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.

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.

Several times last week I was tempted to write this post, only to hold off for a while longer because I wanted to write something for my readers that would go well beyond a news rehash.

As I said in previous posts, it is easy to lose sight of the essentials in the dizzying onslaught of "Steve said, Jerry said…" titillation, investor and market timer stock price considerations, and "what’s the next step" agonizing. Instead let’s go back to Business Mind Hacks basics:

I have argued that the deal was never a good idea in the first place, and that this should have been the first and foremost question on anyone’s mind. Even now, there appear to be major Yahoo stockholders such as Carl Icahn, who are attempting to employ corporate board machinations to force the deal after all.

And of course there has been plenty of speculation that Microsoft would come back with the same or lower offer after having Yahoo’s stock price pummeled for a little while (incidentally, it didn’t go down quite as much as some had predicted, possibly a sign that the market viewed the deal was as in fact much less of a clear winner).

None of it would really matter as far as the fundamentals of the deal: That Google is the uncontested market leader in search and paid search ads, that neither Yahoo nor Microsoft have been able to compete effectively, and that they are falling further behind every day. (Notice recent earnings data showing Google’s search revenue is on track to surpass Microsoft’s flagging Windows/Vista revenues some time in 2009!)

There are several reasons for this, some technical, and some Branding/Positioning related and hence much more basic than the complex issues relating to e.g. paid search optimized monetization. I will further discuss the latter in another post. Let’s go with the branding issues for today.

A recent article in The Economist picks up on the same theme I have been "hammering" in a few recent posts:

Mr Ballmer [...] has invested billions trying to make Microsoft an internet and advertising superpower. But it seems not to matter. According to Danny Sullivan, a web-search analyst, Microsoft “literally has no brand” when it comes to its online services—nobody has ever been advised “to Live” or “to MSN” a recipe or a cute classmate.

But it gets better. While The Economist article was an overview piece on the break-up of the negotiations, ReadWriteWeb wrote a post entitled: "Microsoft’s Brand Confusion Runs Deep". And I couldn’t agree more with the tenor of it, and if you care about branding/positioning issues at all you should by all means read the full post. Here is a sample:

[...] slight differences in design may not be a very substantial issue, it is indicative of the confusion Microsoft has created around their Live brand. [...] Live was sometimes used to brand services, sometimes to brand desktop products, and sometimes destination sites. Worse, at times single products have had multiple names and sometimes the Live branding resulted in very clumsy product titles, such as "Windows Live Search for Windows Mobile."

And in all of this, ReadWriteWeb didn’t even point out the widespread but perennial corporate sin of brand dilution: While it is easy to see how large, powerful companies would prefer to engage in a sort of "brand hubris" and try to spread their brand-around to everything in sight, this just isn’t how things work at the level of the customer’s/consumer’s mental circuitry.

Ries & Trout made it abundantly clear in their seminal works on the matter, and data of decades’ worth of branding studies back it up: Once you have been lucky enough to establish your brand in a category/niche, you should avoid trying to stick it on other categories like the plague.

Because it confuses people, it quite literally messes with their mental mapping of names and what they stand for. It is quite noteworthy in this regard that the ReadWriteWeb post mentions that even Microsoft’s own employees appear at times confused about what "something-something-Live" really stands for!

If you think about it, as far as catching Google is concerned, Yahoo hasn’t been able to do it with moderate resources, but even worse, Microsoft/MSN/Live hasn’t been able to do it with nearly unlimited resources. Why?

Because the Windows/Microsoft brand acts as an albatross around the neck of any Internet play that they have attempted: Henry Blodget over at the Alley Insider already pointed out the unfortunate renaming of Hotmail into "Windows Live Hotmail", and they were even seriously considering ditching the Hotmail brand alltogether.

Horrible idea… and it truly makes you wonder about what might have happened to the (not perfect, but still much preferable) Yahoo brands in the case the Micro-hoo deal had gone through (or still might in the future).

Again, Ries & Trout point out that large companies are always in danger of, from the inside out, hastening their own brand dilution. This is because of the fallacy of the "we’re a big/strong/important brand" mindset, which makes "add-on-naming" things with your existing brand so seductive and almost impossible to argue against in say a company meeting. Nobody wants to be seen as arguing against their own brand, their own "tribe".

As I said, unfortunately it is wrong from a psychological perspective of how brands work in the minds of the consumers. It’s all about "tip-of-mind awareness" for a category. Simply ask "What is a ____?" If the answer is unclear, your brand is already diluted.

Kraft is a good example of this form of brand dilution. Incidentally, their only #1 brand is the one that they resisted naming "Kraft": Philadelphia Cream Cheese (by Kraft). Everyone knows the answer to the question "What’s a Philadelphia?" (in a food context). But "What’s a Kraft?" has no such clear answer.

A company that has done it right is Proctor & Gamble. Each one of their products tends to be built up as its own brand, and typically is the category leader commanding a serious premium: Tide, Dawn, Bounty, Duracell, Gilette, etc. (see the full list of P&G brands here). 

Test it, you’ll likely know the answer to almost each question: What’s a ____?

So Microsoft should create a new internet product that is for once NOT named MS or Windows, because frankly, the internet thing has little or nothing to do with Windows. It appears that it’s their built-in (maybe even unconscious) resistance to the internet that is always at play.

Which is another bad idea. You can’t let your ego get in the way.

What became the leading Web video site? "YouTube", and NOT "Google Video", and even less some theoretical monstrosity like "Windows Media Player Web-Edition Live Video Sharing… Site". :)

But Google had the good sense to let it go and simply acquired YouTube, while resisting the temptation to meddle with the brand. Their reward: A brand name that is already firmly anchored in the minds of consumers as THE video sharing site. "What’s a YouTube?" has a crisp and clear answer. Which is as it should be.

I rest my case… for today… more to come soon.

As CNET blogs, Google earnings may make Microsoft yearn more for Yahoo, but the real meat here is in the post’s Google quarterly earnings chart since Q1/2005. It shows that Google was making about as much all the way back then as Yahoo is expected to earn this quarter ($1.28-1.35 Billion).

Only Google has been killing it in these last three years, and just last week announced earnings of $5.2B.

You do the math, that’s about 4 TIMES as much as Yahoo.

But what is much worse, if the ComScore search engine stats have any semblance to reality at all, Google in e.g. December of 2007 had about 5.6 billion searches (a 30% year-over-year gain) to Yahoo’s 2.2 billion, or only 2.5 times as many. That means they are monetizing searches much more efficiently.

And this is the big damn secret that often gets overlooked by the mainstream media, including the financial analysts, because they do not understand paid search and it’s offspring very well:

Google is refining the efficiencies of their Adwords and Adsense offerings at an alarming rate (if you are one of their search competitors).

Last year alone, they tweaked the core algorithm 450 times! That’s more than once a day…

And the manual stuff gets even weirder…

And that’s not even mentioning the other, more "manual" things that they have done more and more since last year. Such as "firing warning-shots" across the bow of various people trying to game the system, such as "link farms" and Adsense arbitrage garbage pages, etc.

For example by introducing whole-sale Page Rank penalties for entire such link networks, and through the by now famed "Google Slap" (actually there were a number of these in ‘07) where partially manual quality scores could drive you out of the Pay-Per-Click bidding due to massively increased bid prices for offerings deemed as low quality in Google’s eyes.

In fact, recently there have been people trying to devise entirely new strategies to stay in Google’s good (quality) graces from the very beginning with a new Adwords account/campaign (check out the video here, the meat is in the second half).

Arcane stuff to most, I know, but this is the only explanation for how Google has managed to have such a stellar Q1 result despite the doubts in the market that had come from the flat to declining Paid Clicks numbers put out by ComScore the first few months of this year:

While there is certainly some declines in growth due to the current economic environment, Google itself has been cutting into the "inflation" of low-value clicks and low-click-through ads aggressively, shoring up both its per-click and per-search returns.

And while ComScore is scrambling trying to explain the Google discrepancy, it actually appears to be mostly blind to these finer points of how Google operates. Even the Alley Insider didn’t get it a few months ago.

Back to our regularly scheduled programming: Micro-hoo…

So what does all of this mean for Microsoft’s attempt to take over Yahoo? Nothing good. MSN + LiveSearch + Yahoo Search does not in itself equal a viable position vs. Google. The only thing that could work is the idea floated by Henry Blodget to have MSN/LiveSearch spun off into Yahoo plus $10B in return for a 50-51+ % stake.

There would at least be a chance that Yahoo, powered with Microsoft money from its still flush MS Office coffers, might innovate its way out of the current predicament for both companies.

But hearing from my sources how Yahoo just recently internally killed a very innovative new social network-cum-wiki proposal, plus the recent brouhaha over the lame, "is-it-a-spoof-or-not", lame, internal Microsoft Vista sales team video, I wouldn’t bet on it.

For a summary of all the latest twists and turns, read Henry Blodget over at the Silicon Alley Insider.

Apart from engaging in talks with Time Warner and other potential, yet much less realistic "white knight" buyers, Yahoo has been running tests with Google on farming out ad placements through their arch-rival. Shrewd analysis via CNET on this is well worth reading:

What Yahoo’s Google gambit says about the failure of ‘Panama’.

The numbers don’t lie, and these actions speak much louder than any words could: Yahoo cannot compete in paid search ads (Google Adwords) or paid content ads (Google Adsense). 

And neither can Microsoft.

Both are failing to make any serious inroads into Google’s dominant leadership positions in search and ad services. If they had read their Ries & Trout ("11 Immutable Laws of Marketing", etc.), they could have known BEFOREHAND that this was never likely to really work for them.

The way to beat the market incumbent is never to try and go up against them on their turf, it’s to create a whole new market that will eventually obviate or at least cause serious attrition in the incumbent’s market.

Guy Kawasaki calls this "jumping to the next curve", making your offering not 10% better, but 10 TIMES better. Creating a whole new market that wasn’t there before through innovation.

Will this deal sink both Yahoo and Microsoft?

Over at the Alley Insider, Henry Blodget has produced some very keen analysis on why this proposed combination of Microsoft and Yahoo is such a bad idea:

The Microsoft-Yahoo combination is going to be a disaster.

And I’ve laid out previously how the law of complexity has been at work against Microsoft for a long time. The same logic applies to Yahoo:

I have gotten detailed descriptions from inside Yahoo that prove how bureaucratic, hierarchical, and slow Yahoo, the once nimble Internet start-up darling, has gotten, all of which preclude the hungry sort of innovation that is necessary to accomplish these jumps to the next curve.

So 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…

Perry Marshall recently said it even a little more provocatively somewhere (rough quote): It’s as if two kids with a 75 IQ decided that together they could go to the Spelling Bee and win against the 150 IQ kid.

Instead what would likely happen if the deal goes through, is that Microsoft will quickly ruin the one thing that Yahoo still has going for them, which is the sheer number of eyeballs on their Web properties. This state of affairs being a remnant of the Internet wave 1.0.

Microsoft will begin combining the (ubiquitous) overlapping services in order to save costs (and will falsely call this "synergies"), and will likely inject each property with annoying, overly corporate/dry, or both, "features" and attributes (they are masters at this), which will drive the eyeballs away in droves.

Bye bye Yahoo Mail, Yahoo IM, maybe even flickr and MyBlogLog. None of this is even fully taking into account the steep cultural and technology differences between the two companies BTW.

So if size and the complexity that comes with it tends to be so pernicious to companies staying nimble, how is it that Google can manage to avoid many of these issues? The answer is… complex:

First, their non-traditional approach to hiring, teams, and free-creation time lead to very flat hierarchies and retention of that hungry, start-up spirit, to a point.

Secondly, Google has been very quick to buy up emerging Web 2.0 properties, and avoiding excessive meddling, exactly the sort of thing that is to be most feared in the case of the "Microhoo" hostile take-over.

Shareholders from both Microsoft and Yahoo should loudly protest the idea as currently proposed. And if it does ultimately happen, take their money and run… fast.