Posted by by Steve Lohr on 30 July 2009
In their persuasion assault on Wednesday, Carol A. Bartz and Steven A. Ballmer repeatedly explained the Microsoft-Yahoo deal using a term from classical economics: “scale.”
“What this deal is really about is scale,” Ms. Bartz, the chief executive of Yahoo, said in the morning conference call with analysts and journalists, adding that advertisers, consumers and the two companies themselves would all benefit as a result.
Mr. Ballmer, the Microsoft chief, said during the conference call that in Internet search “scale drives knowledge,” which, in turn, fuels innovation. That was his shorthand description of what he said was the particularly powerful “feedback loop” in search and search advertising.
In traditional economics, scale typically refers to the efficiency gains that result from size. These observations were originally applied, and measured, in industrial markets. In high-technology markets, like software and the Internet, scale advantages can sometimes behave as if on steroids — faster and stronger. The mechanisms include the feedback loop Mr. Ballmer described and “network effects,” the concept that a technology or online marketplace becomes more valuable the more people use it.
Microsoft’s Windows operating system is the textbook case of a supercharged scale technology. The more people use it, and the more developers write software applications to run on Windows, the more valuable it is to everyone in that technology ecosystem.
Just how powerful the scale economics and network effects are in Internet search is a subject of considerable debate among economists, antitrust experts, investors and business executives. In the conference call, Mr. Ballmer seemed to be suggesting that the snowballing effects of scale in Internet search were even stronger than in operating systems.
But understatement is not Mr. Ballmer’s first instinct. So in an interview after the conference call, I asked him if that’s what he meant. “In my view, scale is more important in this business than any other technology business I know,” he replied. Which helps explain why Mr. Ballmer has long been so intent on getting hold of Yahoo’s search traffic, one way or another.
The Microsoft-Yahoo partnership will now have nearly 30 percent of the search market. In Microsoft’s thinking, that figure may well be significant. David Yoffie, a professor at the Harvard business school, and co-author with Michael Cusumano of M.I.T. of an insightful book on the browser wars, “Competing on Internet Time: Lessons from Netscape and Its Battle with Microsoft,” pointed out that the 30 percent threshold has been important to Microsoft’s strategy in the past.
In 1996, Microsoft’s goal in catching Netscape was to move from about 5 percent to 30 percent share of the browser market in a year. “The view inside Microsoft was that until you got to 30 percent, you weren’t credible in that market with business partners and developers,” Mr. Yoffie said.
There is another dimension of scale behind the deal, according to Murthy Nukala, chief executive of Adchemy, a Silicon Valley startup that uses statistical models, advanced data mining and machine learning to help target online advertising.
The pursuit of “data scale” in search, Mr. Nukala said, fueled the Microsoft partnership. The data-scale benefit, he added, comes from more than just generating more search traffic, though sheer volume is crucial.
A key challenge in search, he explained, is estimating the likelihood that a given user will click on a particular ad from a certain advertiser. In the search world, this problem is called “pCTR estimation,” for probability of click-through rate. The ranking algorithms for search advertising, Mr. Nukala explained, incorporate not only the price per click an advertiser is willing the pay, but also the estimated click-through rate (calculated by applying clever algorithms and machine learning to vast quantities of query data).
“It is well understood,” Mr Nukala said, “that as pCTR estimates improve, the quality of ranking is better, which leads to higher revenue per search.”
It is also important to understand, he added, that the click-through estimates do not improve merely proportionately as search traffic increases but by something more like an exponential multiplier. Presumably, that is the sort of thing Mr. Ballmer had in mind when he said “scale drives knowledge.”
Mr. Nukala concluded, “I believe that ‘data scale’ drove the strategic imperative and the structure of the deal.”
Resources: http://bits.blogs.nytimes.com/2009/07/30/behind-the-microsoft-yahoo-deal-the-internet-economics-of-scale/?ref=technology
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