Saturday, February 2, 2008

Why Microsoft Wants (Needs?) Yahoo

Clearly the big media business news of this week is Mircrosoft's unsolicited (and unwanted) offer to buy Yahoo for a combination of Microsoft stock and cash. Depending on the price of the MS stock at any particular time, the deal is worth around $42 billion. That represents a steep premium over the pre-offer price of Yahoo.

Obviously, the deal is driven somewhat by the current low price of Yahoo stock. However, the premium offered by MS shows that this is about more than bargain-hunting. Everyone covering the story accurately notes that MS sees Yahoo as a necessary piece of its strategy to take the Internet away from Google. It's about gaining control over as much online advertising as possible. No big mystery there.

What I find interesting is that this is a huge endorsement of the idea that advertising is the key to online riches. Again, this philosophy is nothing new. In fact, there are really only three basic models for selling online content -- subscription, per-unit and advertising-based. So, anyone who wants to deliver any content over the Internet without charging the end-user is looking to make their money from advertising.

My question is how much growth is in that model? Online advertising dollars are predicted to grow by multiples over the next few years, and they probably will. However, what if advertisers start deciding that the bulk of their online dollars are not generating sales? What happens when online advertising stops working as well as everyone thinks and hopes? The prices for online ads could go down, the dollars could migrate to other media, or advertisers could simply cut back.

Honestly, I don't think there's a significant risk of negative growth in online advertising anytime soon. I personally believe that it can be a very effective way to hit target markets and initiate transactions. But it is more fun to think about business growth in the digital world once advertising growth tapers off. What's over the next hill? I think the answer is delivering content that is so compelling that consumers will gladly pay for it. That may not be realistic, but it is a much more interesting challenge than figuring out how many ads on a web page are too many.

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