With Yahoo deal off, what next for Microsoft?

As of Tuesday, a Microsoft-Yahoo megamerger seems far less likely than it did late last week.

But the reason the companies would want to join forces -- Google's continued dominance in online-advertising revenue and in Web-based services in general -- remains as strong as ever. And it raises questions about what Microsoft's next move will be to generate a healthy online-advertising business and avoid losing even more ground to the flourishing search company.

There are many reasons why a Microsoft-Yahoo deal would have been a bad idea, and some in the industry are breathing a sigh of relief that they won't have to deal with the complexity it would have wrought.

Critics questioned how the two companies would navigate separate ad platforms and network infrastructures, as well as how they would integrate their disparate corporate cultures. They also said the full union of the companies would take at least two years to complete, giving Google even more time to solidify its leading market position.

Wall Street analysts also noted it would be a bad idea for Microsoft to undertake such an enormous merger when the company has traditionally made smaller, more strategic acquisitions. A research note by analyst Heather Bellini at UBS advised the company to tackle its online technology challenges on its own while acquiring more customers by buying start-ups and other small companies.

However, she also noted that there aren't a lot of valuable Internet assets on the market now that Google has snapped up Doubleclick, a deal that is expected to close by the end of the year.

So what's a software company that waited too long to capitalize on the new business model of the Internet to do now? Microsoft is in dire straits in the online advertising market, and the company has to change tactics before it becomes too late to even be a serious contender, let alone the revenue leader, as Microsoft CEO Steve Ballmer has promised.

Leveraging its skyrocketing revenue and profits, Google has diversified its line of products and services, moving into areas outside of consumer online services, such as offline advertising, hosted software for businesses and enterprise search. Within consumer online services, it has also expanded beyond Internet search, developing a broad menu of products in areas such as photo management, Web mail, video and instant messaging.

Microsoft, on the other hand, has failed to promote its Windows Live branded services since it launched a major revamp and branding plan in November 2005. Moreover, the company has seen revenues in its Online Services Group rise only slightly since then, and has made new and improved services languish in beta testing only for select users before making them publicly available.

This runs counter to the strategy of Google, which pushes out services to users in rapid-fire fashion even if they remain in beta for years. Microsoft also has had a hard time marketing its Office Live hosted service, which provides a Web presence, CRM, e-mail and other hosted services to small businesses.

Some industry watchers said there still are ways other than merger for Microsoft and Yahoo -- or Microsoft and another competitor -- to team up against Google.

One financial analyst who asked not to be named suggested that Microsoft and Yahoo broaden a deal they have to share ad revenue. It lets Microsoft use the Yahoo Search Marketing platform, formerly called Overture, in overseas markets to provide paid search listings to Microsoft's MSN and affiliates.

Microsoft would not disclose the terms of the revenue-sharing deal, but essentially Microsoft pays Yahoo to push out ads to some of its sites, and in turn earns advertising revenue. Eventually, markets served by Yahoo's search platform will be powered by Microsoft's adCenter platform, which is handling Microsoft's paid search advertising in the United States, U.K., France, Singapore and China.

The IDG News Service is a Network World affiliate.