(Fortune Magazine) -- Struggle? You don't normally think of that word applying to the company Bill Gates founded. But there it is: Microsoft, one of the most aggressively competitive, brainiac-attracting, technologically superior, and oh, yes, cash-gushingly profitable companies of all time, can't for the life of it make a dime on the Internet.
It's not as if earning money on the web is such a remarkable feat. Everyone knows that Google (GOOG, Fortune 500) remains the company of online advertising, generating operating profits of $1.7 billion last quarter on revenues of $5.5 billion. Yet even industry doormats Yahoo (YHOO, Fortune 500) and AOL are profitable.
Yahoo, so badly managed that co-founder Jerry Yang recently demoted himself from CEO to "Chief Yahoo," eked out operating earnings of $70 million in its most recent quarter. Yang's return to Chief Yahoo status (he'll keep his board seat) renews speculation that Microsoft will try again to buy Yahoo, or at the very least, ink a search deal with it.
But that's getting ahead of the story of why Microsoft (MSFT, Fortune 500) wanted Yahoo in the first place. AOL, a shell of its former self (and, like Fortune, a unit of Time Warner (TWX, Fortune 500)), earned $268 million in the same quarter.
As for Microsoft, which has been at this online thing for a decade, give or take, losses continue to mount. The division in question is Microsoft's Online Services Business, which includes the online portal MSN, the aQuantive ad agency Microsoft bought last year for $6 billion, and Live Search.
For the quarter that ended Sept. 30, online revenues grew 15%, to $770 million. But the unit lost nearly half a billion dollars ($480 million, to be exact). That loss was 80% greater than the year-earlier quarter's splat of red ink.
At one level, the explanation for Microsoft's weak showing is simple. Desperate to catch Google, Microsoft has been spending like mad on data centers, people, and marketing. But its online audience is relatively small - much smaller than Google's - and those costs grossly outweigh sales. (Some 72% of the online unit's revenues come from ads, most of which are of the display variety, as opposed to search ads.)
Microsoft may have been noodling on the web since the 1990s, but it was only four years ago that the company woke up to the need to compete in search - where a disproportionate share of online profits are today. Hence it is the new kid on that block, a tough place to be in a world where Google is as much the neighborhood bully as Microsoft is in PC software.
Microsoft is understandably touchy on the subject of its online travails. The company declined to provide any of the five executives who have direct responsibility for its online businesses - Windows chiefs Bill Veghte and Steven Sinofsky, former aQuantive CEO Brian McAndrews, search-engineering head Satya Nadella, or web-marketing honcho Yusuf Mehdi - for interviews.
A different Microsoft executive responded testily when approached at an industry event in San Francisco with the query that is the headline of this article. He argued that Microsoft is all that stands between Google and the destruction of ad-supported media as we know it.
"We're doing this for you," he snapped, jabbing his finger into the sternum of a startled Fortune writer.
Microsoft knows it has a problem. In May the former head of online, Kevin Johnson, told his employees in a widely circulated memo, "The fact is that we are not where we want to be in this business yet, and we've been in this position longer than we'd like." Johnson did find a way out of that position for himself: He left Microsoft in July to become CEO of Juniper Networks, a telecommunications-hardware company.
The next day Steve Ballmer, Microsoft's voluble CEO, used an anatomical analogy to explain the company's online shortcomings. "Our PC muscles are very well developed, and our server and enterprise muscles are very well developed," he told a group of financial analysts. "Our Internet muscles aren't yet as well developed. But we want to go after it with the same energy."
It's quite possible that Microsoft is going after the Internet with too much energy - or at least attacking in too many directions. Rather than carve out some element of the web where it can shine, Microsoft pursues everything.
Its Live Search competes head-on with Google. MSN and Hotmail do battle, unimpressively, with Yahoo's e-mail service and Google's smaller but innovative Gmail. With recent tweaks to its Windows Live product, Microsoft is mimicking Facebook, in which Microsoft itself invested. (Refresher: Last year Microsoft paid $240 million for a 1.6% share of Facebook.)
Yet even where Microsoft racks up the most revenues, in its MSN portal, it relies on partners like Fox Sports and MSNBC to do the heavy lifting in terms of creating content. That dilutes Microsoft's operating leverage as well as its creative control.
"They're trying to do everything every major online company does," says Salman Ullah, a venture capitalist who previously served stints as a dealmaker for both Google and Microsoft. "Yet they only monetize one way: brand advertising. And they share that revenue overwhelmingly with partners."
For a company that has long been known for the clarity of its message - the old mission statement, "A computer on every desk and in every home, running Microsoft software" - Microsoft isn't all that clear about what it wants online.
"You've had Ballmer and [chairman Bill] Gates telling the world for years that online success is critical for Microsoft," says Benjamin Schachter, an online-ad analyst with UBS. "But they don't say what success is."
In part, that's because Microsoft is so busy playing defense against Google. Yet Microsoft hasn't done a great job with that either. Even as it has spent money on data centers and marketing gimmicks like giving cash back to users of its search engine - the online equivalent of banks handing out toasters for opening accounts - Microsoft continues to lose share to Google.
Microsoft's portion of U.S. search queries was 8.5% in September, according to comScore, down from 10.4% in January 2007. During the same period, Google's share rose from 53% to 63%. And Facebook, MySpace, Google's YouTube, and other, newer sites have reduced MSN to also-ran status in terms of web popularity.
That at least five high-ranking Microsoft executives have a piece of the online portfolio illustrates another part of the company's predicament. Microsoft doesn't speak with one voice when it talks about the Internet.
Of the current crop of leaders - Veghte, Sinofsky, Nadella, Mehdi, and McAndrews - all but McAndrews cut their teeth on the software business, not the web. McAndrews is very much an outsider at Microsoft, though, right down to having kept his old office in downtown Seattle, which is culturally a world away from headquarters in Redmond.
What's more, the five all report to CEO Ballmer, who temporarily took over from Kevin Johnson - who has yet to be replaced. Now that Yahoo's board has retained a search firm to find that company a new CEO, two of the highest-profile online jobs in the industry are vacant, which can only complicate matters for Microsoft.
Microsoft, of course, has plenty going for it - namely its balance sheet. With $21 billion in cash, the company can afford to spend money on its online operations for years to come. Its overall revenues grew by $9 billion last year, a testament to those dominant franchises Ballmer alluded to in his comments to analysts: Windows, Office, and its server software.
Microsoft also has a well-deserved reputation for never giving up. Indeed, it continues chipping away at initiatives and deals to improve its online fortunes. It recently signed a deal for its search engine to be installed as a toolbar with Sun Microsystems software, the kind of arrangement that Google has used to great effect with manufacturers like Dell and Mozilla's Firefox browser.
Microsoft also aims to get into "cloud computing" through a new service called Windows Azure. That project has been championed by none other than Ray Ozzie, the company's chief software architect, anointed in 2005 as the guy who's supposed to think deep thoughts about the technological future.
Though Microsoft is late to cloud computing (the term refers to software that never needs to be downloaded), it would enable the company to leverage the costs of the data centers it is building primarily for its search business. Still, Microsoft doesn't even intend to light up Azure until late 2009 at the earliest, so this isn't something that's going to contribute to online greatness anytime soon.
Mediocrity never sits well with Microsoft, which is why Steve Ballmer made a play earlier in the year for Yahoo. Sure, Yahoo has its problems. But its immense traffic fed through Microsoft's expensive search-ad system could be just what Ballmer needs to end his long quest for online profits.
Source: money.cnn.com
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