Is Online Search Microsoft's Vietnam War?

Is Microsoft (MSFT) fighting an unwinnable war with its online business and search obsession?

It’s a valid question and one that needs to be asked. At some point you have to wonder if Microsoft’s Google (GOOG) envy is its Vietnam. As Mary Jo Foley noted Microsoft’s answer to its online woes is to spend, spend, spend. You have to wonder at the returns. Some analysts have dismissed these online investment worries because the Microsoft’s broader business is doing fine. But if these online results become a drag just when Microsoft should be at its peak product and earnings cycle it’s an issue.

It’s not like Microsoft just discovered the Web. It has been there all along. It had its epiphany to squash Netscape more than a decade ago. Its properties aren’t half bad. And Microsoft is a top 5 player on the Web in terms of traffic. Good luck turning a profit though. Microsoft is an afterthought in search. Display advertising is hurting the software giant’s online revenue. And Microsoft is hell-bent on conquering a market it knows little about–advertising. Of course, Microsoft wants to know more about advertising and has been acquiring accordingly, but where are those returns?

After Microsoft released its fourth quarter results the online unit stood out for all the wrong reasons. The online services business lost $1.23 billion for the fiscal year ending June 30. I quipped that it’s no wonder that Microsoft is so hot for Yahoo. Something has to save this online business.

And what’s startling about that figure is that Microsoft only lost $732 million in 2007. Microsoft’s online services business was actually profitable in 2005.

Now you can argue that the collapse of Microsoft’s narrowband dial-up service was the issue, but even so operating income is headed in the wrong direction. What’s the explanation? Microsoft is investing in the future. Microsoft will continue to spend heavily on search. Execs told investors it will compete in search–even if it has to pay people for their queries.

But all that spending may not add up to much. Unless Microsoft buys AOL (TWX) or Yahoo (YHOO), its online business isn’t likely to turn a profit in the current fiscal year. Why? The online business is headed for a dry spell. What does that mean for Microsoft, which has an online business that wasn’t profitable even during good times?

Indeed, Microsoft is already seeing a slowdown. It noted that “monetization lagged” because of “tightening advertising budgets combined with a more competitive display pricing environment.” Sure Microsoft is investing in more premium online content, but that’s also more expensive.

CFO Chris Liddell made it clear the online services business is in investment mode. On a conference call he said:

The online services business has a totally different dynamic and is in a period of significant investment. We do not make these investments lightly, as the loss in this division will be a drag on an otherwise exceptionally good performance. Translation: Microsoft’s online business will lose money in fiscal 2009 too.

However, we believe that the additional investments of several hundreds of millions of dollars is worth the short-term cost, given the opportunity to participate in a market where the opportunity is measured in the tens of billions of dollars.

Liddell also talked about improving social networking assets across all delivery vehicles–PC, phone and Web. Microsoft also plans to “invigorate our MSN portal experience” and blow two-thirds of its online investing dollars on improving search.

When asked how Microsoft will compete with Google on search with or without Yahoo, Liddell said:

In the search area, clearly that’s the one where, relatively speaking, we are the most behind and that’s why we’re taking a different approach, which again I mentioned in the prepared remarks where we are focusing in particular on the areas of search where there’s a strong commercial intent, our verticals like retail, travel, real estate, local. We’re looking at different approaches where we might potentially take a disruptive and innovative business model, for example, Cashback, and then looking at winning distribution deals.

Now in the short-term, that isn’t going to make the division profitable and I think clearly from our guidance, that’s not the case. So as I said in the remarks, if you look at the operating margin structure of the company, you really have to look at the three distinct businesses. We feel good about the margin structure for our core businesses in particular growing double-digit revenue on. Entertainment and devices will be broadly flat but online is going to be negative

In other words, Microsoft’s online business is the appendage that’s going to dilute good gains in its core businesses in fiscal 2009. Microsoft wouldn’t address fiscal 2010 or 2011 or make any projections about when the online business would be profitable.

Bottom line: Microsoft’s online war will continue with no end in sight.

Comments

[Bored]

Man, do you have anything better to write, other than regurgitating online materials... write something that's actually useful - like emerging trend or exciting new developments. All you are doing is throwing cold water on a company that's struggling in one portion of the business without even using your head or provide any insightful original thoughts...

[user225084]

The customers simply do not want Microsoft to be successful in advertising. They have seen what Microsoft success leads to, and they do not want to see it again. So even if Microsoft can get their technical stuff together, the customers will resist..

[blah-blah]

MSFT is trying to do something no technology company has ever done before; change before it becomes a shadow of itself.

All people can do is bash them for it.

[Dizzul]

Like every great empire the rise and fall is always a harsh reality. But if history proves us correct it is a reality that is inevitable. Make no qualms about it I love Microsoft just as much as the next guy and/or gal but I’m also a conscious investor. These last numbers that were presented as earning tell a continuing story. Without burdening you with margins and other technical expectations that you’ve already seen lag, I can only reaffirm that Microsoft is slipping. If you don’t understand where I’m coming from its simple pull up a one year chart and take a look at the technical’s for yourself. Call it Google envy…Market crisis….or maybe Yahoo frustration. Whatever you want to call it doesn’t mean it isn’t taking a long term effect on the stock and that’s my point. I’m definitely not qualified to tell any of you where or not to put your money but I can say be careful. I’ll just end my little 2 cent input with a comment my Mom use to say. "No matter how fast you are there’s always someone faster".

[GoogleDoubter]

Microsoft has lost the search war(s) to Google. The larger battle between the two giants is not search but the desktop, via word processing, spreadsheets, et al.

In the war of the desktop, Google is at a disadvantage in a bunch of way via Google Apps. The folks at Google have given hundreds of thousands of FREE versions of Google Apps and now most firms won't pay money for the service.

The worst part in the war of the desktop for Google is they suck at customer service because Google doesn't like talking to people. Just try and find ANY customer service phone number for Google on their web site.

There is no published customer service phone number for Google.

There isn't a software company with at least $10M in sales that doesn't publish tech support and customer support phone numbers on their web site.

Google also screwed the handsome revenue stream of Postini, an aquisition made just one year ago.

Google may own search, but they suck at making $$ on everything else.

Google may have the brightest people on the planet within their search team, but Google Enterprise is managed by a bunch of idiots.

[Flash Gordon]

If Microsoft wants to grow and expand I think they should look at IBM not Google/Yahoo. 10 years ago companies did many things for e-mail management, now most of them are using Exchange. Companies are making money modifying Unix servers to use Windows authentication services. Providing IT infrastructure is a lucrative business and Microsoft is starting to be very successful in this space. I disagree with people who say the only future in computing is finding the next new hot app on the web, once you set a standard in IT, huge revenue streams result from supporting and enhancing that product going forward. Microsoft already has set important standards in many areas and is doing well with Visual Studio and MS Sql. If I were Ballmer, I would stick to my knitting and let Google go back to a 15 p to e on their own power.

[contrariwise]

Just to be clear, Vietnam is a country, not a failure. The *Vietnam War* was a failure for the United States. So, a more appropriate title for your article would be "Is Online Search Microsoft's Vietnam War?". Or, "Is Online Search Microsoft's Iraq War?". Or, "Is Online Search Microsoft's George W. Bush?".