Microsoft Spends Billions to Take on Google

TechFlash reports: Microsoft has made some precious progress against Google in recent months, with its Bing search engine pushing the company's share of the U.S. market above 10 percent for the first time in more than two years.

But beneath the surface, those gains have not been cheap. The costs of boosting Bing’s market share have so far exceeded the resulting revenue—putting Microsoft’s online division into an even deeper financial hole. The situation underscores the challenge the Redmond company still faces in Internet search, five years after spending billions of dollars to develop and launch its own search technology.

“It’s been a lot of money, a lot of noise, a long period of time, and very little to show for it,” said Matt Rosoff, an analyst at the Directions on Microsoft research firm.

Microsoft is looking ahead to its pending search deal with Yahoo to give it critical mass and better traction. Internet search is a key part of Microsoft’s quest to make money on the Internet, expand beyond its traditional software franchises, and ensure its long-term relevance. The online business is a small slice of Microsoft’s overall revenue of nearly $5 billion a month, but the online losses are a drag on the company’s earnings. Putting the division into the black, even slightly, would provide a boost to Microsoft's overall profits.

"If we grow share, we will grow our way into profitability, and we have confidence we can do that," said Yusuf Mehdi, a Microsoft senior vice president, in an interview with Reuters.

Microsoft is not a newcomer to the online world. It launched its MSN portal nearly 15 years ago, along with the debut of its Windows 95 operating system. But the financial statements in the company’s Online Services Division could be mistaken for those of a struggling startup—albeit a well-funded one. In its latest quarter, ended December 31, the operating loss in the division increased 46 percent, to $466 million.

The economy hasn’t been helping. For example, the unit’s advertising revenue fell 2 percent during that period, to $516 million, which the company blamed on a shaky market for Internet display advertising.

But the bigger drag on the Online Services Division’s bottom line was a 50 percent increase in its cost of revenue, to more than $500 million for the quarter. That was “primarily driven by higher online traffic acquisition costs,” the company said in its quarterly filing with the Securities and Exchange Commission.

The filing doesn’t break down those costs, but Microsoft has announced a series of deals in which it pays computermakers such as HP and Dell undisclosed sums to make Bing the default search provider on many new computers. Microsoft also made a deal for Bing to be the default on Verizon Wireless devices, except for those running Google’s Android operating system.

In a possible sign of how badly Microsoft wants to gain ground in search, the company has also been reported to be talking with rival Apple about making Bing the default on iPhones.

However, the deals aren’t paying for themselves—at least not yet—in the form of significantly larger advertising revenue from the ads next to search results. The problem for Microsoft is that such deals make Bing the default on new computers, not those previously sold. As more and more computers are sold with Bing as the default, the company could see a bigger revenue benefit, but it would happen gradually.

Users of such computers and devices are free to choose any search engine they want, by changing the settings for built-in search boxes or browsing manually to Google or another site. But Microsoft is counting on many of them simply sticking with the default out of habit or a lack of technical knowledge.

The good news for Microsoft is that those types of traffic-acquisition initiatives appear to be helping the company boost Bing’s market share. Bing held 10.7 percent of the U.S. search market in December, up from 8.4 percent in June, according to comScore Networks data.

Theoretically, even if they aren’t successful in boosting Microsoft’s profits, the deals with PC makers could help Microsoft keep Google from grabbing more market share. But the search giant has continued to rise slightly over the past six months—to 65.7 percent of the U.S. market in December, from 65 percent in June.

At the same time, Yahoo’s market share has declined two full percentage points, to 17.3 percent—diminishing the benefit that Microsoft would ultimately see as a result of joining forces. The Microsoft-Yahoo partnership, in which Microsoft will handle the underlying search engines for both companies, is currently undergoing regulatory review and is expected to close in the first half of this year.

A drama currently playing out in China also could factor into the competition. Google has said it will no longer censor its Internet search results in the world’s most populous nation, after its Gmail service was targeted by a cyber attack alleged to have originated in the country. That could force Google to pull out of the country, creating a wider opening for Microsoft to compete there.

The search market overall is still in such a state of flux that it’s too early to count Microsoft out, said analyst Susan Feldman, vice president of search and discovery technologies for the IDC research firm. Microsoft has made headway by targeting specific search niches, such as online shopping and commerce, and Feldman said there are still opportunities to make progress.

“I think there’s certainly room,” Feldman said of Microsoft’s prospects. “It’s still a multibillion-dollar market. They don’t have to dominate the market in order to get a significant share.”