Why Ballmer Bailed on Yahoo

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After all, it had been 13 years since the infamous Pearl Harbor memo when Microsoft "discovered" the Internet—and still the company had not made a dime of profit from online services. This was despite Ballmer's stated goal that online "eventually" would deliver a quarter of Microsoft's revenue. So the grand gesture to secure Microsoft's status (at long last) as a major force on the Web—Ballmer's secret plan, if you will, to win the war—quickly became bogged down and unpopular, even among his own brethren.

It Wasn't Cheap

Enough said? Yes, $45 billion is a very, very big number. Leave aside that the largest acquisition Microsoft had ever made was last year's purchase of aQuantive for $6 billion. And never mind the decline in Microsoft's share price after announcing the deal meant that the combined cash and stock offer for Yahoo would be even more expensive in equity if the price stayed the same. Consider that $45 billion would be enough to buy both Ford (F) and General Motors (GM) with nearly $20 billion to spare. More pertinently, it would be enough for Microsoft to clear the market if it went shopping for other major Net assets.

For the same money, Ballmer could roll up AOL at, say, $25 billion; either Facebook or MySpace (NWS) at $15 billion; and ValueClick (VCLK) at $3 billion, again with a few billion left over. And if Yahoo continues to weaken over the longer term, Microsoft could always pick over its bones on the cheap, buying what it really wanted instead of the entire enterprise.

It Was Also Wrong

Ballmer's argument for going after Yahoo was ultimately about audience. Given Microsoft's trailing performance among the Web majors in search traffic and ad dollars, it was easy to fall into the trap of believing a solution for its consumer online business was also the answer to the question of Microsoft's future. Microsoft makes its big money in computer operating systems and desktop applications. Google may be lapping Microsoft in search share and online ad dollars, but the real threat is Google Apps—its free Web-based desktop applications.

The big bucks in apps are generated among corporate users, who buy site licenses for Microsoft's Office software. Despite Google's ad-based model, success for Google Apps will pave the way for paid Web services based on site licenses rather than exploiting the corporate desktop as new real estate for ads. While Yahoo might have soothed some of Microsoft's pain on the consumer side, it would have done nothing to address the real dagger threatening the heart of Microsoft's business model.

So the market may be betting Microsoft will make another run at Yahoo (its shares are trading several dollars above the average analyst target price of $24), but don't count on it. Ballmer may go shopping again—indeed, arguably, he must—but it's not likely to be with Jerry.

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.