Column: MSN and AOL to merge?

by Mathew on October 7, 2005

Here’s a column I posted on globeandmail.com about rumours of a tie-up between AOL and MSN:

“Earlier this year, reports started filtering out that Microsoft and Time Warner were considering a merger of the software giant’s MSN division and the cable and entertainment conglomerate’s America Online unit. Nothing much came of the rumours, however, and sources said later that the talks had fallen apart as a result of disputes over technical issues, as well as the question of who would control the combined entity. Now, the Wall Street Journal and others say the talks are back on, and that the two sides hope to reach a deal by the end of the year — a deal that might even lead to the merged company going public.

There are a couple of ways of looking at this news. One is that such a deal would create an on-line colossus, one with the content provided by AOL and Time Warner, and the reach and muscle of Microsoft — a combination that could easily go head-to-head with both Yahoo and Google. The cynical (or perhaps more realistic) view is that this proposed deal isn’t so much about a merger of giants as it is a marriage of convenience — a partnership between two tired and slow-moving behemoths, one a faded relic that never managed to capitalize on a market it virtually invented, and the other a money-losing oaf that has consistently failed to gain any ground despite spending billions.

If nothing else, both MSN and AOL have taught us valuable lessons. AOL taught us that even the much-hyped “first-mover advantage” isn’t enough to protect a company from a stupid business model (although it might let you hoodwink an even stupider company into merging with you at a ridiculous price). And MSN taught us that a cash-rich parent and a place on 90 per cent of the world’s desktops isn’t enough to guarantee success. Both AOL and Microsoft have gotten smarter over the years, but can they overcome their legacy of mistakes?

Five years ago, America Online founder Steve Case managed to convince old-world media giant Time Warner that he had the secret to on-line success, and offered to buy the company for the mind-boggling sum of $180-billion (U.S.). This, of course, turned out to be the worst business deal in the history of capitalism, by almost any measure. Although the combined company had a theoretical market value of almost $250-billion, that figure began to shrink almost immediately, since Mr. Case and Time Warner CEO Gerald Levin had somehow managed to time the deal so that it was being signed just as the bubble was popping.

Within two years, the new AOL Time Warner wasn’t even worth as much as Time Warner was before the merger. In part, that shrinking value was a reflection of the overheated tech sector. But it was also a sign of the problems at AOL, which were two-fold: It relied too heavily on its dial-up customer base, which continued to shrink as people switched to broadband, and it stuck to the “walled garden” model long after it became obvious most people preferred the wide-open (and free) world of the Web.

Over the past year or so, the company has been trying hard to evolve into something different, by focusing on free content and deriving an increasing amount of its revenue from advertising (this week, it acquired Weblogs Inc., a network of “blogs”). And some of those changes are starting to have an effect: Analysts say AOL’s subscriber base is still shrinking, but that its cash flow has actually been growing, which could be one reason Time Warner hasn’t just sold the division off — in fact, it said recently that it remains committed to owning the on-line company.

MSN, meanwhile, has spent the past seven years or so trying to beat Yahoo at its own game, and failing miserably. In 2002 and 2003 alone, the division that includes MSN lost more than $1-billion, and Microsoft has spent more than $8-billion since it started MSN. Despite all that cash, however, it has very little to show for it. The network of websites and services has high user numbers — thanks in large part to the numbers of surfers who are driven there either by Microsoft’s Hotmail service or its instant messaging tool — but it has been a financial drain, and has never achieved the popularity other sites have.

That too seems to be changing, however. Last fall, MSN actually made a quarterly profit, and while it slipped back into the red earlier this year, it made another profit this summer. Analysts who follow the company say that like AOL, Microsoft has been focusing on monetizing its traffic through advertising, and a recent reorganization of the software company made it clear that MSN is a big part of its future plans. Among other things, Microsoft is trying to find ways of competing more effectively with Google, the leader in both search and on-line ad sales.

While both MSN and AOL are doing better, they are still miles behind Yahoo and Google, and it’s not clear that even a merger will produce more than just the sum of its parts. It’s true that AOL’s parent Time Warner has plenty of content it can provide through its magazines and TV programs, all of which can be delivered to MSN’s user base — but if success were that simple, then MSN would already have won on its own. As tempting as a merger might seem, Microsoft and Time Warner may want to consider that roping together two fat and slow-moving dogs doesn’t necessarily make it any easier to compete with a greyhound.”

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