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Inside Microsoft's war against Google

Even before yanking the Yahoo offer, Microsoft's Steve Ballmer had begun laying the groundwork for a strategy to compete with Google in online advertising.
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/ Source: Business Week

It's April, and Microsoft's top U. S. salesman for online advertising, Keith Lorizio, is visiting clients in New York City. In a midtown office tower, he sits down with Nicholas Utton, the gregarious chief marketing officer at online broker E*Trade. Utton is plenty impressed with Microsoft's technology, and he's a big advertiser on the company's MSN Money site. But when it comes to Internet search sites, the largest and most lucrative advertising market online, Utton makes it clear that Microsoft is, as he sees it, way behind front-runner Google. "They're not getting much of our search dollars," he says.

Lorizio's pitch just got even tougher. On May 3, Microsoft CEO Steven A. Ballmer withdrew his offer for Web giant Yahoo!, the No. 2 power in online ads, after the two sides failed to agree on a price. Ballmer had said that the proposed acquisition, which valued Yahoo at $47.5 billion, was the best way for Microsoft to gain the scale necessary to compete against Google for online advertising dollars. Now, after three months of talks, it looks as though Microsoft and Yahoo will be left trying to catch Google on their own, at least for now. And their prospects are grim. "We think Google's the winner," says Clayton F. Moran, analyst with the financial-services firm Stanford Group. "Its two main competitors are separate and floundering."

For Ballmer, however, the game is far from over. Even before yanking the Yahoo offer, he had begun laying the groundwork for a strategy to compete with Google in online advertising. He's convinced that getting the online ad business right is essential to Microsoft's future. The reason: Consumers and businesses increasingly are switching from desktop software like Microsoft's to free online services that do the same things. "We are absolutely committed to be the leading player in that endeavor," Ballmer told employees at a recent gathering. ( is a Microsoft-NBC Universal joint venture.)

It may be impossible to catch Google in search advertising. The company dominates the market, taking in 77% of the revenues from those little text ads that show up alongside the results for Internet search queries. Microsoft, after years of trying, is at 5% of U.S. search revenue, according to search marketing firm Efficient Frontier.

But Microsoft has a fighting chance on several other fronts. Perhaps most important is display advertising, the colorful banner and video ads that run at the top or along the side of Web pages. Microsoft is among the leaders in the fragmented field, while Google is a bit player. Although the display market is smaller than search, it's expected to grow faster over the next few years because of a surge in video ads. Market research firm IDC figures that by 2012 the display market will double, to $15.1 billion; revenue from search will reach $17.6 billion.

Microsoft makes money in the display business in two ways. It sells ads on its own popular Web sites, such as MSN and Hotmail, and it acts as a broker by placing ads on other companies' Web sites and then splitting the revenue with them. Smaller Web sites use Microsoft because they don't have a salesforce to call on advertisers and ad agencies. And even large players like media giant Viacom have found that letting Microsoft sell some of the space on sites like Comedy Central and MTV can lead to higher revenues. "They can achieve better monetization than we can on our own," says Viacom CEO Phillipe Dauman.

It's Lorizio and his 180-person salesforce who are leading Microsoft's fight for this up-for-grabs market—and for the future of Microsoft itself. Their pitch is that, in display advertising, Microsoft has the most sophisticated technology of any company. It can help advertisers precisely target display ads and assess the value of ads even when Web surfers don't click on them. Microsoft is also making the case that search advertising, Google's gold mine, is overrated. In the months ahead, it plans to introduce new ad technology that it says will demonstrate that to advertisers. "We're going to win with this strategy," Lorizio says.

Google isn't giving any ground. It's pushing hard into the display business, even as it builds on its lead in search. In March the company closed on its $3.2 billion acquisition of DoubleClick, a leading player in placing banner and video ads on other companies' Web sites. Google plans to combine DoubleClick's display technology with its own technologies—and its broad base of advertisers—to establish a stronger position in the market. "Google now has the leading display ad platform," said Google CEO Eric Schmidt at the time, adding that together the companies will be able to "dramatically improve the effectiveness, measurability, and performance of digital media." Google also bought YouTube, the top video site on the Web, although it hasn't generated much revenue from it so far.

There's plenty of skepticism that Microsoft can make real headway even in display advertising. The company has floundered in the online ad business so far. Besides getting trounced by Google in search, Microsoft has flummoxed consumers with a muddle of online products, including its dueling MSN and Live brands. The Yahoo deal would have more than doubled the size of Microsoft's Web audience, to north of 250 million visitors a month, and tripled its online ad revenues, to $10 billion. Without Yahoo, the company is expected to generate $3.3 billion in online advertising this year, compared with Google's $22 billion. Microsoft has lost $1.5 billion in its online division over the past three years. "They're behind the eight ball," says Charles Di Bona, an analyst at Sanford C. Bernstein & Co.

Persistent competitor
Still, Microsoft is a fearsome competitor, with nearly unlimited financial and engineering resources. It has proven its determination to take down upstarts again and again over the years, from the Web browser market to the market for mobile-phone software. "We're very persistent," said Ballmer at a wireless conference last year, "If we don't get it right, we'll keep coming and coming and coming."

Plenty of advertisers would like to see Microsoft succeed, if only to blunt Google. Although they appreciate the effectiveness of Google's search ads, they're nervous about one company dominating the online advertising market. "Competition from an advertiser's perspective is a really good thing," says Rob Master, director of media for North America at consumer products giant Unilever Group.

For Ballmer, this isn't just about taking Google down. Indeed, it's hard to overstate how important it is for the company to master online advertising. While Microsoft is phenomenally profitable today, adding $1 billion each month to the cash hoard from its lucrative software business, it faces a serious long-term threat. The company's fortunes have been built on software that runs on PCs, especially its Windows operating system and its Office word-processing, spreadsheet, and e-mail programs. But that kind of software is beginning to shift online. People with pretty much any kind of computer can go to the Web and use applications for things like word processing and communication. The programs are typically available for free, funded by online advertising. Google is offering a number of these programs, and there are a flock of others doing the same, such as upstart Zoho.

So far, the shift to online software is more of a drip than a flood. The programs often don't work as smoothly as, say, Microsoft Office, and they can require some tech savvy to use. But the shift seems sure to accelerate in the years ahead, and no company has more to lose than Microsoft. If the tech giant doesn't develop a strong ad business to pay for programs it will eventually have to offer online, it will face big trouble. "Microsoft's biggest fear is that once you start putting Google [software programs on the Internet], then the price Microsoft can charge for its software will erode markedly," says David B. Yoffie, a professor at Harvard Business School. "Just the threat means that Microsoft has to be able to offer advertising as a choice."

That's why there are few jobs more important at Microsoft than Lorizio's. Kevin Johnson, president of the division that includes Microsoft's online operations, says the salesman and his team are "front and center" in the battle for the online ad market. Unlike the stereotypical Microsoftie—a frumpy, maladjusted code freak—Lorizio is every bit the polished professional. He's tall and lean, a gym rat when he's on the road. A salesman at Yahoo before he joined Microsoft in 2005, he favors starched shirts and designer shoes.

He grew up in an Italian Catholic family just outside of Boston. His dad ran a trucking business, and his mother taught him to cook classic dishes like braciole. The 43-year-old still lives in Boston, though his primary office is in New York. And when he talks, the New Englander in him shows through, turning words like park into "pahk" and idea into "idear."

When Lorizio deals with advertisers, though, it's clear that his pitch for Microsoft's display technology is resonating with some. In E*Trade's offices, marketing chief Utton has spreadsheets splayed across a conference table when Lorizio comes to visit. Utton loves how Microsoft's analytical tools give him the ability to track the precise effectiveness of his display advertising. He knows, for example, how many people came to E*Trade after clicking on an ad on MSN Money, how many of those people set up brokerage accounts, and even how many became active traders. "It's a math project," he says, as Lorizio grins across the conference table.

Next up on Lorizio's New York tour is MindShare Interaction, a media buying unit of ad giant WPP Group. Microsoft has worked with the company to create a Web site called In The Motherhood, with video programming targeted at new moms. Lorizio stops in to chat with Margaret M. Clerkin, head of MindShare's North America operations, about the show and its advertisers. Microsoft not only manages the ads that run with the show, it also provides the technology for streaming the video and tosses in editorial content from its MSN pages. "They do a different level of customer service than anyone else," says Clerkin.

Over at Viacom, Microsoft has a substantial presence. The two companies cut a wide-ranging $500 million deal in December, which includes Microsoft selling ads on Viacom's Web sites. What impressed CEO Dauman is Microsoft's ability to generate decent ad sales on what's known as "remnant inventory," those rarely visited Web pages deep inside sites. Microsoft uses its Web-tracking tools to find out what individual Web surfers are interested in and then delivers relevant ads to them when they're on Viacom's less-clicked-on pages. The ad space is cheap, but the value for advertisers is substantial. "We don't have the kind of targeting capabilities that Microsoft has," says Dauman. This sort of "behavioral targeting" is becoming more widely used by a number of companies, including Yahoo.

The most provocative pitch from Lorizio and his sales team will come late this summer. It goes like this: Search advertising is vastly overrated. Today, when a Web surfer is looking for a car, he might type "Chevrolet" into Google and then click on an ad alongside the search results. Google gets all the money for that click, even though other marketing efforts, both online and off, probably helped persuade that person to conduct the search. Ideally, an advertiser would know about all the ads that a potential customer sees before he makes a purchase. "They're trying to say that Google's getting too much credit, and there's probably a lot of truth to that," says Curt Hecht, chief digital officer for the media buying giant Starcom MediaVest Group.

Putting ad campaigns to the test
Microsoft has been developing a technology that will give advertisers a more complete picture. It's called Engagement Mapping, and 16 advertisers and agencies have been testing it out since February. The technology anonymously tracks cookies, those digital footprints left on PCs by Web sites, to see if a consumer saw display or video ads within a month of making that ultimate click. Then it places values on each related online ad, weighting things like videos more heavily, since they're likely to have more impact. That way publishers and marketers have a better understanding of the effectiveness of ad campaigns and can adjust pricing accordingly. "It's not anti-search," says Brian McAndrews, the Microsoft senior vice-president overseeing the effort. "It's just a better way to measure."

Ben Winkler is a believer. He's director of interactive media at the Ingenuity Media Group, part of ad firm The Martin Agency. He's been testing the Microsoft technology for one of his clients, wireless provider Alltel. The technology, he says, shows that display ads have an impact that had never been clear before. As a result, he plans to advise clients to spend a greater share of their ad dollars on display vs. search ads. "We're taking credit away from search to a high degree," he says.

Google declined to comment on Microsoft's initiative for this article. In the past, the company has said that it doesn't think that advertisers should focus exclusively on the number of clicks on search ads. In fact, it's developing its own tools to give a broader view of all kinds of advertising.

Will all of this be enough to help Microsoft become a top competitor in online advertising? It's not at all clear. Even as Google moves into display advertising, Yahoo presents a serious threat. For all its struggles of late, an independent Yahoo is a potent rival. The Internet portal helped pioneer the display ad business, and analysts say it has a somewhat larger share of the market than Microsoft, thanks to its more than 500 million monthly users. Yahoo also has leading positions in online media segments such as news, sports, and finance. "I still maintain that our great consumer experiences, combined with our leadership on the advertising side, make us truly unique," says Yahoo CEO Jerry Yang in an interview.

Ballmer could ultimately turn back to his investment bankers. He may decide that Microsoft needs an acquisition to have a legitimate shot at Google in online advertising. There has been speculation that Microsoft could buy America Online or a social-networking site like Facebook to gain some of the scale it would have gotten with Yahoo. People are convinced that Microsoft and Yahoo will end up together, despite protestations that their talks are over. "I have to believe that they will get back to the table," says Anant Sundaram, professor of finance at Dartmouth College's Tuck School of Business.

But for now, Lorizio and his sales force have to battle with what they have. The New Englander sees himself as the underdog, much like his beloved Boston Red Sox, who were runners-up to the New York Yankees for decades. Ultimately, the Sox defeated the Yanks in 2004 on the way to their first World Series win since 1918. Lorizio thinks Microsoft has the technological firepower and financial wherewithal to persevere just the same way. "I'm here to win," he says.

With Robert D. Hof in San Mateo, Calif.