Why Free Software Is Such A Big Deal

People have come to expect certain types of software to be free - like browsers. In fact, that's how Netscape started, making its software available for nothing. Eventually Microsoft beat them back with its own browser, Internet Explorer. But interestingly, the free browser wars are not over, according to a story in Computerworld quoting a Net Applications' study:

Mozilla Corp.'s Firefox browser is on pace to hit the 20% market-share mark next month, a Web metrics company said today. Firefox boosted its share by 0.6% in May, accounting for 18.4% of the browsers used during the month and putting it within shouting distance of a major milestone, according to Net Applications Inc. "Firefox is trending to hit 20% market share sometime in July," said Vince Vizzaccaro, the company's executive vice president of marketing, in an e-mail.

This is fascinating, not because someone other than Microsoft can give software away, but because in doing so, a company can take so much market share. It's another sign that the Redmond-based corporation needs significant change and some direction that stresses real invention.

If You Can't Buy Yahoo, Maybe You Can Buy The Customers

Microsoft is trying to pay users to shop online with its Live Search. According to a BBC story:

Under the cashback service, the software giant promises to pay back a portion of the purchase price of anything shoppers buy online from any of its 700-plus selling partners who are offering more than 10 million products.

Among the big box retailers who have signed up are Barnes & Noble, Sears, Overstock.com, Home Depot, J&R Electronics and a host of others.

Money will be paid either via PayPal, a cheque or into a user's bank. It will only be open to people living in the US.

The story then quotes Om Malik, a tech heavy weight and founder of GigaOm, as saying, "This is not going to affect Google. Google is so much better." I'd have to agree that it's no great shakes, but more because I think it's simply a bad business idea.

This is not the first time Microsoft has tried paying users to switch to its search technology. Last July there was a report on how it had fared. My comments then still go: this is bribing consulers, and the result is attracting only mercenaries who will be gone at the hint of the next offer. The only way you keep them is to keep increasing the incentives. In short, paying people is a tacit acknowledgment that you offer nothing else they might value. That means the cost of maintaining the customers will be extremely high and they will feel virtually no loyalty to the vendor, just loyalty to their billfolds.

Now lets add the new wrinkle. This is money back for purchases made from searches. Given that Microsoft wants huge markets, they are probably assuming that this should be a big part of the search business. But how often does a search end in an immediate purchase? I'm guessing fairly seldom. People and companies buy according to their own schedules, not to the seller's. What if they use search to get information and eventaully get around to buying days, weeks, or even months after? Google keeps that business and that means so many more times to help tie the customer close.

Furthermore, if this was such a good strategy, why didn't it work so well when Microsoft started it last year that they didn't need to try and buy Yahoo? What Microsoft needs is not an old strategy based on where they were, but a new, forward-looking stategy based on where they want to go. The more they stick with the old playbook, the more they are stuck in an old game, while Google and other companies are in a different open field using different rules.

Microsoft Won't Take No For Answer

According to at least a story in the Financial Times, Microsoft has proposed to Yahoo something between a partnership and full buy-out. The subject of speculation is whether Microsoft is trying to buy Yahoo search.

Even though Google is huddling over what to do, as they find the combination threatening (and want to partner with Yahoo themselves), I don't see why. They might lose the revenue opportunity that advertising on Yahoo search might bring, and that would be a pain. But there is nothing that Microsoft would add to Yahoo search to make it particularly enticing. They can't integrate it into Windows because of their past anti-trust dealings, and if they had something compelling for users, you'd think it would have come out on MSN already.

Microsoft continues to push only because it doesn't know what else to do, and management there isn't willing to encourage real innovation because, well, it's not guaranteed to be a blockbuster. Here is where Microsoft could learn a whole lot from the old IBM. Not bloated bureaucracy - the Redmond company already has that in spades. No, it's the concept of a research lab that can hit on not just innovation, but out and out new concepts. They could even do it in software alone and fund it for what would be a song to them. The current state of affairs is management by fear. Perhaps the company could use someone at the top who is a little bolder. It will take some daring to move in some direction, because change is inherently threatening to the old order, and so far the company has communicated that it wants to stay exactly where it is.

MicroWahoo is a Corporate Disaster

They want to do a deal, they don't want to do a deal - the only way to figure out where the two companies have been going is to find a lower-case "o" oracle. I think that the CEO and board at Yahoo are now toast because they turned down a major premium on a stock price that hasn't yet heard a value low enough to make it satisfied. Push will come to shove, and look for either major resignations or institutional investors to push for a dissident slate of directors.

As for Microsoft, if the Yahoo deal was that important, what happens to Ballmer for not being able to make it happen? I'd ask if there was a plan B to find a direction for folks in Redmond, but I think that the Yahoo pitch was just whistling in the dark, because it was essentially an approach that was a me-too-more-of-the-same strategy. In other words, they aren't moving anywhere and probably won't be in the near future. Of couse, there is that little probelm of needing to protect the revenue base of Windows and Office.

Microhoo: Why a Microsoft Acquisition of Yahoo Won't Change a Thing

Money can buy almost anything you want, and for Microsoft, that would be Yahoo – for something over its original bid of $44 billion. Many experts agree that the software giant will likely have its way. But getting what you want can be different from getting what you need, which may not be available at any price.

During a February 1 conference call, Microsoft CEO Steve Ballmer said that acquisition talks had occurred “off and on for the last 18 months.” Microsoft wants Yahoo badly enough to offer an amount greater than its combined net income from 2005, 2006, and 2007 because it is stuck.

Once PCs ruled supreme; now the Internet is king, Microsoft is “struggling,” says N. Venkat Venkatraman, a professor of management at Boston University. Traditional Windows and Office products – 80 percent of company revenues – are mature businesses that won’t fuel accustomed growth. For example, the newest version of Windows, Vista, has had relatively poor sales because of technical problems and a chilly user reception. According to statistics from NetApplications.com, it has a market share of only 12 percent market, versus the nearly 75 percent for XP, the older version. To avoid future financial stagnation, needs a way to grow.

Online advertising seems like the answer to a prayer. According to Kevin Johnson, Microsoft president of platforms and services, it is currently worth $40 billion a year, and may double in size over the next three years.

But Microsoft has had a problem called Google. “I can’t think of a company that has controlled the direction of an industry [to the same degree],” says William Mahnic, professor of banking & finance at Case Western Reserve University. According to Jeffrey Rayport, a partner in consulting firm Monitor Group, Google makes twice the online ad revenue as Microsoft and Yahoo put together, with half the user traffic. Furthermore, the Internet whiz is giving away software functions – such as spreadsheets, word processors, and email programs – that that directly competes with Microsoft’s cash cows.

Microsoft’s has had a roughly 6 percent share of online advertising for a few years, which is “essentially been flat,” according to Karsten Weide, program director of digital media and entertainment for market analyst IDC. But add the 11 percent share of Yahoo, and “it would give them a much better fighting chance” against Google’s 24 percent.

Johnson said that the combination would offer a number of strengths. By eliminating duplicated R&D, freed-up staff could “improve our ability to drive innovation in emerging areas such as video, mobile, and online commerce.” Yahoo and Microsoft have both proven that trying to charge users for services is literally a losing game. That’s how Google has moved ahead: by providing a lot of free content and delivering ads that tie in with someone’s interest.

So, if online advertising is the name of the financial game, why focus on R&D? Because advertising online must still draw audience the way it must in print or television. On the Internet, that means novel and clever applications and services. R&D is supposed to deliver that innovation, as well as finding ways to use data about users to effectively pair ads with people.

Plus, Microsoft management is betting that by combining forces with Yahoo, the combined online advertising revenues would be better, while cutting redundant costs would actually mean more profit to keep shareholders happy. It all sounds smart on the surface, and Weide says, “We think a merger between Microsoft and Yahoo would make a lot of sense.”

But there’s a problem. Neither Microsoft nor Yahoo has been setting records in making money from online audiences. Between 2005 and 2006, Yahoo grew revenue by about 22 percent. Microsoft grew by over 11 percent. Google grew by close to 73 percent. It’s gross profit for 2006 was bigger than its gross revenue from 2005, and it’s significantly larger than Yahoo. Expecting the simple combination of the two companies to better address Google’s market dominance and momentum is unrealistic.

To fend off Google, Microsoft doesn’t need more of the same old thing, whether its own packaged software past or Yahoo’s online business. It needs entrepreneurial spark and invention. But innovation is the result of people, and getting the employees at Yahoo and Microsoft to work effectively in this way will be incredibly difficult.

First there are practicalities. “They’ve not done an acquisition of this size before,” notes Georgia Institute of Technology finance professor Narayanan Jayaraman. The mistakes that could come from an acquisition badly done could cost Microsoft the efficiencies and focus it is counting on.

The two groups may also get along badly. “[Yahoo employees are] always making jokes about Microsoft and the evil empire,” says Mike Grishaver, now CEO of Thingfo but until last fall a director of product management at Yahoo. Rayport agrees: “You’re talking about two cultures that are not just far apart, but that have active animosity.” Should key Yahoo employees become annoyed, they can find many other opportunities in Silicon Valley.

Furthermore, neither Microsoft nor Yahoo has shown the particular type of innovation that is necessary. “[In 2005] I laid out 13 things that Microsoft should buy or start building,” says Robert Scoble, a former Microsoft developer who used to write a popular blog about the company when still an employee there. But management turned down all the ideas because they weren’t big enough at the time to warrant Microsoft’s interest. Those small potatoes included MySpace, photo sharing site Flickr (later purchased by Yahoo), and Internet phone service Skype.

As for Yahoo, its glory days of Internet innovation may also be over. “The problem that Yahoo’s facing, and the reason they’ve been going downhill, is management bloat and lack of vision from the top,” Grishaver says. “When I started at Yahoo, the teams were small and days were about getting things done. Then they started to hire management layer over management layer over management layer who just go to meetings all day.”

In other words, Microsoft’s planned purchase of Yahoo could be nothing more than an expensive “me too” strategy of trying to follow Google, without an infusion of business innovation to start leading. And in the world of the Internet, another term for following is being an also-ran. The tens of billions of dollars could come to nothing more than an expensive way for Microsoft to stay exactly where it is now.

Microsoft Selling Against Microsoft

I've mentioned a number of times before how the lack of sales velocity for Vista could hurt Microsoft, whose business is held up by the twin pillars of Windows and Office. According to a link on Slashdot.org, Microsoft has tried advising IT managers how to make a case for upgrading from XP to Vista.

Given the claims that Microsoft made when XP first came out (disclosure - I happily use XP), about the robust security, selling on the strength of improved security - no, really, we mean it this time - is probably not the most convincing argument that the company could make. If it didn't deliver with XP, when it claimed that it did, why would anyone believe that it would this time? Wouldn't there be another argument for a future version that the previous versions were inadequate and there was no good way to patch them to get up to snuff? And the argument of having to upgrade "to match the capabilities of their competitors" is the same tired hog wash that the software industry (including analysts) have been peddling for years. Software doesn't make the product or the company. At best it's a tool. At worst, an expensive excuse. According to this PC World article, Microsoft is also claiming that Vista is cheaper than XP when run on mobile PCs (read as laptops) by some $606 less a year:

Peculiarly, the study actually was based on XP usage and extrapolations based on Vista capabilities because there was not a substantial base of Vista clients in use yet when the study was done early in 2007. Now, the installed base of Vista is 60 million PCs, Microsoft said.

I wonder if Microsoft actually included the upgrade costs - including new hardware - as so many of the early users had already paid for the upgrades under a site license agreement, and so would not have shelled out additional money. Whatever the case, it's not a good sign when company has to use fear, uncertainty, and doubt - the great software FUD - against its own products because so few people want the new one.

Microsoft Vista Hits New Problems

Microsoft's love of operating systems is a direct result of its bottom line, with probably 40% of its revenue owing to the product line. Key to any successful operating system introduction is business acceptance - companies buy in bulk, and if you're Microsoft, they also condition people to use the latest version. Only, evidence continues to mount suggesting that's not how things are going this time. According to this Computerworld UK article, studies on both sides of the Atlantic suggest that IT professionals are not keen to introduce Vista into their companies:

The survey, echoing one from Forrester last week, shows most IT professionals are worried about Vista and that 44% have considered non-Windows operating systems, such as Linux and Macintosh, to avoid the Microsoft migration."

Clearly many companies are serious about this alternative, with 9% of those saying they have considered non-Windows operating systems already in the process of switching and a further 25% expecting to switch within the next year," the report "Windows Vista Adoption and Alternatives" reads.

Microsoft has been concerned about Linux for a long time, and that has only grown as some versions of Linux have become more user-friendly. But this is the first time I can remember seeing that large a part of the IT world considering not just Linux, but the possibility of moving back to the Mac, which would have its own slew of problems, as would trying to manage a selection of operating systems - and the versions of business applications they'd need.

A New World on the Business Desktop?

There are three threads on Slashdot.org that, taken together, offer an interesting look into what might be happening in corporate computing. A Computerworld article quotes a study from a third party software vendor indicating that a vast majority of businesses have any intention of moving their computers to Microsoft Vista:

In a just-released poll of more than 250 of its clients, PatchLink noted that only 2% said they are already running Vista, while another 9% said they planned to roll out Vista in the next three months. A landslide majority, 87%, said they would stay with their existing version(s) of Windows.

Those numbers contrasted with a similar survey the Scottsdale, Ariz.-based vendor published in December 2006. At the time, 43% said they had plans to move to Vista, while just 53% planned to keep what Windows they had.

That's a big difference from what I've seen in past cycles. Old versions of Windows would stick around for years - far longer than most people generally thought. I can remember that when Windows 95 came out, at least a third of companies were still running some amount of Windows 3.1 several years after the new platform's introduction. Businesses prefer the devil they know.

But if this study is actually representative, then the results have to be stoking the fear furnaces in Redmond. The company simply cannot survive financially without heavy adoption of new versions of Windows, and business buyers have generally been more pervasive adopters. New machines will likely run with some version of Windows, but Microsoft also needs older machines to upgrade. Here's another clip from the article:

Although Microsoft recently announced it had shipped 60 million copies of Vista so far, it has declined to specify how many buyers are businesses, or even what percentage of the estimated 42 million PCs covered by corporate license agreements have actually upgraded to Vista.

What is the problem? The article speculates that it may be because of changed perceptions of what Vista would add from the security front. My guess is that the reluctance has much more to do with the many problems that people have reported with Vista - often slow operation, even on machines designed for it, and the difficulty in installing the operating system on existing machines. Comapnies like hardware to last at least 3 to 5 years. If you want to upgrade to Vista, you pretty much have to go for new or very recent hardware, as I understand it. That means the software has an effective added cost of at least hundreds of dollars, which is really expensive, particularly if you have to replace a whole lot of machines.

Attempts to supplant Microsoft's dominance in the office software world by an open standard not owned by any one party seem to have gone nowhere. LinuxWorld basically threw in the towel on the OpenDocument standard. So Microsoft is probably safe on that front - for now. But if the OS landscape starts to change, then its grip on other aspects of software life might also loosen.

And now we add the third thread. CareGroup CIO John Halamka, an influential chief information officer, has been publicly testing various desktop operating systems, reporting on progress in CIO Magazine, and sees a shift in strategies that is starting to make sense:

"A balanced approach of Windows for the niche business application user, Macs for the graphic artists/researchers, SUSE for enterprise kiosks/thin clients, and Ubuntu for power users seems like the sweet spot for 2008," says Halamka. "I’ll continue to watch the marketplace evolve and report on my progress. For now, the only devices I’ll be carrying are a Dell D420 with Ubuntu Feisty Fawn and a BlackBerry 8707H e-mail device."

If a few other influenctial CIOs also start moving down this route, business as a whole could see the biggest single computing realignment since the shift from the mainframe to the PC.

It's a Case of Out with the New, In with the Old at Microsoft

An article in Computerworld (though it comes via PC World) says that Microsoft will see increased Windows XP sales in 2008 than in 2007, even though Vista is available:

During a conference call with analysts following the earnings results release Thursday afternoon, Chief Financial Officer Chris Liddell said the company has changed its fiscal year 2008 forecast from an 85/15 split in sales between Vista and XP to a 78/22 split. Windows XP sales will, in other words, be nearly 50 percent higher in the next 12 months than Microsoft had estimated earlier.

Alright, so it's not that Vista is going away, or even that it's selling less than XP. But this really is an astounding situation for the company. It's continuing to set aside revenue into the "unearned income" category for the year because of "undelivered elements." That translates into having to ship unannounced upgrades and enhancements to Vista. Another way of saying that, I think, is that Vista has too many problems and gaps, which shouldn't surprise if you've followed stories about the product, or even know someone who has shifted to it.

Microsoft is planning to stop selling XP to resellers and retailers after the end of next January. What does this all say about Vista specifically, and the software business in general? The industry is on a painful tredmill. They sell products, which probably don't really need to be replaced for years, and then keep adding new features that few people ask for and create new file formats to make older versions obsolete. This is why Microsoft and other companies are trying to push software as a service - not because it's good for customers, but because they're trying to get themselves out of the pricing jam they've been in for a good 20 years and get people locked into a leasing model. There you know customers will be regularly paying money.

Early Results of Microsoft Buying Search Audience

An InformationWeek story notes that MSN and Microsoft Live slice of search volume jumped from 8.4% in May to 13.2% in June, according to Internet metrics company Compete, and that what has increase business is prizes for users:

"A good portion of the additional Live searches are coming from the Live Search Club, where you can apparently play games for points which you can redeem for fine Microsoft products," said Steve Willis, a Compete analyst, in a blog post Monday. "All of the games involve using Live's search engine - to get the points, you have to search with Live."

Much of the story looks at whether this is realistic, but even if it is, this actually isn't good news for Microsoft. This is a classic example of bribing customers - I actually mentioned it here in April. Glad to hear that volume may have increased, but the problem still remains that this is not sustainable customer development. The theory is that if you bribe people to do business with you, some amount will remain out of habit so that when the bribes (whether called rebates, subsidies, or by another name) eventually stop. That might be true, but does anyone check the profitability of these "catches?" Someone drawn nothing more than one company's freebie is subject to being distracted by another's, and so the likely lifetime value of said customer mercenary will be low. Compare that with the acquisition costs, and it could be that you're actually losing money with each increment.

Strange Sitings from the PC Wars

The PC market is an obviously competitive one, but some stories (via Slashdot.org) show a number of odd things happening right now. For example, Microsoft is apparently in a sales jam, because it has launched a "fact rich" program to convince customers that they should adopt Vista now, according to The Investigator blog at APCMag.com:

"Some customers may be waiting to adopt Windows Vista because they've heard rumors about device or application compatibility issues, or because they think they should wait for a service pack release," the company said in a newsletter.

"To help partners and customers get the real story, Microsoft has created a comprehensive set of fact-rich materials illustrating how Windows Vista is ready today and tomorrow."

However, a link in the newsletter leads customers to a place only available to computer makers that will sign a non-disclosure agreement - which pretty much means that they can't tell you what they just read, and so, theoretically, can't pass on any of the information they just learned. But then, the story proceeds:

What we do know, however, is that Vista service pack 1 is, in the company's own words, designed to address "deployment blockers and high impact issues", suggesting that until the release of SP1, you will have to contend with ... deployment blockers and high impact issues. Hardly the basis for proceeding with confidence.

Maybe the facts are a little too rich for customers. But this puts Microsoft into an awkward position. They clearly released the system before it was ready to use - probably because of pressure of hardware manufacturers and, possibly, demands from those corporate clients that had already paid for the product through site licensing of Windows.

Money has to be a big issue. Yes, Microsoft got a big financial boost earlier this year and was claiming market success with Vista. But what many journalists covering the story missed was that the company does a lot of this site licensing. By accounting standards, although they collect the money, they don't get to treat it as income until they ship a product. Lack the income, and your stock looks bad. But now it's gone through that initial wave and needs the next chunk of money, which generally means the smaller purchases and consumer sales.

But people aren't adopting the way management wants and needs because Vista has received such bad press about the "deployment blockers and high impact issues." In other words, if your computer isn't pretty new, it won't work, and even if you do have a new machine, the system can run incredibly slow, as I've heard from people I know who are using it.

So what might happen is maybe another quarter of "good" results but then a pot hole when the continued sales don't continue. It sounds like Microsoft was hoping that people would buy anyway because, well, they always have. But I think users are tired of paying for complete and total crap. That's why Dell has started selling XP on systems again and why Linux continues to expand, particularly with Ubuntu offering what is supposed to be a more user-friendly version.

This all makes the second story sound even odder: Dell refuses to sell a system with Ubuntu to a business. So why won't it? Is there some licensing agreement with Microsoft or someone else that makes it impossible for them to do so? Or do they want to upsell into a more expensive model with an operating system that adds a bit of additional margin dollars?

What is going on with these companies? They seem to have lost sight of how important customers are. To play such games - because that's what they are, playing with people for your own ends - is essentially is the essence of the con job. You may not get caught, but when you do, it's painful. Better to forgo some profit today and keep your customers than to pump up your numbers for one quarter and find that no one likes doing business with you.

Google Wants to Know Everything - About You

According to a piece in the Financial Times (I'm not sure how this got to be a free link, but who am I to complain?), Google wants to know everything about everybody. Literally:

Asked how Google might look in five years’ time, Mr Schmidt said: "We are very early in the total information we have within Google. The algorithms will get better and we will get better at personalisation. The goal is to enable Google users to be able to ask the question such as 'What shall I do tomorrow?' and 'What job shall I take?'"

There you have it - Google with the gloves off. Aside from questions of privacy, civil liberty, and propriety this naturally raises, there are some serious business issues.

To the degree that Google succeeds, it puts virtually all businesses in its debt. Depending on how it decides to analyze and answer such questions, it directs people in their choices. If your company is on the outs with Google, might there be a chance that it freezes out your chances with customers? Will you have to - eventually - pay a fee to remain in the running, if not with the current management, then with a future team? People who think that all the tumult over Google and Yahoo and Microsoft is solely about online advertising aren't looking at the bigger pictures. In a society where an increasing number of people want to be told what to do, having an ever-increasing collection of information on them as well as an ability to be a front end to the Internet means controlling business beyond what can happen even in a monopoly.

More Online Ad Acquisition Madness

Within a 24-hour span we've seen WPP, a British marketing services company, acquire 24/7 Real Media (search marketing, advertising management, and digital media), and then Microsoft spend $6 billion for aQuantive (digital ad agency, marketing technologies, and ad space wholesaler). What seems to be happening is the logical continuation of Google's acquisition of DoubleClick and the alleged merger talks between Microsoft and Yahoo. Everyone's trying to get into online advertising - because they know that companies will spend ad money somewhere and it's likely going to be increasingly for digital forms. It's one huge growth area, and companies want to get in line for the cash payouts, and to control important future directions of communications and business.

One good rule of thumb is that the more companies pay for acqusitions, the more they'll ultimately have to charge to recoup the price. Furthermore, the crossover between marketing services and underlying technologies that make digital marketing possible have been significant. That spells potential conflict of interest and growing costs, which, if taken to an extreme, could make digital advertising a lot less cost effective.

A New York Times article notes this:

“To effectively compete with the likes of Google and Yahoo, Microsoft needs to have a large base of advertisers,” said Anthony Noto, an analyst with Goldman Sachs. Mr. Noto said that Google had more than 500,000 advertisers and Yahoo about 300,000, while Microsoft has only a small fraction of that. “As long as that gap exists, they will have an inferior ability to monetize their own product,” Mr. Noto said.

Now aQuantive, which is based in Seattle, will bring many advertisers to Microsoft — and more.

I'd have to disagree a bit. What drives an online advertising business is not having a lot of advertisers, but having a lot of people who want to see those ads. It may be that Microsoft will get those people, but can they keep them? So far the company has done poorly in attracting audiences, so the question becomes whether they can maintain the viewers they will need for real success.

Microsoft Yodels Yahoo

(The following is a story of mine running translated right now in Newsweek Japan)

It only took one initial report a little over a week ago about potential merger talks between Microsoft and Yahoo to generate some of the biggest buzz the online industry has seen. Even as further stories suggested that the two companies were actually considering a strategic online partnership, interest was still intense because of one word: Google.

The search engine company has competed online with Yahoo and Microsoft and thrashed them both, becoming the premier destination for finding information and delivering ads. And so Yahoo and Microsoft hope that somehow the combination of the former’s audience – the top ranking web destination according to site ranking service Alexa.com, with visits from more than 25 percent of all global Internet users – and the latter’s technology leadership might let them compete more effectively.

Were this any other industry, the combined forces would be powerful: almost $51 billion in 2006 revenue and well over 80,000 employees. However, on the Internet, size isn’t enough. Customers must identify a company and its site as the preferred spot to get something done, whether to keep in contact with friends, share video, get news, or look for some piece of information. Lack that connection with people, and your business is bound for bad times. Microsoft and Yahoo is just one example in the online industry of how companies are trying to use alliances to gain a spot in the hearts of customers – though it’s not clear that the approach will often work.

Finding examples of corporations that are using acquisitions for greater customer contact is easy. For example, Yahoo bought the popular photo sharing site Flickr (recently closing its own service, Yahoo Photos, because so few people used it). News Corp acquired personal networking destination MySpace as part of Fox Interactive Media, the Internet division the company created in 2005. “That’s working out quite well,” says a top venture capitalist Todd Dagres of Spark Capital. “MySpace already had presence in the online world that Fox didn’t.”

The difference between these acquisitions and a possible Microsoft-Yahoo marriage is that they were targeted at popular but still niche properties that had enthusiastic customer bases. Amalgamating more broadly based companies, however, is too unfocused. Unless companies can catch the eye of the public, they will remain stuck where they are as their competitors blow past them.

Google is a danger to Microsoft and Yahoo because it competes with them in the vital areas of search engine services and online advertising, being far more successful at both. According to NielsenNetRatings, Google’s share of U.S. searches in March was 53.7 percent, while Yahoo had 21.8 percent, and Microsoft, 10.1 percent. So Google brings more people in who want information.

Then it delivers small ads whose content matches the search terms that users choose. The result is advertisements that people often actually want to read – and many advertisers willing to pay lots of money to Google. According to Karsten Weide, program director of digital media and entertainment at market researcher IDC, Yahoo was the online advertising leader until 2005, when Google blew past them. Last year, according to research firm eMarketer, Yahoo had 15% of U.S. paid search advertising, compared to Google’s 58.7%, and next year it projects Google as taking over three-quarters. “It’s dominant already and growing so fast that it will be difficult for the other players to catch up,” he says.

That spells trouble for the other two. According to Yahoo’s 2006 annual report, 88 percent of the company’s revenue came from advertisers. And while 80 percent of Microsoft’s income is from selling copies of Windows and Office product families, the company sees its economic future elsewhere because the old software lines are now mature businesses that are unlikely to offer high rates of business growth. Before becoming vice president of media development at PodTech.net, Robert Scoble was a Microsoft developer who also wrote a popular blog about the company. He remembers upper management stressing two years ago “that the growth of the company will come from advertising, not from selling another copy of Windows or another copy of Office.”

Yet Microsoft’s online advertising revenues have been flat at about $2.3 billion for the last four years while the industry has grown at an annual rate of over 30 percent, according to Weide. That means the company has faced a constantly declining market share. “I’m at a loss,” he says. “How do you pull zero percent in a growth climate like that? It’s an accomplishment in itself.”

The problem is that bigger is not necessarily better on the Internet. The attitude comes from an old strategy of traditional industries. By acquiring other businesses, a company could create economies of scale, driving down manufacturing and distribution costs and pressuring competitors. On the Internet, though, a small and reasonably funded company can quickly reach millions of consumers: look at MySpace or YouTube.

Microsoft’s difficulty is that it understands selling packaged software, not the media world of online, so it tries to copy someone else’s success. According to Scoble, Microsoft is preoccupied with FOG – fear of Google. “Microsoft has some technologies that are really good, but they’re in clone world right now,” Scoble says. “They’re trying to clone everything that Google is doing.” For example, Microsoft is emphasizing online ad sales and even giving away use of software business applications on its Live.com site. Unfortunately the drive to copy another means that the company remains reactive to the Internet and not developing the new services that will catapult it to the lead among consumers.

Yahoo has a grasp of media, but can’t force how consumers will react. Look at its acquisition of photo sharing service Flickr. That step was necessary because Yahoo’s own photo sharing service, Yahoo Photos, simply never caught on with users. “Now you’re going to bring that together with a behemoth like Microsoft and be able to operate in a nimble and innovate way in an industry that really thrives on rapid [change]?” asks Willan Johnson, formerly a vice president at Yahoo and now general manager of SupplyFrame.com. “Many have speculated that if that deal went through, you’d want to buy Google stock.”

In the view of Kim Caughey, a senior investment analyst at Fort Pitt Capital Group, the combined entity would have a hard time hiring the “cool people … to continually create new products to drive people to your web sites and capture eyeballs.” They would find a large-scale company a bad fit. “If they have a really great idea, venture capital will give them money,” she says.

Smaller entrepreneurial divisions might do the trick, but large companies typically don’t have interest in such endeavors because the returns are too small. Scoble found this when he worked at Microsoft and in 2005 urged management to consider purchasing such companies as MySpace, Flickr, or Internet phone service Skype when they were much smaller and less expensive to acquire. “I was telling them to pay attention to something that hadn’t yet sold for $20 million,” he remembers. “I asked, ‘Why aren’t you doing things in this market?’ and the answer was, ‘We’re too busy … running multi-billion dollar businesses.’” By the time large companies see the value, it’s often too late to acquire the truly innovative businesses that are now literally worth billions of dollars.

There still might be sense in a close alliance between Microsoft and Yahoo, even if not for an online consumer market. Caughey says there might be natural synergy for corporate customers – an integration of Microsoft’s commanding presence on desktops with Yahoo’s search technology. The two could become a way to pull together data scattered throughout a large company in the form of word processing documents, spreadsheets, and other files – an area that has caught Google’s eye. Or Yahoo and Microsoft could develop software and systems that would allow others to create the next big thing for consumers. Maybe even Google developers could give the products a test. They probably wouldn’t have to search too hard to find them.