Monday, February 25, 2008

Poor Goliath Seeks a Bride

Before we get to the marriage, what’s this “poor Goliath” nonsense anyway? Why should we feel any sympathy for Goliath, in this case Microsoft? Microsoft is a colossus: In 4th quarter 2007 alone, revenues were up 30% to $16.4 billion, operating income was up 87% to $6.5 billion, and Earnings Per Share (EPS) were up 92% to $0.50 per share. That sounds great, except for one thing.Goliath is trapped in the past. Microsoft’s financials are almost entirely due to its near monopoly status in the Windows operating system and Office suites. Despite its never ending public relations campaigns about its focus on “innovation”, and despite its multi-billion dollar annual R & D budget, the fact remains that the company's new breakthroughs in cool stuff—be it in music, social networking, video, games, search, advertising, or whatever—have been almost nonexistent. It’s all been imitative, from Zune to Xbox. That’s why the stock has flattened. Even worse, everything in computing is moving to the Web, threatening the very foundation of Windows and Office. That’s why Microsoft proposed marriage to a reluctant Yahoo. And that’s why I feel sorry for Goliath. I feel bad for any forced, desperation shotgun marriage that’s likely doomed from the outset. Forget the questionable merits of a $46 billion offer which will be no doubt be upped since Yahoo rejected the initial deal. Forget the “$1 billion savings in operational efficiencies”, a rationale used in every mega-merger that has turned out to be a bust. The real issue is this: Online search is a big driver of this marriage, but both companies are ailing and struggling in search. Microsoft has a 2.9% share, Yahoo a 12.8% share. Compare that to David, a.k.a. Google, which has a 64% share and, more importantly, continues to pull ahead with innovations in targeted and display advertising. So why should a marriage of second-raters who couldn’t do it on their own cause investors (and talented employees) to cheer?Second, keep in mind that Google’s targeted ads are the category killer, where buyers pay only if users click on their ads. Yahoo and Microsoft are heavy into display ads, which are becoming less relevant to both advertisers and users. Further, emerging companies are popping up which put together “ad networks”; they stitch together ad space on thousands of Web sites that collectively reach millions of users—all at a cheaper price than Yahoo’s or Microsoft’s. Third, think about the “soft” but deadly stuff: The difficulty and the distractions in integrating two very different companies, the ongoing cultural clashes, and the probabilities that the best and brightest talent will walk across the street to Google headquarters. Especially in a hostile acquisition like this one.True, the new company will be bigger, but bigness per se is no predictor of competitive success. The new company will take the lead in web based (but mostly free) e-mails. It will “own” the biggest directory of registered internet users—which is good for users and advertisers if you’re providing them with something that’s unique and exciting, but otherwise it’s just a list. Steve Ballmer is probably a lot smarter than me; he’s certainly a lot richer. So maybe he knows something I don’t. But in my book Break From the Pack, I describe many failed mergers that were headed by brilliant people hanging on to eloquent (but ultimately flawed) logic. The bottom line is that there is no wave of compelling new technology, talent, agility, foresight or vision that will emerge from this union. On the contrary, I fear the marriage will further lock Microsoft into the past, at a very big price. In this case, my sympathies are with Goliath.


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