Yahoo, Microsoft: The Bigger They Are, The Harder They Fall

Microsoft (MSFT) and Yahoo (YHOO) are demonstrating the dismal results of becoming entangled in the economics of failure.

The economics of failure is about missed growth opportunities and financial expectations, rampant brain drain and stalled competitive position. These can be fatal flaws in an intense, fast-moving global marketplace in which the more savvy rivals Amazon (AMZN), Google (GOOG) and Apple (AAPL) are gaining, despite double-digit pullbacks in consumer and advertiser spending.

The economics of failure result from not executing transformative must-do strategies and resorting to alternative drib-and-drab gains that fail to accomplish the mission. This reality is taking hold at both companies, evident in their most recent quarterly earnings and in comments from management during meetings with analysts.

Yahoo CEO Jerry Yang and Microsoft CEO Steve Ballmer essentially concede they cannot come to terms on their defunct $47 billion merger or a lesser search alliance; their employees and shareholders will have to settle for incremental financial and competitive growth maneuvers. Their financial results and comments underscore both companies' escalating vulnerabilities and challenges, which could undercut the gains they are projecting for the remainder of 2008.

For instance, after reporting a $1.2 billion net loss on its online business in fiscal 2008, Microsoft said it will increase its planned investment in the unit by an additional $500 million–without providing a convincing plan of action for the new fiscal year. Just ahead of an annual review with 250 analysts in Redmond, Wash., Thursday, Microsoft abruptly announced the departure of Kevin Johnson, president of Microsoft's platforms and services division, who oversees the struggling online business as well as the virtual conversion of the Windows franchise. Microsoft is in a race against time as Google and Apple begin squeezing its longtime operating system stranglehold with their own operating systems, applications and cloud computing strategies.

The best Microsoft could come up with Thursday was a lot of double talk, references to marginal efforts like its new cash-back search, and announcing a live search ad partnership with Facebook in which it has a minority stake. That's hardly a sure bet–since, despite its 90 million users and recent international growth, Facebook is a case of another social network unable to monetize itself.

In complete indifference to Yahoo's 20% market share, Ballmer characterized search as a "mission critical" two-horse race between Google (70% share) and Microsoft (with 9%). He conceded that under current conditions, Microsoft cannot hope to match Google's estimated $25-per-search revenues until it can increase its user queries, which increase advertising, keywords and price bidding. All this could have been achieved through a Yahoo deal. "We're done [with Yahoo]… there are no discussions," Ballmer said for the umpteenth time this year, once again leaving open the door to future talks.

Instead of encouraging Wall Street with examples of new revenue and profit-generating products and innovations in pursuit of what Ballmer says is "a $1 trillion Internet opportunity," Microsoft executives talked about plans for using Xbox as a Trojan horse for all things digital in the home, adding avatars, Netflix movie streams, television shows and interactive advertising that extends to smart phones. In fact, Ballmer & Co. were most demonstrative in their snide references about competition from Apple and Google, and in their commitment to moving the company's PC-rooted competencies to more mobile devices, online and the computing clouds.

Yahoo delivered a similar rehash during its second-quarter earnings call earlier this week. Yahoo's painfully slow growth is just made worse by its tacit dismissal of Microsoft's overtures, the falling market value of its Asian investments and failure to use its cash on any intriguing acquisitions. After missing second-quarter net revenue and earnings-per-share estimates, Yahoo narrowed its full-year guidance. (That did not include a proposed search deal with Google, which may be its only significant uptick for 2009.)

At best, the outlook for both companies is a mixed bag, analysts say. Clearly, both companies have lost time and value with the distraction that has cost Yahoo more than $22 million in related legal expenses, directly cutting into operating cash flow. Microsoft is said to have spent even more. The frustrating, tense counterproductive environment that has cost Yahoo a steady stream of high-level executive exits could begin taking a similar toll at Microsoft.

It certainly appears the companies would have more going for them together than apart. None of their existing operations or plans promise to create the same level of value or excitement that their combined search effort would offer against Google. In a protracted economic downturn, in which revenue growth and profit margins will be tighter than ever, that can only mean more shareholder disappointment and balance sheet angst. It could even mean that Microsoft and Yahoo continue to fail to reach their own and Wall Street's financial projections and stated goals.

The view from the cheap seats is pretty clear: Microsoft and Yahoo should take heed to something Ballmer emphatically declared Thursday. "We're going to have to ante up in a significant way even to be in this game."

Comments

[marketwatchr:]

Ego's often get in the way of sound business decisions.

2008 Jul 27 06:50 AM

[Saint Peter II:]

after reading your analysis it becomes more apparent than ever that bureaucracy is the #1 problem facing this country. ibm downsized and is today more successful than ever mainly because of bureaucracy and there is no need to outline the impact of bureaucracy with respect to our government, but corporations also face this problem. it is the largest least spoken about problem in every area of out culture. john k galbraith wrote a book. "the nature of bureaucracy" which out lines the nature the characteristics of bureaucracy, unfortunately it is 700 - 800 pages long and for today's crowd it may as well have been written in Sanskrit! he maintains bureaucracy has a nature, as in the nature of living organisms. it has predictable behaviors in which it will engage in and those it will avoid. quite a while ago pres carter spoke about being powerless in the face of entrenched bureaucrats and things haven't improved since. microsoft and yahoo are huge bureaucracies and it matters not that they are private corporations the demonstrate the systems of bureaucracy namely the negative reinforcement of initiative that leads to brain drain and lost opportunities and stalled competitive position as bureaucracies resist above all things, change. it's incredible that bureaucracy isn't a primary issue but it may be as geo w said when asked how one could fool all the people all the time, "it's hard to see an elephant if it's sitting on you." undoubtedly the Oily One has something there. see listed web on the role of bureaucrats in the death of mister dollar. saintpeterii.com

2008 Jul 27 07:30 AM

[techy:]

the author seems to imply that MSFT is going to lose money in core competencies of desktop and server softwares.

can that happen by 2010?? are people really switching to Macs pc en-masse(personal computers can be replaced upto 50% if mac became cheap but business computers cannot be replaced for a long time, too hard to develop software for them, except for browser enabled ones)

i am not sure i know where companies are switching to online apps offered by google??

from what i know, MSFT has failed to create anything outside their windows dominance......and thats it. but the author is implying that they are like a dying business....

when it comes to yahoo its true that their core business of online is being taken over by google and others.....and they are on the verge of shrinking......(earnin... are already falling since many quarters).

its a false premise to compare yahoo and msft as same when it comes to business.

msft is struggling to grow in other areas......but yahoo is losing its bread and butter.

BTW it appears MSFT has decided not to pay $33/share for yahoo because of its shareholders protest.....who think yahoo is not worth more than $25/shares. market thinks its worth only $21.

yes MSFT has no idea how to grow anywhere else.........so what, what about google....apart from their search business have the done anything to make money??

its easy to critic....why not throw some idea if anyone has one.....MSFT is willing to spend 10 billion if anyone has an idea to compete with google's to attract their addicted users.

2008 Jul 27 11:59 AM

[rrkl:]

Before the end of the year, microsoft & yahoo will combine into one company. Simple reason is - they will have no other choice. This will be more clear after their 8-1 meeting.

2008 Jul 27 12:34 PM

[Neil Anderson:]

"i am not sure i know where companies are switching to online apps offered by google??"

How about Telegraph Media Group (TMG)? They are moving to Google Apps and phasing out Microsoft Office and Exchange.

2008 Jul 27 02:26 PM

[petten:]

This article is a waste of time. If offers nothing new.

2008 Jul 27 02:30 PM

[shmigal:]

microsoft is shooting itself in the foot simply by trying to force itself into every single aspect of computing. if microsoft would just stick to the o.s. and xbox they wouldnt have the need for yahoo. as for yahoo,they are a dying company and sooner or later they will be acquired. the acquisition of yahoo by microsoft wont happen now and yahoo will more likely be acquired by google or AOL which either way is a much better fit. and just for the record i am not a microsoft hater but i do hate having something forced upon me like microsoft is attempting to do to all of us.

2008 Jul 27 04:10 PM

[croflags:]

why is Ballmer still in charge
He is clueless
It is sad that the stock hlders don't start a class
action law suit against this b##stard

2008 Jul 27 04:28 PM

[SmilingAssa...:]

MSFT is a dying business? You must be insane. AAPLE has a near useless operating system to business users and the hardware is incredibly overpriced. I don't know one person wh uses Google's apps in the real business world right now. The Xbox is a Trojan Horse and it is just now starting to gain momentum. I don't look for any meaningful growth in MSFT for the moment but they sure aren't dying out either.

2008 Jul 27 04:33 PM

[shmigal:]

"as for yahoo,they are a dying company"
didnt see anyone say anything about microsoft being a dying business.....try reading before being commenting. as for xbox,that is how microsoft is breaking into the hardware business,my point is microsoft need to stick to its core business and stick with xbox because they are the only places that microsoft is making money.

2008 Jul 27 06:20 PM

[Jason Rines...:]

There are some mixed comments here, I'll throw in mine since I am in the consumer health/online marketing world:

Read the book Innovator's Dilema if your in management. It speaks loudly to the success or failure of an enterprise based on conducting ongoing research. Failure to understand what the customer wants which does indeed change now every few short years is paramount!

This kind of research requires a Regression Model, one that charts anticipated behavior of a five year forecast and then company conducts ongoing surveys of existing and prospective customers on a monthly basis to chart the slight changing trends and the inevitable tipping point (Also a good read, Tipping Point). It is tedious work that requires a consistent effort. Lack of research kills! But I love those companies like AT&T that become beurocracies, stock drops to $5 while company has billions in reserves and then brings on new management! I didn't need Mr. Buffet to explain that one to me. He does indeed seem to find these companies the best, demonstrating a high level of research propensity. Some simply call this 'dilligence' but it does way beyond this mere word.

2) Advertisers like the rest of our culture have gotten lazy (not all but most). Hard work is required in advertising to return healthy margins. You must care about the customer as if it were your son or daughter. Abuse them and bad things happen. Companies operated this last decade like this:

A) management does initial market research, raises tens of millions for start-ups, early stage companies
B) liquidity is injected in product development, marketing models
C) marketing managers count how many cheap widget ad units were bought in a quarter or per year. Results are lousy but the thought process was it was OK to spend five bucks to earn one customer worth a lifetime return of $2. That was because the management will do a billion+ deal next time based on the INFLATED valuation of a customer asset.

Hmm, overinflated valuations? This seems to be cropping up everywhere these days!

I was a Jr. Partner of the first opt-in email company on the web in 1997. When Dennis Kovloski and Mark Schwartz asked me to sign a document that each person in the database was worth $15 when current market prices (even at the high end) was $5, I left the business. Dennis is now in jail and I was successful, it just took me longer as I slept well at night knowing the right thing was done for my children, my dear customers.

This has all abruptly ended. Those with a value proposition on how to earn a profit using fundamentals (which does include some proper capitalization) step forward. Those without one step back. Very simple to understand.

2008 Jul 29 05:19 PM