Amid all the speculation about Microsoft (MSFT) buying Yahoo (YHOO), Yahoo buying AOL (TWX), etc., one thing is nearly certain: One of these transactions will eventually take place–and probably sooner rather than later. Why? Because Google has locked up the No. 1 spot in the sector, and market won’t support more than three competitors.
There’s a dynamic in most industries called the Rule of Three: Most mature markets support three big “generalists” who together control about 70% of the market and a handful of focused “specialists” who each have less than 5% of the market. The generalists survive on economies of scale (volume), and the specialists survive by controlling a defensible niche. The companies that are screwed are the ones in the middle–a death-zone that academics charmingly refer to as “the ditch.”
Right now, Google, Yahoo, and AOL are clinging to their slots as the three big successful generalists and Microsoft–yes, Microsoft–is stuck in the ditch. Unless Microsoft buys AOL or Yahoo, it will likely never get out of the ditch (unless AOL simply disintegrates, which is a reasonable possibility). How do we know Microsoft is in the ditch? Because Google, Yahoo, and AOL are still printing money, while Microsoft is losing nearly $1 billion a year.
Microsoft’s own internal targets are likely achievable only if it buys Yahoo, so we imagine it will eventually make a serious run at this. In the meantime, we imagine AOL will quietly be put in play, which should bring both Yahoo and Microsoft to the table. (Google, too, but Google really doesn’t need to buy AOL, and it won’t be mortally wounded if AOL falls into Yahoo’s or Microsoft’s hands).
The most likely scenarios?
- Microsoft buys AOL
- Microsoft buys Yahoo
Logic: Microsoft can outbid Yahoo for anything, and, in this case, will.
The best scenarios? (The one most likely to create a successful global Google competitor)
- Yahoo buys AOL
- Microsoft buys Yahoo and spins out the combination into a separate company.
Logic: No matter what Microsoft does, as long as the online effort is housed within the Redmond whale, the online effort will always play second fiddle to the Windows/Office monopoly. The only way to get around this is to free it: Create a separate company with a separate management team and a separate currency–and let it compete with the mother ship. Chances of this happening? Slim to zero.
In any event, ignore the daily speculation, but look for a major combination involving Microsoft, Yahoo, and/or AOL within the next year.