Google’s Deal on AOL is Microsoft’s Setback

December 22, 2005 0

This time, it was Microsoft that was snubbed at the last minute
In 1996, America Online agreed to offer Netscape’s Internet browser to its five million customers. A day later, the nonbinding agreement was shunted aside when AOL announced that it had instead chosen Microsoft’s Internet Explorer browser in a $100 million deal.

America Online sealed a deal lately with Google Inc. to deepen their relationship, while leaving Microsoft Corp. as the spurned suitor.


As recently as two weeks ago, Microsoft executives said they believed that their company was going to win the endorsement of Time Warner, AOL’s parent, to form an advertising venture with AOL and become its provider of Web search technology.

But shortly, Time Warner is expected to announce that it will instead renew its three-year-old partnership with Google as the provider of search technology. The deal, in which Google will invest $1 billion for a 5 percent stake in AOL, will also significantly expand AOL’s advertising opportunities on Google sites, among other things.

Google has given AOL ads special placement on its site, something it has not done before. Until now, Google prided itself on its auction system for ads, which treated small businesses on an equal footing with its largest customers.

The software titan’s failure to woo AOL away from Google in favor of its own search technology highlights the uphill battle Microsoft faces as it tries to gain traction in the lucrative business of selling online ads.

Yet industry analysts say the lost bid also shows that Microsoft, its fiercely competitive culture notwithstanding, was not willing to go to unreasonable lengths to make a deal work.

I think they have learned that you do not do a deal at any price just to do a deal. You do a deal that makes sense for you, said analyst Michael Gartenberg with Jupiter Research.

The turn of events shows just how much Google – hotter now than Netscape was nine years ago – has supplanted Microsoft as the force to be reckoned within technology. And it raises questions about Microsoft’s stated goal of becoming the leader in Internet searching, as well as about its emerging plans to offer more online services under a new brand, Windows Live.

I thought Microsoft would pay just about anything to get this, said David B. Yoffie, a professor at Harvard Business School. For Microsoft, he said, AOL was the single best way to gain market share.

Yet Google found a way to trump Microsoft’s hoard of cash, in part because losing to Microsoft was a strategic risk. Mr. Yoffie characterized the deal as "crucial and purely defensive" for Google because it "prevents Microsoft from being credible in search."

This is Google’s first test as a chess player in a major corporate battle, said John Battelle, the author of The Search: How Google and Its Rivals Rewrote the Rules of Business and Transformed Our Culture.

They are saying, “We will take some of our pawns and block the move to our queen by Microsoft.” Until now, Google has said: “We do not think about our competitors. We spend all our time building better products for our users.”

Time Warner rebuffed aggressive overtures from Microsoft in agreeing to sell a 5 percent stake in America Online to Google as part of an expanded partnership between AOL, once the dominant company on the Internet, and Google, the current online king.

For years Microsoft and its chairman; Bill Gates, won business from AOL and many others with money, power, technology and a presumed dominance of technical standards. For many Internet companies, it appeared to be the safest partner despite continuing regulatory scrutiny of its business practices, much as I.B.M. was considered the surest bet for computers and information technology by a generation of corporate managers.

But for Time Warner, it was Google that appeared to be the safe choice in uncertain times. Google’s search technology has been the leader in innovation, its advertising network has been a volcano of cash for AOL, and its brand is the hottest of all Internet companies.

Moreover, under this deal AOL will get assistance from Google that it did not have before. Google will help AOL in sending traffic to AOL’s free, advertising-supported Web sites. It will also give AOL the ability to offer its existing advertisers search ads for the first time and will allow AOL’s sales force to sell display advertising on Google’s extensive network.

At stake in this battle was leadership in Internet advertising, which is a growing threat to other media companies. The loss is a blow to Microsoft, which had sought AOL as a partner in its advertising venture to undercut Google, its potent rival.

Though Google is only seven years old, its lucrative search advertising business and its technical prowess could enable it to offer consumers free software and services that would directly attack Microsoft’s core software business.

Microsoft – despite its many advantages, including promoting MSN services on Internet Explorer and on the Windows desktop – has not been able to become a clear leader in any online business. While MSN has strong global operations and some popular products, like its Hotmail e-mail service, it ranks third in reach in the United States behind Yahoo and AOL.

Like AOL, MSN’s strategy has oscillated in recent years. For a time, MSN tried to compensate for a decline in its dial-up Internet access business with fee-based subscription services meant for broadband users, which proved unpopular. Then it pulled back from consumer marketing and diverted much of its resources away from MSN’s advertising-supported Web portal to build an Internet search business meant to rival Google.

Now, Microsoft is building a second portal at Live.com and plans to introduce improved e-mail, instant messenger and other services under the Windows Live brand. At the same time, it is increasing its hiring to revive the MSN portal.

Even without paying much attention to the MSN portal, Microsoft was able to earn its first profit from the online unit in 2004 because of the booming market in online advertising. In Microsoft’s fiscal year ended in June, MSN had $2.3 billion in revenue, of which $1.4 billion was from advertising and $417 million came from operating income.

Meanwhile, Yahoo became a strong No. 2 in searching to Google by spending $2 billion to buy Inktomi, a Web search firm, and Overture Services, a Web advertising company. Microsoft’s progress in searches and search-based ads has been slower because it is trying to build an entire business from scratch.

Still, Microsoft, despite its lagging position, had some appeal for Time Warner executives. Combining Aspects of AOL and MSN could have created a third online network with resources and users to rival Google and Yahoo.

While the terms of the proposed five-year deal are largely set, it will not be final until it is ratified by the Time Warner board, an executive who was briefed on the negotiations said.

Representatives of Time Warner, Google and Microsoft declined to comment about the negotiations.