Microsoft’s High-Tech Arms Race

REDMOND, WASH. Microsoft greeted 700 advertisers and agency executives assembled on its sprawling campus here last week with a simple message: The software giant is dead serious about advertising.

How serious? Enough to double its R&D budget for its online business to $1 billion in the next fiscal year, setting up the possibility of an arm’s race with archrival Google that should spur more sophisticated ad options. And serious enough for both chairman Bill Gates and CEO Steve Ballmer to predict advertising would act as a major growth driver across its $40 billion-plus business.

“I want you to know that we are a patient, determined, long-term participant in everything that we do,” Ballmer told the MSN Strategic Account Summit last week, “and we are patient, long-term and committed to really having a more and more significant footprint in the advertising arena.”

Microsoft last week officially rolled out for U.S. advertisers the centerpiece of its strategy, Microsoft adCenter, a potentially wide-ranging platform that would allow advertisers to place demographically and behaviorally targeted ads everywhere from Web pages to search results to Internet-connected TV to video games to cell phones.

Unlike Google’s AdWords and Yahoo!’s search platform, adCenter gives advertisers audience intelligence data, which allows them to target ads to customer segments. While adCenter is now only serving text ads on search results pages, Microsoft envisions it stretching across several forms of digital media.

Microsoft’s outsized ambitions are in stark contrast to its current position in the Web ad market. Its ad growth significantly trails both Google and Yahoo!. In the most recent quarter, Microsoft’s ad revenue grew 7 percent against 80 percent for Google and 38 percent for Yahoo!. Analysts have doubted the company’s ability to make much headway in the near term.

Yet the overall shift to digital media, whether it’s the Web, Internet protocol TV or wireless, presents Microsoft with a longer-term opportunity to take part in a much larger market than advertising on Web pages, said company executives. Joanne Bradford, corporate vp of global sales and marketing at Microsoft, spoke not of the current $13 billion Internet ad market but of a $100 billion market opportunity in 10 years’ time.

Bill Gates, speaking at the conference during an interview that will be used for an episode of The Big Idea with Donny Deutsch, vowed Microsoft would catch up to and surpass Google and Yahoo!. He dismissed the idea that Microsoft was too late to the ad market, noting that until recently, nearly all media was offline. Now Microsoft is investing heavily to advance. “This is a rare case where we’re being underestimated,” Gates said.

In an interview with Adweek, Ballmer predicted the shift to digital media would quickly cause a ripple effect of changes in both consumer behavior and advertising in a matter of years. “It’s a huge, huge change,” he said. “We’ll have the ability to get good targeting, targeting being based on a user’s knowledge, and a user’s activity, not just demographics.”

While focus is often placed on Microsoft’s uphill battle to unseat Google as the top search engine, Bradford sees its advertising strengths coming from its traditional role as a software platform. As a sign of a companywide mandate, last week it quietly replaced “MSN” with “Microsoft” in front of adCenter’s name.

“Ultimately, I believe Web services are the future of this company,” Bradford said. “The company realized consumers like free ad-funded products.”

As a platform provider for video games (Xbox), productivity software (Office), portals (MSN) and cell phones (Windows Mobile), Microsoft is banking on acting as a digital media platform that enables advertisers to reach audiences wherever they are throughout the day—at work, home or on the go. In a nod to this multiplatform view, Microsoft said last week it agreed to buy Massive, an in-game video advertising firm.

“Microsoft’s in a position where they can accelerate the development of the digital world from a single device to multiple devices,” said Jeff Lanctot, general manager of aQuantive’s Avenue A/Razorfish.

“They’re innovating, which is really nice,” said Josh Stylman, managing partner of Reprise Media, a New York search agency. “While Google and Yahoo! were pushing each other on the consumer front, there wasn’t tons of innovating for advertisers.”

But Microsoft is not alone in its ambitious ad platform plans. Google is expanding AdWords to include print ads, and it plans to add radio advertising following its dMarc acquisition. Google executives have expressed interest in including TV. Similarly, Yahoo! this week will release an updated version of its search platform, which it said could eventually handle ads on TVs and cell phones.

While adCenter is engineered to handle many forms of media, its release is keyed on the Internet search market, where Microsoft has struggled against Google. MSN attracts just 13 percent of queries, compared to 45 percent for Google and 28 percent for Yahoo!, per comScore Media Metrix.

Moreover, those who do search on MSN are less loyal than Google and Yahoo! users, according to Compete, another research firm. “They’re bleeding consumers, and those consumers they’re retaining are becoming less loyal,” said Greg Saks, a Compete analyst.

Search marketing firms testing adCenter report strong results, with return on investment surpassing that of Google and Yahoo!. Thanks to registration data, adCenter gives marketers the ability to see demographic data of searchers, letting them alter creative and bid strategies accordingly. “The marketplace is always hoping there’s a new player to spur creativity and new inventory opportunities,” said Kevin Lee, CEO of Did-it.com, a New York search marketing shop that tested adCenter.

With Microsoft pouring money into R&D, it could blunt criticism that it’s fallen behind Google in innovations. “One of the reasons Google is running circles around Microsoft is rapid iteration,” Rishad Tobaccowala, CEO of Publicis Groupe’s Denuo, said during a panel presentation, drawing a flip response from Bradford that he’d have to find his own way to the airport.

Talk of an innovation lag is anathema in Redmond, where executives believe the digital media age is just beginning and moving in Microsoft’s direction. Blake Irving, corporate vp of Windows Live Platform group, points out Microsoft has released dozens of Live products since November.

Microsoft execs drove home the point to advertisers that it would take the lead in innovating through its vast resources, whether by sending fleets of cars outfitted with cameras through city streets to improve local search or developing clickable video ads. It is already working to bring Massive’s technology, used with console games, to place in-game ads in MSN’s casual games and instant-messaging software.

“We’re moving very quickly, and I feel good about that,” Ballmer said.