Microsoft made big noises about advertising revenues, but the company continues to retrench in the infrastructure business it knows so well. Can infrastructure pay off as well as Internet search? In this post, we explain why it can’t.
I’d forgotten about Steve Ballmer’s ludicrous 2007 goal to turn advertising into a quarter of Microsoft’s revenues within two years, but last week, Jordan Golson at GigaOM was a babe in the woods about Microsoft’s two-year-old aQuantive acquisition. I covered this topic extensively at Yankee Group, but it’s worth a quick mention here. At the time, 25% of Microsoft’s revenues would have been a $12-15 billion business. That’s roughly what Microsoft makes with Office and Windows respectively. Assuming the margins would be in anywhere near the same ballpark as the legacy businesses.
An admirable goal…if not a little unrealistic.
The Buzz
From GigaOM:
Nearly two years ago, Microsoft CEO Steve Ballmer told a group of European advertising executives that he saw online ads generating one-quarter of Microsoft’s revenue within a few years. Yet in the quarter ended June 30, Microsoft’s Online Services Business turned in sales of just $731 million, some 5 percent of its $13.1 billion total. It was also the company’s worst-performing division, with an operating loss of $732 million. In other words, Microsoft spent $2 for every $1 it made online. So with the recent Yahoo search deal and today’s sale of its Razorfish digital ad shop, is Microsoft trying to get out of the ad business?
Yep. Already addressed this years ago. It’s old news. Yes, Microsoft makes money from Office and Windows. Has lost money for years in Online Services Business (OSB). Doing so on a bigger scale in recent years after aQuantive. An also ran in mobile. Consumer electronics is plagued with confusing accounting and what appears to be revenue padding (or loss minimization).
In other words, Microsoft doesn’t actually make money in the businesses we talk about (Xbox, Mobile, Advertising) — the company makes money selling legacy software. And that business is quite profitable.
But that’s not what we see at GigaOM and on Twitter. All the talk is about product strategy and alignment. Things that don’t really matter in the big picture.
Back to the Numbers
The challenge as I see it is that the only way Microsoft can make money is by selling software infrastructure. If we talk about advertising, we’re getting into the media business. There are two types of companies willing to invest in software platforms for advertising: media companies and communications providers. This is where things diverge. The media industry invests about 2.3% of revenues in infrastructure that includes publishing platforms, data centers, storage, advertising software and so on and so forth.
Meanwhile, the communications industry (telecoms, wireless and PayTV), invest far more — between 12% and 14% of revenues — on infrastructure.
| Industry | IT Infrastructure (as % of revenues) | Total Market Revenues (for $12 billion MSFT business) |
|---|---|---|
| Internet Media |
2.3%
|
$522 bn
|
| Communications |
12%
|
$100 bn |
We quickly get to a total available market (TAM) question. How big is the opportunity…really? In an overly-simplified approach to the world (100% market penetration, etc.), we can back into the total market required to build a business of a certain size.
Dollar for dollar, the communications industry is a far better place to be selling infrastructure. First of all, it’s big — hundreds of billions of dollars. Second, a company like Microsoft would need to play in a market with $100 billion in revenues in order to build that $12 billion advertising business. That’s a far sight easier than finding $522 billion in media industry revenues. Actually, the media industry in the U.S. is much smaller than $500 billion, so it’s a major challenge to build $12 billion in revenues by selling advertising infrastructure and services in the media industry.
The Big Picture on Microsoft in Advertising
Can Microsoft build a $12 billion business in advertising? Sure — by going head-on at the direct advertising revenues. That’s 100% payout…versus <5% for an advertising network and 2.3% for infrastructure.
The U.S. Internet advertising market is approximately $24 billion in revenues, so Microsoft has a viable chance to use Bing! build their Online Services Business (OSB) from ~$2.5 billion to something closer to $4 or $5 billion in the next two years. That’s a reasonable goal with room to over-shoot.
Beyond that, Microsoft is selling infrastructure and advertising networks, such as: DRIVEpm; the (Rapt) yield management platform; the Silverlight online video platform; and the company’s IPTV advertising platform. These businesses payout at a rate between 2.3% and 12% of revenues. With the 12% coming from the communications industry where advertising revenues (presumably those enabled by Microsoft’s platforms) are miniscule. Twelve percent of nothing is still…a very small number.
In the businesses where Microsoft has the most experience, the company is trying to create a market that’s bigger than the one that exists today. Creating TAM is an uphill battle to say the least.