MSN: The Dr Pepper of Search
Google and Yahoo! are like Coke and Pepsi of the online advertising business, but Microsoft remains a distant number 3.
NEW YORK (CNNMoney.com) -- "We're number three! We're number three!"
Call us crazy, but it seems highly unlikely that the folks at Microsoft's Redmond, Wash., headquarters use this rallying cry when talking about the company's MSN unit.
Microsoft (Charts, Fortune 500), despite the ubiquity of its Windows operating system and $26 billion in cash that it could use to invest in new technology, has been unable to make a major dent in the online search business.
Some industry pundits have suggested that Microsoft needs to make a major acquisition, possibly even of Yahoo, in order to become a bigger player online.
According to search market share figures for March, released by Web research firm comScore on Tuesday, MSN had 10.9 percent of the U.S. search market. While that's up from 10.5 percent in February, MSN still trails Google and Yahoo by a wide margin. Google had market share of 48.3 percent, while Yahoo had 27.5 percent.
Google, for example, outbid Microsoft to acquire a stake in Time Warner's AOL in December 2005. (Time Warner (Charts, Fortune 500) also owns CNNMoney.com.) Google also bought online video leader YouTube last year, while Microsoft's effort in online video, Soapbox, has gained little traction with Web users.
Google scooped up online ad placement firm DoubleClick on Friday for $3.1 billion, once again beating out Microsoft, which was said to be interested in acquiring DoubleClick.
And even Yahoo, despite reporting disappointing first-quarter results and weak second-quarter guidance Tuesday, arguably has more momentum in the online advertising business than Microsoft.
The company's new search platform, Project Panama, is said to be leading to more relevant search results for advertisers. In addition, Yahoo recently signed new online advertising partnerships with media company Viacom and newspaper publisher McClatchy.
Yahoo also has been active on the social networking front, purchasing companies like photo-sharing site Flickr, Web bookmark-tagging site del.icio.us and online video editing tool Jumpcut in the past few years.
So is there anything that Microsoft can do to vault itself into a leadership position in online advertising?
Richard Williams, an analyst who follows Microsoft for ICAP Equity Research, said Microsoft desperately needs to add more online video content to MSN in order to get people interested in visiting the site more regularly instead of going to places like YouTube or News Corp.'s (Charts, Fortune 500) MySpace.
"It's an intractable problem. What Microsoft needs is something that will make people want to come to MSN, something that attracts buzz," Williams said. "Frankly, I find it astonishing it's taken this long to bring together the pieces for a significant online presence. They've got to do something to keep MSN alive."
John Lervik, chief executive officer of FAST, a search company based in Norway that develops search tools for corporate Web sites, said Microsoft may be hamstrung by its corporate culture. While Google and Yahoo are more nimble online media firms by their very nature, Microsoft is a company that tends to profit most by developing updates to existing products, a process that takes years.
"Microsoft is really trying and talking a lot about search. But they are a very different company from Google or Yahoo," Lervik said. "If you look at the core competence of Microsoft, it's developing products within a five-year release window. You can't do that in search."
David Garrity, director of research with investment bank Dinosaur Securities in New York, said Microsoft clearly needs to do something to boost its online ad business, and he argues that the only way for Microsoft to effectively do that is through an acquisition.
Garrity said that in the wake of losing out to Google on the DoubleClick deal, Microsoft could turn its attention to one of DoubleClick's rivals such as aQuantive (Charts) or 24/7 Real Media (Charts). But a purchase of one of those companies would not be enough to increase significantly its presence in search, he argues. The one thing that would, however, would be a Microsoft deal for Yahoo.
"It's going to take the acquisition of Yahoo for Microsoft to be a bigger player in search. I don't see any other way for the company to become a more meaningful competitor to Google," Garrity said. "Rather than focus on peers to DoubleClick, management is better served by thinking in terms of the larger online game instead of just the ad-serving business. Why focus on the refried beans when you can get the whole burrito?"
To be sure, Microsoft may not be feeling a sense of urgency with MSN since it represents only a tiny portion of its overall business: the company's online services division accounted for 5 percent of sales in Microsoft's fiscal second quarter (which ended in December).
But MSN is a drag on Microsoft's profits. The online services division posted an operating loss of $155 million in the second quarter. Microsoft will report its fiscal third-quarter results on April 26. ICAP's Williams said he expects Microsoft's online division to report another operating loss, although it may be narrower than the second quarter's loss.
Still, one search analyst said that Microsoft can't be ruled out just yet.
"One ought to recognize that although the current hierarchy of the top three has been pretty stable for a while, there are a lot of new technologies that are still green that Microsoft is pursuing aggressively," said Andrew Frank, an analyst with tech research firm Gartner.
Frank adds that some of Microsoft's newer features, such as its social networking Windows Live Spaces service, are popular in Europe. But he agreed that Microsoft needs to do a better job of developing new Web offerings that will differentiate Microsoft from Google and Yahoo.
"They need to come up with solutions that people want. They need to beat competitors in the innovation game," Frank said.
Analysts quoted in this story do not own shares of the companies mentioned, and their firms have no investment banking relationships with the companies.