It's Down to Two: Microsoft and Google

(page 2 of 2)

That means the remaining 100 million or so sites on the Web outside the top 10, and whose businesses are predicated on online ad revenues, must choose between giving up pricing power by selling through the Big Four (and other major players like them) or selling directly but competing with everyone else for their sliver of the last percentage point of online ad market share. (In the U.S. market, that last percentage was worth about $220 million in 2007.) This unattractive choice applies to just about every major media, content, or entertainment brand doing business online.

Consolidating Traffic…

Online advertising is a big business and rapidly getting bigger. Last year, the average major corporation spent 7% of its marketing budget online, while U.S. consumers spent over 30% of their total media consumption time with digital media, according to our analysis. As marketers close this gap between brand budgets and consumer behavior, it's no wonder that the U.S. online ad market in 2007 hit $22 billion, that it will top nearly $30 billion in 2008, and that it's projected to reach $60 billion (and $80 billion worldwide) by 2011. It's also why Steve Ballmer, CEO of Microsoft, observed not long ago that "the future will be ad-funded," at least as far as digital business is concerned.

Which brings us to the question of how Microsoft and Yahoo combined could expect to compete for position with Google's rapidly expanding scale, features, and analytics. By acquiring Yahoo, Microsoft doubles its unique visitors to nearly 240 million, roughly twice Google's (not counting the reach of DoubleClick, its recently acquired ad network). Even discounting for duplication of visitors, Microsoft gets to mark up its online traffic easily by 50%, to 180 million visitors, which vaults it to the top traffic position on the Web. Combined online revenues last quarter would amount to $2.6 billion, still only half Google's, but nonetheless establishing a powerful No. 2 position. While the aQuantive acquisition helped Microsoft close the competitive gap in online analytics, Yahoo brings traffic and features with the kind of sex appeal Microsoft itself could never achieve.

All that still makes this a long bet. With the acquisition, Microsoft has finally cried 'Uncle,' admitting to the world it cannot not build its way into online dominance, despite billions of dollars spent on online content, search technology, and analytics. Meanwhile, Yahoo has fallen far from its perch as the world's dot-com darling, and, at $31 a share, the acquisition price is only a quarter of its all-time high during the Internet boom.

…By Consolidating Players

Now get ready for more consolidation—from the Big Four to the Big Two. Time Warner has been looking to shed AOL for years, so consolidation of AOL is pretty much a sure thing. Yes, Microsoft needs the Justice Dept. and its European counterparts to sign off on the deal. And, yes, it needs to avoid a bidding war with News Corp. for Yahoo. And if AOL goes to Google (Google has flirted with AOL ever since the former went public), we'll soon see the online world divided between two iconic technology titans. If this really is a scale game, then it's a game only the supersized can play.

Sure, the "creative disruption" for which Silicon Valley is known will undoubtedly change the game at some future date. But, for now, there is an immediate need: More than $400 billion in global advertising is looking to make sense of online media, and no garage-based startup, no matter how visionary, can meet such high-volume needs. For the foreseeable future, it will be the reigning behemoth of the PC operating system vs. the emergent giant of the online world, competing for online consumers with resources of gargantuan proportions.

Who wins? Even with Microsoft's dramatic move, the answer is clear. It's a face-off, for sure, but it's still advantage, Google.

Jeffrey F. Rayport is founder and chairman of Marketspace, a digital strategy and customer experience practice affiliated with Monitor Group. Rayport was previously a faculty member at Harvard Business School.