Why the Big Deal Isn’t Such a Big Deal

NEW YORK The price tag — $44.6 billion — puts last year’s Internet deals to shame. But Microsoft’s unsolicited offer to buy Yahoo! doesn’t address the core problems they both face in the online advertising market.

Combining the companies won’t cause more people to use their search engines and does nothing to address the fragmentation of audiences to smaller Web sites. Also, any benefits would only begin to appear after a long transition period.

“They’re going to spend six months to close to a year integrating while Google keeps innovating,” said Bryan Wiener, CEO of 360i, a New York digital agency, predicting it would take until 2010 before advertisers saw tangible benefits. In the meantime, there is the risk, he added, that Google would widen a perceived “innovation gap” it has opened with its slower-moving competitors.

After more than a year of discussing possible alliances, including an outright acquisition, Microsoft went public last Friday with its offer: a $44.6 billion half-cash/half-stock deal that would give Yahoo! shareholders a 62 percent premium. Microsoft did not make its executives available for comment, but in statements made it abundantly clear the driving rationale for the deal is attaining scale to compete better with Google.

“The market is increasingly dominated by one player who is consolidating its dominance through acquisition,” Microsoft CEO Steve Ballmer wrote in a letter to Yahoo’s board of directors, referring to Google’s pending acquisition of DoubleClick. “Together, Microsoft and Yahoo! can offer a credible alternative for consumers, advertisers and publishers.”

Financial experts said Yahoo!’s board of directors would likely approve the deal.

“It’s a huge multiple,” said Linda Gridley, CEO of boutique investment bank Gridley & Co. “Who else is going to do that?”

Yet while the combined company would have an impressive, if overlapping share of consumer and advertiser products, ad agency execs expressed doubt whether this deal would break Google’s grip on Web ad budgets.

“Until they can tell me there’s a strategy other than scale, I don’t see the upside,” said Scott Shamberg, svp of marketing and media at Critical Mass, an Omnicom-backed digital agency.

The No. 1 problem area in terms of attracting more advertising? Internet search. Yahoo and Microsoft continue to fade as more users choose Google for their searches. As a combined entity, they would still only have 31 percent of the search market, according to comScore. Would more start to use their search engines?

Unlikely, said Wiener: “The real problem is Google keeps taking search market share. I don’t see how adding these two properties will fundamentally change that.”

Despite some gains made by Microsoft and Yahoo!, the online ad market continues to be Google’s show. The company is enjoying what economists call a “virtuous cycle”: As it gains more users, it can provide more volume to advertisers while attracting more publishing partners.

Additionally, the combination of Microsoft and Yahoo! properties is highly unlikely to raise ad rates. Even in display advertising, Microsoft and Yahoo! both got late starts diversifying from their portal origins by building and buying ad networks that place ads across the Web. The problem is, users migrated more quickly to new locales, including MySpace, Facebook, YouTube and blogs. Meanwhile, major media properties like ABC, NBC and CBS began using their top-tier content and deep advertiser relationships to muscle into the brand advertising business.

“There are sites cropping up in lots of different places. We have so many options nowadays,” said Sarah Fay, CEO of Carat, part of Aegis Group.

What’s more, Microsoft and Yahoo! would face the Herculean task of integrating two enormous and fundamentally different companies. Yahoo! is a Silicon Valley icon, with a corporate culture to suit, while Microsoft at its core is a software company. Fay described the mixture as “almost like Republicans and Democrats.”

A major rationale offered by Microsoft for the deal is the efficiencies that come with scale in a technology-fueled ad market. Yet to accomplish that, the companies would have to make hard choices, which were left unaddressed by Microsoft in its offer letter or subsequent conference call. Will it maintain two brands? And if not, how will they combine their many consumer assets, like instant-messaging, e-mail and search? What would happen to Yahoo!’s Panama search ad system? How would they combine their ad networks, exchanges and serving platforms? Perhaps most importantly, how could a combined company establish an underlying data infrastructure to derive insights from the large consumer base and ad-serving platform?

The biggest opportunity for the merger may lie in behavioral targeting. But that is dependent on Microsoft and Yahoo! successfully integrating different data platforms. “Unless I can do better behavioral targeting and segmentation, will it really matter?” asked Michael Winter, director of media at Omnicom’s Agency.com.

The big risk, according to Amanda Richman, director of digital services at Publicis Groupe’s MediaVest, is “creating a bigger, slower-moving behemoth during a rapidly accelerating marketplace.”