What the hell is Microsoft doing

The continued Microsoft-Yahoo! drama continues to take over headlines, which, as someone who loves to read articles online at work, has become a growing irritation for me (hello, college football two-a-days start in a few weeks. No pre-season hype?) I have been for the longest time wondering why Microsoft would even want to buy Yahoo!:

• They don’t have a brand consumers trust, much less one which people associate with Search
• Their bread-and-butter segment is business. They have room to grow in small-to-medium size businesses. They can really build their services business for businesses. Their sales force and product offering is more compatible with business solutions oriented customers. (I used the word business a lot in that sentence).

And yet, the people who work there who are much smarter than me continue the pursuit. It started to haunt me – why? What was I missing that all of these other smart people were seeing? Even other smart people agreed with me. Microsoft is fighting on too many fronts (consumer electronics, enterprise applications, online media), ignoring acquiring B2B competitors that would make much more sense. Could it be hubris? Even one of the most ego-centric Valley CEOs (Oracle’s Larry Ellison) wasn’t bothering to go after the wealth of the Interweb.

After doing some digging, to shake this constant contemplating I was going through (though I have no stake in either company, don’t work in that industry, am not an analyst of any kind – FUCK AM I A DORK), I think I finally get it.

Microsoft doesn’t have any room to grow significantly in their current businesses. Much like their dividend escalation over the last few years has suggested, they don’t really have a lot of growth opportunities internally on which to blow their wad (of cash), and so started returning it to shareholders.

The Interweb, on the other hand, represents unparalleled growth. The Google has a ridiculous stock valuation that suggests the market believes that, anyway. As this article so succinctly states: Microsoft doesn't see any other large business that it could conceivably enter that compares with search-related advertising for its profit potential.

And, in spite of Microsoft’s overpaying for many online advertising agencies and exchanges (see $6 billion acquisition of aQuantive), it hasn’t been able to make a dent in Google. As Rich Skrenta suggests here, it’s because of the nature of competition of online search: it is a winner take all market.

The Google’s true advantage isn’t necessarily superior search technology (though it may very well have that). What Microsoft is really up against is The Google’s brand and the scale of its advertising market. Consumers respect Google’s brand, and search there almost exclusively. More searches are performed there than anywhere else, and so advertisers flock to the AdWords Exchange to bid on keywords, with little incentive to move to other search exchanges, since fewer consumers are searching there.

Microsoft is basically pursuing Yahoo for its volume of consumers and advertisers so it can scale up against Google. Is it enough? And, how much are they paying per advertiser? Not being smart enough to figure out how to estimate how many firms advertise with Yahoo! (that’s why those equity analysts work the long hours), I can’t wager a guess. But given the premium that Microsoft is looking to pay for Yahoo….what does this say about the value of The Google?