Steve Ballmer says he is willing to invest 5%-10% of Microsoft’s operating income over the next five years on search.
That’s a boatload of money.
Specifically, assuming Microsoft’s operating income stays constant (it will likely grow), it’s $5.5-$11 billion.
So, is Steve making a smart $5.5-$11 billion bet?
In our opinion, no. Even for a company as cash-rich as Microsoft.
Microsoft has been investing hundreds of millions a year in its Internet business for more than a decade and that investment has yet to generate a single dollar of return. If you add up all the losses investment, in fact, you get a number that is similar to what Microsoft plans to invest over the next 5 years: $8 billion.
In other words, Steve has already been investing about 5%-10% of Microsoft’s operating income on the Internet for the past decade, and he has nothing to show for it:
But this time it will be different?
We doubt it.
Look at it this way:
Imagine that your stockbroker came to you and told you that there was a great new IPO you had to buy. It was a company called “BING.”
Bing was not a new company. Bing had been in business for about 15 years, during which time it had lost a cumulative $8 billion. But Bing had a new product–a search engine–and this product, unlike all of Bing’s previous products, was going to be a huge success.
Of course, it was going to cost a bit to make the new product a success. In fact, it was going to cost about $8 billion. In five years, though, after Bing had invested $8 billion, it was going to mint money.
How much was Bing going to “mint”?
Well, there was another company in the industry, Google, that had already become so successful that it was now generating $8 billion of free cash flow per year. So if Bing eventually became as successful as Google, it would generate $8 billion a year!
So, Google was going to lie down and let Bing roll right over it?
Well, no, probably not.
So maybe it wasn’t realistic to assume that Bing would have the same free cash flow as Google?
Well, no, probably not.
In fact, maybe it would be more realistic (but not actually very realistic at all) to assume that Bing might make a lot less than $8 billion a year–say, $1-$2 billion a year, if it was very successful. Or that, more realistically, once Google saw that Bing was actually making some headway, it might decide to spend some or all of its own $8 billion of free cash flow a year to protect its franchise, given that Bing seemed intent on destroying it. And that, because Google already had 65% market share of the search market versus Bing’s 10% and had weathered all of Bing’s previous attacks, it might very well succeed in defending itself.
Well, OK, that might be more realistic.
So if Bing was super-successful, it might end up running a distant No. 2 to the market leader, Google, and always be only a fraction as profitable? Like, say, Yahoo.
So would you buy that IPO?
Especially once we remembered that the reason Bing had lost $8 billion over the previous decade was that it had been trying desperately to catch up with other industry leaders–namely, AOL and Yahoo–and that it had tried and failed to do this despite hemorraging money while both of those companies coined it.
Search just isn’t strategic to Microsoft, no matter how obsessed Steve Ballmer is with beating Google. Microsoft can’t do everything–no company can–and winning the search war is not critical to Microsoft’s long-term survival. Protecting its operating system and office suite monopoly is critical, however, and that business is also under attack.
We think Steve Ballmer will lose his search bet, no matter how much he spends. Given the relatively unimpressive returns we think we’ll get if he wins, moreover, plus all the other things he has to worry about, we’d rather he just didn’t make it.
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