Commentary: Pros and cons of a Microsoft-Yahoo mashup

By Forrester Research
Special to CNET News.com
May 4, 2007, 11:30AM PT

By Charlene Li

On Friday, stories of a rumored merger between Yahoo and Microsoft appeared in the New York Post and on The Wall Street Journal's Web site.

On paper, the deal makes sense, but in the end, it would be so hard to pull off that it's unlikely to actually happen.

First, let's take a look at why it makes sense:

• Audience combination. Yahoo and Microsoft have two of the largest online audiences--107.8 million and 95.4 million respectively in the U.S. in March, according to Nielsen/NetRatings. (Note that these are brand level unique users for Yahoo and MSN/Windows Live). Google had slightly more uniques than Yahoo (108.4 million), but the combined unduplicated audience for Yahoo/Microsoft is 129 million.

• Advertising power. While Google leads in search marketing, Yahoo and Microsoft dominate display advertising. (which Microsoft was bidding for as well) puts extra emphasis on the need to shore up their dominance in this space. Microsoft's Strategic Account Summit next week should be particularly noteworthy, given the rumors.

• Technology strengths. Microsoft is a powerhouse when it comes to engineering talent. Between Microsoft Labs and its worldwide investment in technology research centers, the company has fingers in all aspects of information technology ranging from enterprise search to mobile software. Yahoo is no slouch, either, with particular (specifically behavioral targeting) and search, but in this area, Microsoft is providing the bulk of the value.

In the very long term (beyond three years), there's a chance that a revitalized company would be in a better position to compete, but this assumes that Google stands still for them to catch up.

• Media and Web 2.0 smarts. This is where Yahoo really shines--its acquisitions of Flickr and Delicious, coupled with its emphasis on social search and media, position it well for new challenges. Yahoo's executives--with their strong media roots--truly understand what it means to build and maintain an audience.

On the surface, it looks like a merger would be a good idea. Fueling the fire is the strategic need that the companies have for a union. Why would Microsoft want to ante up $38 billion for Yahoo? For one reason--and no, it isn't just Google.

It's Windows, or rather, the declining importance of the operating system as it gets relegated to the background. I personally (almost) seamlessly switch between a Windows machine at work and an Apple at home, using the Firefox browser and online e-mail. Microsoft has the technology to do parts of this, but not all of it. To survive, , and Live.com-MSN synergies just don't cut it.

Yahoo comes to the table needing something too, but with less urgency. While it's struggled with the launch of its , it's in a much better position to compete in this new world because of its focus on media and content. Its biggest weakness is that the fight is also on the Web services-application programming interface front, where the technology smarts that Microsoft bring would be a benefit.

Why a merger wouldn't work
But instead of debating the merits of whether this makes sense, I'd like to paint a picture of what the future would have to look like for a merger to work--and why I don't think this future will come to pass.

• Separate Yahoo, Live.com and MSN brands get merged into one brand. To fully realize the value of the merger, there needs to be true audience consolidation under one brand. This will be tough to do, as there are huge overlaps in the audience, and it would be tough to give up on all of that extra traffic and page views.

In some markets--in Europe, in particular--the MSN brand trumps Yahoo, and in others, Yahoo is much stronger; in the United States, the brands are equally strong. So why consolidate at all? Because maintaining separate destinations for essentially the same audience and purpose diverts valuable resources that could be used to create a unique, powerful experience that can compete and win.

But there is one major reason why I don't think Microsoft executives have the stomach for any sort of brand rationalization--the continued dual branding of Windows Live and MSN. Each time I have a conversation with Microsoft about Windows Live, I get a different explanation of what it is and how it fits with MSN. If the company can't even figure out its branding strategy with existing properties, I don't hold out much faith that it could do so with a premium brand like Yahoo.

• A new company emerges with new leadership. Note that this would be a merger, not an acquisition. This means that Microsoft and Yahoo would each have to come to the table ready to forge a new company from the assets of the individual ones.

Egos and innate disdain from being competitors over the past decade would have to be set aside. Geographic distances (Seattle to Sunnyvale) would have to be bridged. And most importantly, a new company ethos, leadership and culture would have to be created.

Neither company has ever been through a merger, or even an acquisition of this size and scope. And all of this would have to be done in the context of one of the most dynamic, innovative areas of business and . Even in the best of times, successful mergers are hard to pull off, and I'm not hopeful that executive time spent on company politics would be minimal.

• The new company dominates over Google. Given the problems of a merger, the key metric of success in three years is whether they would have made any progress in fending off--and catching up to--Google. After all, that's the main impetus behind the merger--that together, they would be better able to compete against Google. But given the distraction of the merger, and also, given that Google won't be so encumbered, I think it unlikely that a combined Microsoft-Yahoo entity would be able to do anything against the powerhouse.

In the very long term (beyond three years), there's a chance that a revitalized company would be in a better position to compete, but this assumes that Google stands still for them to catch up.

Given the messiness of a full-out merger--and also the limited benefit it would bring to Yahoo--I believe that a merger won't be in the works anytime soon. More logical would be partnership agreements where the strengths of each company are shared. These tentative first steps to a merger would make a lot more sense, giving both companies the ability to test the waters before jumping into the deep end.

But if I'm wrong, and a merger does get announced, I wish the two companies good luck--they're going to need a lot of it.