could command a price at least somewhat competitive with Microsoft’s offer.

As for Microsoft — despite successes in individual Internet areas, it has consistently failed to build a coherent Internet business. Yahoo has its own issues, obviously, but on the whole it’s maintained pretty decent Internet status even as its technological efforts have been consistently disappointing. If Microsoft doesn’t buy Yahoo, it probably needs to buy somebody else with a consistent record of Internet leadership, such as Amazon. That would also involve paying a large premium. And here’s a twist: If Amazon for any reason wants to sell to fellow Washingtonian Microsoft at a big premium, it’s best move may be to sabotage the Microsoft/Yahoo deal somehow.

One final note: If Yahoo outsources its search business to Google, the possibility of a Microsoft deal is gone forever. Microsoft can not be assured of winning a waiting game, the way Oracle outlasted Peoplesoft.

Bottom line: The Microsoft/Yahoo deal should and probably will happen, and Yahoo should and probably will be able to squeeze Microsoft for more money than has first been offered.

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2 Responses to “A game theorist’s view of Microsoft/Yahoo”

  1. A Fan on March 5th, 2008 5:10 pm

    “If Yahoo outsources its search business to Google, the possibility of a Microsoft deal is gone forever.”

    Why do you think so?

  2. Curt Monash on March 5th, 2008 5:41 pm

    Search is the central business idea of the deal, I think.

    I think there’s more to it — but search is clearly central.


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