Microsoft-Yahoo deal still worth doing

Merger rumors have cooled, but the idea is still hot

When Sun Chairman and then-CEO Scott McNealy first heard about the HP/Compaq merger in 2001, he likened it to ‘two garbage trucks colliding with each other.’ Some analysts see the rumored Microsoft-Yahoo discussions in the same light: an act of desperation by two lumbering incumbents that are falling further behind Google each day.

If you remember, Yahoo's stock went on a roller coaster ride late last week, after reports of merger talks with Microsoft surfaced, first in the New York Post. Stock pickers bid up Yahoo's shares around 10 percent. Subsequent reporting, from the Wall Street Journal and others, cast doubt on the rumors, noting that the companies had been in talks for months and that insiders felt a deal was unlikely in the near future. Nevertheless, the active trading suggested that Wall Street believes what Silicon Valley insiders have been saying for a while: that when you peel back the onion on this deal, it may actually make a lot of sense.

Let's look at some of the pros and cons.

For starters, there’s the obvious: neither Yahoo nor Microsoft has been able to get much traction in the fast-growing web advertising business and are distant number two and number three competitors to Google.  Would joining forces result in more web searchers straying from Google? Would Yahoo’s established advertiser base be a good compliment to Microsoft’s technology platforms and expertise, or would the integration of the two simply create more delays and lost momentum?

Verdict: toss up.

Then there’s the issue of enterprise applications and services. Here’s where the concept really starts to make sense. Google’s been sticking its toe into the enterprise waters with efforts like "Apps for Your Domain," Gmail, and Google Docs and Spreadsheets – but clearly there’s potential for them to go much deeper and hit Microsoft harder.  Microsoft needs to bulk up its web capabilities faster, to design and deliver scalable internet services way beyond its early "Office Live" efforts. With Yahoo, they’d be buying a leapfrog into the big(ger) leagues of Web delivered services.

Verdict: do the deal.

Next, there’s the culture issue. Google’s been the rare bird that is able to combine a culture of innovation with execution and scalable monetization. Microsoft excels at execution and monetization (as we all know), but it’s innovation DNA seems still stuck in the fat client era.  Yahoo "gets" the Web, but is notorious for a scattered approach to innovation and acquisitions, for its lack of focused execution on key businesses (recall ‘The Peanut Butter Memo’) and its inability to monetize traffic as well as Google.

Combining the companies would allow Microsoft to bring some disciplined execution to Yahoo’s younger, Web-savvier workforce, resulting in faster organic growth for both companies.

Verdict: do the deal.

Still, there are big questions hanging over this deal. Will consumer and enterprise Web businesses ultimately be synergistic, or will they end up being completely (or mostly) separate? Microsoft has "committed" to the consumer world through MSN and Xbox (not to mention Office and XP), but its still unclear if consumer products are really Microsoft’s best prospects, given its massive enterprise market share and standout products like SQL Server 5 and Sharepoint.

If the consumer/enterprise convergence trend accelerates, a Microsoft/Yahoo deal right now would be brilliant in hindsight. But if having a strong consumer Web capability ultimately adds little value to enterprise customers, and vice versa, Microsoft might be better off making its leap into the Web big-leagues through a acquisition, for example. And Yahoo might do better with a large media or communications parent, like a Verizon, Comcast or (gulp) Time Warner.

The next question centers on customers: would they view a Microsoft/Yahoo deal as a distraction for both companies, or as an accelerator for most robust competition not just to Google, but to Oracle, IBM and SAP?

And finally, there’s the people question. When Terry Semel took the reins at Yahoo in 2001, most of the top talent were 20-something Web entrepreneurs. Semel added a heap of traditional entertainment and media folks from places like Readers Digest, CNET, print publishing and the big Hollywood studios. None of these folks ever had a lot of love for Microsoft, by the way.

Now throw into that mix Microsoft’s 40-something techie/product manager army, and who’ll come out on top and after what kind of carnage? It’s anybody’s guess.

One final thought. With the exception of small tactical acquisitions along the way (Great Plains, Groove Networks, Hotmail, etc), Microsoft has grown organically into what it is today: the largest technology company on earth by market value and the most profitable by a mile.

Yahoo, by contrast, would be nowhere if not for it’s big acquisitions (Four11, eGroups, Geocities, HotJobs, Overture, etc). Maybe a Microsoft buyout is just the last, logical stop on a long M&A tour for Yahoo co-founders David Filo and Yang.

So let the negotiations begin… and lets hope the result is something Yahoo!ing about, for both enterprise customers and consumers.