Microsoft's "Cash Back" Google Search Killer: Great Idea, Won't Work

Microsoft (MSFT) will announce its Hail Mary attempt to stave off a Google (GOOG) search monopoly this morning, TechCrunch reports. This is the “disruptive” development Microsoft’s Kevin Johnson alluded to last week. It is also a plan Microsoft briefly discussed a couple of years ago (to applause, at least from this analyst).

First, we think this is a smart idea. It’s a natural market response to a sector in which one player has suddenly absconded with absolutely fantastic profits (and profit margins), leaving all other competitors flopping in the dust. We think Kevin Johnson was right to describe it as “disruptive,” and we’re sorry we needled him for that. (Of course, we would have inserted the word “potentially”–see below.)

Second, Microsoft appears to have executed the plan intelligently: 18 high-profit verticals in which searchers get cash back if they buy something from participating merchants.

This announcement will likely create uncertainty in the industry, and we expect Google investors will worry about it for a while (needlessly, in our opinion). At first blush, the plan also sounds as though it will turn the industry on its head, forcing Google to implement a similar plan or go bust. So why won’t it?

Three reasons:

* Microsoft will not likely offer enough “cash back” on each purchase to make the service worth using for most users. The search business is wildly and fantastically profitable in aggregate, but it is composed of billions of small-value revenue events. 1 million $1 clicks generate $1 million of revenue for Google, but even if Microsoft gives 50% cash back on each click, that’s only 50 cents per user per transaction. If you’re buying a $5 item, 50 cents is a nice refund, but if you’re buying, say, a $25 item, it’s chump change. Folks who clip coupons in the real world will be very excited about Live Search Cash Back and will likely use it religiously. But there’s a reason coupons, Discovery cards, etc. haven’t taken over the world.

* The program only covers “participating” retailers and “participating” products, at least initially. Although the initial names involved are impressive, right away you have concerns about breadth of coverage and objectivity. If the coverage is super-broad (including Amazon, eBay, and all the online biggies), the objectivity will be less of an issue. But, at least initially, a significant percentage of users will assume they are either seeing only a small portion of the available choices or are getting screwed. Google has built its franchise on comprehensiveness and objectivity, and we suspect that its initial response will be to argue that this is really what consumers want. And unless Microsoft is paying a huge amount of cash back, they’re right.

* If necessary, Google can always respond with a similar plan–and its economics will always be far better than Microsoft. If Google really starts to lose share to this plan (which we don’t think it will), it will likely launch a similar plan for certain searches. Because Google makes more per search, it will be able to offer more cash back, and it will be able to point out that users don’t have to change habits. Google could even offer a hybrid–organic search and special cash-back offers. A response might eat into Google’s margins (which would hit the stock temporarily), but it wouldn’t upend the industry. And, in our opinion, it wouldn’t take long for Google to starve Microsoft out.

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