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Microsoft moves beyond Yahoo

Steve Ballmer pledges to redouble efforts to go after Google and the online ad market.

By Yi-Wyn Yen, reporter
Last Updated: July 24, 2008: 4:58 PM EDT

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Steve Ballmer said Microsoft's online losses are tiny compared to the potential future gains in the market.

(FORTUNE) -- Microsoft CEO Steve Ballmer put on his game face Thursday and told investors it was imperative for the company to "ante up" in its struggling online business.

During a 1 1/2-hour presentation with Wall Street analysts at the software giant's Redmond, Wash., headquarters, Ballmer said the opportunities to make money from the Internet are too big for Microsoft (MSFT, Fortune 500) to ignore. The company has already spent billions in an effort to catch up with Google (GOOG, Fortune 500) and he said the company will continue to invest heavily in the search market because it is "the starting point" of the web.

Ballmer said shareholders often ask him why Microsoft is focusing so much attention away from its core Windows business, and he says the answer is simple. "There is at least a trillion dollars' worth of opportunity in media, communications and advertising online," Ballmer said. "We don't have a lot of trillion dollar markets that are being transformed. That is such a big opportunity that at least in our scale, our size, our market cap, we have to seize and go after those opportunities."

The chief executive argued that the company's online losses are small potatoes in comparison to potential future gains. Ballmer said Microsoft loses a few hundred million dollars, or around 5 percent of the company's operating income, each year on its Internet investments. He predicted that Microsoft can grow its online divisions, which include Windows Live and its search and advertising units, so that they one day account for between 40% and 60% of the company's overall business.

Ballmer spent about an hour discussing the company's web strategies on behalf of its top online executive, Kevin Johnson. One of the main drivers behind Microsoft's bid to buy Yahoo, Johnson announced Wednesday afternoon that he is leaving the company to become CEO of Juniper Networks (JPNR). Microsoft said it will look for a replacement for Johnson and is reorganizing the platforms and services unit.

The way to better compete with Google, Ballmer said, is to achieve more ad relevance and get more people searching on MSN Live Search. He admitted that was a bit of a dilemma since advertisers will only come if there's more queries, and users will search more if there's better ads. Ballmer, who referred to Microsoft as the "Avis of the [online] business," said the company will have to spend about $1.5 billion in research and development to drive better search results.

For months Wall Street had expected Microsoft to buy Yahoo (YHOO, Fortune 500) to catch up with Google, but Ballmer was visibly exasperated by the whole ordeal. "We were talking about 40 whatever blah blah blah billion. And then we were talking about a search deal. And then we weren't," Ballmer said as he paced back and forth on stage, waving his hands excitedly. "There's nothing under discussion between the two of us. We had a set of principles. We talked about them. It didn't work out. Fine. We're done! We can move on."

"People say we have to buy this," he added. "We say no. It was always a tactic, not a strategy. Frankly, without a big commitment to buy Yahoo our flexibility to reinventing the search and advertising model is greater. If we had put 40 odd billion dollars out there, we'd have to lock into the current economic model."

As part of its non-Yahoo game plan, Microsoft's search executive Satya Nadella says the company will run its search service on Facebook. The social networking, which has more than 90 million users, will begin running Live Search's results and paid search ads on its site this fall.

Microsoft's reinvention as a search player began with its Live Cashback program in May after it first walked away from the Yahoo deal. The company is offering users money in return for searching and buying products through Live Search. It's still too early to tell how much traction the scheme will get, though comScore showed that Microsoft gained a small 0.7% gain in search queries from May (8.5%) to June (9.2%) while Google slid 0.3% from 61.8% over the same period.

To the disappointment of analysts, Ballmer said he would not discuss the company's master plan to drive organic growth now that it isn't buying Yahoo. Ballmer insisted there was "an internal path."

And much to no one's surprise, he kept the door open to buying Yahoo. "Does that mean nobody will ever talk to anybody again? I suspect the answer that question is also no. It's a long time and a big world." To top of page

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