Why A Microsoft-Yahoo Merger Would Spell Disaster For Both

An open letter from Eric Schmidt to Bill Gates: "Dear Bill, reports suggest Microsoft wants to buy Yahoo. Go for it! Please! I'll lend you the money!" OK, that's not really from Google's CEO to Gates, but it could be.Based on afternoon trading Friday, here's how Wall Street scores a possible Microsoft-Yahoo merger: It's wonderful for Yahoo shareholders (up 5%), there's downside risk for Microsoft (down 2%), and it's no great shakes for Google (down 1.5%).

This suggests traders believe a combined Microsoft and Yahoo would produce an entity capable of seriously challenging Google--which recently acquired DoubleClick--in the otherwise unassailable areas of search and online advertising.

I think the Street has it wrong. Just like Yahoo benefited from the cluster, uh, "screw up" that was AOL-Time Warner, Google would be the clear winner if Microsoft buys Yahoo for $50 billion, as the New York Post says it might do.

The biggest risk: The sheer task of integrating Yahoo would suck up so much senior management time at Microsoft that the company, which has developed a dubious track record for getting working products out the door on time, could fall behind competitors for years to come in several key areas.

One of those competitors is Google. Schmidt and company are taking aim at Microsoft's franchise Office productivity apps with a series of low-cost online offerings. Microsoft has responded with its Windows Live program. Great, except that Windows Live is a confused mess that almost no one inside or outside of Microsoft really understands. Throw a major corporate integration effort into the mix and things would get a whole lot messier.

Similarly, Microsoft is still nurturing its newly born Windows Vista operating system. Numerous reports, including some of my own, indicate that that the OS is getting a less-than-warm embrace from both businesses and consumers, and that Microsoft still hasn't solved a number of compatibility issues that could hurt sales. Dell even took the unusual step of reintroducing Windows XP as an option on home systems.

Again, add the monumental task of integrating Yahoo's operations to the challenge of shepherding Windows Vista through its early days--not to mention keeping Windows Longhorn server on track for launch this year--and you have a recipe for utter chaos in Redmond. The last thing Microsoft's IT customers would want right now is for the company to go through with this merger.

All of these might be acceptable risks for Microsoft if there were a good chance that the goal of any such buyout--catching Google in the online search and ad markets--would be realized. But that's doubtful.

Yahoo is a reasonably strong competitor to Google on its own, even though it gets about half of Google's online revenue and search traffic. Still, Yahoo continues to thrive because it's the best portal out there in terms of content aggregation and building online communities. Its search engine is iffy but if it can fix that it could still threaten Google in the pay-per-click market.

By contrast, Microsoft hasn't thrived in the consumer content or product arenas. MSN is an also-ran as a portal, and it gets a mere fifth of Google's search traffic. Truth is, Microsoft just isn't very good at creating products that appeal to a wide, nontechnical audience. Its internal culture is too geeky and it's unable to grok what people really want.

Yahoo could wither in such an environment.

Let's remember that Microsoft reached its zenith at a time when PC buyers had little choice but to purchase a Windows-based machine. The culture of monopoly that that produced still infuses many of the company's offerings today, even in markets where buyers have lots to choose from (how else to explain that the Zune music player debuted in one color beyond the basic black or white models--and that the color was … brown).

That's why Microsoft has had trouble transforming the PC from a hard-core geek machine to an everyday appliance Aunt Betty can use and entering new consumer markets. As recently as today, Internet Explorer threw this inscrutable gem at me, verbatim: "The exception unknown software exception (0x0eedfade) occurred in the application at location 0x77e7aafc." Huh??

What's that got to do with Microsoft buying out Yahoo? The risk is that, under Microsoft, Yahoo would lose the consumer-friendly attributes that have made it the Web's most popular portal and at the same time it might gain a lot of unwanted baggage. Microsoft's slow and bloated MSN client software, for instance, feels like it's imported from the former Yugoslavia. Any attempt to integrate Yahoo into that environment would be a disaster for Yahoo and its users.

It would fall further behind Google.

The bottom line: A Microsoft buyout of Yahoo won't help it catch Google on the Web, but the chaos that such a move would produce could seriously jeopardize its core Windows and Office products at a time when real alternatives are emerging.

Microsoft's best move: Stick to software, ditch the failed online efforts, and strike a partnership with Yahoo, or at the most take a minority stake in the company. As for buying Yahoo outright, that's a move only Eric Schmidt could love.

Agree or disagree?