I consider this a must-read to get yourself back up-to-date on everything that has transpired over the past 3+ months behind the scenes, while we were all busy watching something else, the global financial melt-down, say.

It is almost precisely 1 year and 1 month to the day that Microsoft first launched its unsolicited buy-out bid, and you know the endless back-and-forth that ensued. What stands out is that as of today, while Yahoo’s stock has fallen from its pre-offer price of about $19 on 2/1/2008 to about $12 (and Jerry Yang was so maligned for not taking Ballmer’s offer that he ultimately resigned a few months ago), Microsoft’s stock has gone from $32 to now around $17 during that time!

If you do the math, that’s worse than Yahoo’s stock has done. So who still wants to argue that Ballmer would have really been much better at steering Yahoo (or really worse: the combined Micro-hoo “Franken-carrier”)? Which brings me back to the headline, and this quote from Blodget’s post that sums it all up very neatly:

Another six months of Microsoft Internet futility.  Last summer, Microsoft had been struggling to succeed online for 13 years, and it had only managed to run a distant third.  Now it has been struggling for 13 and a half years.  The company’s Internet branding, strategy, and organization is in its usual chaotic disarray.  Perhaps the new search head, stolen from Yahoo, can cut through the bureaucracy and fix everything.  After 13.5 years of a lot of talent and money being thrown at this problem, however, we wouldn’t hold our breath.

So the saga continues. The patient (Micro-hoo) indeed isn’t completely dead yet… but Yahoo’s new CEO Carol Bartz now appears to have the upper hand in any negotiations from here on…

Note: In case you don’t recall how badly Microsoft’s branding in particular has been going, refresh your memory here. Branding is where it all begins, after all, how can you know what you should be doing if you don’t know who you are?! And hoping that an engineer like Lu, however talented, is going to fix branding and related woes is simply delusional.

You might also enjoy this post on complexity, and why even the 800 Pound Gorilla such as Microsoft cannot avoid it’s pernicious effects.

Such as the fact that Yahoo’s stock has been declining dramatically over the last few weeks, falling through a relatively steady support level around the $19 mark that it had stood at on January 31 of this year before the beginning of the "Micro-hoo" attempted hostile take-over saga.

Having already slid a few more dollars from a range around $21 after the regulatory headwinds to the Yahoo-Google search ad serve outsourcing deal started picking up, it then fell through various support levels all the way down to as low as $15.50 (settling at $16 for the week). I don’t mean to bore you with stock market speak, this is only to get across the increasingly precarious situation that Yahoo finds itself in:

1) I have argued repeatedly that the entire Micro-hoo saga would take a severe toll on the productivity at both Yahoo AND Microsoft, and judging from the dearth of useful roll-outs and even mere announcements (and I doesn’t take much to keep Wall Street happy with announcements) from either company, I was right.

Steve Ballmer has claimed that the Yahoo purchase attempt had been just a tactic, and that Microsoft could go it alone, but since then he really hasn’t said much of substance that could be construed to be a credible Internet strategy for Microsoft.

UPDATE: Incidentally, I just looked up the beginning of year prices pre-bid (1/31/08) again:

As of 10/8, YHOO has lost 26% from $19 to $14, but MSFT has lost almost as much: 25% from $32 to $24! Sign of superior management skills and credibility at MSFT?

Check out what David Einhorn said today in his letter to his hedge fund clients (via AlleyInsider):

… Since then, management has acted in an overaggressive and almost panicky fashion regarding its online offering. First, it sought to acquire Yahoo! and then after that failed, it announced extremely high internal investment requirements to pursue this “huge” opportunity (read: “Google-envy”). We doubt the opportunity is what they say it is and wish MSFT focused on its core strength: software.

The CEO is a very smart and very wealthy man. Perhaps, he is so wealthy that he has bigger ideas and aspirations than making MSFT’s shareholders wealthier. We’ve given up on MSFT for now…

2) I said it would take a massive effort by Yahoo’s Jerry Yang and Co. to get the ship righted at Yahoo after all of the distractions, and the deteriorating economic conditions haven’t helped. I guess I had really been hoping for Jerry to jump into full-scale survival mode and ride on a wave of adrenalin from the Micro-hoo negotiations.

But it now looks as if Yahoo is drifting helplessly, with consulting firm Bain apparently hired to set up major lay-offs in the coming weeks.

3) The stock price mentioned above is almost exactly half the offer of $31 per share that Microsoft had launched (though that number was partially in non-price-guaranteed Microsoft stock, which was already moving down after the announcement).

So that puts the speculation of Microsoft buying all or part of Yahoo back on the table. (Not to speak of the continued rage that most Yahoo shareholders have been venting toward the board over the failed/prevented deal for months.)

I have written several posts worth of arguments on the lack of soundness of a simple buy-out plan, and could write several more, but thankfully I don’t have to:

Henry Blodget of the Silicon Alley Insider has written a very concise, yet thorough post this week on why the original plan was never a good idea, and why an alternative proposal, a spin-out of Microsoft’s own foundering Internet division into Yahoo plus cash, would be a much better idea.

I have participated in the discussions on his blog for months, and so feel that at least in some small measure I have contributed to various points made in the post. Here a quote that rings of my repeated arguments about the Internet going against Microsoft’s corporate DNA:

At Microsoft, the Internet will always play second fiddle to the Windows and Office cash cows. At Google, every idea that will disrupt Microsoft is rushed into production. At Microsoft, every such idea will be buried in politics and bureaucracy. This will make it very hard for Microsoft to attract and retain the best talent… 

If you have any interest in the future of either of those two companies, the competition against Google for domination of the Internet, or simply the business strategy examples inherent therein, the post is absolutely worth a read. Here the link again:

"Microsoft Smart Not To Buy Yahoo… But Now’s The Time To Do The Better Deal"

Best wishes during "interesting times"

- Alex Schleber

But beyond that, it’s anybody’s guess as to what will happen next:

Is it a case of "Keep your friends close, but your enemies closer" that will allow Yahoo to move Jerry Yang and Yahoo forward less distracted by Microsoft’s various advances and the joint Icahn-MSFT proxy threat?

Or is it just the overture to a renewed round of negotiations that could still lead to Microsoft buying Yahoo outright?

Given that last week’s developments had seemed to indicate Microsoft growing weary of Icahn as an intermediary, and that some observers had previously bet on a renewed MSFT offer before August 1 to bolster the chances of unseating Yahoo’s entire board in a proxy fight led by Icahn, the latter possibility appears increasingly dim.

But given the now nearly 6 months history of the Micro-hoo saga, who really knows at this point. What we do know however is that if negotiations continue at whatever level, it would continue to serve as a distraction for both Yahoo and Microsoft from what they should be concentrating on:

Innovation.

The three-way "negotiations" between Carl Icahn, the Yahoo board, and Microsoft turned up another non-starter offer for MSFT to cherry-pick Yahoo’s search assets, which in turn led to much finger-pointing, and general acrimony.

The result is that Icahn may now be out of the picture, and that Yahoo will survive through its August 1 shareholder meeting. Unless Microsoft comes back with a last minute complete buy-out offer at a guaranteed, cash-equivalent price that is ($29 per share would seem like the absolute minimum in this regard).

But it all seems increasingly unlikely, leaving Microsoft without a strategy, and Yahoo desperate to get past the distraction of the entire episode, and its operation back on track.

Jerry Yang is apparently begging his troops to keep working (for the second time in two months), and as I previously pointed out, for good reason. And even though we don’t hear similar exhortations form inside the Microsoft bunker, there is little doubt that Microsoft is not similarly affected:

During the entire first half of 2008, the only news out of Redmond other than the Micro-hoo botched deal attempts, has been the announcement of the "Live Search Cashback" (LSCB) attempt to sort of buy search query share using a rebate gimmick (that had failed to work before). That MSFT and some commentators touted this as a "game changer" proves the depth of their dilusion.

I have been working on a detailed post for why LSCB was such a bad idea in many (technical) ways, but the end-result is much easier to ascertain through some simple tests: I occasionally have been checking LSCB price quotes against Google search results for identical items, and the FREE(!) product listings at the top of Google Universal Search beat the LSCB prices with the "discount" (that MSFT is kind enough to hold in escrow for you for up to 2 months) MOST OF THE TIME!

I expect ComScores due out this week to tell the tale that Live Search Cashback has caused nary a blip on the search share radar screen. Even Microsoft seems to not be talking about it anymore…

During the same time frame, Google has had major announcements regarding their OpenSocial, GoogleGears, Google App Engine, and Google Android (Google’s mobile phone) software kits, all the while honing their core search and search ad serve in the background. Even Yahoo recently announced a relatively substantial opening up of their search toolkit to developers for third-party applications.

Back to Yahoo’s Serious Issues

In recent weeks, high level departures and reorg moves by the Yahoo board’s Sue Decker, have highlighted again how deep the rot of bloated hierarchies and excessive middle management has gone inside Yahoo. I had previously reported some signs of the same thing on this blog.

The question is if this can be turned around in any meaningful way. And by the way, there is a huge question as to whether MSFT/Steve Ballmer would be doing any better, they are not exactly masters of nimbleness and have ZERO credibility when it comes to making a profit on the Internet.

Yes, Yahoo still has reach and scale, but what is really needed is a clear vision and marching-order on what Yahoo is supposed to stand for going forward. Their lack of focus has been their achilles heel the entire time.

While Google has built "Google = Search" brand in a (mostly) disciplined way, which is one of the key reasons for why they have been able to monetize better on search (people come to their site with a relatively defined mindset), Yahoo = what?

Yahoo’s portal strategy has been an albatross around their neck almost from its beginning.

Add to this the slowness in response due to the excessive hierarchies, and that is all you need to know as to why they haven’t been able to compete with Google. It’s a simple focus and positioning issue.

(The argument repeated again in a comment on Silicon Alley Insider by supposedly a Yahoo employee that Google monetizes better vs. Panama due to larger query share is simply false: It is about the average user mindset/context gap. Remember that Yahoo once had a lot larger share of search. So that’s not it.)

The only thing that Yahoo can do now is to decide how they want to position themselves, ideally in a new category instead of as an also-ran, and then stick with it and execute. But that decision must come first.

I for one see a lot of potential in making Yahoo into one gigantic open social network from the inside out, and among other things leveraging their user base to create a supplementary user-generated/rated search a la Mahalo and Digg.

Plus open up all of the spickets to leverage open source development assistance. If they still want to be in search and search ads, outflank Google by opening up the kimono to advertisers and become the "transparent search ad platform" vs. Google who like to keep things close to their vest.

At this point, they need to create an undeniable, compelling reason to get the advertisers back and hence the monetization up. Also, if they can begin to create context-targeted "social ads" a la Facebook (only better) inside of a newly created "Yahoo as Social Network" (see above), they could leap-frog Google search because Google still knows very little of real substance about the individual user at this point.

It’s all about proof of concept right now, and the more radical the better, as only that can have a chance to generate mindshare and get people to start using the new services. Everything must be on the table. I hope Jerry and Co. are seeing this on the inside.

Today, Microsoft apparently walked away from a Yahoo deal more thoroughly than they previously had, which in itself makes little sense and proves how much Ballmer and Co. have kept themselves in suspended animation during this ongoing saga.

Now, as far as Yahoo was concerned, we knew that they wouldn’t get a lot done given the continued wheeling and dealing by billionaire investor Carl Icahn. Despite Jerry Yang’s pleading with the troops to keep their noses to the grindstone, there is simply no way that Yahoo has not been deeply affected:

I was at Sprint in a former life at the time when the proposed merger with WorldCom was going on, which ultimately, and it turns out mercifully, was blocked by the DOJ. And I can tell you from that experience that very little of substance beyond basic maintenance mode happened inside Sprint for well over 6 months.

All eyes, minds, and water-cooler conversations were cued on the proposed deal and its ramifications. And that was under relatively amicable circumstances mind you.

So, with the pronouncements by MSFT today, Yahoo’s stock taking a big hit, and Yahoo in turn announcing that a deal to outsource search ad serves to Google may be happening as soon as today, someone might be tempted to say: The nightmare is over.

Or Is It?

Despite all of the "titillation", the Icahn back-and-forths, the rumor, the innuendo, and the inflated/bruised egos, let’s take a step back and look at the fundamentals of this:

MSFT + Yahoo = Still Can’t Compete

As Henry Blodget of the Alley Insider has previously argued (and I agree with him on this), the Micro-hoo deal as originally proposed does preciously little to make the combined entity more competitive against Google. MSFT has amply proven as much recently by having to resort to touting their "Live Search Cashback" gimmick as a "game changer." NOT a good sign. (I was in the middle of putting the LSCB discussion into this post but will save it for later).

You see, entrepreneurship is fundamentally concerned with arbitrage, that is, putting resources towards their highest and best uses. And combining MSFT’s money and inferior technology together with Yahoo’s inferior technology and user eyeballs does NOT a winning combination make. Period.

If you combine money with eye-balls, what have you got? A waste of $ and a combinatory nightmare.

I previously said that

joining the two juggernauts into one operation is the equivalent of having two huge battleships collide at about a 45 degree angle and hoping that somehow during the collision they will weld themselves into one aircraft carrier. Ain’t… gonna… happen.

And MSFT has proven with each of its Internet moves in 12 long years that it is very adept at actually driving AWAY eyeballs despite all of its supposed and real advantages (its installed browser base, money, influence, etc.).

Part of this is their extreme misunderstanding of branding and the resulting branding mess that I have been reporting on here several times already, and their failure to understand the internet at a fundamental level.

So if Yahoo moves to outsource the ad serves for its search to Google, in entrepreneurial terms, they are doing the right thing. Take the money now and gear up to fight another day on NEW battle-fields where it can actually WIN.

Remember that Google’s monetization advantage is somewhere between 50-100%. Now that is a combination that actually makes economic sense: Leading eyeballs to instantly higher monetization, something that Micro-hoo might well have never achieved.

While it is true that Yahoo shouldn’t completely get out of the search game, instead of playing also-ran, they need to innovate on a massive scale. Keep the R&D going in the background, and use the newfound money to do something worthwhile.

Which is by the way what MSFT should be doing rather than continue to try to throw its weight around. It hasn’t worked on the internet in 12 years. In this context it is ironic that MSFT might now be trying to push for regulatory protection against a Goo-hoo outsourcing deal. THE monopolist of the late 20th/early 21st century crying foul… that would be so rich…

Even more ironically, if MSFT hadn’t been able to stop the DOJ proceedings against it through the arrival of the Bush admininistration, and had been broken up into say three smaller, more nimble, more hungry units, both those resulting companies and all the rest of us might well be better off today:

Vista might have been less of a failure, the Office company might have actually innovated in the "productivity" space, and the Internet division would have been free to "get" the internet unencumbered by other interests.

Back to the Goo-hoo outsourcing deal

Critics of this scheme are right that this can only be seen as a short-term fix to boost Yahoo revenues. If it’s not accompanied by very serious efforts to innovate and therefore outflank Google or create new markets that Yahoo can take a leadership position in, then it does hurt them in the long term. Their capabilities would definitely erode.

This was described in some detail by Mahaney in the TechCrunch interview, where he recounted the developments at AOL. (The full text of the interview is really a must-read for anyone interested in this entire situation.) But of course it would be up to Yahoo with how they spend that money.

If they invest it in serious innovation instead of mee-too projects, they might have a shot. As it stands now, there is very little in terms of core competencies that they have really kept even or led on.

Whatever they have going for them up to now is largely a hold-over from its successes during the Web 1.0 phase. That is predominantly the user eye-balls, people who became accustomed to using Yahoo services circa 1996-2000. They have since bungled almost everything else they touched, from search ads (where they should have led with Overture), to the rise of social networking and web video (where they largely missed the boat).

So again the critics are partially right in that Yahoo’s search share will likely keep declining over time (not rapidly though), simply because they will fall further behind in search development as well. UNLESS they make a very serious effort to come up with a next generation of search that somehow bypasses what Google is currently doing. Otherwise, they would of course be more and more dependent.

Of course, it’s Google that is hard at work figuring out the next steps in search… while MSFT and Yahoo just wasted another 4+ months on this diversion. And who knows, maybe Ballmer or Icahn will do it all over again in a few months.