Outside the Lines

Steve Ballmer is changing the script in the Microhoo saga.

During a speech Ballmer made Friday at a tech conference in Moscow, Reuters reported him as saying, "Yahoo was never the strategy we were pursuing, it was a way to accelerate our online advertising business...We will spend money on some acquisitions. You can do a whole lot of things with 50 billion dollars."

The money must be burning a hole is his pocket, given how ready he was to hand it to Yahoo, when he now says that the combination was "never the strategy."

If Yahoo was never the strategy, what was the last three-and-a-half-month pursuit of Yahoo for nearly $50 billion? It makes Ballmer look like a flip-flopper, distancing himself from his previous hot pursuit of the Internet portal. In his initial letter to Yahoo's board on January 31, which was clearly not a love note but a business solicitation, Ballmer wrote:

While online advertising growth continues, there are significant benefits of scale in advertising platform economics, in capital costs for search index build-out, and in research and development, making this a time of industry consolidation and convergence. Today, the market is increasingly dominated by one player who is consolidating its dominance through acquisition. Together, Microsoft and Yahoo can offer a credible alternative for consumers, advertisers, and publishers. Synergies of this combination fall into four areas:

• Scale economics: This combination enables synergies related to scale economics of the advertising platform where today there is only one competitor at scale. This includes synergies across both search and non-search related advertising that will strengthen the value proposition to both advertisers and publishers. Additionally, the combination allows us to consolidate capital spending.

• Expanded R&D capacity: The combined talent of our engineering resources can be focused on R&D priorities such as a single search index and single advertising platform. Together we can unleash new levels of innovation, delivering enhanced user experiences, breakthroughs in search, and new advertising platform capabilities. Many of these breakthroughs are a function of an engineering scale that today neither of our companies has on its own.

• Operational efficiencies: Eliminating redundant infrastructure and duplicative operating costs will improve the financial performance of the combined entity.

• Emerging user experiences: Our combined ability to focus engineering resources that drive innovation in emerging scenarios such as video, mobile services, online commerce, social media, and social platforms is greatly enhanced.

From that letter, it would appear that Yahoo was a strategy, and it went beyond just search.

Perhaps Ballmer's remarks in Moscow could be construed as a way to avoid uttering the "Google" word. Yahoo may not be the grand ultimate strategy, but preventing Google from getting in bed with Jerry Yang and company is--hence, Ballmer's continued pursuit of Yahoo's search business.

In speaking with CNET News.com on February 20, Chairman Bill Gates laid bare the Yahoo bride, revealing Microsoft's real strategy (as opposed to "the" strategy) around Yahoo, which it is now pursuing:

We have a strategy for competing in the search space that Google dominates today, that we'll pursue that we had before we made the Yahoo offer, and that we can pursue without that. It involves breakthrough engineering. We think that the combination with Yahoo would accelerate things in a very exciting way, because they do have great engineers, they have done a lot of great work. So, if you combine their work and our work, the speed at which you can innovate and get things done is just dramatically more rapid. So, it's really about the people there that want to join in and create a better search, better portal for a very broad set of customers. That's the vision that's behind saying, hey, wouldn't this be a great combination.

When Yahoo played too hard to get, Ballmer came to realize that swallowing Yahoo whole perhaps wasn't as good a strategy for Microsoft as it was for Yahoo shareholders. Doing anything to stop the fast-growing Google, which will generate about half the revenue Microsoft does this year, is the strategy. Hence, pursuing Yahoo's search business on one end and Facebook on another front to create more inventory and ride the social-networking wave.

It all sounds a bit desperate. Perhaps it should be looked upon as an "evolving" strategy. What's clear is that Ballmer and Yang never had the kind of relationship that could lead to a marriage. In the end, emotion trumped "the" strategy.

The latest wild rumor circulating is that after doing a search ad deal with Yahoo, Microsoft will spend its cash acquiring Facebook for $15 billion to $20 billion.

At a press conference in Tokyo on Monday, Facebook CEO Mark Zuckerberg was asked about Facebook's future as a standalone company. "You can tell, from our history and what we've done, that we really wanted to keep the company independent, by focusing on building and focusing on the long term," Reuters reported.

Zuckerberg declined to comment on a follow-up question regarding the prospect of a sale. Microsoft invested $240 million to acquire 1.5 percent of Facebook at a $15 billion valuation. After walking away from the negotiating table with Yahoo, Microsoft's bankers supposedly had some conversations with Facebook about an acquisition.

Microsoft has not lost its lust for Facebook, which would be a much cleaner acquisition than Yahoo and provide a lot of ad inventory, though social-network advertising isn't as lucrative as search.

Here's some of the logic trail that could lead Microsoft to the conclusion that it could end up with deals for both Yahoo and Facebook. This can be viewed in the context of the four pillars of Microsoft's online strategy:

1. Consolidate ad platform and win in display

2. Innovate and disrupt in search

3. Deliver end-to-end user experiences across the PC, the phone, and the Web

4. Reinvent portal and social-media experiences

• Yahoo was surprised when Microsoft walked away from the table. Yahoo wanted $37 per share, and it threw the Google ad deal in Microsoft's face, so CEO Steve Ballmer withdrew his $33-per-share offer. Miscalculation on Yahoo's part.

• Since then, Yahoo shareholder lawsuits, plus Carl Icahn's buying up of shares and proposing a complete new board of directors for the July 3 shareholder meeting, have put serious pressure on Yahoo to rethink its stance.

• Doing a deal for Google to sell text search ads on Yahoo's sites would not only bring up possible antitrust issues, but it would also turn off Microsoft.

• Turning off Microsoft by getting in bed with Google would give those influential Yahoo shareholders--as well as disgruntled employees who view an acquisition by Microsoft as the right ending to the saga--more ammunition to fry Yahoo's board. So, it's wiser to keep the door open to Microsoft than to embrace Google to keep Microsoft out of the picture.

• Microsoft seriously needs to ramp up its search ad business. It has a deal with Facebook, but it lost out to Google on AOL and MySpace.com. How about taking over Yahoo's text search ads business as a way to gain inventory and to continue the tough love for Yahoo, which could then lead to a full acquisition, especially in light of Icahn's machinations and the shareholder meeting coming up July 3?

• As a bonus, announce the search ad transaction at Microsoft's Advance08 Advertising Leadership Forum this week.

• As the summer gets into gear, Microsoft will talk to Yahoo shareholders such as Icahn, various intermediaries, and eventually Yahoo, about a union at $33.50 per share.

• There is the chance that Microsoft will cool to a Yahoo acquisition--too many bad memories during the unfulfilled courtship--and just settle for a search ad deal to keep Google at bay. A joint venture for search covering both the search and advertising technology, as well as sales, would be a stronger play versus Google, but that might be hard to execute.

• Microsoft has been attracted to Yahoo for more than its search business. It has engineering talent, 500 million members, and some compelling services that would work across the MSN and Yahoo brands.

• If Microsoft doesn't acquire Yahoo outright, Facebook becomes more enticing. Zuckerberg has said many times that he plans on going public when the time is right.

• However, times have changed. Facebook has found that selling ads on social networks isn't as profitable as selling search ads. The company has reduced its revenue forecast for the year. The growth curve for bringing in new users has slowed somewhat, though Facebook is expanding outside the United States. Competitors such as Google, AOL's Bebo, and MySpace have not gone away, and the notion of data portability means that the walled gardens that keep people fenced into a social network are becoming porous.

• Thus, Zuckerberg & Co. might be more open to taking $15 billion to $20 billion now for their four years of work, rather than taking a chance on an uncertain market. I suspect that is what the elders are telling the Facebook management team.

• Now for the ideal scenario for Microsoft: acquire both Yahoo and Facebook. First, do the search ad deal with Yahoo to pre-empt Google on that front. Over the summer, acquire Yahoo as the pressure builds from shareholders such as Icahn. Finally, as Facebook realizes that its dreams of becoming the next Google are less certain, acquire the social-networking giant.

• If this scenario were to occur, Microsoft would have a lot of online territory. It's not as cheap as the Louisiana Purchase, and it's not clear how Microsoft would integrate and leverage the various platforms and audiences.

The 35-year-old Microsoft has a long-term view, and has been known to be persistent and tenacious. However, it's not clear that by cobbling together and integrating different services, Microsoft can lead the way to Web 3.0.

In this week's EIC Squared podcast, ZDNet's Larry Dignan and I discuss the latest news from SAP, Sun Microsystems, Advanced Micro Devices, and Microhoo. At SAP's Sapphire conference this week, company executives explained the delayed rollout of the new on-demand enterprise suite, Business ByDesign. SAP CEO Henning Kagermann said that the total cost of ownership (TCO) equation on Business ByDesign and the upgrade procedures weren't good enough:

"We know we can have TCO, but need NetWeaver enhancements. There's a very close link between the TCO of Business ByDesign and NetWeaver. The TCO is not so much hardware; There are too many processing steps in our hosting. We can continue to do manual steps when first upgrade Business ByDesign from 1.0 to 1.1, but it's not predictable in way where every client got it at once and in the same way."

Larry remarks on AMD's lack of transparency about its chip fabrication plans and product roadmap, and I recap my visit to JavaOne, where I met rocker Neil Young and interviewed Sun CEO Jonathan Schwartz about his plans for JavaFX and cloud computing. Schwartz has a good plan, but getting developers on board will take some heavy lifting.

We also debate whether Microsoft is open to a union with Yahoo after the parting of ways.

Based on comments by Chairman Bill Gates and CTO Craig Mundie in the last few days, you might think Microsoft has not lost its lust for Yahoo. With no alternatives in sight, Yahoo may be rethinking its terms and conditions for becoming part of Microsoft. In this video, I outline the latest moves and nuances of the Microhoo affair.

Yahoo CEO Jerry Yang talked to a few press outlets Monday, opening the door to further negotiations if Microsoft is willing to show him the money, or what he considers the appropriate price.

Microsoft's final bid was $33 and Yahoo held out for $37, or something close to that number, but Ballmer decided on Saturday not to continue the courtship. With Yahoo flaunting its possible ad serving deal with Google and holding out for an 80 percent premium over the January 31 closing stock price, Yang appeared to overplay his hand.

According to Reuters, Yang said it was Microsoft who decided to cease negotiations. With shareholder lawsuits piling up in the wake of the failed deal, the stock suffering, and no other suitor in sight, Yang may now be looking for rapprochement with Ballmer.

"If they have anything new to say, we would be open...I am more than willing to listen," Yang told Reuters.

SAP CEO Henning Kagermann has some advice for how Microsoft CEO Steve Ballmer should spend $45 to $50 billion.

"I'd encourage him to spend it on Yahoo. For Microsoft, the challenges are more on the side of the consumer space, not the enterprise space," said Kagermann.

While Ballmer walked away from Yahoo over the asking price and other issues, he might be back if Yahoo fails to show that it can gain momentum.

Kagermann was speaking at SAP's Sapphire conference in Orlando, Fla. ZDNet's Larry Dignan captured the action. Kagermann speculated that Microsoft wouldn't have made the offer if it didn't have a good handle on how to integrate the two companies.

In 2004, Microsoft and SAP were in talks to merge but nothing came of it. It could be that Kagermann hopes that Microsoft acquires Yahoo so it will be distracted with the merger and not get any ideas about trespassing on SAP's enterprise software territory.

In a memo to Yahoo employees, co-founder and CEO Jerry Yang asked his troops to redouble their efforts and to focus on executing what he called the most important transition in the company's history. It was the expected post-game motivational speech after declining to take Microsoft $33 per share offer.

On Monday Yang, will face some irate investors and employees. The stock is expected to head south at the market open. He will need to provide more evidence than slideware about doubling operating cash flow in three years that Yahoo has a plan to grow revenue and profits ahead of competitors.

In the note, Yang mentioned the exclamation point in Yahoo's name (we leave off the "!" in references to Yahoo!) and looking forward to the future:

there's a reason why we're the only fortune 500 company with an exclamation point at the end of our name, and now is the time to demonstrate what that exclamation point stands for.

I am intrigued by the rendezvous of the most important transition in company history and the exclamation point. Yang appears to acknowledge that Yahoo hasn't fully earned an exclamation point after its name, and his memo wasn't explicit on what the most important transition entailed.

What would it take for Yahoo to reach its manifest destiny, to put the exclamation point in bold, and get rid of the "struggling" label on its forehead? It's not going to come from selling search ads. Google is lapping Yahoo, and Microsoft is highly motivated to reinvigorate its efforts sans Yahoo.

Yahoo and Google are talking about a deal in which Google would sell search ads on Yahoo's site, which could generate incremental revenue for both. Google's return on search ads is about 60 percent to 70 percent more that what Yahoo gets via its search ad serving.

This deal might have trouble getting past regulators, but it signals that Yahoo is willing to cede search ads to Google. How long before it cedes display ads to Google? Probably never, especially since regulators would balk at this move and Yahoo has built what is viewed as a solid ad platform. One issue is whether Yahoo can retain the talent to sell ads and to evolve its technology.

My guess is that Yang and company hope to earn the exclamation point with a new platform that adds a social dimension to its services. This transition involves inserting a Facebook-like social graph into the core of Yahoo's platform and making it available to any application from Yahoo or third parties. In a note to the troops this evening, Yang wrote:

"We'll continue to execute on our plan -- making your Internet experience as personal, relevant, open and social as possible, serving advertisers so well they insist on working with us, and opening up Yahoo! in a way that developers dream of."

Last month, Yahoo CTO Ari Balogh outlined what he called Y!Open, following a sneak peek of the concept by Yang at CES in January.

During his CES sneak peek, Yang demoed a scenario of planning a dinner for friends in a future version of Yahoo. You can drag the thread of an email conversation into a map, and the profiles of those on the e-mail string are surfaced, noting preferences (for food in this case) and suggesting appropriate restaurants in the area.

Balogh laid out the Y!Open challenge in his Web 2.0 Expo keynote:

"We are taking open to a whole other place. We are rewiring Yahoo from the inside out with a developer platform that will open up the assets of Yahoo in a way never done before, making the consumer experience social throughout and providing hooks to developers."

He noted that Yahoo has 10 billion latent connections across its 500 million users and properties, such as e-mail, instant messenger, and fantasy sports.

Will Y!Open prove that the company and its leadership deserve the exclamation point? Balogh told me that the rewired Yahoo, which is slated to trickle out this year, will have a material impact on Yahoo's page growth and time spent on the site, resulting in increased revenue. It was baked into the calculations projecting a doubling of its operating cash flow from $1.9 billion to $3.7 billion in a three-year span.

However, Y!Open is a major technical and marketing challenge. "We have to replumb Yahoo to use a single profile and create feeds, a way to consume feeds and Web services APIs and to layer those mechanisms into the platform," Balogh said. "The goal is nothing short of creating the best developer environment for creating Internet applications across the Web."

Y!Open is the right move strategically, but it's a long way in Web time from the exclamation point.

If Yahoo's chief executive expects to have credibility, render shareholder value, keep the company independent, prevent the exclamation point from falling off the brand, and maintain his current job, he had better hope that Y!Open comes sooner than later and is a massive success.

When the media talks about the Web giants these days, it's Google, Yahoo, Microsoft, MySpace.com, and Facebook, with AOL as an afterthought.

Since its merger with Time Warner in 2001, AOL has been an odd duck among the swans, trumped by competitors despite its more than 100 million U.S. users, according to ComScore (below).

Speaking at a Bear Stearns Media Conference on Monday, Time Warner CEO Jeff Bewkes said AOL's ad revenue is flat, advertising has slowed, and the shift from paid subscriptions to free membership has cut into search ad revenue.

Bewkes also he would consider making an acquisition to strengthen AOL's market position.

"Would something added to AOL, or AOL added to something else, make it stronger and more valuable? We can't rule it out, and we wouldn't," Bewkes said at the event. "It's our obligation to make sure AOL gets into whatever configuration that makes it the strongest and most valuable."

I guess he knew something we didn't. The company on Thursday announced its acquisition of social network Bebo, which has 40 million members (mostly in the United Kingdom, Ireland, New Zealand, and the United States) for $850 million in cash.

AOL can now claim to have 80 million "socially networked" members by adding its AIM and ICQ instant-messaging users. AOL's spin is that Bebo helps the company in growing internationally and among a younger demographic.

Bebo does give AOL a credible social network, which already has some integration with AIM and ICQ, and lots of ad inventory. In the U.K., Bebo and AOL rank about the same in unique users, according to ComScore.

The combination of AOL and Bebo, which has adopted both Google's OpenSocial and the Facebook platform for its application developers, will be a much stronger competitor versus the other major players in the social-networking arena. At this point, Google and Microsoft lack a strong social network, though Microsoft is in bed with Facebook, and Google is expected to bring its Orkut social network, which rules in Brazil, to OpenSocial.

AOL has been investing heavily to go more international and revive its brand, which has struggled to move from Web 1.0 to 2.0.

The big question is whether the addition of Bebo to AOL will equal 2 or 3. If AOL can manage to integrate Bebo into the fabric of the AOL portal experience, such as with AIM and what's left of AOL mail users, it could be a 3. But it won't do much to slow down MySpace and Facebook.

Read more of News.com's coverage: "What Bebo means to AOL"