Inside Microsoft's war against Google

By Jay Greene

updated 4:59 p.m. ET May 9, 2008

It's April, and Microsoft's top U. S. salesman for online advertising, Keith Lorizio, is visiting clients in New York City. In a midtown office tower, he sits down with Nicholas Utton, the gregarious chief marketing officer at online broker E*Trade. Utton is plenty impressed with Microsoft's technology, and he's a big advertiser on the company's MSN Money site. But when it comes to Internet search sites, the largest and most lucrative advertising market online, Utton makes it clear that Microsoft is, as he sees it, way behind front-runner Google. "They're not getting much of our search dollars," he says.

Lorizio's pitch just got even tougher. On May 3, Microsoft CEO Steven A. Ballmer withdrew his offer for Web giant Yahoo!, the No. 2 power in online ads, after the two sides failed to agree on a price. Ballmer had said that the proposed acquisition, which valued Yahoo at $47.5 billion, was the best way for Microsoft to gain the scale necessary to compete against Google for online advertising dollars. Now, after three months of talks, it looks as though Microsoft and Yahoo will be left trying to catch Google on their own, at least for now. And their prospects are grim. "We think Google's the winner," says Clayton F. Moran, analyst with the financial-services firm Stanford Group. "Its two main competitors are separate and floundering."

For Ballmer, however, the game is far from over. Even before yanking the Yahoo offer, he had begun laying the groundwork for a strategy to compete with Google in online advertising. He's convinced that getting the online ad business right is essential to Microsoft's future. The reason: Consumers and businesses increasingly are switching from desktop software like Microsoft's to free online services that do the same things. "We are absolutely committed to be the leading player in that endeavor," Ballmer told employees at a recent gathering. (Msnbc.com is a Microsoft-NBC Universal joint venture.)

It may be impossible to catch Google in search advertising. The company dominates the market, taking in 77% of the revenues from those little text ads that show up alongside the results for Internet search queries. Microsoft, after years of trying, is at 5% of U.S. search revenue, according to search marketing firm Efficient Frontier.

But Microsoft has a fighting chance on several other fronts. Perhaps most important is display advertising, the colorful banner and video ads that run at the top or along the side of Web pages. Microsoft is among the leaders in the fragmented field, while Google is a bit player. Although the display market is smaller than search, it's expected to grow faster over the next few years because of a surge in video ads. Market research firm IDC figures that by 2012 the display market will double, to $15.1 billion; revenue from search will reach $17.6 billion.

More from BusinessWeek Microsoft: The Difficult Ballmer Years Yahoo Through the Years The Real Threat to Google

Microsoft makes money in the display business in two ways. It sells ads on its own popular Web sites, such as MSN and Hotmail, and it acts as a broker by placing ads on other companies' Web sites and then splitting the revenue with them. Smaller Web sites use Microsoft because they don't have a salesforce to call on advertisers and ad agencies. And even large players like media giant Viacom have found that letting Microsoft sell some of the space on sites like Comedy Central and MTV can lead to higher revenues. "They can achieve better monetization than we can on our own," says Viacom CEO Phillipe Dauman.

It's Lorizio and his 180-person salesforce who are leading Microsoft's fight for this up-for-grabs market—and for the future of Microsoft itself. Their pitch is that, in display advertising, Microsoft has the most sophisticated technology of any company. It can help advertisers precisely target display ads and assess the value of ads even when Web surfers don't click on them. Microsoft is also making the case that search advertising, Google's gold mine, is overrated. In the months ahead, it plans to introduce new ad technology that it says will demonstrate that to advertisers. "We're going to win with this strategy," Lorizio says.

MORE FROM BUSINESSWEEK

BusinessWeek Section Front

Marcial: Behind General Dynamics' Soaring Stock VoIP Goes Mobile Can Obama Turn Friends into Voters? Computer Hardware: Recession-Proof? A New Front for Defense Contractors Obama and the Economy: Can He Connect? Movers: Lehman, JDS Uniphase, Ambac, Limited Brands, Burger King European Movers: Lafarge, Continental, SAS Book Publishers: Learn From Digg, Yelp -- Even Gawker Analyst Actions: Lehman, Hewlett-Packard, Novatel Wireless BusinessWeek Section Front