Text c. Truth in advertising

San Francisco

Feeling unusually threatened, the software giant does an unusual deal

Ever since Bill Gates disrupted IBM’s dominance of the computer industry and made Microsoft the world’s biggest software company, he has feared being disrupted in turn. That is why in 2005 he hired Ray Ozzie, a veteran software guru. On arrival at Microsoft Mr Ozzie wrote a memo, “the internet services disruption”, in which he detailed the threat (Google), the trend (toward free web services) and its new revenue model (online advertising). By buying a Quantive, an online-advertising agency based in Seattle, Microsoft has began to implement Mr Ozzie’s anti-disruption strategy in earnest.

Last week’s deal is nonetheless unusual for Microsoft. At $6 billion in cash, it is more than four times bigger than its previous big acquisitions (of Navision and Great Plains, two software companies, in 2002 and 2001). In “frothiness” it resembles only Microsoft’s investments in cable and telecoms firms during the late 1990s, says Matt Rosoff at Directions on Microsoft, an independent research firm.

It might therefore look like a somewhat desperate response to Google which, as the most popular search engine and biggest seller of online advertising, has been upstaging Microsoft. In April Google increased its market share of searches to 55%, whereas Microsoft, in third place after Yahoo!, slipped to 9%, according to Nielsen/NetRatings, a market-research firm. Google’s lead in keyword-related advertising, thanks to its huge network of affiliated websites, is even larger. Last month Google extended that lead into display advertising by outbidding Microsoft to buy DoubleClick for $3.1 billion.

That deal set off a round of panic buying. Yahoo! bought Right Media, a smaller display-advertising firm, and WPP, a more traditional advertising conglomerate, snapped up a firm called 24/7 Real Media. Microsoft initially responded – with a certain cheek, given its own record as a monopolist – by objecting to the DoubleClick deal on antitrust grounds, arguing that Google was becoming “dominant”. But it then bid high for aQuantive.

Buying aQuantive poses some problems, however. Its largest unit, Avenue A| Razorfish, is an agency that designs websites and online-marketing campaigns. Its second business, called Atlas, serves advertisements and sells tools that other agencies can use to design and track campaigns, and that website owners can use to make the most out of their inventory. Its third business consists of two advertising-syndication networks, called DRIVEPM and MediaBrokers. This is aQuantive’s smallest business, but the one most relevant to Microsoft’s strategy. Combining these businesses with Microsoft presents conflicts of interest. The same company will, for example, now own an agency that buys web space on behalf of advertisers and one of the biggest sellers of such space – MSN, Microsoft’s web portal.

But Microsoft feels that it had no choice. Google appears intent on offering ever more of the things that used to be sold as software – such as word processing or spreadsheets – as free online services. This week there was talk of a tie-up between Google and Salesforce.com, a firm that offers business software as an online service and thus also competes with Microsoft.

Mr Ozzie counters that Google and Salesforce have it wrong by thinking that the world will shift entirely to “software as a service”. Instead, he says, the future lies in “software and service” – ie, in coupling web-based services with local software. He recently introduced a set of technologies called Silverlight, which will allow such hybrid software to be built. Such software will also involve advertising – and demonstrating how this might look during Mr Ozzie’s launch speech was a creative type from Avenue A| Razorfish.