Since last Friday the Internet has been abuzz with analysts’ reactions to Steve Ballmer’s letter to the Yahoo! board (NASDAQ:YHOO) asking for quick approval of a buyout at $31 a share in cash or Microsoft (NASDAQ:MSFT) stock.
A broad sampling of these reactions was provided by Dan Gallagher in his MarketWatch technology column “Microsoft-Yahoo deal draws mixed reactions.” No fewer than nine analysts from seven companies weighed in on the deal just hours after it went public. They split about evenly between pro and con. One of those reactions struck me as speaking to the heart of the matter on two critical dimensions: synergies and integration (the emphasis is my own).
Although the synergies between the two companies, which Microsoft asserts are worth at least $1 billion a year, are certainly great, the merger also raises the question of how effectively they'll be able to continue operating during their integration. The online-advertising business requires significant levels of account service and even the perception of a diversion could wind up delivering business to their competitors. -- Andrew Frank, research vice president at Gartner Inc.
I’m not qualified to speak to the integration issue, which largely is a technical question, but I am able to speak to one important dimension of synergy. As Mr. Ballmer put it in his letter to the Yahoo! board "eliminating redundant infrastructure" inherent in the merged companies. The purpose of this article is to document the sources of competitive redundancies based on the latest financial accounting data.
18.8¢ Ain't a Heck of a Lot
18.8¢ does not seem like much until you realize it was at one time the difference between Microsoft and Google’s (NASDAQ:GOOG) cost per dollar of revenue. On April 17, 2007 I posted an article “Microsoft’s $8 Billion Problem.” In that piece I concluded that:
It cost Microsoft 18.8¢ more to generate a dollar in sales than it cost Google. Multiply that 18.8¢ by its sales revenues and you find that Microsoft has an $8.3 billion problem. That's how much the company was over-spending on enterprise marketing in 2006 compared with Google.
In that same article I introduced “Gerstner’s Rule.” In his book Who Says Elephants Can't Dance? Lou Gerstner laid out a rule of thumb on enterprise marketing efficiency. It's simple and revealing: How much does it cost to generate a dollar in sales revenue compared with your competitors? This is Gerstner's cost per dollar [CPD] rule: less is more. If you’re interested in how much CPD varies among companies see my May 11, 2007 article “Gerstner’s Rule in High Tech Industries.”
Inside Enterprise Marketing
There’s a huge difference between enterprise Marketing, with a big M, and traditional marketing. In an audio slide show I define Enterprise Marketing Expenses as …
… all the costs of the people and programs that influence how consumers, customers and investors think, act and feel about a company.
Fortunately the income statements of MSFT, YHOO and GOOG give us a pretty clear picture of all those expenses. The following table reports all the costs found inside the enterprise marketing expense [EME] category: Selling & Marketing [S&M], General & Administrative [G&A], and Research & Development [R&D]. These line items accounted for 53%, 16%, and 32% of MSFT’s total enterprise marketing expenses, respectively.
I colored EME a cautionary yellow because earnings occur only after all three expenses are covered. And I colored S&M expenses red because they often are the culprits in a company’s failure to maximize earnings. By the way, the approximately $12 billion that Microsoft spent on S&M included traditional marketing as well as sales force expenses. These data were downloaded from Edgar Online I*Metrix services. For MSFT and GOOG the most recent four quarters ended in December 2007, while YHOO’s ended in September 2007.
The basic data make a lot more sense when standardized using Gerstner’s Rule: in enterprise marketing, less is more. The next table reports the cost per dollar [CPD] of revenues by source for each company.
Microsoft’s gross CPD (in the right-hand column) was $0.40 in December 2007. This compared with $0.46 in June 2006 (not shown). This represents a decline in Mr. Ballmer’s CPD of nearly 12% in 18 months. On the other hand YHOO’s cost per dollar increased 8% from $0.42 in June 2006 (not shown) to $0.45 in December 2007; while GOOG’s went from $0.27 to $0.29. But G&A expenses as well as R&D expenses per dollar sales were comparable across all three companies. It’s Sales & Marketing expenses that raise the red flags for MSFT and YHOO.
It's Selling & Marketing Expenses!
The next table reports the cost per dollar for MSFT and YHOO net of GOOG’s cost per dollar by source. Notice MSFT posts a net competitive advantage on G&A expenses as well as R&D costs per dollar revenue.
Still there’s a bothersome -12¢ CPD in net Selling & Marketing expenses. Not to mention YHOO’s net CPD disadvantage of -16¢, most of which is also attributable to Selling & Marketing expenses.
The Pajama Game
This final table brings the analysis back to the central question: What are the potential synergies to be found in this merger of equal over-spenders? Like Eddie Foy, Jr. sang in the 1954 hit Broadway play The Pajama Game, 11¢ doesn't buy a hell of a lot ...
… till you multiple it by MSFT’s nearly $58 billion 2007 revenues. That produces an eye-popping net competitive redundancy of $6.367 billion … all of which is associated with MSFT’s Selling & Marketing expenses. To be sure that’s nearly $2 billion less than the $8.3 billion competitive redundancy from 2006 mentioned above. A big improvement, but this just begs the original question.
Why Shell Out $45 Billion?
Dan Gallagher’s MarketWatch technology column “Microsoft-Yahoo deal draws mixed reactions” also quoted Leland Westerfield as saying:
Microsoft would ultimately need to sweeten its initial offer price …
(BMO Capital Markets)
Why shell out $45 billion or sweeten the deal more for a house in the country – pardon the garish play on words - when the goal should be to fix a problem in Mr. Ballmer’s own back yard?