How to Make Billions in Advertising

Microsoft CEO Steve Ballmer last week said his company aims to have as much as 25 percent of its revenues coming from advertising within a few years.

Those comments, given during a keynote speech at the !MAGINE 07 trade show in Paris, didn’t include details on exactly when that might occur. Nevertheless, the claim is not too surprising given Ballmer’s well-known intention to shift the software giant to a “software plus services” business model.

The question remains how the Redmond, Wash., company intends to accomplish that plan, especially since it has a considerable way to go. Microsoft last booked about $51 billion in annual revenue, only about $1.2 billion of which came from advertising, according to its most recent financial results.

Still, the effort has been underway for years.

Most recently, the company purchased online ad server aQuantive for $6 billion, a move designed to help it gain a larger footprint and more advanced technology in that arena. It also took over aQuantive’s interactive agency unit Avenue A|Razorfish through the deal, making it a player in the agency space as well.

Then, of course, there’s the company’s Internet Live Search engine which, like Google’s, is advertising-supported. The same is true of Microsoft’s new HealthVault Search, which it will use to fund its recently introduced HealthVault medical records storage and retrieval service.

Microsoft also places ads on its MSN and Windows Live Spaces pages.

Then, there’s Live Hotmail. Like Google’s Gmail, it’s free to consumers who are willing to put up with ads. Ditto for Live Messenger. At last count, the company said it had 310 million active Hotmail accounts and more than 280 million Messenger accounts.

Beyond that, however, there’s an area of thin ice onto which Microsoft is starting to venture: making software applications themselves free in exchange for showing on-screen ads to users.

This summer, the company announced it would soon launch a pilot project to test the reception for a version of its low-end, home productivity software suite, Microsoft Works, which would be free but ad-supported.

The company has not said that it would do the same for its Office productivity applications suite, of course. After all, Office is one of Microsoft’s biggest cash cows. But, some analysts say, the writing is on the wall.

“[Long-term] I don’t think they have any choice but to have an ad-supported version of Office,” Rob Enderle, principal analyst at researcher Enderle Group, told It’s unclear when Microsoft might reach such a point, however.

“If they do it too quickly, they’ll cannibalize one of their biggest money makers,” Enderle said.

In the meantime, Microsoft will have to go much further if it wants to achieve 25 percent of revenues from advertising.

“This is a game-changer for Microsoft,” Enderle said.

Microsoft is not taking the same tack as, for instance, Google, which has a hosted suite of office productivity applications called Google Docs & Spreadsheets that it offers as a low-end rival to Works and Office in the online applications marketplace.

In fact, the move to an ad-supported model (or models) may be one of the toughest challenges that Microsoft has faced in its 30-plus years in business. It has an established marketplace and culture based on locally installed software – so-called “fat client” computing – a business model that brought in some $50 billion overall last fiscal year.

Thus, it’s no surprise that the company is pursuing what it refers to as a “software plus services” strategy, as opposed to most of its competitors, who are going with what the much-discussed “software as a service” model.

Microsoft seems to be working hard to leave as little as possible to chance. For instance, August’s purchase of aQuantive may help transform the company into both the world’s largest media company as well as the largest interactive ad agency.

The acquisition “will enable us to strengthen relationships with advertisers, agencies and publishers by enhancing our advertising platforms and services … [and it] also provides us with increased depth in building and supporting next-generation advertising solutions and environments such as cross media planning and video-on-demand,” the company’s 2007 annual report states.

This contrasts somewhat with Google, which is in the process of purchasing DoubleClick. Whereas the DoubleClick acquisition will make Google the largest purveyor of Interactive ads, Microsoft’s acquisition of aQuantive establishes it as both a seller of ads and advertising services as well as a purchaser of advertising through Avenue A/Razorfish.

Still, don’t look for Microsoft to try to start pitching ad-supported software to enterprises just yet. The company said it sees a clear difference between consumers and enterprise users. While enterprise users of Live Search already encounter ads, some analysts — and Microsoft itself — see advertising as distracting for corporate users trying to do word processing, spreadsheets, and presentations.

“We believe that there is a distinct difference between consumers’ and enterprise customers’ tolerance for the ad-funded model of delivering software,” Whitney Burk, a Microsoft spokesperson, told in an e-mailed statement.

“In the enterprise, tolerance for ad-funded software is much lower,” she added. “Where it is common practice to target advertising to consumers based on browsing habits, enterprise customers tell us they are far less willing to share with advertisers the proprietary information that they have on their corporate intranets or in business documents, in exchange for a free software product.”

So for now, at least, expect Microsoft to continue directing most of its advertising moves at consumers in its bid to make good on its CEO’s prediction — and, if Enderle is to be believed, continue the software giant’s trend of increasing revenue.

“If they don’t have 25 percent out of ads, I don’t see how they can get the kind of growth shareholders expect,” Enderle said.

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