Why Microsoft can’t give up on search

Last week, a Reuters Breakingviews piece that was picked up by the New York Times generated controversy and counter-commentary over Microsoft’s struggling efforts in search. Breakingviews suggested that Microsoft abandon its money-losing search business and sell the Bing search engine to Facebook. This is a bad idea, even though Microsoft’s online business, mostly due to search, suffered a fiscal-year operating loss of $2.6 billion. Microsoft hasn’t cracked the code on how to make Bing a winner, though it has made incremental improvements in areas like user interface and social integration. But Microsoft has to keep at it, because it needs search for several reasons: 1) to defend its core platforms, 2) to compete with its biggest rival, Google, and 3) to solidify its ad business and open emerging revenue streams.

Defending the franchise

The foundation of Microsoft’s success has been the Windows platform: an operating system with APIs that powered an ecosystem and locked in developers, and that owned end users via its user interface familiarity. But search is the main navigation UI for the web, and it is playing an increasing role in desktop, application and local information navigation. Search can also set UI standards, and it threatens to wean users off their Windows dependency as cloud computing proliferates. Microsoft’s classic product strategy — integration — is one way that it can use Bing to hold off Google’s search UI incursions on Microsoft’s position in establishing cloud and enterprise APIs and services.

Competing with Google

Search is Google’s cash cow, and Google is Microsoft’s chief head-to-head competitor in a number of markets and in API platforms. Google’s massive profitability in search funds its efforts in applications, mobile platforms and online media (YouTube).

And what each company learns from search informs its efforts in machine learning, natural language development, personalization and e-commerce. Operating under the strategy that the best defense is a good offense, anything Microsoft can do to eat into Google’s search profitability forces Google into those other already-competitive markets.

Search marketers need a viable competitor to keep Google honest. Back in 2008, when Microsoft’s hostile $47.5 billion takeover offer for Yahoo threatened to consolidate search engine competition from three players to two, a Jupiter Research survey of advertisers and publishers showed that the majority of clients were worried about search advertising price increases. Think how much worse that could be if there were only one search engine. Realistically, Microsoft is one of the few companies that can afford the investment necessary in search.

Microsoft and advertising

Search is the biggest segment of online advertising, and it could be profitable for Microsoft if it can achieve scale. Microsoft believes that 10 to 15 percentage points more of market share would produce the necessary liquidity in its advertising marketplace, meaning better conversion rates and thus higher pricing (without gouging advertisers, because those results would convert better). If Microsoft were bigger in search, it could offer more accurate tools for advertisers trying to connect the dots across search and display advertising, producing more-valuable brand advertising analysis as well as targeting.

Contrary to what Henry Blodget thinks, Microsoft needs an ad business: It is likely that advertising will be a key source of cloud-based software revenues, especially for small businesses. After all, most consumer web businesses and cloud services get their money from a combination of fees and ads. Microsoft could create a marketplace of B2B services where search ads are one of the “currencies” buyers and sellers use. Another place where Bing could gain a toehold via integration is in mobile search, which may well pay off before mobile brand advertising, if Apple’s mobile ad network struggles are any indicator.

Finally, Facebook has plenty on its plate without trying to take on Google directly in search. It’s far more likely that Facebook hopes to continue to partner with Microsoft in search and advertising with social integration, while it concentrates on creating more valuable — and pricier — display ad inventory and sponsorships. In fact, the Microsoft-Facebook partnership’s continuing on its current course might just be Redmond’s best chance to gain search share.

Question of the week

Why should or shouldn’t Microsoft abandon search?