Why Microsoft really wanted Facebook
The computer software maker’s deal with Facebook may prove to be a good investment in the future, but the real value for Microsoft lies in the legitimacy the arrangement lends to its burgeoning online ad business and the potential it offers to play catch-up with rivals
November 3, 2007
For $240-million (U.S.), Microsoft Corp. got more than you might think in its deal with Facebook Inc. On the surface, it is fairly straightforward. Microsoft gets a 1.6-per-cent stake in Facebook, and worldwide rights to sell banner and display advertising on the site.
But the $240-million question remains: Why would a software company like Microsoft shell out nearly a quarter-billion dollars for less than 2 per cent of a site where people meet to share pictures, play scrabble and chat?
Everyone has a theory. Maybe it was as simple as making a good investment: Facebook is the fastest growing social networking site in the world and seems to be gaining about $5-billion in value every six months. Or perhaps it was good, old spite: Google Inc. wanted in and Microsoft was tired of losing out to its chief online rival. The most compelling explanation is that the Facebook deal is a calculated move by Microsoft to become a major player in brokering advertising on the Internet, a business in which it has been sorely outpaced by Google.
The deal may prove to be a good investment in the future, but the real value for Microsoft lies in the legitimacy the arrangement lends to its burgeoning ad business.
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A fourth pillar Microsoft is built on two main pillars, namely its business and consumer software product divisions. Last year, consumer software generated $14.9-billion of the company’s $51.1-billion in revenue, while the business division racked up $11.1-billion. However, Microsoft recently established a third pillar based on entertainment products, with the Xbox consoles at its core, which generated $6-billion.
By comparison, the online services division brought in only $2.4-billion in revenue, but advertising is becoming a more important piece of the Microsoft puzzle. Consider that its largest acquisition yet came in May when it paid $6-billion for the online ad brokering firm aQuantive, a clear departure from Microsoft’s traditional strategy of developing its own businesses from the ground up. It was widely believed the deal came after Microsoft had lost a bidding war for DoubleClick Inc. to Google.
Microsoft’s future online Co-ordinating Microsoft’s strategy in this market is Joe Doran, the general manager of Microsoft’s digital advertising solutions unit, which is part of its online services business.
“We really needed to double down in the advertising business,” Mr. Doran said, borrowing a poker analogy to describe the aQuantive deal. “We needed to build out our suite of software services that we can sell to agencies and to publishers to really accelerate the marketplace and help advertisers get what they need.”
Microsoft realized some time ago that much of the revenue companies will generate from the Internet in the future will come from advertising, he said. “Microsoft is clearly making a bet on online services and on advertising and we’re clearly saying this is one of the growth revenue streams for us in the future,” he said.
How it works Microsoft’s advertising business encompasses both paid search advertising through its adCenter platform, as well as display and banner ad sales. Much like Google’s AdSense platform, Microsoft clients can pay to have their ads associated with certain keywords on the company’s search and portal sites. Clients can also purchase display or banner advertising on Microsoft properties such as Hotmail or on any of the third-party sites for which Microsoft provides ads, such as MSNBC.com, ESPN.com and Facebook.
According to the company’s 2007 annual report, the online division lost $732-million last year - its third loss in the past five years. Much of that loss came as Microsoft expanded the division by increasing research and development by $230-million, while raising employee spending 44 per cent. Microsoft now has more than 300 employees selling display advertising in the U.S. alone, and that number is growing.
Much as it did with the entertainment division, Microsoft is content to lose money on the online services business in the short term because of the massive growth potential in online advertising, a market it believes could be worth $80-billion within four years.
Coming full circle Prior to the dot-com crash of the late 1990s, many companies were experimenting with advertising on their various web properties. Microsoft was no exception, building ads into their portals, Hotmail and instant messenger software.
“Before the bust … we were thinking about what would be the right business model for the Internet,” Mr. Doran said. “Are these software services going to be paid for by consumers, or are they going to be consumed free with an advertising model?”
When the crash came, Microsoft downgraded its advertising business to focus on subscription-based services, namely its Internet access business.
But advertising never totally disappeared from the company’s radar.
“I wouldn’t say that we ever de-invested in any of it,” Mr. Doran said. “We kept figuring out what was the right level of incremental money that we should be investing in that business.”
In the early days of search-based advertising, the bulk of the advertising on Microsoft’s search engine was brokered through Overture Services Inc. When Yahoo Inc. bought out Overture in 2003, it left Microsoft in the awkward position of paying a competitor for advertising services. Soon after Microsoft launched its own search advertising platform, adCenter, to fight back against Google and Yahoo.
Why it needs
to move quickly
Microsoft has been slow to enter new markets, and Google already has a big lead in online advertising sales.
Revenue for Microsoft’s entire online division in the most recent quarter was $671-million, a fraction of the company’s total of $13.7-billion. Google, by contrast racked up $4.2-billion in advertising revenue alone.
Microsoft has also yet to syndicate its adCenter software for use on non-Microsoft websites, something Google has been doing with its AdSense software for some time.
However the Facebook deal represents a golden opportunity for Microsoft to gain ground on its rivals. The value of advertising on social networking sites lies in the ability to mine users’ personal data and deliver targeted ads using that information. If and when Facebook develops technology allowing advertisers to tap into that information - and some analysts believe just such an announcement could come as early as this week - suddenly Microsoft’s deal becomes much more valuable.
“You could say that we were late in the search marketplace,” Mr. Doran said. “But we think that the battle is not over yet. We think there is clear opportunity for change and disruption to happen in the future and we’re invested in this for the long term.”
Joe Doran
Title: General manager of Microsoft’s digital advertising solutions unit
Age: 40
Family: Married with three children
Education: Undergraduate degree from United States Military Academy at West Point, MBA from Harvard Business School.
Thoughts on Facebook: “We believe in their vision, where they’re going and where they’re taking their company. That growth that they have creates an audience that we believe is highly valuable and will continue to be highly valued by advertisers in the future. We believe that Facebook has a high quality site and a high quality audience.” Matt Hartley
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