With yesterday’s announcement that Yahoo and Microsoft have broken off all discussion of a merger (partial or otherwise) and that Yahoo has closed an agreement with Google to carry the latter’s paid search ads on the former’s search engine, it certainly seems like MicroHoo has bitten the dust.  Perhaps both companies have decided that the expansion of Yahoo’s fabled acronym (referenced in the title of this post) is the best philosophy.  I still believe there’s a lot of posturing going on, and I still believe a deal is necessary.  I also think a deal is possible, but I don’t think it’s guaranteed.

I once owned my own firm and I remember how strongly I felt that I would never sell it.  My own pride was wrapped up in the company and its success, and I took any subjugation of the company’s identity to equate to that of my own.  I suppose Jerry Yang may feel likewise about Yahoo.  But, with all due respect (whatever that means), that kind of internalized, emotional approach to business is more appropriate to running a candy store than to being the CEO of a top-tier Internet company.  I sold my firm in 2004 so that I, and my employees, could move on to bigger projects and new technologies.  I suppose the analogy's a weak one, but why won’t Jerry Yang do the same for his team?

Jerry may get over himself or Carl Icahn may succeed in ousting him and force Yahoo to pursue a Microsoft merger deal with vigor (instead of with passive aggression).  But the fact that so much time has elapsed since the beginning of this round of deal-making truly complicates things.  Whatever Microsoft may have felt was a fair price for Yahoo several weeks ago, the reality is that the passage of time and events have changed Yahoo’s intrinsic value and its value to Microsoft specifically.  Consider:

• The Yahoo brand is now tarnished.  And a shareholder rebellion led by Icahn will tarnish it further.  This would ostensibly have impact on the reach of Yahoo’s network of sites and the enthusiasm and satisfaction of its customers while surfing it, which could impact click-through rates.
• Microsoft has already lost valuable time and momentum pursuing this deal.  With each passing day, the potential boost to its Internet advertising prowess that a Yahoo acquisition could provide diminishes, and the lost potential revenue piles up.
• The caché for Microsoft on the Web that would have come from a swiftly and amicably executed deal with Yahoo is now beyond reach.

All of the above are Yahoo’s losses, first and foremost, but they hurt Microsoft too.  There’s no other deal that Microsoft can do that will bring them the audience share, and the demographic diversity of it, that Yahoo can offer.  And whether you believe that Microsoft should go into the Web advertising business or not, it’s important to realize that Microsoft is absolutely convinced that it must do so.  Under these circumstances, it becomes important that it do so as shrewdly as possible. 

At this point, doing a deal depends on (a) Carl Icahn’s maneuvers, and their success, (b) Microsoft’s willingness to accept acquiring a distressed property, rather than a trophy prize and, quite possibly, (c) Yahoo willing to accept a significantly lower price than the one it has already turned down.  That’s a lot of intrigue and compromise, and it’s far from certain that either company knows how to endure each or both, let alone do so quickly.  There’s a good business school case study in here somewhere.  It remains to be seen if it will be a study of success or failure.

Microsoft’s withdrawal of its Yahoo acquisition proposal may just be a negotiating tactic.  Or it could in earnest.  Time will tell.  And many shall opine.  But what is the significance of the move?

I have heard a few people express relief that the deal won’t be happening.  I can understand this, to a point.  Almost exactly one year ago, I told Liz Montalbano of ComputerWorld that I thought Microsoft’s heart wasn’t in it when it came to acquiring a Web advertising firm.  And when MS bought AQuantive for 3x what Google paid for DoubleClick, I was worried that the deal made no sense and was just a big waste of money.

But when MS announced their intent to acquire Yahoo, things started to make sense.  Effectively, Microsoft has decided that being on the Web, and being a major player in Web advertising, is crucial to the evolution (and survival) of the company.  They’ve also decided that the combination of tactical acquisitions and organic development of MSN/Live ain’t cuttin’ it.  By bringing in Yahoo, Microsoft could thrust forward in this game, and bring in developers and executives who understood the space.  Furthermore, they could begin to derive real value from the AQuantive deal, since AQuantive’s ad serving platform and Razor Fish’s agency savvy could combine really well with the reach that Yahoo’s network of sites would provide.  Add Silverlight to the equation, with its rich media capabilities, and things get really exciting (and Yahoo’s presence on the Web could easily get Silverlight over the adoption hump it now faces).

Sure, Microsoft + Yahoo looks like a difficult cultural combination, and a difficult technological combination too, given Yahoo’s prolific use of Open Source software.  So what?  Let Yahoo operate largely separately, but let its executive and senior technical ranks collaborate closely with AQuantive and Microsoft “proper” on the necessary ad serving and ad network technology.  Let Microsoft re-invigorate Yahoo’s once exemplary developer program; after all, that’s what Microsoft does best.  And let the coalescing among the ranks take place gradually and naturally.  The people on most Microsoft product teams are bright, good-natured, and enthusiastic about their jobs.  Executive-level bickering aside, I strongly believe that technologists at both companies would get along really well, once all the animosity stopped being newsworthy and people got down to work.  Does that sound naive?  I stand by it.  Cast aside the stereotypes; the techies at Microsoft are talented and welcoming and I can’t believe the Yahoo guys wouldn’t reciprocate.  Some would leave right away, but the rest would really start to like coming to work.

I don’t think Microsoft should have paid $37 a share; I think $33 was already very generous.  So, from that point of view, walking was the right thing to do.  But if Yahoo doesn’t come back to the table with more reasonable demands, what will Microsoft do?  They need this deal, despite Steve Ballmer’s protestations to the contrary, and despite the prevailing wisdom that the merger would be unsuccessful.  And they’ve showed their hand, so the market knows they need the deal too.  I don’t see a good alternative acquisition.  And I’m considering AOL when I say that.  If Microsoft fails here, and continues to mis-handle its damage control around Vista, then the company will be in a bad place.  The setback won’t be irreparable, but it will be significant.

We’ll have to wait and see.  But watch carefully.  The next few months are crucial to the world’s largest software company.