• There are plenty of times when voice is a more convenient form of input than typing.
• Voice recognition was good but far from perfect.
• Editing search strings was annoyingly difficult.
• Search results themselves aren’t 100% perfect.

No big surprises there.

It’s hard to imagine what the former could mean other than “Please make an all-cash offer (or, better yet, go away).” But I previously noted, Microsoft can indeed afford to buy Yahoo entirely for cash.

The latter part is a reference to the antitrust boogeyman, obviously a non-trivial concern whenever Microsoft is involved.

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• Yahoo wants to be the internet “starting point” for ever more relatively naive users.
• Yahoo wants to be an advertising “must buy.”
• Yahoo doesn’t need to excel technologically in its user experience.

This is exactly what AOL tried in the late 1990s, except that they also had the best dial-up connectivity in the world. I know; Linda and I were strategic consultants to AOL then.* And we told them that while the rest of their strategy was excellent, it would be to no avail unless their tools matched the quality of what people could get in the office or elsewhere online. Because if AOL’s technology didn’t catch and keep up, people would just laugh and go elsewhere. (Even my parents, who still use AOL mail, go outside AOL for their web surfing. AOL is getting very little revenue from them, and they’re about as captive as AOL users get.)

*Please note — AOL was a great client, but the people we dealt with are (for the most part) long gone, and our NDAs ran out years ago.

That’s brain-dead. Just consider how far technology has taken Google, how fast gaming technology advances, or how fickle internet users are about switching to the latest and greatest online services. What’s worse, Yahoo seems to mean it, given how many serious technology leader types are out on the street in connection with the recent layoffs.

Pretty much the only remaining hope for the Yahoo brand(s) and services is for the Microsoft acquisition to go through, and for Microsoft/Yahoo to unlock the deal’s huge potential synergies — which, while far from being certain, is at least realistically possible.

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It’s all nonsense. According to Microsoft’s 10-K statements, they have $27 billion in cash and equivalents and have $14-17+ billion/year in cash flow from operations. Assume they have to pay $40/share for Yahoo’s 1.4 billion shares in an all-cash deal (meaning they have to borrow around $30 billion). Assume that building out data centers adds a couple of billion of dollars a years in new capital costs. They can still pay all the debt back in three years. It’s all a non-issue, if they think the acquisition is worth it.

So is it? I see tons of synergies, but I’ll confess to not having quantified them. I’m also more optimistic about post-merger execution than many observers are. I do think Microsoft will have to pay up to complete the deal.

And I think Henry Blodget is proposing a false dichotomy when he suggests Microsoft is wrongly favoring ad-supported online software over subscription online software. Ad-supported personal use and subscription-supported enterprise use can co-exist.

EDIT: I forgot about the FAST deal when I wrote this, which will cost a few billion dollars more when it closes. But there was enough slack in the calculations to cover it. Microsoft could indeed pay the debt off over 3-4 years, although it would surely arrange a somewhat longer term for flexibility.

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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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Technorati Tags: Trip Chowdhry, game theory

1. Microsoft and Yahoo were never more than a small part of the exit opportunity anyway.
2. A merged Microsoft/Yahoo will be so slow-moving it will create more opportunities for competition than it destroys.

Andreesen certainly knows about slow-moving behemoths making wasted acquisitions; Netscape was acquired by two companies (AOL and Sun) that both dribbled away the parts they respectively acquired.* However, I think he and a lot of other observers are missing something this time — the Microsoft/Yahoo synergies are too large to ignore.

*The legalities of the merger were a lot more complicated than that, but in essence AOL got the “internet” piece of Netscape and Sun got the enterprise side.

Given the opportunity, here are some reasons I think integration would go a lot better than most people think:

• Search relevancy algorithms are essentially collections of clever tricks, tested against actual search indexes and results. Integrating two companies’ operations in that regard shouldn’t be hard.
• The same goes for algorithms to determine contextual relevancy for ads.
• Microsoft has a lot of resources to reinvent the search interface. Yahoo isn’t much of a player there. Not a big integration problem.
• The next successful marketing campaign for a search engine — other than search box placement and word of mouth — will be the first one. Merger integration is the least of the problems in that area.
• The same goes for most other marketing of online services.
• Antispam — see search algorithms.
• Integration of web search, enterprise search, email, instant messaging, group chat, other social networking, and a partridge in a pear tree — OK, I admit it, this one is both central to my synergy argument and easy to screw up. But painful though it will be, I think Microsoft/Yahoo is more likely to do it right than anybody else is. I hope my reasons for thinking that will become clearer as I spell out what “doing it right” actually entails.

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The Microsoft/Yahoo combination could revolutionize the Internet. I’m serious. The opportunities for huge synergies might just be enough to blast the merged companies out of their current uncreative, Innovator’s Dilemma funks. Search is open for radical transformation in user interface, universal search relevancy, Web/enterprise integration, and just about everything to do with advertising and monetization. Email stands to be utterly reinvented. Portals and business intelligence have only scratched the surface of their potential. And social networking is of course in its infancy.

Here’s an overview of where some synergies and opportunities for a combined Microsoft/Yahoo lie.

Search and contextual advertising

Query serving costs are variable, and some marketing costs are performance based. But there are major economies of scale in:

• Web crawling. Those huge server farms are needed irrespective of query volume. It’s easier to compete in search overall when you can afford to do all the crawling you need.
• Indexing. Ditto. (Recent discussion of Google MapReduce quantifies this processing effort a bit.)
• Relevancy algorithm research. The challenge for relevancy algorithms keeps going up. Adversarial information retrieval is an ongoing struggle. Universal search and local search just multiply the challenge. Neither Microsoft nor Yahoo has consistently challenged Google’s search quality. A merged Microsoft/Yahoo, however, just might.
• User interface research. Some day search results pages will change, offering more useful user drill-down. And mobile-device search is a whole different interface challenge, for input (e.g., voice) and output alike. This is one area where I think a merged Microsoft/Yahoo could easily make major contributions.
• Advertising platform research. Unlike text search, which goes back to at least the 1980s, contextual advertising platforms were really introduced just in the current millennium. It’s still early in their life cycles, and a great deal of innovation is yet ahead, in all parts of the system. That’s true even on text-heavy Web pages, and it’s even truer on other platforms such as video and perhaps gaming. To see just how primitive the technology is right now, consider this: Google gets greatly more revenue per search than Yahoo or Microsoft, and there are only two reasonable explanations for the disparity – difference in the searchers/subjects, or technology. Surely to a large extent it’s the latter.
• Hand assists to search. These are more important than you might first think. Google manually reviews a number of possibly-spammy sites, both to adjust their rankings directly (and those of sites in link networks with them), or to learn of needed algorithm tweaks. In the future, it’s easy to imagine user “voting” on sites becoming crucial to search in a variety of ways; while it may not identify the best sites, at least it will weed out spammy/bad ones. But whatever the system, people will try to game it, and human intervention will be needed accordingly. Again, there’s a lot of potential in this area to make the world – or at least the Web – a better place.
• Marketing (partial). Marketing of search services seems to consist mainly of paying for placement, plus a whole lot of word of mouth. Neither of those is an obvious economies-of-scale cost center. But here’s the problem – Google is way ahead in the branding battle. Indeed, “to google” is a much-used verb. Microsoft, Yahoo, and/or Microsoft/Yahoo have a lot of branding ground to cover if – well, if they wish to recover. So if they ever do manage to achieve superior product to Google, an expensive advertising/sponsorship campaign might turn out to be a really good idea.
• Combining enterprise and web search. As I mentioned in my initial reaction to the Microsoft offer for Yahoo, FAST could be more important to the merged entity than is at first apparent. While relvancy ranking is a very different problem on the Web than in an enterprise, user interface issues are more similar. What’s more, there are potentially major benefits from truly integrating Web and enterprise search – again mainly on the UI side, but maybe in ontology leverage as well.

Email and antispam

Mail storage and serving costs, for the most part, are variable according to usage. Even so, there are important economies of scale in:

• Antispam. Google, perhaps due to the Postini acquisition, is doing a great job of antispam right now. Yahoo, however, is a disaster in that regard, with much legitimate mail not getting through at all. And antispam is an arms race, with new development constantly needed.
• General email software development. Antispam aside, online email software is still in sad shape. User interfaces, searching/filtering, and general stability are all problematic. Integration with client email software and other messaging is often even worse. Advertising potential is hard to monetize without unacceptable privacy violations. All told, there’s a lot of email software development ahead.
• Marketing. If it were easy to market online email services other than by word of mouth, more marketing would probably be happening. If the challenge ever gets solved, the solution may be expensive.
• Email integration with other messaging. As noted below, chat and social networking stand to be utterly transformed. What emerges will transform and perhaps even subsume email-as-we-know-it.
• Email integration with search. One of the worst things about email is its primitive filtering, both when it arrives and when you’re looking for it later. Google has taken the lead on email/search integration, but this will be a long race that currently still in the early laps.

Information portal and business intelligence

A few hundred thousand people rely on investment terminals such as Bloomberg or Reuters for their business news and general information. They’re pretty locked in. But the whole rest of the market is still up for grabs. Bill Gates’ “Information at your fingertips” speech was over two decades ago, yet Microsoft is still not doing great as a provider of information or analytic tools (with the huge exception of Excel).

One obvious synergy is to deliver tame MSN-style traffic to the more established Yahoo portal. A second is to finally get serious about making SharePoint an integrated Web/enterprise portal. A third, less-obvious one – and an area I really need to write a lot more about soon – is the integration of business intelligence tools with public data sources.

Gaming, virtual worlds, identity, and social networking

Social networking and gaming are both evolving at ferocious speeds. Just think of Facebook, Twitter, Scrabulous, Second Life, or console games. Some major and almost inevitable future developments include:

• Integration of instant messaging, group chat (IRC, Twitter), email, and perhaps other social networking, for both personal and enterprise uses. On both the client and server sides, there are good reasons for the functions to come together.
• Subscriptions or other monetization strategies that cover a broad range of casual gaming, virtual world, and possibly other online recreational activities. Consoles, and standalone games with tens of hours of play value each, seem to work well as products. Other recreation categories need other monetization models. And by the way, massively multi-player online (MMO) games are on the upswing even in categories where standalone games are also viable.
• Integrated identity. This is a huge subject, all the more as the number of services we want to participate in mushrooms. I think the technological part of the solution will wind up being XML-based (LDAP is in no way enough).

These are all big problems, where Microsoft and Yahoo actually gain from adding each other’s heft.

As long as the above list is – 19 items – it is far from complete. Please point out any you feel I overlooked. As for merger negotiations, antitrust, and eventual operational issues – I’ll leave those to another time. This post is long enough already.

Related:

• Long Zheng runs through the Microsoft and Yahoo brands that would need to be combined.
• Google fear-mongers about Evil Microsoft.
• Charlene Li opines that Yahoo will fight the merger. (I think she may be underrating tired-founder syndrome.)
• Bill Burnham thinks the deal would be very bad for M&A prices.
• Edit: Follow-up re: implementation.
• Edit: Follow-up re: deal terms and likelihood.

• Wow.
• Both sides needed it.
• Yahoo wasn’t going anywhere fast on its own.
• Microsoft wasn’t going anywhere fast in search on its own.
• This may be enough critical mass to matter.
• Conference call at 8:30 am

I’ll try to be a bit more analytical than that, but this is still going to be quick. Assuming the deal goes through:

1. Microsoft will recombine both parts of the old FAST/alltheweb.com Therefore, Microsoft will be able to use the same technology for web and enterprise search, to the extent that such commonality makes sense.
2. I’d expect Microsoft to try to differentiate its technology via faceted/structured search. That’s a FAST strength.
3. The old FAST search-as-BI dream might become pretty appealing to Microsoft/Yahoo.
4. In a non-search point, Microsoft is strong in games and Yahoo is strong in fantasy sports. Look for some synergies.
5. There sure would be a whole lot of non-Windows technology inside Microsoft.

Basically, Microsoft is a company that’s a lot more sophisticated in its thinking about user interfaces and experiences than Yahoo is. That’s where the really interesting competitive innovation would be most likely to occur.

I look forward to hearing why this won’t be a problem.

Technorati Tags: Microsoft, FAST, search