08 January 2010

In Search, Microsoft May Race To The Bottom

Business Week

The world is finally waking up to the full implications of Google's business, and they're not all pretty.

Leading the rebellion is News Corp. (NWS) CEO Rupert Murdoch, who is threatening to keep his newspaper content beyond the reach of Google (GOOG) searches. Murdoch wants to keep Google from reaping so many of the financial benefits of advertising placed adjacent to News Corp. content. He's being aided and abetted by Microsoft (MSFT).

In a scenario under consideration, Microsoft would pay News Corp. for making articles from The Wall Street Journal and other Murdoch-owned publications searchable exclusively through Microsoft's Bing search engine. If the effort encourages other powerful content providers to demand compensation from Internet companies that generate revenue from online ads, the Murdoch-Microsoft partnership could create a big problem for Google.

Search is not Microsoft's core business, but it generates a lot of tech industry revenue—and funds Google, Microsoft's No. 1 competitor. So the best play for Microsoft in the Web search market could be to diminish the revenue stream for everyone involved. If Microsoft could reduce the overall market value of Web searches, it could protect its own software revenue while hurting Google.
Changing the Economics of Search

Blogger and entrepreneur Jason Calacanis recently suggested a strategy whereby Microsoft could gain search market share by paying content providers more than they're getting from search referrals.

Google's threat to Microsoft and other software and telecom companies is manifold. Google is competing not only in search engine software, but also in mobile phone services, personal navigation, and operating systems.

In concept, it wouldn't be especially difficult for Microsoft to change the economics of the Web search market, as long as the company can tolerate losses. Microsoft could take advertising revenue generated by Bing and pass it along to media providers, in return for exclusive arrangements to make their content available on Bing. Microsoft would modify the money flow.
Alternative Model: GDS

The search-engine economy doesn't need to work the way it does; there are alternative models. Consider the travel industry's global distribution systems, used by airlines, car rental agencies, and hotels to make their inventory available to travel agents. The systems amount to search engines for the travel industry.

As time went on, the global distribution systems (GDS) had to pass more money from airlines to travel agents in order to motivate them to use the systems. So an airline might pass $8 per booking to its GDS, which then must pass $5 on to Expedia.com (EXPA). Like Google, the GDS centralize great power over finding information. But unlike Google, companies that invest in the travel systems don't keep all the profits for themselves.

Similarly in the Web search market, Microsoft could redirect the flow of funds. The company doesn't need the money from search. In its most recent quarter, Microsoft generated more than $7 billion in sales from its main businesses, Windows and Office. By reducing the value of Web searches for media content, Microsoft could strike a blow at Google, which is challenging its main applications and operating system businesses. In other words, Microsoft could make Internet search more like the GDS model and sap the profitability from it.

Microsoft is likely well aware of the potential. In 2008 it tried to follow exactly the GDS model by "incenting" consumers to use Bing through a program that provided consumers with cash back on purchases made via its search engine. The program wasn't successful, but it reflected Microsoft's willingness to try to shake up the Web-search economy.
Will Others Emulate Murdoch?

Today, Microsoft is focused on working with companies that care dearly about revenues—media companies such as News Corp. Search-related ad revenue is the bonanza on the Internet, and News Corp. doesn't make enough from display ads to pass up Microsoft's deal. News Corp. could strike an arrangement that lets it lock in a disproportionate share of search ad revenue from Bing-driven hits on News Corp. sites. That kind of deal would work to Microsoft's advantage, too.

Microsoft could sweeten the deal for News Corp. by sharing a cut of broader Bing search ad revenue. Microsoft could in effect say, "Rupert, old pal, we really like you. Here's a big chunk of our search revenues, as long as you're willing to work with only us."

Other publishers have reasons to follow News Corp.'s lead. If payments from Microsoft exceed the value of ads generated by Google-related traffic, it would make sense for other publications to delist from Google, too.

As more content becomes available exclusively on Bing, users could switch away from Google search. That in turn will move market share. Google may even begin to pay incentives, putting pressure on its margins. Microsoft could be willing to race all the way to the bottom.

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