Thursday, August 6, 2009

Microsoft's Sweet Deal for Yahoo! Search Businesses: WYSIWYG for SLA's

Five days after announcing the deal for licensing of Yahoo’s search technology in return for Microsoft’s commitment to manage the search functions for Yahoo!, on August 4, 2009, Yahoo! revealed the details of the Microsoft-Yahoo! agreement to enter into a definitive “global Search and Advertising Services and Sales Agreement.”

The details are not very pretty for Yahoo! as an outsourcing customer of back office support for its core business of Internet search services.

Maybe something is better than nothing. Yahoo! was essentially not saleable at any price due to the 65% market share of Google, Yahoo!’s smaller market share and the financial strengths of Google and Microsoft to make future technology investments.

As an “outsourcing” deal, there are some key issues, including termination contingencies and Service Level Agreements (SLA’s). Yahoo! is very exposed on each of these key performance indicators (KPI). It gets what Microsoft delivers, WYSIWYG. It has the flavor of a divestiture, not an outsourcing.

Scope. Microsoft will take over R&D expenses for improving the Yahoo! search engine. Microsoft’s role is limited to website technology for Internet websites, applications and other online digital properties designed for use and consumption on personal computers. If Yahoo! wants, it can implement Microsoft mobile search and mapping services, either exclusively or non-exclusively (though the financial terms were not disclosed). Yahoo! will be the exclusive worldwide sales force for the “premium search advertisers” of both parties.

Transition Costs. Microsoft is paying $50 million for each of the first three years to assists Yahoo! in paying Yahoo!’s transition costs. This looks like a payment for the value of the 400 IT staff that Microsoft is rebadging from Yahoo!.

Transition Plan: “WYGIWYG”. The transition is scheduled to compete within two years after the “Commencement Date.” Most outsourcing deals have much tighter schedules. New “best practices”: “What you get is what you get.”

Termination Contingencies.

Shotgun Marriage – Arbitrators to the Rescue? There is “no deal” if the parties cannot reach
definitive agreement by October 27, 2009 (about 90 days after the deal was reached). But
that does not matter. The parties adopted a binding arbitration process to choose, without
any modification, one party or the other’s proposed contracts. They agree to sign the
contracts within 3 days of the panel’s ruling, but they leave some room “to resolve potential
inconsistencies” in the final deal terms.
Regulatory Approvals. Microsoft agreed to use its “best efforts” (a high standard of care,
including moving mountains to get there) to get regulatory approvals, including
commitments to restrictions on its own activities in “search and paid search.” If Microsoft
fails, Microsoft must defend antitrust enforcement action, though it’s unclear when it can
Shotgun Marriage – Risk of “Annulment” due to Possible Misrepresentations. Either party
can escape the deal by declaring that the other is in material breach of its representations.
However, without “Definitive Agreements” being signed, no one knows what those
representations are.
12 or 18 Month Window to Get Started. The deal dies if “the conditions to commencement
have not been satisfied by July 29, 2010. If Yahoo! wishes, it may extend this window by
another 6 months. In short, Microsoft insisted on the right to walk away in 18 months if the
deal has any loose ends.

WYSIWYG Service Level Agreements. The Microsoft Windows® operating system became dominate because it allowed users to see formatting. Well, in this deal, the SLA’s for R&D are nothing other than whatever Microsoft does for itself, in Microsoft’s own format. Also, “Microsoft will not treat Yahoo! or Yahoo!’s Syndication Partners less favorably than Microsoft and Microsoft’s partners in connection with its delivery and operation of the services.

Such non-SLA’s are common in the sale of a business unit, where the selling parent company agrees to manage the administrative back office functions of the spun-off or divested subsidiary for a year. This “non-SLA” is useful to prevent unfair or discriminatory treatment, but does nothing to ensure competitiveness, continuous improvement, minimum features or other metrics of quality.

So, it’s not a classic outsourcing deal with classic SLA’s and the customary clauses giving flexibility in termination, scope change, adaptation to the market. It’s an exit plan with a hope to compete against Google! Yahoo! is hoping Microsoft will rescue it from further decline, and it represents the best alternative to simply exiting the market that requires further investment and faces heavy competition from Google!

Tuesday, August 4, 2009

Yahoo! Deal with Microsoft: Joint Venture, Outsourcing or Exit from Core Business?

Times are tough. Maybe it’s time to do a joint venture with your competitor, and license your core technology to your competitor and get it back as outsourced services, to save some expenses and hopefully allow you to stay in business…for a while.

What has been announced as a joint venture and technology license has a strong resemblance to an outsourcing deal that shifts operational responsibility to the “service partner” (Microsoft) who gets a 12% gainsharing compensation package plus talented personnel plus elimination of a potential competitor.

The global economic decline and the Internet search market domination by Google pushed Yahoo! to explore selling the company, On July 29, 2009, Yahoo! and Microsoft announced their “joint venture” to enable Yahoo! to rely on Microsoft for future software development in the search engine business while Yahoo! retains its customers. The 10-year deal includes a license by Yahoo! to allow Microsoft to use Yahoo! search technology. Yahoo! gets 88% of search and ad revenues from its own websites (subject to repricing after five years) and Microsoft keeps 100% of corresponding revenues from Microsoft websites. The business value for Yahoo! lies in the estimated $500 million annual savings in operations (including transfer of personnel to Microsoft), capital expenditure savings of approximately $200 million and a savings of annual operating cash flow of approximately $275 million. The deal is estimated to take 24 months to implement after completion of regulatory review and approval.

This “joint venture” is not only a classic outsourcing deal with some twists, but resulted in a licensing deal. In February 2008, Microsoft offered by buy for $44.6 billion. Microsoft then projected economies of $1 billion a year, to come from a more efficient company with synergies in (i) scale economics driven by audience critical mass and increased value for advertisers; (ii) combined engineering talent to accelerate innovation; (iii) operational efficiencies through elimination of redundant cost; and (iv) the ability to innovate in emerging user experiences such as video and mobile. Because of regulatory opposition to such consolidation and convergence in a concentrated market, instead of a merger Yahoo! got just a licensing deal. Google also attempted to acquire Yahoo! For a further chronology, see

“The potential risks and uncertainties include, among others,
  1. the expected financial and other benefits of the agreement with Microsoft maynot be eralized, including as a result of actions taken by United States or foreign regulatory authorities and the responseor acceptance of the agreement by publishers, advertisers, users, and employees and Yahoo!s strategic and business partners;
  2. the impact of management and organizational challenges;
  3. the implementation and results of Yahoo!'s ongoing strategic and cost initiatives;
  4. Yahoo!'s ability to compete with new or existing competitors;
  5. reduction in spending by, or loss of, marketing services customers;
  6. the demand by customers for Yahoo!'s premium services;
  7. acceptance by users of new products and services;
  8. risks related to joint ventures and the integration of acquisitions;
  9. risks related to Yahoo!'s international operations;
  10. failure to manage growth and diversification;
  11. adverse results in litigation, including intellectual property infringement claims;
  12. Yahoo!'s ability to protect its intellectual property and the value of its brands;
  13. dependence on key personnel
  14. dependence on third parties for technology, services, content and distribution and;
  15. general economic conditions and changes in economic conditions."
What's missing form this list? The press release is silent on:

  1. the "service level agreement" performance obligations of Microsoft for software development of the Microsoft Bing search engine;
  2. transition planning;
  3. the definition of "in-scope" personnel who will transition from Yahoo! to Microsoft;
  4. the impact on Yahoo! of its loss of its IT personnel to Microsoft's team;
  5. the re-definition of Yahoo!'s strategic position in the online marketplace;
  6. any prohibitions on competitive transactions with Google or others; and
  7. the conditions governing termination.

The deal offers several strategic advantages for Yahoo! These include finding a buyer of its information technology (though it’s only a license for 10 years, with pricing firm only for 5 years), avoiding further investment in such technology in the face of competition from Google and Microsoft, and retention of roughly 7/8ths of its existing cash flow from search engine and advertising services.

For Microsoft, it gets to focus its competition on Google and gains some revenue (12%) for its Internet search operations. Microsoft saves about $35 billion in the deal.

The regulatory review process will include U.S. antitrust and European Union competition law. Regulatory approval is far from certain. Furthermore, while such regulatory review is pending, customers may conclude that Yahoo! has effectively moved away from its core business and might migrate to Microsoft or Google in any event. Indeed, regulatory review in IT and Internet businesses has proven to be slow, sometimes so slow as to nullify the business opportunity and too slow to reflect rapid changes (which regulators find difficult to identify or define) in the markets. All this may explain why Yahoo! shares tumbled 15% on the announcement.

Lessons for outsourcing service providers:
  • If you want to make an acquisition, try offering a licensing and co-branding structure that resembles an outsourcing. This could be cheaper than bank financing for a full-blown acquisitions.
  • Your competitiors may make great outsourcing customers.