44.6 billion? Hmmmm… Smacks of desperation to me.

Its been well known for a long time that Microsoft couldn’t in any way keep up with the migration to the internet. In 1994, instead of admitting that the internet was something good and useful, they come out with the Microsoft Network, branded MSN. At the time, it was effectively another AOL or CompuServe. In 1997, AOL bought CompuServe but Microsoft was still trying to be an ISP with MSN. By the time Windows 98 rolled around, the MSN Explorer was starting to show its face and by 2001, it shipped as a default application in Windows XP.

Microsoft were still looking at AOL as being the type of market and service they wanted to provide to their customers on MSN. Just as they completely missed the whole internet boom in the early 90s, they were still looking in the wrong direction.

In 1994, Yahoo! started in the college dorm of two Stamford students. (Sound familiar?) It wasn’t much more than a web page containing links to all the sites they liked or found and wanted to visit again. Their friends started using it. Then friends of friennds started using it. In the fall of 1994, they got their first 1 million hit day. Worked out to about 100,000 unique users. What started out as probably the first true web directory of websites became the directory of websites in a time before search technology was anything more than a lab project.

Yahoo! was incorporated as a company in March of 1995. With support from Sequoia Capital, they were able to put together nearly $2 million in initial VC funding. Instead of providing access to the internet, the initial idea was to continue to provide a directory to the services that people wanted on the internet. Of course, these services grew and things started taking on a life of their own. By 1997, Yahoo! had established themselves as one of the largest networks (and locations) on the internet.

Microsoft eventually conceded that it had to open its network up to those outside their own small network of subscribers. Eventually it shut down running as an ISP and moved all its services over to a similar model that Yahoo! was using at the time. Unfortunately, even still they didn’t quite get it. For a while they still tried to charge people for “premium” services that could be had for free from other companies, such as Yahoo! This allowed Yahoo! to keep growing. The fact that there was no barrier to entry made it extremely popular and allowed it to grow its services rapidly.

Too late, Microsoft realised that it was behind the 8 ball. However, Yahoo! also got blindsided by another school project by 2 university students when Google was started.

The power of the Yahoo! search results was that initially all results and sites in their directory were hand picked. All the search results you got were the result of someone going to those sites and cataloguing them into the correct directory categories. The only time an bot or crawler came in to play is if there were no results from a human. This meant that your search queries were extremely relevant. Otherwise, the results you got were simply keyword based. How many times did a word appear on a page?

Google changed that rather rapidly with their PageRank algorithm in 1998.

Hand reviewing sites that go into a directory is great for getting really good meta data, but by this stage there are millions of pages around the web. Its inordinately impossible to get through all those pages. PageRank provided something that was able to return results that were almost as useful to people. And being entirely automated, could work a whole lot faster to get more websites. And this is where things started hurting for Yahoo! in the search and directory space.

What really hurt was the invention of Adwords. Google’s very smart advertising program. Today, Google owns more than 60% of the online advertising market. Not because they’re bad and naughty, but because their product allows anyone, anywhere to advertise easily. They also have the largest network of advertising sites because they opened up the AdSense network and started paying people to put these ads on them.

Yahoo! wasn’t slow to react, but the damage had been done. Yahoo! started to build its own advertising network and tried to compete. Initially, all they could do was put the advertising on sites they owned. Then they started to sign advertising deals with other companies. However, the number of companies out there offering banner advertising was pretty significant and the ultimate issue wasn’t so much that banners were bad, but more that text ads were great. Text adds were far less intrusive and generated a lot higher CTR.

Overture started down this path, and Yahoo! bought Overture to try and catch up. But it was too late. Google had the market and there was no way they were going to let go. They had the lion’s share of the search market now, they had the lion’s share of the advertising market. Yahoo! could keep all those other fluffy things, it didn’t matter much.

Where was Microsoft? Sleeping. Once again, Microsoft failed to see the shift in the market. They came late to the internet, trying to be the next AOL. They came late to the realisation that wouldn’t work and so tried to provide a compromise. Access via the internet, but with a paid premium. Too late they realised that catching up wasn’t going to work.

Current search market share estimates from ComScore show that MSN Search and Windows Live search collectively make up about 1/2 the number of total searches per day that Google’s YouTube on its own gets.

Microsoft dropped the ball. Their AdCenter product is so new its still mostly unheard of. In fact, they had to grab attention by making big deals with companies like Facebook and Digg.com (just to mention 2 I use) to get it noticed by a wider audience. Even then, thats not really helped much.

If comScore is to be believed, Yahoo!’s is the only search engine that grew market share between November and December last year in the US. And that was taken mostly from Ask.com.

Microsoft is in a bad place. The company has now become the very thing that it took advantage of in the 1980s to build the empire. It is the modern equivalent of the 1980s IBM. Through smart/illegal licensing deals Microsoft was able to establish itself as the only player for the home computer market. Through smart development decisions and releases, it was able to wipe out the competing development platforms from the SME markets. It built a monopoly on top of its Operating Systems and its Office suite of applications.

Microsoft thought it had won the Browser Wars. The whole Netscape vs IE mantra can now rest in pieces, but what Microsoft failed to see was that future battles would not be about the software on the computer, it would be about the services people used.

So now we find Microsoft very much in the same place IBM was in the 1980s. IBM tried to lock everyone into using their PS2 platform. Microsoft tried to lock everyone into using Windows and IE. When everyone started shifting away from the proprietary model of the PS2, IBM failed to see the change and thus spent the rest of the century catching up to companies like Hewlett Packard and later Dell.

When people started moving their applications to the internet, Microsoft failed to see the shift and has ended up playing catch up. And I personally believe that this complete inability by Microsoft to see where the market has been going is not only the reason for MSN and Live being such poor performers, its also the reason Vista has been so universally reviled. Microsoft has spread itself too thin and is trying to keep track of too many different markets.

So, instead of consolidating themselves and going back to what their core business really is, they’re going to continue to play catch up.

Bill Trancer at Hitwise has an interesting take on the deal.

If we combine the top properties for the three companies, the combined market share of visits (U.S.) for Microsoft and Yahoo! would be 15.6% of all Internet visits, with Google at 7.7% for the week ending January 26, 2008.

But if we consider only search volume, the picture is very different. For the four weeks in January 2008, Google accounted for 65.98% of all executed searches in the U.S., while combining executed searches for Yahoo! Search and MSN Search would amount to 27.84% of executed searches for the same time period.

Microsoft and Yahoo!: Putting the Offer in Perspective – Bill Trancer – Hitwise

Why this is relevant is because the services that most cross over between Yahoo! and Microsoft are not services that Google offers, or are not core products. For example, Google Bookmarks are nice, but not really a competitor to del.icio.us. In fact Gmail and Blogger are really the only products that Google puts a lot of weight behind (outside of search and advertising) and the company wouldn’t die if it sold them off. But up till now its been Yahoo! Mail and Hotmail that have been fighting over the email market. Its been Yahoo! and MSN that have been fighting over the Portal market. Its been Yahoo!, MSN and AOl that have been fighting over the IM market. In all these markets, Google might have its toes in the water, but its not concentrating on them.

Where does the money in the only world lie? Search and Advertising. Why can no one, absolutely no one, touch Google in these markets? Because Google knows their core business and their full focus is on these markets. Nearly everything else that has been produced by Google (not bought or purchased) have been 20% time projects. Including Gmail.

Does this take-over bid give Google any reason to be afraid? Not in the slightest. It will have no negative impact on its core business. In fact, given the product overlap of MSN/Live and Yahoo!, it is the staff of those two that are losing sleep right now. How many will lose their jobs? Yahoo! has already announced a significant amount of lay offs at the end of January. How many more will come about because of this take over?

No, the worst that will happen to Google is that it will stay exactly as it is now in the market place. The more likely outcome is that Google will expand its market reach. How many Yahoo! users will stop using Yahoo! because they dislike or fear Microsoft? What products will die off at Yahoo! to be replaced by Microsoft’s? There is a group of users that will leave Yahoo! simply because Microsoft now owns it.

Google has nothing at all to fear from this.

Ultimately, what this take over means is simply that Microsoft is admitting it cannot do it on its own through old fashioned hard work. It is admitting that it cannot catch up without buying its way to the top.

Microsoft is admitting that it fears Google more than it has ever feared any company it its entire history. And that is a telling tale.

I’ll finish up with a quote from the New York Times about this deal.

Today, Microsoft lacks both the weaponry and the nimbleness to compete with Google. Its operating system monopoly gives it no advantages in this battle. People can use Microsoft’s operating system and browser to get to the Internet — and to Google — or they can use Apple’s. It truly doesn’t matter. Meanwhile, with every new Internet fad, like the current frenzy over social networking, Microsoft is invariably caught flat-footed and has to race to just get a foot in the game. But that’s always the way it is when companies get big — and it is why real innovation always comes from small companies that don’t have a predetermined mind-set, or monopoly profits to protect.

[...]

But let’s be honest here. Microsoft isn’t exactly buying a high-flier. Even after a Microsoft-Yahoo merger, Google would still have twice the search market of its competitor. Its ad placement service is superior to either Microsoft’s or Yahoo’s. And Yahoo has struggled enormously in the last few years. It, too, could have been early in social networking; its chat rooms could have lent themselves easily to something that might have rivaled Facebook. Just like Microsoft, it missed the opportunity. It is quite clearly a company that has lost its way, and the question of whether Microsoft can refocus into a viable Google competitor, well, let’s just say I’m dubious.

A Giant Bid That Shows How Tired the Giant Is – Joe Nocera – New York Times