Analysts: Outlook grim for Microsoft online business

Microsoft is underperforming against Google and Yahoo in online advertising, UBS analysts said

Despite its CEO's claims that Microsoft eventually will trump Google to be number one in online search revenue, the company's online business is "massively underperforming" against the competition, according to a leading financial analyst.

On a conference call Friday, Heather Bellini, an analyst with UBS Investment Research, said Microsoft is actually losing ground against competitors Google and Yahoo Inc. in online search revenue and the frequency of search queries that leverage its Windows Live Search engine.

Since Microsoft ramped up its plan to provide Web-based services through the Windows Live and Office Live brands in November 2005 to bolster online ad revenue, CEO Steve Ballmer has proclaimed more than once that Microsoft will chip away at the market until it takes the top spot.

According to UBS, Google's worldwide search query market share grew from 56 percent to 65 percent between August 2005 and December 2006. At the same time, Microsoft's declined from 11 percent to 8 percent, even though the company launched its rebranded and revamped Windows Live Search during this period. UBS cited research from comScore Networks for this data.

Yahoo also lost search query worldwide share, dropping from 21 percent to 19 percent. Search queries are the key to deriving revenue from online ads tied to the number of times users click search links, said UBS analyst Benjamin Schachter on Friday's call.

Microsoft also lost search query share in the U.S., declining from 16 percent to 11 percent, according to comScore data cited by UBS. During the same time, Google increased its search query share in the U.S. from 35 percent to 47 percent, while Yahoo also lost share from 32 percent to 29 percent.

Google continues to be number one in worldwide online search revenue, taking US$10.5 billion of the US$24.5 billion online advertising market in 2006, according to UBS, citing figures from ZenithOptimedia and company reports. Yahoo came in second with US$5.6 billion in revenue, while Microsoft was a distant third with US$1.6 billion online advertising revenue in 2006.

"Google clearly outpaces Microsoft significantly, and we don't see the disparity between the two slowing anytime soon," Schachter said. "Things are not improving for Microsoft. The strategy they have thus far is not working."

UBS' Bellini had several suggestions for how Microsoft can improve its weak position in online advertising.

Quoting research that only one in four people who purchase Windows also buy Microsoft's Office desktop application, she suggested Microsoft should offer an ad-supported online version of Office for free to customers who don't purchase Office to boost its ad revenues.

Microsoft also should leverage its strong position with large enterprise customers and strike deals to distribute its Windows Live Toolbar and Windows Live Search as the default in applications, Bellini said. She likened such a deal to one struck between Google and Dell to preload Google Desktop on Dell PCs and add Google Search in a side pane on Internet Explorer.

Additionally, Microsoft should "push the regulatory envelope" to see how far it can go with legally integrating its Windows Live Search and Toolbar with its own software products, Schachter said.

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