This is a challenging problem that doesn't fit nicely into comments or short blog posts, but I'll try.
Search is a tremendously expensive game to try and win. It's economics are such that the more search share you have, the more money you earn per search. This is a critical point, so I'll spell it out a little further.
All search companies have more advertiser dollars than they have searches to spend them on, Google, Yahoo and Bing included. It's a supply constrained marketplace. The search ROI is so good for advertisers that they all want to spend more money at their current CPCs, but there aren't enough searches. This supply constraint leads to a problem for the smaller players. Search revenue is driven by having lots of advertisers compete in every auction. The larger the share, the more clicks each advertiser will get, and thus the more advertisers you attract. The smaller scale players don't drive enough clicks for some advertisers for it to be worth their time to set up and manage campaigns on them, while the larger scale players it is worth their while (the return they get exceeds the fixed cost of advertising in the marketplace). So with fewer advertisers, there are fewer bidders in the 2nd price auction, and the revenue per search is lower for the smaller scale players.
So how does this apply to Microsoft's online division? Well, if they want to catch Google, they're going to have to do it at a scale disadvantage, meaning that Google is going to make more off of the same searches than Microsoft will simply because they have a bigger marketplace. To beat that, Microsoft has to commit to spending lots of money to try and close that scale gap by buying share through distribution deals and spending a ton on technology to differentiate the search product while accepting that they don't monetize the searches they do have as well. If they can eventually build a product that will pull enough marketshare from Google to be roughly equal, then they should start to see better monetization.
The valid questions are:
1. Is it possible to catch Google? Or are the market dynamics such that without a transformative difference in how the product works that Google will never be caught.
2. If it is possible to catch Google, how much money will you have to spend, and what will your eventual ROI be when you get there.
Since Microsoft is a company that does 60B in revenue, it has to look at big businesses to drive a 10% growth in that revenue. Your hot little startup that does $100MM doesn't make a dent. Even Facebook only does 1-2B, depending on which report you believe. Search is a 10B going to 20B market, and if Microsoft can spend 5B over 5 years to get half of that market and earn 10B every year it's worth it.
Of course, the division has been horribly mismanaged for years. Qi Lu now runs it, and he's a different breed from most Microsoft execs. So time will tell if it's a good bet or not for Microsoft.
This analysis seems right to me. MSFT's annual cash flow from operations is in the $24 billion+ range. MSFT has $44 billion of cash in the bank. What is MSFT going to do with all that cash? Watch Google slowly eat its business? I'm surprised MSFT hasn't invested more in web services -- $2 billion seems small given its resources. Could it be a shortage of opportunities?
The $2b is what they spent IN EXCESS of the value they currently carry on the books for the business - they invested far more.
It's an abysmal performance by anyone's standard BUT they could probably sell that business for considerably more than the book value.
Even if the book value is fair and they lost $2b, they got the only viable (albeit still money-losing) alternative to Google, which was a strategic imperative if they want to link Office and Windows to the cloud.
Your analysis is very good. I just want to add that dynamics of "more searches -> more revenue per search" also holds for every individual niche. In order to make good money, one can build substantial market share either in certain geographies (e.g. Indonesia, India, China, Russia...) or verticals (shoppings, deals, travel, cars...).
Are Microsoft actually seeking to obtain market dominance in a particular vertical or region? I'd have thought this would go against their grain. I haven't seen any particular evidence of this, but I'd be interested to know if I've missed something.
Also dominance in verticals/regions won't necessarily net them the £10bn/year that they'd like - of course it might be a good stepping stone to broader dominance.
So, they lose 4 cents every time a search is performed (2 B USD in loss, 4 B searches per month, or 50 B per year) but they will make up on the volume? Not to mention: they still use Overture to monetize search...
First, the original comment is spot on with his/her analysis.
I don't think you get how search and advertising works. Clicks lead to revenue, but you need clicks first. In order to get clicks you need to be competitive. With Google just a URL away they need to be nearly as good, if not better (due to name recognition) than Google to get a large share of the pie.
So the problem is that they must effectively spend (or outspend) Google on search (data centers, employees, etc...) pretty much all the way to the point where they reach parity and beyond. All the while they bring in a lot less money than Google.
If Bing can continue at its current pace and couple it with some real marketing strength, I think they have a real chance of flipping quarterly income from a $500M loss to $500M in earnings.
The two wildcards in this space are social (Facebook) and mobile. I feel like mobile is a bigger deal than social. IMO advertising is the current and future business model of computing. I think MS gets this and realizes that this is the one fight they have to continue to fight.
I'd say Q3 FY12. The Yahoo search deal will be in place, but paid ads are lagging. Once the paid ads from Yahoo get bolted on with Bing, give it another quarter, to deal with the upfront costs.
At that point I speculate they'll be close to $500M in earnings. And at that point, every percentage point they get it should increase earnings by $100+M.
are you telling me that they still use Overture for ads on Bing + Yahoo! Search but they are still using two different and separated versions of Overture, so that I have to get two accounts to advertise on the two search engines? wow...
This is from Aug 31. Not sure what the state of it is now. Whenever this transition is complete.. .I'd add a quarter or two before we start seeing some respectable (relatively) earnings from Bing.
I think they need to come in at $100M+ earnings at least. That would be "high-class hooker" respectable. I think they really do need to look more at the $500M range though to say it was an unqualified success.
how much does Google earn in a quarter in the US? 1.5 billion? 2 billion? Bing + Yahoo is about 20% of the market, or 1/4th of Google (in the US). So, 500 M is good, but 100 M means it would take years and years just to earn back what they have lost online in all these years, don't you think?
Search is a tremendously expensive game to try and win. It's economics are such that the more search share you have, the more money you earn per search. This is a critical point, so I'll spell it out a little further.
All search companies have more advertiser dollars than they have searches to spend them on, Google, Yahoo and Bing included. It's a supply constrained marketplace. The search ROI is so good for advertisers that they all want to spend more money at their current CPCs, but there aren't enough searches. This supply constraint leads to a problem for the smaller players. Search revenue is driven by having lots of advertisers compete in every auction. The larger the share, the more clicks each advertiser will get, and thus the more advertisers you attract. The smaller scale players don't drive enough clicks for some advertisers for it to be worth their time to set up and manage campaigns on them, while the larger scale players it is worth their while (the return they get exceeds the fixed cost of advertising in the marketplace). So with fewer advertisers, there are fewer bidders in the 2nd price auction, and the revenue per search is lower for the smaller scale players.
So how does this apply to Microsoft's online division? Well, if they want to catch Google, they're going to have to do it at a scale disadvantage, meaning that Google is going to make more off of the same searches than Microsoft will simply because they have a bigger marketplace. To beat that, Microsoft has to commit to spending lots of money to try and close that scale gap by buying share through distribution deals and spending a ton on technology to differentiate the search product while accepting that they don't monetize the searches they do have as well. If they can eventually build a product that will pull enough marketshare from Google to be roughly equal, then they should start to see better monetization.
The valid questions are: 1. Is it possible to catch Google? Or are the market dynamics such that without a transformative difference in how the product works that Google will never be caught.
2. If it is possible to catch Google, how much money will you have to spend, and what will your eventual ROI be when you get there.
Since Microsoft is a company that does 60B in revenue, it has to look at big businesses to drive a 10% growth in that revenue. Your hot little startup that does $100MM doesn't make a dent. Even Facebook only does 1-2B, depending on which report you believe. Search is a 10B going to 20B market, and if Microsoft can spend 5B over 5 years to get half of that market and earn 10B every year it's worth it.
Of course, the division has been horribly mismanaged for years. Qi Lu now runs it, and he's a different breed from most Microsoft execs. So time will tell if it's a good bet or not for Microsoft.